California Tax Panel Calls For Overhaul Of State Laws

by Leroy Baker, Tax-News.com, New York

01 October 2009

California's Commission on the 21st Century Economy has issued recommendations on how the state's out-dated tax system can be modernized to make it more reflective of a modern economy and to put an end to chronic fiscal deficits.

The report reflects nine months of work by the 14-member bi-partisan commission that was jointly appointed last December by the Governor Arnold Schwarzenegger, and legislative leaders. The Commission’s remit was to suggest ways to reform California's out-of-date revenue laws in order to improve the state's economic competitiveness and to reduce the revenue volatility that has led to "feast-or-famine" budget cycles.

“The boom-and-bust economic cycles the current tax system depends on has turned our state budgeting system into an unpredictable roller coaster ride that brings windfalls one year and painful deficits the next,” said Schwarzenegger. “I asked the commissioners to think outside the box and they certainly did. I applaud the hard work of the bipartisan commission and encourage everyone to give the recommendations a thorough review.”

The panel's recommendations are as follows:

• Reduce Personal Income Tax (PIT) for every taxpayer. The number of tax brackets would be reduced from six to two. The new tax rate would be 2.75% for taxable income up to USD56,000 for joint filers (USD28,000 for single) and 6.5% for taxable income above that amount. These changes would retain the PIT’s progressive nature but reduce income tax rates for all taxpayers. The proposal would reduce the amount of income tax paid by 29%.
• Eliminate the corporation tax and minimum tax, which is currently at 8.84 %. The USD800 minimum franchise tax should also be eliminated.
• Eliminate the state general purpose sales tax, currently 5%, with the exception of the sales tax on gas and diesel fuels which would continue to be dedicated to transportation. Elimination of the sales tax would phase in over five years.
• Establish a business net receipts tax (BNRT), which would not to exceed 4%. Small businesses with less than USD500,000 in gross annual receipts would be exempt from this tax. This tax would have a much broader base than the sales tax (since it would apply not only to goods but also to services and to sales into the state from businesses located outside the state) and, unlike the sales tax, be deductible against federal taxes.
• Create an independent tax dispute forum to provide taxpayers with a forum for resolving disputes with the state.

According to the panel's final report, all these recommendations could be made effective upon passage by a majority in the state legislature. Another recommendation, to strengthen the state's rainy day reserve fund from 5% to 12.5% of revenues will require a change in the state constitution or a state ballot.

“This Commission was given a tremendously difficult task,” said Commission Chairman Gerald Parsky. “The fact that our tax system needs updating is something that almost everyone can agree on, but how to go about fixing it is the subject of much debate. I believe that these recommendations represent true bi-partisan compromise and have the potential to get the state back on track with a more modern, stable and fair tax system to better serve all Californians.”

The Commission recommends a five-year phase-in plan for the changes to the tax structure. The five-year plan, beginning in 2012, is designed to smooth the process and limit the impact on any particular sector of the economy. A technical review panel would help to ensure a smooth transition into the new system.

Last February, Schwarzenegger signed a budget with numerous temporary tax hikes, including a 0.25% surtax on personal incomes, a 1% increase in sales tax and an increase in vehicle licensing fees in a bid to reduce the massive USD42bn state budget deficit, caused by plunging tax revenues and inflexible spending rules. In September, the state was forced to borrow an additional USD8.8bn.

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