Commission Weighs Major Tax Overhaul, Flat Income Tax Rate

While lawmakers and the governor lurch toward a budget compromise, the Commission on the 21^st Century Economy is starting to wind up its work to transform California’s Depression-era created tax system.

At the 14-member commission’s penultimate meeting in Los Angeles June 16, its members appeared to narrow its potential recommendations, due July 31, to two proposals.

Both would lower the top income tax levels and, in one case, eliminate the state’s corporate tax and the portion of the sales tax pocketed by the state.

Each proposal is aimed at smoothing out the spikes and valleys in the state’s increasingly volatile tax system.

“You can’t have lived in California for the last X period of time and not feel there’s volatility,” said Gerald Parsky, the commission’s chair.

Both proposals are also designed to be “revenue-neutral” – not resulting in a net overall tax increase.

One of the more revealing charts in the “Tax Structure Alternatives” Power-Point presentation by the commission’s staff shows tax revenue trends from 1963 to 2008. The chart has the wild ups-and-downs of an 8.0 earthquake measured on the Richter scale.

Elsewhere are other charts highlighting the system’s volatility. One reveals that nearly 80 percent of California’s personal income tax collections come from taxpayers earning more than $100,000. Another shows the bulk of capital gains assets concentrated in the hands of taxpayers with income of $5 million or more.

Because of numerous oral amendments it is somewhat unclear what precise proposals the commission is moving forward. However, the gist of them is this:

Under one proposal, what the commission refers to as Tax Package 1B, all Californians would pay a 6 percent income tax rate. The state’s wealthiest residents currently pay 9.3 percent with lower percentages as earnings fall.

The effect of the proposal would be to increase the taxes on Californians earning less than $100,000 to broaden the tax base.

If taxpayers do not itemize they would receive a $5,000 personal exemption. If they do itemize, mortgage interest, charitable contributions and property taxes could be deducted.

The state’s 8.8 percent corporations tax would be eliminated, as would the 5 percent of the sales tax the state retains.

Gov. Arnold Schwarzenegger’s revised budget, unveiled in May, showed the state receiving $48 billion from income tax, $37 billion from the sales tax and $8.8 billion from corporate taxes.

A new “business net receipts” tax makes up for much of the lost revenue from the sales and corporation tax eliminations.

The idea is create a tax that encompasses more of California’s economy than the sales tax, which does not extend to services. Under Tax Package 1B, all businesses would pay a tax 2.77 percent on their net receipts.

A study by Ernst & Young on the commission’s web-page estimates a 3 percent tax would yield revenue of more than $28 billion.

As visualized in the report, net receipts would be defined as “all receipts minus all purchases from other firms.” Small businesses earning $500,000 or less would be exempted. 

There’s some ambiguity as to the exact form of the second proposal, Tax Package 2, but its chief difference with the other proposal is it contains income tax brackets, rather than a flat rate.

No one earning $10,000 or less would pay any income tax. Those earning up to $50,000 would have a 4 percent rate and those earning over $50,000 would pay 7 percent.

All current deductions and credits would remain unchanged.

The original Tax Package 2 also contained the business net receipts tax and an investment tax credit that would refund the sales tax paid on business investments such as vehicles and computers.

From a webcast of the commission’s hearing, it appeared that Parsky removed those two components.

The corporate tax rate would fall to 7 percent and the sales and use tax would fall by 1 percent, under the second proposal.

Prior to the commission’s July hearing, its staff was asked to include in the modeling of both plans the imposition of a tax on refiners of gasoline, diesel and jet fuel.

Creation of a “carbon tax” has been a goal of commissioner Fred Keeley, a former Democratic state Assemblyman from Santa Cruz.

Keeley also wants the commission to consider a $25 fee for each recording of real property with the proceeds earmarked for the state Resources Agency, which oversees the state’s park system, among other responsibilities.

Commissioner Christopher Edley Jr., dean of Boalt Hall School of Law, sought to have Tax Package 1B modified so that it included a higher bracket for higher income taxpayers.

Doing so, he argued, would avoid the appearance that the proposal was a “crass transfer” of the tax burden from high income earners to middle class earners.

It appeared that Parsky directed the commission’s staff to study that possibility.

-30-