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The Rich Will Always Be with Us

May 12, 2008 - 5:26pm

Like generals who are always fighting the last war, California's pundits are still fighting their way out of the last budget crisis. Latest case in point: George Skelton of the Los Angeles Times, who recently complained again that California's income tax "depends too heavily on the wealthy." In Skelton's world, the wealthy are just like those men mothers always warn their daughters about: they'll show you a good time, and then disappear, leaving you heartbroken. "Their incomes rise and fall steeply with the economy," he writes, "and therefore so do state budget deficits."

Except that's not why California has a budget crisis. As the state controller reported on May 9, personal income tax collections for the first nine months of the current budget year are $1.4 billion over the estimate in Gov. Schwarzenegger's January budget and within a whisker of the amount budgeted last summer. Through the first nine months California revenues are up 1.2 percent over a year ago, thanks entirely to the income tax, which has more than made up for the decline in sales tax revenues caused by the housing crash.

The pundits' obsession with the volatility of income tax revenues is a holdover from the past. In 1999 and 2000 the incomes--and income tax payments--of the wealthy, powered by huge capital gains and stock option grants during the Internet stock market bubble, soared. Then they fell back to earth in 2001 and 2002, dragging California into a budget crisis. But as I've explained in more detail elsewhere, the bubble and its subsequent popping were an unprecedented event. Just look at the chart below, showing California's four largest sources of general fund tax revenue over the last three decades.

Big Four taxes
Uploaded with plasq's Skitch!

Take out the bubble years, and revenues don't resemble a "roller coaster," as Skelton puts it. They rise when the economy grows and flatten out when it shrinks, as it did in the sharp recession and restructuring that hit California in the early 1990s. Charts of federal revenue, also dependent on income taxes, show the same pattern. The Internet boom was an anomaly.

But let's suppose for a moment that it wasn't. What would the pundits do so that California no longer "depends too heavily on the wealthy"?

Raise taxes on the poor and middle class? According to an analysis done for the California Budget Project by the Institute on Taxation and Economic Policy, low- and middle-income households already pay a higher percentage of their incomes in state and local taxes than do those in the top 1 percent.

Cut income tax rates on the wealthy? California has already done that. The state had top marginal rates of 10 percent and 11 percent on the wealthy through the 1970s, most of the 1980s, and some of the 1990s, but lowered them to 9.3 percent (in 2004 voters added, by initiative, an extra 0.7 percentage points on incomes over $1 million, with the funds earmarked for expanded mental health care.) Yet the amounts collected by the income tax continue to grow.

Why? Because of an underlying economic shift the pundits rarely mention: California gets an increasing share of its budget from income taxes on the wealthy because that's where all the money is. According to California Franchise Tax Board data, in 1979 the top 10 percent of taxpayers had about one-third of the state's total adjusted gross income. In 2005, their share had grown to roughly half.

If the pundits know a way to balance the budget, reduce the share of taxes paid by the wealthy, and not widen this growing income gap between the wealthy and everybody else, they should let us in on the secret.