As Californians suffer through the worst recession in decades, the Commission on the 21st Century Economy and the governor are seeking massive tax cuts for the super rich. How can such an outrageous proposal be sold to unemployed, underemployed, and underpaid Californians? By calling this giveaway a “reform” to our budget crisis.
The Commission and governor suggest that the source of our budget woes is a sinister monster called--(cue scary music)--“revenue volatility.” As their story goes, if we slay the revenue volatility monster all our budget problems will disappear. So we have no choice but to give very rich people jaw-dropping tax cuts.
Their rationale is that Sacramento cannot responsibly manage a one-time spike in revenues because the revenue volatility monster tricks the Legislature into committing to long-term spending of money the state does not have, thereby condemning California to years of budget stalemates, and tough choices between higher taxes and painful spending cuts. The inference is that these tough choices can be avoided if the state changes its tax structure to eliminate the volatility monster.
Here is the real volatility problem. Very rich people pay a lot of income taxes when they make lots of money in good economic years. Their income taxes go down in recessions because they earn less money. Equity markets, stock options, bonuses, and capital gains depend upon the health of the economy, and with the economy, are volatile. Volatility is not limited to the State of California; we have seen the same volatility across the nation as the richest of the rich have begun to accumulate wealth and income at proportions not seen since the 1920. As a result of accumulation of income in a few hands, the state collects more in income taxes because our personal income tax (PIT) is progressive.
About half of California's General Fund revenues come from the PIT, a progressive tax which increases as amount of taxable income grows. Although the PIT revenues have gone up and down throughout the years, since 1989 it has increased by an average annual rate of 6.7 percent. This outpaces the growth of other taxes, such as the sales tax. Most economists support a progressive tax system – even Adam Smith praised its merits in The Wealth of Nations. And, almost all tax systems in the world contain progressive elements.
The Commission’s report proposes reducing volatility by reducing the tax burden on the wealthy. The Commission proposes flattening the PIT tax structure by reducing the number of tax brackets from six to two. The new tax rate would be 2.75 percent for taxable income up to $56,000 for joint filers ($28,000 for single) and 6.5 percent for taxable income above that amount. Under this proposal, a person struggling to eke out a living on $28,001 will pay the same rate (6.5 percent) as someone earning $2,800,001. If we just don’t tax upper incomes much, voila—we slay the volatility monster.
The benefits to the wealthy don't stop there—the higher income earners still get the benefits of mortgage deductions, property tax deductions and charitable contribution deductions. On the flip side, the Commission’s report recommends we eliminate child care deductions and dependent credits which benefits low-income taxpayers. For some families this leads to a tax increase—a family of four making $65,000 per year with $15,000 of itemized deductions and special credits worth $500 for child care would see their PIT liability increase by a whopping 437.7 percent
This is classic supply-side, “trickle down” economics. The Commission’s report assumes that the super wealthy and corporations which benefit directly from their proposed tax cuts will translate the cuts into lower prices and more investment. In fact, some have argued that lowering the tax rate is going to spur so much investment that overall tax revenue is going to increase. But we’ve heard that tired sales pitch before when the Reagan and Bush federal tax cuts didn’t result in tax revenue increases.
“Trickle down” economics has been thoroughly discredited. The true response to solving the volatility problem is to make sure Californians are fully employed and decently paid.
The Commission proposes reducing PIT revenues under the fig leaf of stabilizing revenues. Using this logic, if California just stopped collecting taxes, the problem of volatility would be solved forever.