The Corner

California: Can Desperate Times Bring Tax Reform?

Earlier this week, a bipartisan tax commission proposed reforming California’s taxes in a way that would promote growth, make state revenues less volatile, and make the tax code simpler. Governor Schwarzenegger is expected to call a special session of the legislature to consider the proposal, which he has said he would sign if presented to him as a bill.

The structure of the state’s income tax makes revenues swell and shrink disproportionately as booms and busts change the fortunes of its highest-paid residents. The commission’s mandate was (in part) to devise a tax reform that stabilized revenues while neither decreasing nor increasing state revenues over the course of a business cycle. (The commission could not consider the effects of different tax policies on growth in meeting this goal of revenue neutrality.) The commission’s plan cuts income-tax rates quite a bit–the top rate would go from 10.3 to 7.5 percent–and the commission estimates that the lower income tax would bring in 30 percent less revenue. It abolishes the state’s corporate income tax and its retail sales tax.

To make up for the lost revenue, the commission would institute a new business net receipts tax. It would apply to services, and thus have a broader base than the sales tax. To make sure this tax replaces other taxes rather than being layered on top of them, the commission urges swift action: It recommends getting rid of the corporate tax immediately, implementing half of the personal income tax cut immediately, and implementing the other half within two years. In an attempt to forestall one common conservative objection to this type of tax, commissioner John Cogan tells NR that California law’s requirement that two-thirds of the legislature support a tax increase would apply to the new tax. The commission further recommends that the tax be capped at 4 percent. These features have been enough to keep Americans for Tax Reform, a conservative group opposed to a Value Added Tax, on board with the proposal.

Democratic leaders have responded cautiously to the commission’s proposals. But some liberals are outraged by what they see as “a radical right-wing attack on the progressive elements of our tax system.” Businesses are understandably concerned about the new tax.

Cogan, a scholar at Stanford University’s Hoover Institution (where I was recently a media fellow), hopes that the legislature will take a look at the big picture. “You have to think about it as a package. California has the highest retail sales tax in the country and the highest individual [income tax] rate among major states. . . . It has one of the top ten highest corporate rates at 8.4 percent. . . . It has one of the most progressive codes of any state in the union. This package lowers tax rates dramatically. The base of taxation gets broadened enormously. . . . The treatment of investment is greatly enhanced. We think it will be very beneficial to capital formation, which is essential for productivity so you can get growing wages.”

The state could do a lot worse, and probably will.

Ramesh Ponnuru — Ramesh Ponnuru is a senior editor for National Review, a columnist for Bloomberg Opinion, a visiting fellow at the American Enterprise Institute, and a senior fellow at the National Review Institute.

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