July 28, 2009
California Tax Reform Proposal Would Put State Back on Stable Ground
Consumption Tax Could Replace General Fund Sales Tax, Corporate Income Tax
Washington, DC - As California's Commission on the 21st Century Economy weighs three proposals to stabilize the state's finances, a Tax Foundation analysis shows that one plan would go furthest to reduce revenue volatility by replacing the general fund sales tax and corporate income tax with a net receipts tax (NRT) and flattening the individual income tax to one rate.
"California has been too dependent on taxing personal and corporate income, which as history has shown results in unpredictable booms and busts that wreak havoc on the state's budget," said Tax Foundation adjunct scholar Kiran Sheffrin, who co-authored Tax Foundation Fiscal Fact No. 181, "Finding Stable Ground: California Reform Commission Puts Tax Overhaul on Table." "By replacing the corporate income and sales taxes with a broader based consumption tax, the state eliminates that volatility and puts in place a more reliable tax structure."
"Simplifying California's current seven-rate personal income tax system to a single flat rate also would provide more steady revenue projections for the state legislators," noted co-author and adjunct scholar Micah Cohen. Fiscal Fact No. 181 may be found online at http://www.taxfoundation.org/publications/show/24928.html.
An NRT can be described as a consumption tax or Value Added Tax (VAT), which is widely used around the world and is similar to a retail sales tax levied on all end-user goods and services. The proposal would add an NRT of 2.77% to replace the current 5% general fund sales tax and 8.84% corporate income tax. The personal income tax, which currently has a top rate of 10.55%, would be flattened to one rate of 6% and allow only personal exemptions and deductions for mortgage interest, charitable donations and property taxes.
A second proposal would simplify the personal income tax to two brackets at rates of 3.5% and 7% and retain current deductions and credits, reduce the corporate income tax rate from 8.84% to 7% while eliminating the investment tax credit, and reduce the state sales and use tax rate. While the plan is a significant improvement over the current system, Sheffrin and Cohen note that it pales in comparison to the first proposal, which represents more fundamental reform.
A third alternative, dubbed the "blue proposal" for its left-of-center backers, attempts to control volatility by reapportioning some revenue for the future into a rainy day fund, broadening the sales tax base to include services (not just goods) and lowering the corporate income tax rate. It also includes some provisions that would steer the state in the wrong fiscal direction, such as weakening Proposition 13 and adopting a carbon tax on energy.
Sheffrin and Cohen note that neither of the first two proposals are perfect, but they are leaps and bounds ahead of both the blue proposal and the current tax structure.
"All proposals on the table will encounter political opposition, whether because they disturb entrenched interests or reduce progressivity or both," the authors conclude. "However, no great progress can be made in California without doing both, because much of the volatility stems from the highly progressive nature and the innumerable special exemptions, credits and deductions in California's tax code."
The Tax Foundation is a nonpartisan, nonprofit organization that has monitored fiscal policy at the federal, state and local levels since 1937.
Fiscal Fact No. 181 may be found online at http://www.taxfoundation.org/publications/show/24928.html. To schedule an interview, please contact Tax Foundation Manager of Media Relations Natasha Altamirano at (202) 464-5102 or naltamirano@taxfoundation.org.
