Editor’s Note: The CEO of an Orange County-based company with half a billion in annual sales recently told the Business Journal that he might consider moving out of state if California increases its tax rates. The reason? “My wealth management team says that if I die in Texas, based on current tax levels, there will be $50 million more in the bank versus dying in California. Seems like a no-brainer. And that’s before the proposed tax increases.”
Chapman’s Doti and Sfeir biannually issue economic forecasts, which are among the nation’s most accurate predictors of gross domestic product (GDP).
It seems a day doesn’t go by without learning about some new or higher tax being dreamt up in Sacramento.
Emblematic of these efforts is a proposed increase in the top income tax rate to 16.8% from the current 13.3%—a rate that is already the highest in the nation.
An Assembly bill has been introduced that would add a 0.4% wealth tax on assets over $30 million.
And then there’s the split roll property tax measure that is estimated to add $12.5 billion in commercial and industrial property taxes.
The major impetus for these and other tax hikes is the coronavirus pandemic. As COVID-19 wracked the California economy, Gov. Gavin Newsom announced in May that the state would face a staggering budgetary shortfall of $54.3 billion. He added, “These numbers are jaw-dropping.”
Our response is: “It’s not as bad as it sounds.”
It turns out that the jaw-dropping $54.3 billion shortfall is actually not for one but three fiscal years. In addition, it covers an extra $13 billion in payments not included in the General Fund for the added costs of safety net programs like Medicaid and coronavirus-related emergency spending, costs that are largely being covered by CARES Act funding.
What is most pressing now, especially in light of the legal requirement to produce a balanced budget, is the budgetary outlook for the state’s budget for the current July 1, 2020 to June 30, 2021 fiscal year.
The “May Revision” to the governor’s budget proposal to the Legislature pointed to a deficit during that 2020-21 fiscal year of $28.5 billion. That deficit is the result of General Fund revenue projected at $124.9 billion instead of the $153.4 billion anticipated before COVID-19 hit. While the resulting difference of $28.5 billion is less alarming than the $54.3 billion shortfall announced by the governor last month, it’s still a big nut to crack.
As shown in Chart 1, to bolster revenue, the “May Revision” proposed that $7.8 billion be added from the “Rainy Day” fund, another $6.5 billion from various transfers, and $1.6 billion from the prior-year surplus. Those increases of $15.9 billion in revenue helped reduce the $28.5 billion deficit to $12.6 billion.
The “May Revision” also recommended that budgeted expenditures be cut $12.6 billion from $148.5 billion to $133.9 billion in the upcoming fiscal year. That represents a drop of 8.2% in General Fund expenditures. Since then, various political machinations have resulted in virtually no proposed cuts in K-12 budgeted expenditures. As a result, the actual decline in proposed expenditures is only 3.7%. Thus the actual spending will be virtually the same, $147.7 billion, as the 2019-20 fiscal year.
As shown in Chart 2, reducing budgeted expenditures by $12.6 billion and adding the $15.9 billion in revenues covers the projected $28.5 budgetary shortfall. So for now, a workable balanced budget of $140.8 billion is in place that does not rely on a bailout from the federal government or a tax increase.
But we’re more optimistic than what these numbers suggest. The May Revision’s projected $124.9 billion in revenue during the next fiscal year is predicated on a pessimistic L-shaped recovery. Such a conservative forecast is prudent when putting a workable budget together. Our Chapman University forecast, however, points to a stronger recovery with General Fund revenue of $138.3 billion, an amount $13.4 billion higher than the $124.9 billion projected in the May Revision. That difference is shown in Chart 3. If the Chapman forecast pans out, that will give Newsom and the Legislature some breathing room, perhaps even the wherewithal to help cities and counties encountering far greater financial duress than the state.
Bottom line: No increase in state taxes is called for to deal with the adverse economic effects from COVID-19.
Rather than dreaming up one new tax after another, our state legislators and the governor should be focusing attention on how best to reduce taxes. California’s state and local tax rates are already the second highest in the nation, with New Jersey in the No. 1 position and New York No. 3. Not surprisingly, these three states also have experienced in recent years the largest net out-migration of people (i.e., taxpayers).
California is on the downward slope of the Laffer Curve. That means higher state and local taxes won’t generate much in new revenues and will only serve to exacerbate the net migration outflow.
Our state’s public servants need to get a grip on themselves.