Latest California Trend: Taxes

By Michael Fumento

Investor’s Business Daily, October 3, 1991
Copyright 1991 Investors Business Daily

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To the Eastern establishment media, California’s Republican Gov. Pete Wilson, fresh from having signed into law the largest tax increase in the state’s history, is a heroic, pragmatic politician.

The Wall Street Journal, in a highly favorable profile, quoted one pundit saying Wilson "could be the prototype governor of the 1990s." Time called him a "can-do politician with the guts to cast aside ideology for the sake of better government."

Dan Quayle

USA Today assembled a panel that gave Wilson kudos as the nation’s top new governor, and the Washington Post’s Lou Cannon touted him as presidential material for 1996.

Indeed, Wilson’s feat of balancing the budget, in what would be the world’s seventh-largest economy if it were an independent nation, has put him on a lot of short lists for president in 1996 and on many lists of replacements for Vice President Dan Quayle on the presidential ticket in 1992.

But as a poll released yesterday showing Wilson with a 29% approval rating indicates, in the state that spawned the national tax revolt of the 1980s with the Proposition 13 property assessment limitation, there are a lot of angry Californians whose idea of sending Wilson packing doesn’t mean sending him off to the White House. The primary reason given by those who gave Wilson a poor rating was the tax increase.

Included in the new tax package designed to raise almost $8 billion in revenues:

1) A 0.75-cent sales tax increase, part of which is supposed to be temporary, with local governments also allowed a 0.5-cent increase.

2) Expansion of the state sales tax base to include candy and snack foods, bottled water, newspapers and periodicals, and jet fuel.

3) An approximately 180% increase in the alcohol tax equal to about nine cents on a six-pack of beer, four cents per bottle of wine, and $1.20 to $2.60 per gallon of distilled spirits.

Charging more for a cold one can really set people off.

4) An approximately 30% increase in vehicle licensing fees.

5) Establishment of a 10% income tax bracket for individuals with incomes over $100,000 or joint filers with incomes over $200,000 a year, and an 11% category for individual taxpayers with more than $200,000 and joint filers with more than $400,000 in annual taxable income.

Other measures used to close the spending gap included switching the state’s accounting method to count income when earned rather than when received, and decreases in projected outlays for public schools, higher education, welfare cost-of-living increasers and other government projects.

It is difficult to measure what the "average" Californian pays in taxes now vs. what he paid in the past. But taxpayer organizations in the state are in general agreement that the cut provided by Proposition 13, enacted in 1978, has long since been erased by other taxes.

While many of the new taxes have provoked outrage — and, in the case of the "snack tax," plenty of confusion over what qualifies as a snack and what does not — it may turn out that adding two new brackets for high earners was the most ill-conceived, due to a phenomenon which has become known as the Laffer Curve.

The Laffer Curve, publicized by and hence named for former University of Southern California economist Arthur Laffer, describes the tendency for higher tax rates to, after a certain point, begin to take in less and less money as the taxes rise. This results from a number of factors, including taxpayers who intentionally earn less money to keep out of higher brackets, an increased use of tax shelters, and increased cheating.

The Reagan administration provided a marked demonstration of this effect in reverse when it slashed the top marginal rate for federal taxes, the result of which was that those in the abolished upper brackets ended up paying for far more of the federal budget than they had been.

Conversely, the Bush administration’s "luxury tax" on boats selling for more than $100,000 has dropped the bottom out of the market, with the result being very little collected by the new tax and a net loss to the tax base as a result of thousands of boat builders being laid off.

State and local revenue collectors are as subject to the effects of the Laffer Curve as is the federal government. But persons burdened by state and local taxes nave another way to beat the system — moving.

Fleeing The Bust

More and more, that is what wealthier Californians are opting to do. Those whose forefathers wrote "California or Bust" on their oxen-pulled wagons before making the perilous journey west are now leaving the state in an effort to avoid being busted.

Diane Sanchez manages Miller Heiman, a corporate management firm. A native San Franciscan, she first heard discussion last April of what would later become the 11% tax bracket. It was the final straw for her.

She and her husband packed up and left for Reno, Nev., where today Sanchez employs 25 people, five of whom followed her from California.

"I’m one of the few who actually use the ’T-word,’" she said, meaning that many refugees from California will cite other problems such as smog or traffic when, as for her, taxes were really their main concern.

In Nevada, there’s no state income tax at all. The state’s sales tax, at 6%, is relatively high compared with other states’ but still lower than what Sanchez was paying in the Bay area.

Loss Of Revenue

In fact, all of Sanchez’s non-federal taxes in Nevada are considerably lower. Add to this that the Reno area provides much easier living in general than congested California and Sanchez couldn’t be happier with her move.

"Look," she said, "it’s not just the 11%, it’s what I was going to get for it — the state’s massive problems, the poor leadership, the inability of the government to get anything done.

"Now," she said, "they’re not only not going to get that increase from me, they’re not going to get anything." Nor, she added, is California going to get anything from the 25 people she employs now and the others she may employ in the future as her business expands.

Sanchez is just one of a growing number of entrepreneurs and other middle-class and upper-middle-class Californians who have been steadily fleeing their state for more hospitable surroundings in Nevada, Oregon, Washington, Arizona, Idaho, Utah and two dozen other states. They have prompted what the Washington Post has called an "economic boom" in states contiguous to or near California.

The exodus has not escaped the attention of the state Legislature or Gov. Wilson. But Wilson has chosen to focus the blame on the state’s onerous workers’ compensation system, which nationally ranks third in costs but 35th in benefits.

This is indeed a problem cited by many businesses, as are the tightest environmental regulations in the nation. But California’s corporate tax rates, sixth in the nation right now, have not been the subject of any proposed Wilson reform.

Further, just this week he signed into law a bill that would require larger businesses to grant employees up to four months of unpaid leave to take care of a sick child, spouse or parent.

The problem, however, is not just one of businesses, nor even just of persons, leaving.

Taxes On Wealthy

Many would-be Californians with hefty incomes are probably deciding to stay out. The July issue of Money included an article titled "Retire to Florida, Not California." It advised retirees, whose income and assets are considerably higher than the national average, to take their life savings to states where they would pay only half as much in state and local taxes. "In the Golden State," it said, "taxation is as active a pastime as growing exotic fruits."

According to statistics compiled by the Washington-based Citizens for Tax Justice, while California’s taxes on what the group defines as the poor rank it a formidable eighth in the country, up from No. 14 before the tax increase, its taxes on the wealthy as a result of the tax increase will probably rank highest in the nation.

But while the poor have little choice about where they’ll live, those with the money to have the option of moving are increasingly exercising it.

"Every firm in California now has an escape plan," said Robert Boyd, marketing director for the Nevada Commission on Economic Development, which actively pursues disgruntled California businesses. "ABC — Anywhere But California" is the catch phrase being used by such commissions.

Studies show that this isn’t just wishful thinking on his part. One recent survey by the California Business Roundtable indicated that 41% of companies in the state have plans to expand outside of California and that 14% of companies intend to relocate outside the state.

Yet that poll was conducted before the latest tax increases were even proposed.

Pete Wilson critics, many of whom are in his own Republican Party, say the latest tax increase cannot but open the spigot of fleeing Californians even wider.

It isn’t that the state is about to run out of people. Indeed, almost one-eighth of all Americans now live in California, and the population growth in the state continues at a phenomenal pace.

The problem is, those entering the state, about half of them immigrants, tend to put less into the tax base than those moving out and tend to draw more in the way of government support and services.

Potential Vicious Circle

The result may be a vicious circle in which California’s per capita tax base is shrinking, which leads to revenue shortfalls, which in turn may prompt new tax increases, which will then drive out even more businesses and more taxpayers in the upper brackets.

But if one can’t slap higher taxes on the wealthy, and doesn’t want to force them upon the already burdened poor and middle class, then who or what is left?

According to Republican Assemblyman Tom McClintock, considered the most fiscally conservative member of the California Legislature, the solution would have been to not raise taxes at all.

Pete Wilson seems to hang out on the wrong side of this curve.

No one denies that Wilson was put into a tough position in inheriting by far the biggest shortfall the state has ever seen. But, asked McClintock, "Is it really so difficult to cut a budget which has more than doubled in eight years?"

Indeed, for all the talk of belt-tightening, combined general and special fund spending in the Wilson budget increased by almost 7%.

McClintock, who originally sponsored Wilson’s candidacy in the Legislature but has since come to view him as something of a traitor, offered an alternative proposal.

It would have eliminated the deficit through such changes in state outlays as conforming Medi-Cal services to match restrictions imposed by federal Medicaid, privatizing local government operations for emergency medical services, reforming pension plans, and replacing the present method of distributing educational funds with a voucher system similar to that proposed by President Bush for the nation as a whole.

Along with eliminating the need to increase revenue, McClintock notes, the best aspect of his plan would have been that the cuts would save money year after year.

One-Time Fix

By contrast, he says, much of the Wilson budget, such as switching accounting methods, was nothing more than a one-time fix. Even the increased revenues from the new taxes will rapidly fall off — $3 billion in the very first year after the increase, according to the state’s Legislative Analyst’s Office.

"You had no structural reforms and no real budget cuts," said an aide to McClintock of the Wilson package. "Unless there is extremely strong growth, another deficit in the near future is inevitable."

None of which is to mention the drag that higher taxes will have on a state economy trying to recover from a recession.

Arthur Laffer believes that the taxes could prompt as much as a 30% increase in unemployment. But Donald Booth, an economist at Chapman College in Orange, Calif., thinks it will "hurt the recovery, but not drastically."

It’s possible for a sales tax to actually stimulate growth, says Booth, if the revenues are allocated properly. "But this is mainly a transfer program that doesn’t increase wealth but does decrease consumption," he said.

Gearing Up For Revolt

The Continental Congress was merely a tax revolt; might California do the same, 200 years late?

Meantime, opponents of the tax increase say that they are gearing up for a new revolt the likes of which hasn’t been seen since the heady days of Proposition 13.

At a recent convention of the state’s Republican Party, Pete Wilson was tarred and feathered in effigy.

Wilson opponents are convinced that everything he does, including the tax increase, he does not in the best interests of Californians but rather in the interest of gaining the Republican presidential nomination in 1996.

They believe the tax increase that placed him on the media’s short list of presidential candidates will in fact prove to be an albatross around his neck, as well as for Californians as a whole.


Read Michael Fumento’s additional work on politics, economics, and on the media.