California’s fiscal crisis isn’t over–and this year’s tax proposals won’t solve it

150 150 Darien Shanske

(Photo Credit: Willem Van Bergen/Flickr)

If you want to understand California’s current fiscal situation, you can do no better than California Forward’s Financing the Future, a series of reports that are exploring ideas for building a stable, adequate, and sustainable revenue system.

There are two takeaways that I would emphasize: one explicit, one implicit. The explicit takeaway is that, despite considerable progress, California’s fiscal crises have not gone away. They will return. The second, implicit, takeaway is that none of the fiscal reforms on the table – either singly or together – address the scale of the challenges that we face and that we are currently ignoring as best we can.

First, as to the scale of the challenges, CA Fwd makes a number of sobering points. Among them: 

  1. Even if the Proposition 30 tax increases were continued, we cannot responsibly plan on their producing revenues at their current level.
  2. Even with the Proposition 30 taxes raising more money than expected, California has only managed to provide a level of public school funding that approaches the national average. Leave aside for the moment whether you think that California schools currently spend their money wisely, just consider how it is possible that a wealthy and (relatively) high tax state has such trouble reaching the national average.
  3. The major proposals for more revenue for infrastructure would still leave a multi-billon dollar gap compared to what Caltrans says is needed to maintain current infrastructure. Consider whether you consider our current infrastructure adequate.
  4. No matter which – if any – new revenues are approved, local governments are going to have their ability to implement sound policies hamstrung by legal constraints, many of which are unique to California. The proposals surveyed by CA Fwd would address this issue, but only on the edges. In general, California local governments would remain far more limited in their powers than local governments in other states.

I would add one more sobering point as regards expanding the sales tax base: Broadening the base of the sales tax to services is good tax policy, as CA Fwd explains. However, continuing to apply the sales tax to business-to-business sales is bad tax policy. To understand why, imagine I decide to open a new small store selling clothes. Suppose the sales tax now includes services – that means I now need to pay sales tax when I pay my lawyer, accountant, architect, plumber etc. My competitors, big retail chains like Gap and J. Crew, do not need to pay the sales tax for these services because they perform them in-house. That is neither fair nor efficient.

Today’s tax proposals don’t go far enough

Taken together, what does this all mean? The major tax proposals would either leave our tax system volatile (e.g., continuing Proposition 30) or simultaneously make our tax system both more and less efficient and equitable (e.g., SB 8, as currently understood). Further, there will be continued pressure to spend more revenue on education and infrastructure even as California’s local governments have limited tools to come up with creative ways to address these (and many other) problems.

And so we need to do better and we certainly could do so using what I would call “twentieth century tax policy technology.” So, for instance, we could broaden the base of the sales tax while excluding business-to-business sales. This reform would not be undertaken to raise money, just make the tax system better. If we wanted to raise money, as it seems like we need to do to some extent, we could then raise the sales tax rate and raise more money more efficiently and fairly from a more stable revenue source. If we were worried about the impact of higher sales taxes on poorer people, as would be right, we could give a sales tax credit using the income tax.

There are other excellent and proven 20th century ideas just lying around. For instance, lots of states limit local property taxes, but generally those states allow local voters to override those limits. California could do this too, perhaps also requiring that a share of any money so raised be shared. The inability to pass overrides is a big part of the answer to the riddle of California’s low relative investment in public education; we do not have an effective mechanism to channel local citizens’ enthusiasm for local schools. Again, if we are concerned that property taxes might get too high for poorer homeowners, we can use the income tax to give credits.

In short, the proposals on the table would, if implemented, give California a substandard 20th century tax system that does not meet the goals set for it by CA Fwd. We should at least aim for a state-of-the-art 20th century tax system, one that could at least meet modest goals, like maintaining our infrastructure and funding our schools at the national average.

What would 21st century tax system look like? At least in part, it would be a state-of-the-art 20th century system with a carbon tax. What is so promising about a carbon tax? For one thing, as everyone knows, people respond to taxes. The income tax has many merits but it does, in some cases, discourage producing taxable income, which is, of course, not the goal of the tax. But we want to discourage carbon production – hence this is the only tax reform proposal that might also save the planet! Even better, discouraging carbon production has other positive impacts, such as reducing our overall need for infrastructure. If we need less infrastructure, then this takes pressure off of our revenue needs. A carbon tax, theoretically anyway, could be part of an overall tax reduction, at least in the long term.

But could a single state have a carbon tax? Yes, British Columbia has one and, though controversial, it seems to be working well. Are there legal obstacles in the U.S. to a carbon tax at the state level?  Perhaps, but I do not think they are insurmountable. What about California’s successful cap and trade program? First, if done properly, a carbon tax could complement cap and trade. Second, there is good reason to believe that a carbon tax will be more successful than even the best cap and trade program. Third, cap and trade does not produce general tax revenue and thus, for instance, cannot help fund education. Fourth, we have to at least consider alternatives to cap and trade because the California’s cap and trade program will need to be re-evaluated in 2020.

There are states that do not have the governmental – or civil society – structures in place to institute cutting edge policy reforms. California is not such a state: Our sustained leadership on environmental issues is a testament to this. Many of the fiscal reforms currently being considered are clearly worthwhile. Furthermore, the passing of Proposition 2 last year, which created a new rainy day fund, is an example of a sensible fiscal step forward.

Seen as starting points rather than final results, the reforms currently proposed suggest that California might, at long last, be ready to put its fiscal affairs in order.

Darien Shanske is a professor of law and political science at UC Davis.


Darien Shanske

All stories by: Darien Shanske