California Budget Bites

One of the last-minute changes to the budget agreement substituted a 0.25 percentage point increase in each of the state’s basic income tax rates in place of a 5.0 percent income tax surtax. The enacted change would increase each of the tax rates for two or four years, depending on whether the spending cap that will appear on the May special election ballot is approved by the voters. For example, the 4 percent tax rate would be 4.25 percent under the new law and the 9.3 percent rate would go to 9.55 percent. As discussed in yesterday’s blog post, the increase would be cut in half – to 0.125 percentage points – if the Treasurer and Director of Finance certify that the state will receive at least $10.0 billion in “flexible” funds from the federal economic recovery bill. In contrast, the proposal under consideration until the final night of budget negotiations would have required all personal income taxpayers to add an amount equal to 5.0 percent of their tax liability for the two- or four-year period.

Because of this seemingly minor change, lower-income households will experience a much larger tax increase than under the previously considered proposal. The tax liability of a married couple with a taxable income of $40,000 will rise by 12.9 percent under the enacted policy, as opposed to 5.0 percent under the proposal previously under consideration. In contrast, the tax liability of a married couple with a taxable income of $150,000 will rise by 4.0 percent under the final agreement, instead of 5.0 percent under the original surcharge proposal. High-income earners will experience the most significant change – their tax liability will only rise by 2.9 percent under the enacted policy.

The bottom line: this late night change dramatically shifted the impact of the personal income tax increase downward on to low- and middle-income taxpayers, in contrast to a previously considered proposal that would have had a flat impact across the income distribution.

– Jean Ross

My favorite economist, Paul Krugman, has called on the nation to pay heed to the debate over California’s worsening budget crisis. Since Saturday, lawmakers have struggled to find the required two-thirds vote needed to pass the tax increases included as part of a proposed plan to close the gap in the budget for the remainder of the current and upcoming budget years. The package under consideration includes deep spending cuts and a measure that, if approved by the voters, would sharply limit future spending. The package also includes massive corporate tax reductions that, when fully implemented, will reduce state revenue collections by more than $1.5 billion.

This change, while the most costly, is only one of several “sweeteners” added with the goal of rounding up the votes necessary to ensure passage of the total package. Others include a tax credit for homebuyers that is restricted to never-before-occupied residences, leading some to christen it the “developer bailout” bill.  Other provisions would eliminate large commercial vehicles from the increase in Vehicle License Fees (VLF),  while another would allow rental car companies to pass on the cost of the higher VLF directly to consumers as an “add on” on top of advertised rental rates.

If this year’s budget negotiations don’t increase public support for reducing the vote requirement for approval of a budget and tax increases, it is not clear what will. 

 – Jean Ross