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Commentary

California Legislators Should Stop the Revenue Rollercoaster


     
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California’s nonpartisan Legislative Analyst’s Office estimates that the state will enjoy an unexpected $4.4 billion tax revenue gain through June 2014. If you think that means a tax cut in your future, think again. Politicians already have plans to spend it, laying the groundwork for the next huge budget deficit.

The revenue gain resulted from three factors: increased state capital-gains taxes from California residents who sold investments at the end of 2012 to avoid the higher federal taxes that took effect January 1, when the Bush-era tax cuts expired; improved stock and real estate markets; and temporary sales and income tax hikes approved by California voters in November 2012 (Proposition 30).

At least three quarters of the gain will go to education, as mandated by Proposition 98, the so-called Classroom Instructional Improvement and Accountability Act.

California lawmakers—spurred on by the insatiable spending lobby—have been debating what to do with the remaining billion or so.

The new budget deal, likely to be finalized on Friday, includes commitments to increase spending on mental health services, college student aid, and other programs. And Gov. Brown has not dismissed more spending in the future.

But it’s important to note that each factor driving the revenue gain is either explicitly temporary or could reverse quickly. After all, it was just three years ago that California faced a budget deficit of nearly $60 billion.

California politicians are treating these three factors as permanent and making plans to spend the money. This sets a new record for shortsightedness, given the history of state finances.

California’s personal income tax system is steeply progressive and became more so after approval of Prop 30. Progressivity exaggerates booms and busts in state revenue. During good times, revenue surges, both because incomes increase and people are pushed into higher marginal tax brackets. Flush with cash, lawmakers can’t resist the temptation to launch new programs and increase spending.

When the inevitable downturn occurs, the process reverses. Revenue drops and deficits explode because it’s always much easier to increase government spending than to reduce it. Many poor people who come to rely on government programs are often first to be harmed by belt tightening. Ultimately, tax rates are ratcheted up to “fix the deficit” and the cycle repeats.

This “revenue rollercoaster” is severe in California.

U.S. Census data show that California income tax revenues rise more quickly during good times and fall more sharply during bad times than they do in other states.

Now that state coffers have unexpected cash, lawmakers are once again rushing to spend the temporary surplus.

This foolishness will guarantee bigger deficits and higher tax rates at the end of the next rollercoaster cycle. We’ve all been on this ride before and seen how it ends.

Rather than spend the unexpected revenue, California lawmakers should return the money to taxpayers, as Indiana has done, or at the very least set it aside in a rainy day fund, as Texas and other states do.


Lawrence J. McQuillan is a Senior Fellow and Director of the Center on Entrepreneurial Innovation at the Independent Institute.






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