Tax Policy And The Poor

In the wake of the defeat of last week's propositions, the LA Times ran a column on the front page of its website essentially arguing that California's problem is that it doesn't tax the rich enough.

There are so many problems with this column that it's hard to know where to begin, but allow me to start with a bit of levity. In reading pieces like this, and those written about impending public-employee layoffs, it occurs to me that California may eventually wind up with just a single rich taxpayer paying for a single very well paid public employee.

This seems possible because the Leftists appear intent on shrinking both the number of people paying taxes in the state as well as constantly increasing public-employee pay and benefits, even if that means we can't afford as many of them.

The Times column makes a few points in this vein, each of which deserves a response.

The Times author points out that those in the top 1 percent of California earners paid 7.4 percent of their income in state taxes, while those earning under $20k per year paid 10.2 percent. The budget deal widens that gap to 7.8 and 11.1 percent.

I'm not going to argue with the author's facts, but I do not think that such a disparity is concerning or should be a cause for alarm. In fact, I view it as a pretty reasonable situation. And, if you net out the amount people pay into the system against the amount they get out of it, the situation would obviously look far more skewed in favor of the poor. I don't know the exact numbers, but it's a decent bet that people who make under $20k per year pay negative net taxes.

So why tax the poor at all? About 20 percent of Californians make under $20k per year. If, on average, they earn $15k and pay 10.2 percent in taxes, that's about $12B in annual taxes, which is enough to make a difference in state budgeting. Furthermore, taxing them provides some linkage between taxation and spending, meaning that they have some disincentive to vote for higher spending, as that spending will actually cost them something. Finally, the poor pay zero or negative federal taxes, so 10.2 percent is all they pay.

But why allow the rich to pay only 7 or 8 percent of their incomes in taxes? The answer is simply that states compete with one another to woo capital, and capital means wealthy people. California is doing a terrible job in this competition, regularly losing millionaire families to less tax-heavy states. And, lest we forget, when one includes federal taxes, the rich pay far, far more as a percentage of income than the poor.

The Times goes on to argue that the solutions to this "problem" include changing the percentage of legislators required to pass a budget to a majority, repealing term limits and changing Prop 13. In other words, we should do everything we can to make it easier to raise taxes.

And, by the way, if that were to happen, the increased taxes would hit the poor more than the rich.  This is because legislators know from prior experience with an 11 percent tax bracket that raising income taxes significantly will trigger capital flight. That's why the recent budget deal focuses mostly on sales taxes, which hit the poor more than the rich.

I'm not one of those conservatives who argues that California's tax system can't be rationalized. I just don't trust the current crop of legislators to get that done. And I surely don't trust the constitutional convention some have proposed. Both mechanisms are guaranteed to be overrun by those who have the most to gain, and lose: public employee unions and their backers.

My suggestion would be to keep revenue around current levels, but to move from the boom-and-bust of income taxes to more stable revenue sources. In particular, I agree with the Times author that there is no rational reason to allow Prop 13 to protect commercial property owners. I feel the same way about second homes and houses owned by corporations. And, I disagree with provisions such as the one that allows those who inherit property to keep their parents' Prop 13 cost basis. The point of Prop 13 is to enable families to budget rationally when they buy their primary home, not to produce a random windfall for people.

Even worse, there are families who cannot afford to buy a home because Prop 13 disadvantages families when they first purchase homes, by setting the millage rate so high. While Californians on average pay only around 0.5 percent of their homes' values in property taxes every year, a family buying a new home in Oakland must pay 1.35 percent!

So, my advice to California is a straightforward revision of the taxation system:

• Enact a flat, relatively low income tax rate of 6 percent, which is around the national average.


• Create a lower tax rate for long-term capital gains, as does the federal government.


• Set the corporate income tax similarly.


• Set a relatively low sales tax rate of 6 percent.


• Modify Prop 13 as described above.

Such a change would create a more stable revenue stream and make the state a more compelling place for capital to be invested.