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Davis Goal: More Stable Tax System

He is likely to seek new levies to combat state's dependence on revenue from volatile Wall Street profits. Taxes on many services are possible.

January 08, 2003|Nancy Vogel and Jeffrey L. Rabin | Times Staff Writers

SACRAMENTO — When he takes the podium today to deliver his fifth annual State of the State address, Gov. Gray Davis is expected to make a case for basic structural reform of California's fiscal system -- a tax overhaul, in essence, designed to end a turbulent boom-and-bust cycle that is currently in the depths of a bust.

In recent days he has suggested that he will look for a way to shift the state's tax burden so revenues are less sensitive to the ups and downs of Wall Street and the wider economy.

Among the options that Davis could consider are such politically volatile proposals as "flattening" the income tax to reduce the burden on the rich, taxing services such as legal counsel and car repairs, and tinkering with one of the state's most sacred texts: Proposition 13.

"We will not serve the people well if we just find a way to balance the budget without structural reform that prevents this roller-coaster ride from occurring every five to 10 years," Davis said.

"People expect a certain amount of predictability out of government," he added, in remarks delivered at a school construction site outside Sacramento. "They're not going to get it under the current system."

With such statements, Davis has implicitly acknowledged that the tax system he inherited and accepted for the four years of his first term is deeply flawed and helped create an 18-month budget gap that he now calculates at $34.8 billion, or about one-fourth of the money he had hoped to spend over the next year and a half.

Of course, increased state spending, much of it on Davis' watch, contributed to the deficit, and the governor is expected to propose deep spending cuts in the budget he will send to the Legislature on Friday.

But much of California's spending is required by law -- either federal mandates or constitutional ones enacted by California voters, such as Proposition 98, the 1988 measure ensuring that about 40% of the state's general fund goes to schools.

That means any long-term solution will probably focus on revenue -- in other words, taxes.

Structural Reform

Moreover, many analysts say what is needed is not just increases in tax rates but fundamental changes in the nature of California's tax system, so-called "structural reform."

Jean Ross, who heads the nonprofit California Budget Project, said the kind of meaningful structural change Davis is suggesting would require a shift in who carries most of the tax burden, rather than just a change in tax rates.

A significant increase in property taxes or a new tax on services would constitute serious structural change, she said. An across-the-board income tax increase would not.

Any shift in the tax burden is fraught with political peril, since some group will wind up on the losing end. But there are those who say the time is right, given the desperate state of California's finances.

"Crisis is absolutely essential if you're going to get any structural reform in California, because the forces of inertia are enormous," said Bruce Cain, director of UC Berkeley's Institute for Governmental Studies. "The key to any structural change is that it's got to happen in the next year and a half."

More than most states, California relies heavily on a progressive personal income tax, one that puts a large share of the tax burden on the wealthiest Californians. Just under half of the state's revenues in 2002 came from personal income taxes, well over the national average of 37%.

Moreover, the incomes of the wealthy are tightly tied to the bungee cord of the stock market. When the market freefalls, as it did two years ago, California's tax base freefalls with it.

The stock market run-up of the late 1990s and early 2000 sent income tax receipts soaring as high-income Californians sold stocks and cashed out stock options. The Wall Street boom pumped billions of dollars in new money into state coffers.

Davis and Democratic lawmakers used the infusion to support higher state spending. But as stock prices dropped, income tax revenues plummeted. The gap between spending and revenues increased rapidly. The resulting budget deficit is a byproduct of the mismatch of revenue and spending.

Davis and his financial advisors have dropped few hints about what the governor might propose in the way of tax changes. There are a number of possibilities.

One of the simplest would be an increase in the top income tax rate from the current 9.3% to the 11% that was in place from 1973 to 1986 and again from 1991 to 1995.

Although attractive to legislative liberals such as Senate leader John Burton (D-San Francisco), that would do little to free the state from the boom-bust cycle and would be anathema to the Republican minority in the Legislature.

The governor could propose leveling the tax rates so that middle-class Californians pay a larger share. But that could draw fire from across the political spectrum.

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