Background
Over the last several years, the Governor’s January 10 budgets have proposed modest program reductions and cost control measures to mitigate the state’s ongoing budget deficit. However, Democrat opposition killed most of these proposals. Instead of cutting back on spending and bureaucracy, Democrats seem to believe raising taxes on Californians is the “magic solution.”
It is unclear what tax-and-spend solutions the Democrats will advocate in the upcoming 2008 budget. However, if they propose tax increases, it is imperative that policymakers understand how California’s tax structure compares to the rest of the nation, and assess the impact such increases will have on the state’s economy. Are tax increases the magic potion to the state’s fiscal ails? Or will they force tax-paying businesses and residents out of state, thereby deteriorating tax revenues in future years?
How do California’s taxes compare to the rest of the nation?
Tax Freedom Day comes seven days later for Californians. Every year, the National Tax Foundation issues a report determining how many days Americans have to work before they’ve earned enough money to pay all their taxes. This date is also commonly known as “Tax Freedom Day.” In 2007, the national Tax Freedom Day occurred on April 30th. This means that Americans worked for 120 days (or four months), from January 1st until April 30th, to make enough money to pay their taxes in 2007.
Although Americans work a significant number of days in the year to pay for life’s necessities, by far our most expensive annual expenditure is taxes. Taxes require almost double the number of days worked to pay for housing, and about two months more for health and medical care, as shown in the chart below.
Source: Tax Foundation
How does California compare? Tax Freedom Day in California occurred on May 7th 2007, or seven days later than the national average. When compared to other states, California ranked seventh among all states for having the latest Tax Freedom Day.
Highest per capita tax burden among the larger states. Another indicator of California’s tax burden is its ranking on a per capita basis. In other words, how much does each Californian pay in state taxes compared to their counterparts across the country? The most recent data from the U.S. Census Bureau indicates that Californians pay an average of $2,392 in state taxes. As shown below, California imposes the highest per capita state tax burden among the eight largest states.
Source: U.S. Census Bureau: Tax Collections for 2004 (Revised March 2006)
California Business Tax Climate ranked 47th in the nation. How does the state fare in terms of taxes on business? The Tax Foundation ranked California’s business tax climate the 47th in the nation for 2008, based on 113 factors and taking into account the state’s five major business taxes in effect as of July 1, 2007. In addition to higher taxes, California also has more rigid labor rules, stricter business regulations, less reliable energy supplies, and higher building and construction costs – all factors that businesses use in their decisions to expand and relocate outside the state.
What impact will tax increases have on California’s economy?
Liberal politicians will tell you that tax increases are the silver bullet to filling state coffers with more money. What they fail to recognize is that:
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Higher taxes tend to drive businesses out of state, thereby deteriorating future revenues. According to the U.S. Department of Labor, most mass job relocations are from one U.S. state to another rather than to an overseas location. And one of the primary reasons for that relocation is for business tax savings. The Tax Foundation reports that, “States with the best tax systems will be the most competitive in attracting new businesses and be the most effective at generating economic and employment growth.” Essentially, raising taxes will cause businesses to leave California, taking with them not only the jobs and investments necessary for economic growth, but also the associated tax revenues (e.g., income, sales, property tax, etc.) that fund the bulk of the state’s operations.
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Revenue projections tend to be inflated and volatile, setting up potential funding shortfalls. In 1991, various tax increases (primarily on sales and use of goods, high-income earners, and business net operating loss carryovers) were implemented to mitigate the budget crisis. At the time, it was estimated that the tax increases would collectively generate approximately $6.6 billion in additional revenues. Instead, actual revenue collections fell short of estimates by over $800 million, or approximately 12 percent. Revenues in the out-years were also volatile because the estimates did not take into account changing taxpayer behavior, like reducing spending or business relocation. The state’s expenditure plan, however, was based on the $6.6 billion estimates. When revenues did not materialize, it exacerbated the funding problem because the state had already planned on spending at the higher rate.
Conclusion
California already imposes some of the highest taxes in the country and has the fourth worst business tax climate in the nation. Does it make sense to raise taxes even more, given that the businesses and high-income residents who contribute the most tax revenues will flee the state? Does it make sense to raise taxes and rely on inflated and volatile revenues, only to exacerbate the budget shortfall and put off the day of reckoning? As the budget process begins for the upcoming fiscal year, it is important for Democrats to break away from the popular myth that tax increases will solve the state’s fiscal woes. There may be revenue increases in the short-term, but in the long-term, the state’s entire economy will suffer. Instead, policymakers need to focus on scaling back on spending, and implementing tax incentive policies that will promote long-term sustainable economic growth.
For more information on this report or other revenue and taxation issues, contact Therese Twomey, Senate Republican Office of Policy at 916/651-1501.
