The Open Secret about California taxes

California's tax system, which relies so heavily on the wealthy for state income, is prone to boom-and-bust cycles - while it delivers big returns from the rich whenever Wall Street goes on a bull run, it forces state and local governments to cut services, raise taxes or borrow money in a downturn. During the Great Recession, the capital-gains taxes that sustained the state in good times plummeted - school districts handed out 30,000 pink slips to teachers, and the state was so cash-strapped it gave out IOUs when it couldn't pay some of it's bills. California is now enjoying one of the longest economic expansions in state history but the good times can't last forever. With an inevitable recession lurking in our future, people have warned that state and local governments are more vulnerable than ever to teacher and police layoffs, park and library closures and cuts in health and welfare service for the poor. Part bipartisan efforts to reduce volatility without raising taxes on the poor and working class have had limited success. The overall tax structure hasn't been updated, leaving parts of the economy taxes at some of the nation's highest rates while other sectors such as services which many other states do not tax aren't taxed in California. Politicians like to talk about the problem explaining how Proposition 13 - the famous 1978 measure that limited property taxes, has created unequal tax burdens - yet, few have been willing to initiate change.

So, how does it work now? California state and local governments received $487 billion from taxes, fees and federal funding in 2018 based on the most recent data available from the US Census Bureau. Of that, $110 billion came from Washington, while state and local governments raised the remaining $377 billion from a combination of taxes and fees - that includes not only common taxes that residents pay on property, sales and individual/ corporate income, but also other charges and fees that governments have tacked on over the years for hospitals, highways and schools. The differences between taxes and fees can be obscure and often provoke politically charged debates, but in the end, they're both a way to raise revenue for state and local governments. If we were to isolate common taxes, the amount would be $258 billion. The Legislative Analyst's Office, a non-partisan adviser to lawmakers on financial matters breaks down the distribution of revenue sources - it used to be property taxes before, now it is personal income taxes!




Now, where does this money go? As the fifth largest economy in the world, California has big demands - a wide variety of public needs from roads and highways to parks and prisons - however, the state's two biggest services are education and health care. The state is projected to spend $80 billion in 2019 from its own revenue sources on 6 million students in K-12 public schools - that amounts to $11614 per pupil from state and local sources and reflects recent years of improved funding due to improved economy and voter-approved tax increases - taxpayers also subsidize a higher-education network made up of community colleges and the CSUs and University of California systems. On healthcare, California was early to embrace the federal Affordable Care Act which established an individual health-insurance market and expanded Medicaid (Medi-Cal) which covers the poor. Today, California's Medi-Cal program tops $100 billion each year and covers 13.5 million, or 1 in 3 residents. The bulk of that cost has been borne by the federal government but there's much uncertainty about outgoing federal aid as Republicans in Congress propose to scale back spending.  The question of how to sustain this coverage has triggered a public debate about a single-payer health care system for California. On top of all these costs are long term debts that have flown under the radar such as retirement obligations for public workers - California state and local governments now spend $25 billion a year on pension payments and retiree health care for public employees - a 3X increase since 2003 with payments projected to grow.

So what are the trade-offs we're now making? In it's willingness to tax the rich, the state has become more reliant than ever on personal income taxes. Individual wages and business income as a measure of the overall economy aren't that volatile - but California's income taxes are over 5X more volatile than personal income, because they also include investment gains - the state taxes capital gains, partnership income and dividends, interest and rent are areas where the highest income taxpayers derive most of their money. The result? Millionaires and Billionaires contribute a disproportionate share of tax revenue - so much so that the top 1% of taxpayers now generate half of personal income tax receipts. Half the state's personal income tax revenue comes from those making $500k or more annually. Conversely, households making $50,000 or less make up nearly 60% of tax fillings but make up just 2% of revenue. This volatility can mean huge infusions in good times - for example, when Facebook went public in 2012, employees such as Zuckerberg along with early investors plumped state coffers with an estimated $2.5 billion which arguably prevented some school funding cuts amid a $16 billion budget deficit. The opposite is also true in bad times - during the Great Recession, the state faced multiple years of multi-billion dollar deficits including a shortfall of $40 billion in 2009 - as a fallout from the housing and economic crisis. The California Teacher's Association estimates 30,000 teachers were laid off during the recession - when the state ran low on cash in 2009, it issued IOUs mostly to taxpayers waiting for their tax refunds - the state cut benefits to the poor such as dental coverage for those on Medi-Cal - and state workers along with local government employees were forced to take furloughs hitting working-class families. The tech sector has an outsized influence on California's tax volatility - 9 counties that make up the SFO Bay Area contribute to 40% of personal income taxes but are home to only 20% of the state's population - that marks Silicon Valley's largest share since 2000 - it is why California budget watchers pay attention to stock market gyrations - when the Dow experienced two 1000 point plunges in 1 week in Feb 2018, it triggered anxiety over state revenue - there's a saying that Wall St catches a cold and California gets the flu.

Perhaps no other measure has defined California taxes like Proposition 13 - the tax-cap driven by taxpayer revolt. Instead of taxing properties at market value, Prop 13 is based on a property's purchase price - for each year after that, a property's tax can only increase by 2% or the rate of inflation, whichever is lower. While it helps people on fixed incomes stay in their homes, it has created significant disparities among neighbors depending on when they purchased a home, condo or land. There are 2 ways Prop 13 has driven inequality - first, the tax benefits have disproportionately gone to the wealthy and second, because local governments are increasingly using development fees and assessments in lieu of property tax, prop 13 is helping drive up the cost of new housing. For homeowners, the amount of tax relief is proportional to the value of their homes and since high-income households tend to own homes with higher values, they receive the majority of tax relief. Local governments are missing out on billions because of a homeowners exemption to the law that allows children and grandchildren to inherit up to $1 million in property without its having to be reassessed. Over the past decade, 650,000 properties (5% of properties in the state) have been passed down without triggering reassessment - and many of their beneficiaries have used those properties as rentals - this trend is expected to grow as baby boomers age. As a result, housing has become a lot more expensive now and home ownership among the young Californians has dropped.

So, what's now in the works? In the Legislature, there is a proposal to expand the sales tax to business services such as those provided by lawyers, accountants and financial advisers to better reflect today's service economy. Like a hotel tax, a service tax would ensure that out of state corporations that do business in California contribute their fair share to the economy. In response to recent federal tax changes, there are proposals to help Californians find a way to deduct most of their state and local taxes from their federal tax bill. The Realtors Association passed an initiative to let homeowners 55 and older to carry their existing property tax rates to new houses as well - they say that could hep with the hosing shortage by encouraging more seniors to move to smaller homes or closer to their families. However, opponents, including affordable housing advocates say  it widens the generational wealth gap and drains revenue for schools, local services and the poor. They estimate that such a tax transfer would eventually cost schools $1 billion a year and at least cities and counties $1 billion a year. Local governments have already come out against an initiative effort funded by soda companies to block local taxes that pass on a simple majority - instead, the "Tax Fairness, Transparency and Accountability Act" would raise the threshold to two-thirds for passing taxes. Business groups say that a higher bar is needed to protect taxpayers, union leaders say it is a shameless attempt to block communities from imposing soda taxes aimed at improving public health. Soda is already taxes in SFO, Berkeley, Oakland and the Bay Area city of Albany.