June 8, 2009

California Governor Floats Flat Tax

by Joseph Henchman

As a study commission looks at ways to reduce the volatility of California's tax system (caused, in large part, by their overreliance on unstable revenue sources like taxes on high-income earners, capital gains, and corporate profits), California Governor Arnold Schwarzenegger hopes that they will reach for the stars:

Gov. Arnold Schwarzenegger said today that he would like to see such "radical" proposals come out of a commission now studying an overhaul of the state's tax system. The governor told the editorial board of the Sacramento Bee that he hoped the commission would not be afraid to propose something like "a 15% straight tax."

"That's the kind of radical, daring kind of a proposal that I want to see on the table so we can look at it and say, 'Oh, let's study this, maybe that is the way to go,' " Schwarzenegger said during the discussion, which was webcast.[...]

"I hope and I pray that they don't think they have to make a political decision," he said.

It's hard to know what he meant by "a 15% straight tax," especially considering that California's top state income tax rate now is 9.55%, and the highest in the country is Hawaii's at 11%. (Also, the corporate tax rate stands at 8.84% and the sales tax is between 8.25% and 9.75% in most cities, gusting up to 10.75% in South Gate, CA.)

Flat taxes usually (1) have one rate applying (2) to all income, without any deductions, exemptions, or credits (except a broadly available standard deduction). We crunched some numbers (static score) and found:

• A 15% flat income tax (without a standard deduction) in California could raise more than $150 billion, well more than the entire $128 billion budget proposed by Gov. Schwarzenegger and presumably enough to eliminate all other state taxes with money left over. The combined federal-state rate would be high, however.
• A more modest 5% flat income tax with no deductions could raise as much as the current state income tax system (about $56 billion), but be less volatile, less distorting, and more competitive with other states' tax rates.

Less likely to spur long-term growth is an alternative plan put out that raises $44 billion through tax increases and revenue shifts. The proposal from the American Federation of State, County and Municipal Employees (AFSCME) would:

• New top income tax rates of 11% and 10%
• New corporate tax rate of 9.84%
• Impose oil severance tax of 9.9%
• Raise car tax to 2%
• Raise the gas tax by 14 cents per gallon
• Shift an additional one-quarter of one cent of the sales tax from counties to the state
• $1.4 billion additional in liquor taxes
• Aggressive use tax collections through nexus redefinition
• Introduce withholding for independent contractors (one-time revenue shift)
• Expand sales tax base and reduce rate by 2 percentage points

(Thanks to Gerald Prante, Mark Robyn, and Micah Cohen for research assistance with this post.)