The 2014 California Budget is an Improvement, but for How Long? Where is Tax Reform?

The 2014 California Budget is an Improvement, but for How Long?  Where is Tax Reform?
By Gary Wartik
January 11, 2014

Governor Jerry Brown is generating praise for his balanced budget submission to the legislature on January 10, the first with a surplus (about 1 percent) in nearly seven years.  The budget partially restores funds for education and to meet other needs.  The Governor has also included nearly $9 billion to fully retire $15 billion in bonds approved by voters during the second Schwarzenegger administration to cover regular operating costs.

While the budget figures are an improvement, there are many other needs not provided for in the budget.  The California court system sustained more than $250 million in budget cuts in each of the last two years, resulting in the closure of several hundred Superior Court court rooms throughout the state, thus slowing an already overburdened justice system.  Funds for infrastructure upgrades for water projects, streets and roads are in short supply, and funds for unfunded mandates put on local government continue to be elusive.

As well, there is no approach to dealing with the State’s $80 billion obligation to the CalSTRS and CalPERS retirement programs.  As if that is not bad enough, the state also owes the federal government more than $10 billion for loans made to the California Employment Development Department to assist Californians with extended unemployment benefits when state funds were exhausted in 2012.

The improved financial picture is in part driven by an increase in income taxes and capital gains taxes as the stock market has reached record highs, and the state’s economy has improved sufficiently to generate a growth in income taxes.  The challenge is highlighted, however by the fact that without the Proposition 30 tax increases approved by voters in 2012, there would be no budget surplus in 2014, but a continuing budget deficit instead.  Those tax increases expire in 2018.

Proposition 30 brought California the dubious distinction of having the second highest income tax rate in the nation (10.55 percent), only exceeded by the 11 percent rate that high income earners pay in Hawaii.  The result is that California has become even less competitive when it comes to offering a business-friendly environment sufficient to attract business relocations, retain existing businesses and to offer attractive business start-up opportunities.

Gerald Parsky, a Los Angeles area financier and investment specialist, wrote an article in 2013 in which he outlined his view of what California needs to do to stabilize its income while better meeting the needs of its citizens.  Mr. Parsky served three years as Assistant Secretary of the Treasury in the Gerald Ford Administration, was a member of the Board of Regents of the University of California and he has held a number of other significant positions in government and in the private sector. In summary, he suggested the following that is consistent with the recommendations of a number of other specialists offered during the last ten years:

First and foremost, we need broad and significant tax reform that once again makes us competitive and promotes middle-class job creation.

We also need broad and significant tax reform to produce the more stable and predictable revenue stream needed to support education, infrastructure investments, and our social programs.

In the last four years, two bipartisan groups, a commission established by elected officials and a private group called The Think Long Committee, came to the same conclusion regarding tax reform: We need to reduce the dependence on the personal income tax by reducing tax rates, eliminating most deductions and establishing a broad-based tax on services.

Why are we here when it seems clear what type of tax reform is needed? The basic reason is that too many elected officials refuse to think long-term and remain ideologically rigid. Republicans cannot agree to any reform that results in more revenue, even if the revenue results from policies that promote economic growth, and even if excessive spending is addressed with a real “rainy day” fund. Elected Democrats cannot agree to any reform that slightly alters the progressive nature of the tax system even if it may result in more revenue, and protects the lowest income groups. Elected officials on both sides need to do what a private-sector group did — compromise in the interest of all Californians.

In summary, although the business climate may appear negative with storm clouds ahead, the solutions are relatively simple and certainly within our grasp. We need to reform our tax system; we need to streamline the implementation of regulations; we need to reestablish an education system that prepares our children for the jobs that will be available; and we need a government that welcomes business, thinks long term and has the courage to do what is best for our state.

If Governor Brown is the visionary that he believes himself to be, he has the opportunity during 2014 and 2015 to address California’s systemic financial problems while the Democrats hold a commanding edge in the California Legislature.  While some Democrats may run from reform, hopefully some of the legislature’s Republicans will join in to generate a bi-partisan approach to reforming California’s tax code and reform the ever-growing number of regulations that continue to make California far less competitive a place to do business than it deserves.

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