Herdt: A fatal flaw in state tax reform

Periodically, whenever state government revenues are riding high or falling fast, big thinkers in California begin earnestly arguing for major tax reform.

The crux of their argument is the undeniably outsized fluctuations in state revenues.

It’s either caviar or cat food, and there’s no dispute about the reason: The personal income tax accounts for two-thirds of California’s general fund revenues, and more than half of all income taxes are paid by people with annual incomes in excess of $300,000.

Even more telling is that just 5,105 taxpayers who had taxable incomes greater than $5 million in 2012 paid 15 percent of all state income taxes that year. They also accounted for 8 percent of all taxable income.

Most people in that stratosphere derive most of their income from capital gains on investments, and such gains are hypersensitive to slight shifts in the overall economy.

So, many of the big thinkers put forward an elegantly simple solution. To reduce the dramatic swings in the state’s fiscal fortunes, they argue that income-tax rates should be flattened so that the state is not overly reliant on the volatile incomes of the very wealthy.

At a news conference earlier this month, straight-talking Gov. Jerry Brown exposed the fatal flaw in that argument after a reporter asked him about modifying income-tax rates.

Brown’s response: “Reducing it on the very high incomes and then adding to these people you talk about - the middle class, poor people?”

With that, the governor explained exactly why the idea of flattening income-tax rates will never fly. To make up for a 1 percent rate reduction in tax rates on the few with incomes of more than $300,000 would require a 1 percent rate increase on everyone else.

That is a political non-starter and is not particularly equitable.

So what might be done to soften the state’s boom-and-bust revenue cycles?

The most logical idea is to do something to increase the percentage of state revenues that is derived from the more stable sales taxes.

As recently as the early 1980s, sales taxes had been the state’s No. 1 source of revenue. They now account for just 21 percent.

A primary reason has been the shift to a service-based economy. And in California, very few services are taxed. Among the states, according to the Federation of Tax Administrators, it ranks 47th in that category.

Sales taxes are less volatile than income taxes, and extending them at least to services used mostly by individuals with high incomes would arguably be a sensible policy.

Examples: Private club memberships (taxed by 23 states), private limousine service (14 states), lawn care and landscaping services (30 states) and swimming pool cleaning (16 states).

Newly elected Sen. Bob Hertzberg, D-Van Nuys, the former Assembly speaker, is a certified big thinker. Between his stints in the state Legislature, he was a leader of the thoughtful reform group California Forward.

He has been appointed chairman of the Senate committee that oversees tax issues, and has proposed major tax reform. Among the elements of his proposal is broadening the sales tax by imposing taxes on services.

Hertzberg realizes his idea is not going to be enacted overnight, but he’s seeking to start a serious conversation.

The idea is politically explosive. When former Gov. Arnold Schwarzenegger proposed a small-scale version of that, his aides report they received more pushback on that idea than any other issue that came up during his seven years on the job.

Each service that would be proposed for taxation has a constituency, most of them fairly influential. Imagine, for instance, the status of the individuals who serve on country club boards of directors and how they would respond to the idea of taxing private club memberships.

In his just-released book, “Boom and Bust: The Politics of the California Budget,” Fresno State University Professor Jeff Cummins suggests that any successful attempt at tax reform would have to be led by a governor, be conducted in the manner of a political campaign, involve a lengthy period of public education and have to persuade “a clear majority of voters that they will not fare worse under the new system.”

Perhaps there’s a chance of doing some things to mitigate the huge swings in California’s fiscal fortunes, and Cummins says the implementation of Proposition 2’s rainy-day budget reserve “should soften the revenue blow during future economic recessions.”

But his bottom-line conclusion is one that even the big thinkers should accept: California, he writes, “will probably never be fully immune from encounters with crisis budgeting.”

Timm Herdt is a columnist for the Ventura County Star.