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Dan Walters: Merger of statistics shows a structural flaw in tax system

December 13, 2004

By Dan Walters -- Bee Columnist

Published 2:15 am PST Sunday, December 12, 2004

The California Statistical Abstract is not a best-selling publication, but it's fascinating in its own way, with numbers that frame the state's social and economic evolution and thus demonstrate anew that change is its only constant.

The annual report of the state Board of Equalization is an even more obscure statistical document, providing current and historic detail on property values, retail sales and other taxable activities.

If one merges the personal income and tax data from the former with the retail sales data of the latter - and does a little analysis - a significant pattern emerges, adversely affecting the long-term prospects for straightening out the tangled web of state and local government finances.

Historically, state and local governments, including schools, were supported primarily by three major sources of revenue - property taxes for schools and local governments, personal income taxes for the state and sales taxes that mostly went into state coffers, but had a share designated for cities and counties - plus a host of relatively minor sources.

Proposition 13, enacted by voters in 1978, imposed a rigid limit both on property tax rates and the values of taxable property, thus sharply reducing its elasticity. The state immediately assumed a major share of school costs and a more substantial portion of county-administered health and welfare programs, but within a few years, state reserves were exhausted and it settled into a more or less permanent fiscal crisis, or at least a boom-and-bust cycle whose net effect has been an expanding gap between income and outgo.

While foolish political decision-making underlies much of the chronic crisis, the statistical reports provide clues to a major nonpolitical factor: a fast-changing socioeconomic structure. Immigration-driven population growth has been placing upward pressure on public services, the economy has been moving away from manufacturing and toward services and technology, and the huge "baby boom" generation has been aging.

As they aged and their children departed, middle-and upper-income Californians began spending less of their incomes on taxable goods such as cars, clothing and furniture, putting more money into retirement investments and homes and buying more untaxed services. At the same time, as California's economy evolved, affluent Californians saw less of their incomes come from wages and salaries, and more from stock market earnings and other capital gains. And the effects on sales taxes and income taxes have been dramatic.

As late as 1985, the state collected more in sales taxes than it did in personal income taxes, but since then, the former have lagged, relatively speaking. Were Californians buying at the same rate they were a generation ago, it would be generating enough sales taxes to wipe out the state's budget deficit. Income taxes, meanwhile, soared because of the steeply progressive nature of the California system. The state now collects half-again as much in income taxes as it does in sales taxes and thus has become utterly dependent on how a relative handful of high-income Californians are doing in the stock market.

There has also been a sharp impact on local governments, especially cities, which because of Proposition 13 have become very dependent on the local share of sales taxes, even though taxable sales have lagged behind income growth. Local governments finally achieved passage of a ballot measure (Proposition 1A) that protects their finances from being raided by the state. But they are protecting a sales tax-based system that is stagnating.

These trends demonstrate that, however the state's current budget deficit may be resolved, the underlying conflicts will remain intact. They indicate, therefore, that there should be a fundamental restructuring of the intertwined state-local tax system to expand sales taxes to services, broaden the reach of the income tax into middle-income brackets (perhaps with offsetting rate reductions in both) and reshuffle the mix of tax sources for both the state and local governments.

Unfortunately, however, Proposition 1A and other decisions create more rigidity, rather than more creative flexibility, in a taxation system that may be fundamentally flawed.

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