If you're confused about the impact of the legislative Democrats' tax swap proposal, don't feel bad. Everyone is. Some newspaper headlines played this week's report on the proposal from the legislature's non-partisan analyst as bad news for the proposal, since some middle-class Californians would pay more in taxes. Other reports emphasized that the state could benefit by cutting some taxes and raise other taxes -- the raises coming on taxes on personal income and vehicles that can later be claimed by taxpayers as federal deductions.
So what's the real impact? Reading the legislative analyst's report, the overall impression is: this tax swap could be very good for California, since it allows the state and state taxpayers to raise revenues while shifting some of the responsibility for paying that new money to the federal government. But the report also suggests that the legislature would do well to refine the proposal to minimize the impact on certain middle-class California taxpayers.
To review, the tax swap proposal is this: the state seeks to generate $1.8 billion in additional general fund revenues for the new budget years by reducing the state sales tax while increasing the vehicle license fee and personal income tax rates. Since the vehicle license fee and income tax are deductible on federal income tax revenues, the state should be able to increase revenues while not increasing the net tax burden.
The report casts some doubt on that last claim. LAO estimated that, for the 2011-2012 budget year, the tax swap proposal would generate $10.4 billion in additional tax revenue from income and vehicle fees but would cost the state $7.3 billion in lost sales taxes. That leaves $3.1 billion in additional state taxes that should be shifted to the federal government. Unfortunately, the report found, only about half of that $3 billion -- or $1.5 billion -- would be recovered by California taxpayers through federal deductions. So this isn't a wash -- it's a net tax increase of $1.6 billion on Californians.
That said, the legislative analyst likes the idea. It just suggests that different rate increases and numbers be used so there isn't a net tax increase. "Yet, the concept of redistributing the state’s tax burden to increase the benefit of federally deductible taxes has merit. Our analysis was focused on using the specific tax rates suggested by the Conference plan. With different tax rates or other modifications, however, we believe there may be the potential to find a more advantageous solution."
That seems like good advice. There's an opportunity for California here. Let's see if the legislature and governor can grab it.