California

This morning' s Sacramento Bee has a story on all the foreign trips that California politicians took last year -- and the people who footed the bill. These trips are ostensibly about educating lawmakers on all sorts of issues, big and small But in years of talking to people who make these trips, I've never found anyone who has used their time abroad to study how other countries practice direct democracy.

They should. California has a budget and governmental crisis that, by broad consensus, stems from how the state uses initiatives and referenda to govern. Most of the countries on the destination lists of our state's political travels have some form direct democracy. It's a subject far more important to California than U.S.-German relations or the state of universities in Hong Kong -- both of them subjects of 2007 foreign trips.

Just as major league ballplayers were taking the field for the first spring training exhibitions on Feb. 28, Arnold Schwarzenegger was putting taxes in play in California's budget debate.

"I am a big believer that when we have a financial crisis like this, we all should chip in," California's governor said about his state's two-year, $16 billion budget shortfall. "This why I totally agree with the Legislative Analyst’s Office when she says we should look at tax loopholes.... We should go after those tax loopholes."

It won't be hard to find them. California is a big-league loophole-creating machine. It takes only a simple majority of California's Legislature to carve out a tax loophole, but it takes a two-thirds vote to close a loophole or pass a budget. That imbalance has created a ratchet effect in California's tax code.

This is the title for a 2/27/08 New America Foundation and UC Center Sacramento workshop in Sacramento. It will look at a variety of California tax and budget issues and possible remedies that also bring California's depression-era, industrial-based tax system into the 21st century. This blog post serves as place for further discussion on the topic and the workshop presentations.

Here is a link to my presentation topic on broadening the California sales & use tax base and lowering the rate. If other workshop materials are posted on the web, I'll add a link to them at this blog entry.

I look forward to your comments and online discussion.

California continues to have budget deficiencies. The Legislative Analyst's Office (LAO) projects a $1.9 billion deficit for the current year if no actions are taken to bring the budget into balance. And, it gets worse. The LAO projects a shortfall of $8 billion for 08/09 and another $8 billion for 09/10. Thereafter, with debt to fund prior deficits paid off, the annual shortfall is projected to be a mere $3 billion per year.

Wow!

Here are some ideas to address the shortfall:

While global warming has been a problem for quite some time, it is getting heightened attention today, particularly in California which now has a goal to reduce greenhouse gas (GHG) emissions by 25% by 2020. That's ambitious. How can that goal be acheived?

There are a few different techniques for resolving environmental problems.

The Treasury Dept released a report on 7/23/07 on Business Taxation and Global Competitiveness. It precedes a conference they are hosting on 7/26. The report notes several areas in our current income tax that distorts business behavior, increases costs to comply with the system and inefficiently allocates capital.A few interesting points:

• Removal of special provisions would allow the top corporate rate of 35% to be lowered to 27% and still raise the same amount of revenue.
• Businesses spent about $40 billion in 2004 to comply with the federal tax laws.
• Analysis of business tax rules cannot just look at corporate provisions because in the past 30 years, the number of sole proprietorships, partnerships and S corporations has grown.

I think it is great that Treasury is raising these issues. There are many ways to improve the federal income tax system (as well as the California one) to remove complexity, make taxes less important in business decisions, increase equity, and reduce administrative and compliance costs.For example, many, if not all preferences, such as the manufacturing deduction (Section 199), should be removed and replaced with a lower tax rate.For more information on the Treasury report and conference:http://www.treasury.gov/news/index1.html This post was originally published at http://21stcenturytaxation.blogspot.com.

In my July 9 post about the California use tax, I noted that $1 billion goes uncollected every year and in 3 years of giving consumers the easy option of reporting their use tax on their income tax form, only $13 million was collected.

I think it is realistic to collect much more through simpler ways to compute yearly use tax and a public awareness campaign (see 7/9 post).

I think many people might say we should just get rid of the tax. Or some may say we should exempt a certain amount of annual purchases. But these are not the solutions to uncollected use tax.

First - exempting a certain amount of purchases each year still requires taxpayers to keep records to see if they are above or below the exemption amount.

Second - if we eliminate the use tax and keep the sales tax, it will be even more enticing for Internet businesses NOT to set up operations in California. With no operations in the state (offices, warehouses, employees), they will have no physical presence and not have to collect sales/use tax. Their goods will look like good deals compared to the prices at your local store. And who wants to pay more taxes than they need to? Buyers would take the extra effort to find a seller who doesn't have to collect sales tax and buy from them. Sales tax collections would drop.

Third - many businesses and individuals pay their use tax so if we eliminated the use tax, the state would lose more than $1 billion per year.

In my July 9 post about the California use tax, I noted that $1 billion goes uncollected every year and in 3 years of giving consumers the easy option of reporting their use tax on their income tax form, only $13 million was collected.

I think it is realistic to collect much more through simpler ways to compute yearly use tax and a public awareness campaign (see 7/9 post).

I think many people might say we should just get rid of the tax. Or some may say we should exempt a certain amount of annual purchases. But these are not the solutions to uncollected use tax.

First - exempting a certain amount of purchases each year still requires taxpayers to keep records to see if they are above or below the exemption amount.

Second - if we eliminate the use tax and keep the sales tax, it will be even more enticing for Internet businesses NOT to set up operations in California. With no operations in the state (offices, warehouses, employees), they will have no physical presence and not have to collect sales/use tax. Their goods will look like good deals compared to the prices at your local store. And who wants to pay more taxes than they need to? Buyers would take the extra effort to find a seller who doesn't have to collect sales tax and buy from them. Sales tax collections would drop.

Third - many businesses and individuals pay their use tax so if we eliminated the use tax, the state would lose more than $1 billion per year.

Many California residents and companies have not paid their use tax. Over $1 billion of this tax, that has been around since 1935, goes uncollected each year! That money could really help the state improve health care coverage and education.

So, what's a use tax? It's a complement to the sales tax and imposed at the same rate. If a seller is not required to collect sales tax, such as because it has no physical presence (offices or employees) in the state, then the buyer owes use tax. The buyer must self-report and pay the use tax. For example, when you buy books from Amazon.com, no sales tax is charged because Amazon has no physical presence in California. So, you must keep track of these types of purchases. At year end, you add up all your purchases of taxable goods for which you were not charged sales tax and multiply that amount by the sales tax rate for your county.

For the past few years, California has done what many states have done for years - it added a "use tax" line to individual and corporate state income tax forms. This is a generous approach to collecting the tax because it allows taxpayers to avoid sales tax forms and let's you pay the tax late with no penalty (for example, you pay your 2006 use tax on your 2006 Form 540 which you file in 2007). However, the "use tax" line on Form 540 is elective because you could instead pay your use tax in the year it is owed using sales/use tax forms.

As mentioned in an earlier entry, the California tax system has some weaknesses. Here is some data supporting some of these oddities.

Volatile personal income tax

The Legislative Analyst Office (LAO) reports that in 2004: "Taxpayers earning annual incomes of $200,000 or more accounted for about 5 percent of returns but more than 55 percent of liabilities. In contrast, taxpayers with AGI of less than $50,000 accounted for over 45 percent of returns but less than 6 percent of liabilities." [http://www.lao.ca.gov/2007/tax_primer/tax_primer_040907.aspx]

And, the personal income tax provides over half of CA's general fund revenues. Thus, the state is really very dependent on the continued high incomes of a few of its citizens. These high income individuals though, often have types of income which are not steady or predictible (like salaries are). For example, they may have capital gains from stock sales or income from stock options. These amounts will not be steady from year to year and in tough economic times, like the dotcom bust of a few years ago, the state tax collections go down. Basically, when the income of CA's top individual income generators goes down, the entire state feels it.