State’s Tax System Gets Poor Grades

How does California’s state and local tax system measure up? The Lincoln Institute of Land Policy, a nonprofit teaching and research center on land use and property taxation, and the National Conference of State Legislatures have published “Principles of a High-Quality State Revenue System” that offers some guidelines for judging.

Of the 10 principles, California fails or does poorly on five points, passes one unequivocally and gets mixed grades on the rest.

1) A high-quality revenue system should be composed of elements that function well together as a logical system, including the finances of local and state governments.

California’s system is a failure as a logical system. It was created in reaction to the crisis of the Depression and has changed most often in response to subsequent fiscal downturns. The relationship between state and local finance systems has been in turmoil since Proposition 13 in 1978 removed control of the key source of revenue from local governments.

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2) Should produce revenue in a reliable manner. Reliability involves stability, certainty and sufficiency.

California fares badly on this count. The state system reacts with increasing volatility to recession, in part because it is so reliant on the sales and income taxes, which are susceptible to sharp reductions in bad economic times. The property tax is more resistant to changes in economic conditions, but Proposition 13 has limited property tax revenues and has generally held growth below the inflation rate since 1978.

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3) Should have substantial diversification of revenue sources over reasonably broad bases.

California scores well on diversification. Of the total revenue pie, the state income tax accounts for about 28%, the property tax about 27%, the sales tax 23%, the corporate income tax 8% and various other taxes for the balance. But a variety of benefits, tax relief, incentives, credits and exemptions make much of the California system narrowly based. Experts say tax rates could be lowered by broadening the base.

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4) Should be equitable ... (so) that it is not regressive and that it imposes about the same tax burden on all households earning the same income.

California gets mixed marks on this point. The system generally is regarded as equitable as it applies to broad groups on the income scale, with California’s progressive income tax offsetting a regressive sales tax. But there are many seeming inequities brought about by exemptions and loopholes in the major taxes, and tax experts say the greatest inequity in the system involves Proposition 13, which created a disparity in taxes paid by some households earning similar incomes.

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5) Should be easy to understand, raise revenue efficiently, minimize compliance costs for taxpayers and be as simple to administer as possible.

California fares poorly on this point. The system is complicated and inefficient. It is the only state that does not have a single department of revenue to administer all taxes, instead employing two agencies: the State Board of Equalization for sales and property taxes, and the Franchise Tax Board for personal and corporate income taxes.

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6) Should have accountability.

A mixed grade on this point. By accountability, the experts mean that taxes and changes in the system should be explicit. Hidden tax increases should be avoided. Proposition 13 eliminated some accountability problems by establishing fixed property assessments and property tax rates. But the loss of revenue caused by Proposition 13 has forced local government to seek new funds through a proliferation of levies, special fees and assessments--often branded by critics as “hidden taxes.”

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7) Should be administered professionally and uniformly, both throughout the state and within individual jurisdictions.

Another mixed grade. California’s tax collectors generally are regarded as professional, but most experts strongly support consolidation of the Franchise Tax Board and the State Board of Equalization into a Department of Revenue, as most states have. Various state commissions have been proposing consolidation since 1927.

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8) Should result in enough equalization of the resources available to local governments that they are able to provide an adequate level of services.

California fails. The state bailed out cities and counties after Proposition 13 cut property taxes. Now, the bailout money is gone and the state gradually is forcing local government to bear more of the burden. Cities and counties say they will continue to face fiscal crises until they have an adequate and reliable source of revenue.

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9) Should minimize interstate tax competition and business tax incentives.

A mixed grade. California has enacted a variety of business tax incentives in hopes of keeping businesses from moving to other states. In part, this has been a defense against preying by other states offering attractive benefits packages of their own.

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10) Should not be used as an instrument of social policy to encourage particular activities, although it is appropriate to discourage some actions through tax policy.

California fails, granting myriad personal and corporate tax incentives, credits and exemptions.