David Kline, spokesman for the California Taxpayers Association, recognizes the need for taxes.
“Part of living in a society with good roads, and schools and the fire departments and law enforcement, you need to pay some taxes,” Kline said.
But going back to 2016, the California budget has grown 80.6% while the population has shrunk .42%. Inflation in that period has only been 26%.
“If the growth in spending has far exceeded the growth in population, then it does call into question how necessary the spending was,” Kline said.
California’s approach to the budget is static, Kline said. The state has long been able to rely on its top earners to provide tax revenue.
And, when constituents call for more programs, the answer historically has been to increase taxes, said Kline.
But California’s tax strategy is showing cracks with a $68 billion deficit. Fixing it may require a massive rethink.
California Spends Surpluses on New Programs
Except for schools, colleges, and the prison system, California’s major agencies have experienced triple-digit budget growth since 2016-17. Transportation has grown 477%. Business, consumer services, and housing grew by 568%.
The state is coming off of a period of extraordinary budget revenue growth, said Ann Hollingshead, principal fiscal and policy analyst with California’s nonpartisan Legislative Analyst’s Office. Lawmakers expected revenue declines during the pandemic. What they got were sharp increases.
“There was historic revenue in the two years following the pandemic, particularly 2020-21 and 21-22,” said Hollingshead. “And so as a result, the state had historic surpluses to allocate in those years.”
From the 2020-21 tax year to 2021-22, the budget grew by 46.28%. Meanwhile, revenue from personal income tax grew by 9%, sales tax revenue climbed by 17.23%, and revenue from California’s corporation tax rose by 123.9%.
Increased spending followed that same year.
Funding to the California State Transportation Agency grew by 1055% year-over-year. The California Labor and Workforce Development Agency budget grew by 1026% year-over-year.
The trend in California spending has been toward new programs, said Hollingshead. Lawmakers committed money to the environment, transportation, housing and homelessness, an energy package, drought mitigation, and expansions to Medi-Cal for people regardless of immigration status, Hollingshead said.
“When you’re looking at that trend, you’re not seeing, particularly for the last few years, you’re not seeing underlying growth in those programs,” Hollingshead said. “What you’re seeing is the state allocating new money to new purposes.”
But even before the pandemic, certain agency’s budgets grew remarkably. While not the largest budget, going back to 2016, the California Environmental Protection Agency’s purse grew an average of 128.6% each year. In the two fiscal years following the pandemic, it decreased, but still ended up 520% larger than it was in 2016-17.
From wildfires to flooding to homelessness, the state has had to respond to different crises. But data show that as budgets go up, they don’t recede to the same degree in tough economic times.
California’s Self-Destructive Tax Policies
It came as no surprise to Kline, with the taxpayers association, that the LAO forecast a deficit for next year’s budget.
“It is a surprise that it is $68 billion,” Kline said.
Income tax revenues came in far less than what lawmakers expected, according to the LAO. The federal government’s decision to delay tax payments because of flooding left budgeters in the dark about how much money the state had to work with, according to Hollingshead.
California relies heavily on wealthier taxpayers for its income tax revenue. Over the seven years of tax data analyzed, revenue per person increased by 72.4%. The wealthy becoming wealthier drove that increase, according to Hollingshead.
What lawmakers didn’t expect when forming the budget was the degree to which the upper tax bracket had shrunk.
The LAO says the $26 billion less in revenue than expected comes from declines in income, especially from high-income earners.
In Kline’s eyes, the wealthy are leaving California because of its tax policies — further magnifying state government’s boom-or-bust income cycles.
“When high-income Californians do well, the state collects a huge amount of taxes,” Kline said. “When, you know, for example, the stock market doesn’t do as well or they have some investments go bad, the state will see a huge drop in revenue just because of a relatively small population of taxpayers.”
California policies affecting revenue don’t stop with income tax. The LAO also predicts a $6 billion decline in gas tax revenue, driven by a rise in electric vehicles.
Some States Lowering Taxes as California Raises Taxes on Top Brackets
California’s tax strategy assumes that increasing taxes will increase revenues, Kline said. And, the state is continuing its strategy of taxing the rich as the state’s payroll tax for earners over $153,164 will increase 110 basis points to 14.4% in 2024, according to accounting company Holthouse, Carlin, Van Trigt, LLP.
Money will fund paid time off benefits for people earning 70% or less of the state’s average wage.
In contrast, several other states have cut tax rates.
Colorado, for example, reduced its flat-rate individual income tax, according to the Tax Foundation. Iowa lowered its top marginal individual income tax from 8.53% to 6%. The corporate tax rate there decreased to 8.4% from 9.4%. Pennsylvania reduced its corporate income tax rate from 9.99% to 8.99%.
Kline’s group says these kinds of strategies have made their states more attractive to California expatriates.
“Relying on a small population means you have to make sure they’re not going to leave,” Kline said. “And so if you increase taxes additionally you always run the risk of persuading them to just move to a state where there might not be a personal income tax at all or where the tax rate is much lower.”
Thus far, neither the governor nor the Legislature is buying that tax-reduction strategy.
When Kline’s group advocated for a reprieve on sales tax on heavy manufacturing equipment, Kline said lawmakers viewed it as simply lost revenue. The Taxpayer’s Association hoped it would attract employers.
Best Source of Revenue is a ‘Thriving Economy’: Kline
Following the LAO’s report, Newsom issued orders in a letter to state agencies to freeze all spending and not undertake any new contracts. Newsom also told agencies to halt purchases of new office equipment.
“While that seems like a small thing, we think it sends the message that every dollar counts,” Kline said.
Facing a $421 million deficit of its own, San Francisco Unified School District cut more than 900 vacant jobs.
That’s a good start in Kline’s eyes.
However, Kline said the best source of revenue is a thriving economy and commonsense tax structure.
“The solution is clear, it’s to foster economic growth,” Kline said. “And when you have more businesses hiring and paying more employees and you have higher income people making money from their investments and enjoying capital gains.”