Commission Proposal Seeks to Fix Broken Tax System

Progressive taxes, oppressive regulations, bungling bureaucracies, out of control government spending: All reasons for our unprecedented budget mess. But it is not just the politicians who have put us in this seemingly never-ending mess. The entire budget and tax structure they have created is utterly defective, in particular our tax system. Consider this:

California relies on personal income taxes for over half of the budget revenue. But out of those income taxes the state relies on a very small group of wealthy people. The top 1% of income taxpayers, many who are sole proprietor business owners, fork over almost half of all personal income tax revenue. Worse yet, nearly half of taxpayers pay 99% of all personal income tax revenue. That means the other half of taxpayers pay only 1% of the state’s income tax revenues!

As a result, when small businesses and wealthy people make money the state brings in waves of revenue, but when the economy hits a recession like we have today, the state’s coffers sink disproportionably deeper into the red. Simply put, we rely too much on a very small group of people for revenue, which makes us susceptible to roller-coaster revenues. Clearly, the system is broken.

A year ago Governor Schwarzenegger created the Commission on the 21st Century Economy, tasked with making recommendations on how to overhaul California’s outdated tax system. The results released last month show a mixture of recommendations that seem to vary in effectiveness.

In essence, the commission recommends shifting more of the tax burden from individual taxpayers and consumers to businesses. Their plan creates a less progressive income tax structure spreading the burden across income levels and would phase out the sales and corporate taxes. Finally, the commission recommends creating a Business Net Receipts Tax (BNRT) in which all businesses would be taxed every time they invest or add value to their products, rather than taxing the consumer on the end product.

Removing the sales tax would certainly encourage more consumer spending. Many of California’s neighbors have no sales tax and this is very appealing to businesses.

Similar to Europe’s Value Added Tax (VAT), the BNRT, however, could very well have a negative effect on business growth in California. First, the new tax scheme would discourage job creation since employee salaries and wages would not be deductible from gross receipts, business would either hire fewer workers or outsource the work to contractors, out-of-state. In a time when job creation is key, this would be a step in the wrong direction.

Second, the BNRT would tax companies whether they are successful or not. This would put start up companies, such as our highly successful Silicon Valley firms at a severe disadvantage and could really stifle innovation that comes from new companies.

It is hard to say how the newly proposed plan will perform with all of these proposals collectively and will require much more vetting. Everyone on each side of the political aisle and every special interest has their qualms about some part of the plan, but sometimes that means you are heading in the right direction.