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  • Why Tax Reform Is Hard

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    March 11, 2019
    By  Loren Kaye  - March 8, 2019

    Governor Newsom’s musings have set tax reformers buzzing.

    Deflecting a question at a budget briefing about where he stands on a ballot proposal to raise property taxes on business, the Governor disclosed his “desire is to use this as an exercise in bringing the parties together to see if we can compromise on a more comprehensive tax package.”

    After years of stiff-arming by Governor Brown, could this be the moment for comprehensive tax reform? Will California taxpayers soon see a state budget featuring a progressive tax system, healthy revenues, but without our notorious volatility?

    Not likely. To change the tax system, policy makers must overcome structural contradictions and constitutional barriers embedded in an unfriendly political landscape.

    Volatility

    First, a progressive tax system is unavoidably volatile. A “21st century tax system,” either in the interest of more progressivity or more revenues, will lead to more volatility.

    This has been most obvious with the evolution of the personal income tax, which today accounts for 70% of all General Fund revenues, compared to just 45% in the mid-1990s. With greater progressivity has come more volatility: taxes on capital gains have bounced between 3.4% and 11% of total General Fund revenues — which amounts to a difference of more than $10 billion a year, depending on the economic cycle.

    The more stable major revenue source has been the tax on the sale of tangible goods, but what may seem to be a feature is now considered a bug.

    More retail transactions today involve services rather than tangible goods. Reformers therefore insist that the sales tax be extended to services, to reflect the 21st century economy. But purchases of services are more likely to be sensitive to economic cycles than are purchases of goods. Consumers are more likely to forego car washes and landscaping services during a recession than they are clothes purchases. What could be more vulnerable to an economic cycle than real estate transactions or architecture fees?

    If volatility is the question, then a tax on services may not be the answer.  Read More