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Old 09-30-2009, 10:33 AM  
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Tax Cuts in California?? What is the world coming to?

A California Quake
A tax commission releases a ground-breaking plan.

No state's economy, with the exception of Michigan, has careened into a deeper ditch than California in this recession. The state now has the fourth-highest unemployment rate (12.2%), the third-highest rate of mortgage foreclosures, and for two years has had the biggest budget deficit in the history of the 50 states. So it is very good news that yesterday Governor Arnold Schwarzenegger's bipartisan tax commission recommended a road out of this mess.

The heart of the new plan is to broaden the tax base and slash tax rates on personal income, business and sales. California currently ranks at or near the top in all three categories. This has, paradoxically, contributed to the state's inability to pay its bills by driving men and women from the state and leading to revenue boom and bust. We don't agree with everything in this report, but there's no question it would be a huge improvement over the current tax code in its economic incentives, simplicity, revenue stability and fairness.

The commission hasn't recommended a pure flat tax, but something much closer to it. As shown in the nearby table, the income tax rate, which currently tops out at 10.55%, would be chopped to a more reasonable (but still high) 7.5%. (The plan doesn't eliminate the one-percentage-point millionaire income tax surcharge, alas.) Because about 70% of small businesses pay the personal California income tax, the commission found that California's high rate is driving enterprises to the likes of Nevada, Texas and Idaho. The number of tax rates is reduced to three from seven (we prefer one), and thanks to the elimination of credits and loopholes, the new California tax form would fit on a postcard.

Even more impressive is the recommendation to eliminate the corporate income tax and the 5% of the sales tax that contributes to the general fund. These would be replaced by a broad-based Business Net Receipts Tax of no higher than 4%. This taxes businesses on what they produce, minus their costs of purchases from other firms. This is similar to a value added tax.

One benefit of this new levy is that it creates a level playing field among industries and reduces tax favoritism based on the power of lobbyists in Sacramento. The greater virtue is that this tax would exempt all California investment and capital income from taxation. (Michael Boskin and John Cogan offer more details nearby.)

The commission—chaired by California businessman and former U.S. Treasury official Gerald Parsky—also calls for a rainy day fund by requiring annual revenues above a 10-year rolling average to be put into a reserve fund rather than being spent.

One danger is that the revenue-generating efficiency of the Business Net Receipts Tax would eventually increase the overall tax burden in California. To protect against this, the commission calls for a permanent cap on the BNRT at 4%. Some business groups don't like the new business tax because it means they'd have to pay tax even if they don't make money. But a sales tax has that same feature.

A higher rate would defeat the purpose of this corporate tax reform, which by eliminating the corporate income tax would go far to restore the state's competitiveness with other states, as well as Japan, China and Europe. Conservatives should insist that the current two-thirds vote requirement in the legislature to raise taxes applies to this new business tax to protect against jacking up the rate to grow the state government.

Part of Mr. Parsky's achievement here is political, because he managed to convince a bipartisan majority of nine of the commission's 14 members to endorse its proposals. This includes notable liberal Christopher Edley, while Democrats like Senator Dianne Feinstein and former Governor Gray Davis have also praised much of the plan.

They may be motivated by the reality that California's steeply progressive tax rates are defeating the purposes of progressive government. To wit, only a growing economy can create opportunity for the middle class and enough state revenues to finance schools and health care for the poor. A tax code that depends on 1% of taxpayers, 144,000 filers, to finance 50% of state income tax revenues has proven to be unsustainable, notwithstanding the liberal dogma that says tax rates don't matter.

Mr. Schwarzenegger will call for a special session of the legislature to approve this plan later in October, so let the debate begin. The only painless way to rebalance the Golden State's $150 billion annual budget is to expand the tax base by luring capital and jobs back to the West Coast. That's what happened when California passed Proposition 13 to cap its property taxes in 1978. If the legislature fails to act, as it probably will, then the Parsky plan should become central to next year's election debate over how to revive this once dynamic state.

Printed in The Wall Street Journal, page A22

http://online.wsj.com/article/SB1000...ist_smartbrief
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