Tax Analysts Blog

The Governator Considers a Flat Tax

Posted on Jun 19, 2009

California's budget crisis is reaching epic proportions. Sacramento is in turmoil. And, unfortunately, the tenor of the debate has not progressed beyond that of a schoolyard shouting match. Conservatives blame excess spending on unions, immigrants, and bloated bureaucracy, while Democrats complain about corporate tax loopholes and constitutional roadblocks to tax increases.

In a recent interview with the editorial board of the Sacramento Bee the Governator said he wanted his tax reform panel--with the grandiose title of Commission on the 21st Century Economy--to consider bold ideas like a flat tax. Presumably the flat tax would replace California's personal and corporate income taxes.

The flat tax is a perpetual favorite of conservatives. And the Wall Street Journal editorial page is tickled pink by the Governor's suggestion. The individual component of the flat tax has a single rate and all taxation of capital income is exempt. And there are no deductions or credits so it is far simpler than current law.

The particular attraction of the flat tax for California in light of the financing crisis is its revenue stability. With local property tax revenues capped by Proposition 13, there is an extra burden on the state government to fund education, and the only progressive source of revenue available to the state is the personal income tax. In a state full of millionaires, the bursting of the tech bubble in 2000 and the current recession has put state tax receipts on a roller coaster ride. This was great for politicians when revenue was rising because they would boost spending almost dollar-for-dollar as the money came pouring in. The flip side is that every economic downturn means a budget crisis.

So "revenue stability" has become the clarion call for California tax reform. Well, there are some problems with this. As Berkeley economist Alan Auerbach points out, revenue stability may be good for the government but it is bad for the economy. The income tax acts as an "automatic stabilizer"--cutting taxes in a downturn when the economy needs stimulus and raising taxes when the economy is riding high. The better solution to the revenue instability problem, as pointed out by Charles McLure, would be for the government to have the discipline to save some money in "rainy day" funds when times are good.

Second, because progressive taxes--like the personal income and corporate--are generally volatile, and regressive taxes--sales taxes and fees--are stable, all calls for revenue stability are in effect calls to increase the already overall regressive California tax system. One tax that is relatively stable and relatively progressive is the property tax. But, again, increasing property taxes is blocked by the politically immovable Proposition 13.

No doubt California's desperation is a catalyst for new ideas about revenue and budgeting. The tax reform panel is due to present its results to Schwarzenegger on July 31. It will be fascinating to see what its diverse body of 14 members comes up with. Hopefully, the Flat Tax will not be high on its list of recommendations.

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