Tax competitiveness is key to California recovery

California’s budget deficit is currently estimated at $19 billion, but the Golden State also suffers from myriad tax-based problems. To recover economic prosperity, the state needs immediate tax reform and long-term tax relief.

The Golden State relies heavily on personal income taxes, which impose much larger economic costs than consumption taxes by discouraging productive activities such as work effort, savings, investment, and entrepreneurship. California’s tax rates are also out of line with our neighbors, and this combination has imposed enormous costs in terms of lower investment, less entrepreneurship and muted job creation. California is also woefully uncompetitive on two of the most costly and damaging taxes a government can impose: personal and corporate income taxes.

The “progressiveness” of our personal income taxes is worth noting. Progressiveness in the tax system refers to the extent a state’s tax system punishes success by imposing higher tax rates as one’s work output and income increases. California’s personal income tax rates range from 1.25 percent to 10.55 percent, one of the most “progressive” tax systems in the country.

In other words, more than almost any other state, California punishes people for succeeding.

That is not surprising given the political predispositions of the state. The reality of the state’s economy, however, is that it can simply no longer afford to punish the things we need more of.

In terms of competitiveness, most of California’s neighbors either don’t impose personal income taxes at all (Nevada and Washington) or use a single-rate income tax (Utah and Colorado). Arizona imposes a progressive income tax but at less than half the level of California.

California’s top rate of 10.55 percent is third-highest in the country. Our second top rate of 9.55 percent is also quite high and kicks in at $47,055, a relatively low level of income. Indeed, only three states have higher rates than California’s second-highest personal income tax rate. And again, California’s rates are out of line with neighboring states: Arizona (4.5 percent), Utah (5 percent), and Colorado (4.6 percent).

Research confirms that corporate income taxes impose even higher economic costs than personal income taxes. California’s corporate income tax rate of 8.84 percent is the eighth highest in the country. Two of the six states that do not impose corporate income taxes are neighbors of California: Nevada and Washington. Even those neighboring states with corporate income taxes impose them at much lower levels: Utah (5 percent), Colorado (4.6 percent), and Arizona (6.9 percent).

California is similarly uncompetitive in other ways. For example, California has the highest state and local sales tax in the country and despite Proposition 13 protections, the state ranked 16th for its use of property taxes.

Legislators can improve the economy by reforming the state’s tax system and in doing so improve the incentives for work, savings, investment and entrepreneurship. To achieve these goals, tax reform must rely more heavily on consumption taxes while dramatically reducing the use of income taxes, both personal and corporate.

A modernized sales tax that reflects the current nature of the state’s economy, with a much lower rate than exists today, would allow for immediate and dramatic reductions in personal and corporate income taxes. Legislators should make a priority of additional tax reductions above all other considerations, once the state’s budget is balanced sustainably.

Additional reductions in personal and corporate income taxes will result in a rebalanced tax code with a much lower overall tax burden. These long-overdue reforms will restore prosperity and help California achieve its potential as a leader in the nation and around the world.

Jason Clemens is the director of research at the Pacific Research Institute (www.pacificresearch.org) and the co-author of Taxifornia, a recent study of California’s tax system.

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