California is not a bust. not yet. But it continues the way it will lead to it. The fundamental problem is that the progressives running the state – and politics in California are anything but progressive – haven’t figured out the simplest things about tax systems. You cannot run progressive spending on a progressive tax system.
The current problem is big. The expected deficit for next year is $68 billion. Most of us don’t have a measure of how much that is, but it represents 30 percent of everything they will spend. This also represents a decline from the expected surplus of $100 billion just two years ago.
How did this happen?
The small tactical problem that led to this shift is not unique, but rather a feature of allowing politicians a checkbook anywhere. As money flows in, more taxpayer money is allocated to spending for each interest group and political constituency. This is how things work – asking politicians to save is like insisting that children save sweets for next week. So, every time California’s treasury receives some money, there are many plans to spend all that and more. These plans always represent annual spending increases that must be maintained into the future. So, when revenues fall, the deficit becomes a monster – as they are now. Cutting spending is so difficult because it now means frustrating – and fighting – all the interest groups and political constituencies that previously favored it.
The biggest structural problem is that California’s tax system is very progressive. Fifty percent of the state income tax (which itself can be as high as 13.3 percent, on top of the top federal rate of 37 percent) comes from the top 1 percent of taxpayers. Most of that, 33 percent, comes from just the top 0.1 percent. Demanding the rich is a terrible progressive move, of course it is. But it’s also completely unreliable. For those with high incomes, they are not salaries, but rather a reflection of business profits. The economy falters and profits at the top end decline. Stock markets decline and capital gains turn into losses. Interest rates rise and housing transactions fall, killing transaction tax revenues. And that’s exactly what’s happening now, which is dramatically reducing cash flow to pay for all those policy promises.
But, as noted above, spending largely consists of permanent funding sources. And they’re not things that will be usefully financed over time by a completely unreliable tax source, those wildly variable 1 and 0.1 percent dividends. Politicians in California have looked at European social democracy and found it to be good. But they failed to learn the tax lesson. You can’t buy tax-financed gifts for everyone by taxing only the rich. You have to tax everyone, the European way – huge value-added tax rates, payroll taxes, big income taxes on the middle class. European tax systems are less progressive than US tax systems for this very reason – and this is how social democracy is financed. As for the incomes of the rich, the revenues to be obtained from taxing them are highly variable. As they also discovered, raising prices to compensate means that these rich people and their companies are leaving for Texas.
We may think this is helpful, perhaps even sad, but you can’t be progressive using only the wallets of the rich. This is something all politicians, not just California politicians, can usefully learn from.