State Budget:
Democratic Leaders Release New Budget Outline With Tax Increases

Assembly Speaker John Pérez and Senate President Pro Tem Darrell Steinberg held a press conference August 3 to unveil a new budget proposal that includes major tax increases and a reduction in the state sales tax rate. The plan was sent to the budget conference committee the following day in outline form, with no specific language or bill numbers, and the committee voted along party lines to approve the plan, without taking any testimony from the public.

The Governor's Office called the proposal "dead on arrival," saying it would result in a tax increase for many middle-income Californians

The broad descriptions offered by the Democratic leaders in a press conference and press release indicate that the plan includes the following major provisions:

· Extend the temporary personal income tax rate hikes enacted in 2009, and increase the rate an additional 1 percent for all brackets except the top bracket, where the rate would remain 9.55 percent (plus 1 percent on income over $1 million). The increase would be retroactive, taxing all income from the 2010 tax year.

· Increase the state's car tax (the Vehicle License Fee) to 1.65 percent. The tax rate currently is 1.15 percent, but is scheduled to drop to 0.65 percent when the 2009 temporary tax hike expires.

· Reduce the state portion of the sales and use tax by 1.75 percent in 2010-11 and an additional 0.75 percent in 2011-12. In total, the sales tax would be reduced 2.5 percent in 2011-12 when compared with the current rate. (The total statewide base sales and use tax rate – detailed here by the Board of Equalization, and not including additional taxes imposed by local governments – currently is 8.25 percent. Without any legislative action, the tax rate will drop 1 percent next year when the temporary sales tax increase enacted in 2009 expires.)

· Impose an oil severance tax to raise an estimated $1.2 billion a year (based on past revenue claims made by supporters of this tax, the revenue estimate cited by Democratic leaders indicates that they expect the rate to be in the neighborhood of 10 percent). The Assembly speaker referred to this as "closing a loophole."

· Postpone business tax incentives (net operating losses, research-and-development tax credit utilization and single sales factor) for two years.

The plan also calls for the state to make some spending reductions and to suspend Proposition 98 – the initiative that guarantees a specific percentage of general fund revenues for education spending – and includes a plan to send some state prison inmates to the county jails.

The Democratic leaders said that under their plan, most Californians would see a net decrease in taxes because they would be able to deduct the income tax hike and car tax increase from their federal taxes, and would enjoy significant savings from the sales tax decrease. (Cal-Tax: Clearly, this would depend upon many factors. A person who does not itemize federal taxes will not benefit from the federal deduction; a person whose purchases primarily involve non-taxable items like food will not receive a large benefit from the sales tax reduction; a business owner who is forced out of business by the tax increases will not benefit; etc.)

Senator Alan Lowenthal characterized the tax changes as a way to effectively shift some of the responsibility for California's spending to the federal government. "It's about time that the federal government helped California to balance our budget," Senator Lowenthal said.

A representative of the Department of Finance said that the income tax hike, coming late in the year when withholding cannot be adjusted to cover the entire increase, would be a major problem for many taxpayers and would have "a significant economic impact" on individual taxpayers. The representative said the Democrats' plan would lead to major tax hikes for middle-class individuals, which in turn would dampen the economy.

Asked to give an opinion on the numbers, the LAO's representative said the office does not have fiscal estimates completed. He said the idea of shifting more of the tax base to federally deductible taxes is a good idea in principle, but noted that federal tax policy could change in coming years, so future deductibility is not a certainty.

It appears unlikely that the proposal will be able to garner a two-thirds vote, as it is uncertain whether all Democrats support the plan, and Republican leaders from both houses expressed opposition to the budget outline.

Federal Funds May Fall $500 Million Short of State's Expectations. The U.S. Senate last week approved legislation providing $16 billion in additional aid to states, including about $1.28 billion for California in Medicaid dollars, and observers believe the House and President Barack Obama will agree with the plan. The amount of money proposed for California is about $500 million less than what Governor Arnold Schwarzenegger and lawmakers have been counting on in their budget proposals. The congressional proposal also includes about $1.2 billion for school districts in California – money that likely will not help the state's general fund situation, but is intended to help school districts retain teachers. Governor Schwarzenegger called the money "a down payment on what California is owed," and said he will continue lobbying for more federal funds. (Sources: The Sacramento Bee, August 5; News release from the Governor's Office, August 5.)

Cal-TaxReports, August 9, 2010

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