PD Editorial: California hangs on to unreliable, outdated tax laws

California’s tax machine is slowing down.

Gov. Jerry Brown and state legislators modestly scaled back their spending plans after tax receipts fell more than $1.1 billion below projections for April. May’s figures were better but still fell $154 million short of projections that already had been revised downward.

Is this the beginning of a significant downturn?

In his May budget revision, Brown warned that California is headed for a deficit of $4 billion in 2019. Controller Betty Yee, the state’s chief fiscal officer, says it’s too soon to jump to conclusions. This much is certain, the economy will stall sooner or later.

The question is whether California is ready.

Putting money in a rainy day fund will help, but it doesn’t address the fundamental weakness of the state’s boom-and-bust tax system, which is overdue for an overhaul.

“Designed during the Great Depression, California’s tax structure is outdated, unfair and unreliable,” Yee said in a report issued this month. “It reflects economic patterns and demographics of the past.”

The result is wild swings between prosperity and near insolvency.

California legislators introduce about 250 tax-related bills every year, almost all of them addressing incremental matters. Yee’s 94-page report, produced by a panel of scholars, business executives and government officials, is a cautious attempt to push lawmakers toward a broader view of how public services are funded.

It’s hardly a secret that California has grown increasingly reliant on a relative handful of taxpayers. In the upcoming fiscal year, about 70 percent of general fund revenue is expected to come from personal income taxes. And the latest Franchise Tax Board figures show that 48 percent of state income taxes are paid by the top 1 percent. To be a 1 percenter required taxable earnings of about $556,000 in 2014.

There’s nothing wrong with a progressive tax system. But at those stratospheric levels, earnings are dominated by capital gains rather than wages or salaries. So when markets decline, incomes do too. And when top-tier incomes dip, California tax revenue collapses.

In 1950, income taxes generated about 10 percent of general fund revenue, shielding the state from gyrations in the market. A 3 percent sales taxes produced about 60 percent of general fund revenue. Today, at an average rate of 8.42 percent, California’s sales tax is among the highest in the country. But it only produces about 20 percent of state revenue.

Yee’s report explores the potential revenue gains from extending the sales tax to certain services and reassessing commercial property more frequently, but it stops short of any recommendations, probably because, as she notes in the report, comprehensive tax reform “has been elusive and politically unpalatable.”

The last comprehensive overhaul of the state tax code was in 1935, implementing its first income and sales taxes. At the time, California was one of 48 states, and the Golden Gate Bridge was two years from completion.

California is, by some measures, the sixth largest economy in the world. With the state’s finances still solid, it has an opportunity to revise its tax system to end the roller coaster revenue ride. There are signs of a slowdown. Maybe the rainy day fund will see the state through. Even if it does, the structural problems with the state’s tax system will remain. They must be addressed eventually. Why not now?