California's Tax System
California has over 35 million residents, is the sixth largest economy in the world, exhibits tremendous economic and demographic variation, and has substantial and diverse demands in such areas as education, health care, and infrastructure. It is not surprising, therefore, that its public sector is one of the largest and most diversified in the world. Like most governments, California relies primarily on taxes to fund the public services that it provides to its individuals and businesses. California's state and local governments raise in excess of $120 billion annually in own-source revenues to provide public services, with roughly 70 percent of this from taxes.
What are the different types of taxes upon which California relies? What is their relative importance, and how have they evolved over time? How large a "burden" do these taxes impose on Californians, both in absolute terms and compared to other states, and how is this burden distributed? What types of policy issues are associated with the current tax structure, especially in light of our changing economy? The purpose of this primer is to address these and other tax-related questions, so as to aid policymakers and other interested parties in their tax-related deliberations and decision making.
The primer is organized into the following six sections: (1) overview of California's tax structure, (2) the personal income tax, (3) the sales and use tax, (4) corporate taxation; (5) other state taxes, and (6) local taxation. Also included is a glossary of common tax terms.
Taxes play a vital role in California's state and local fiscal system. In 1995-96 (the last year for which comprehensive data are available), over $150 billion was spent annually to provide public services to California's residents and businesses. Of this total, about $30 billion came from the federal government while the remaining $120 billion was financed through own-source state and local government revenues. Of own-source revenues, roughly 55 percent is typically raised by the state and 45 percent by localities. In turn, taxes account for three-quarters of the state share and one-half of the local share.
Approximately 90 percent of the state's own-source revenue comes from four sources: the personal income tax (PIT), the sales and use tax (SUT), the bank and corporation tax, and major motor vehicle-related levies.
Included among other state taxes are the gross premiums insurance tax, alcoholic beverage taxes, cigarette and tobacco taxes, estate tax, lottery tax, various fuel-related levies, and disability and unemployment insurance taxes. The latter two taxes are directed into trust funds, and thus, do not constitute general state revenues.
As discussed in greater detail later in this primer, local tax revenues come from the property tax, followed by the local portion of the SUT, business license taxes, utility user charges, and other miscellaneous revenues. Local governments, particularly counties, are also heavily reliant on state aid.
The basic elements of California's current state tax system were put in place in the late 1920s and early 1930s. Prior to that time, state revenues were raised by
an insurance tax, utility tax, and fuel tax. The severe fiscal disruptions that accompanied the depression, however, led to the adoption of both the PIT and state
SUT. Since that time, California's tax system has remained largely intact, although a number of important statutory and constitutional modifications have
occurred (see shaded box regarding how tax laws are adopted and changed). One of the most important of these changes was the adoption of Proposition 13 in
1978, which resulted in a dramatic reduction in property taxes and altered state-local fiscal relations. Changes occurring since Proposition 13 are shown in the
How Tax Laws Are Adopted and Modified
California's tax provisions are of two general types--statutory and constitutional.
Statutory Tax Provisions. These provisions typically reside in the California Revenue and Taxation Code and account for the vast majority of tax laws. They can be enacted either by the Legislature directly (as most are) or by a vote of the public (placed on the ballot either by the Legislature or through a voter-sponsored initiative). For measures that result in a net increase in tax revenues, a two-thirds vote of the Legislature is required; otherwise, a simple majority vote suffices. Typically, statutory tax provisions approved by the voters can be modified only through a subsequent vote of the people.
Constitutional Tax Provisions. Amending the California Constitution, including establishing or modifying constitutional state tax provisions, requires voter approval. As with statutory tax measures, constitutional tax measures may be put on the ballot either by the Legislature directly or by a voter-sponsored initiative. As with statutory provisions adopted by voters, changes to constitutional tax provisions require a subsequent vote of the people. Examples of constitutional tax provisions are Proposition 13 (involving local property taxation), personal income tax indexing, insurance taxation, and Proposition 99 (involving cigarette taxation).
|Significant California Tax Law Changes
Since Proposition 13
|1982--||Proposition 6 (eliminated gift and inheritance taxes; adopted "pickup" tax).|
|1982--||Proposition 7 (indexed Personal Income Tax [PIT] tax brackets, standard deduction, and exemption credits for inflation).|
|1987--||Federal conformity (repealed deduction of consumer interest expenses; limited business deductions; repealed partial capital gains exclusion; restricted use of tax shelters; repealed income averaging; eliminated PIT sales tax deduction; adopted net operating loss deductions, Subchapter S corporation option, and Alternative Minimum Tax [AMT]).|
|1988--||Proposition 99 (imposed 25-cent per-pack surtax on cigarettes and other tobacco products) for health programs.|
|1991--||Double-weighting of sales factor (amended corporate income tax apportionment formula).|
|1991--||Temporary high-income tax rates (imposed PIT rates of 10 percent and 11 percent on high-income taxpayers, which lapsed in 1996).|
|1992--||Proposition 163 (repealed the "snack tax" and prohibited future taxation of these products).|
|1992--||Proposition 172 (imposed half-cent sales and use tax rate and dedicated revenues to local public safety programs).|
|1993--||S corporation rate reduction (reduced from 2.5 percent to 1.5 percent).|
|1996--||Corporation tax rate reduction (reduced franchise tax to 8.84 percent from 9.3 percent; lowered the AMT rate from 7 percent to 6.65 percent).|
|1996--||Proposition 218 (limited fiscal authority of local governments and required majority of voters to approve increases in general taxes).|
|1998--||Proposition 10 (imposed a 50-cent per-pack excise tax on ciga- rettes and other tobacco products) for health programs.|
The term "tax burden" describes a concept generally used in reference to how significant the taxes are that individuals and businesses pay. Tax burden measures can facilitate comparisons among states.
There are a variety of issues involving how the tax burden should be defined and measured (see shaded box). However, probably the single most commonly used measure of the tax burden is taxes paid as a percent of personal income. According to this measure, California's aggregate tax burden is about average when compared to other states.
Issues Regarding the Tax Burden
Terminology. One basic tax-burden issue involves using the term "burden" when referring to taxes generally. Taxes are used to provide public services that taxpayers value--such as education, parks, roads, and public safety. Without taxes, citizens either would have to pay directly for acquiring such services or forgo them altogether. Some economists argue that because such taxes simply measure the expenditures taxpayers incur to buy public services, a more neutral term--such as "tax price"--should be used as an alternative.
Measurement Issues. A second basic issue is how best to measure the tax burden. Among the most common approaches are taxes per capita, taxes as a percent of personal income, taxes as a percent of total statewide output, and taxes per worker. Another approach is to establish a set of representative taxpayer characteristics for individuals and businesses and compare what their taxes would be in different states. Each of these different measures has advantages and disadvantages in portraying a state's tax burden relative to other states.
Tax Incidence. A third issue is that tax burden calculations say nothing about exactly who ultimately pays the taxes, including: (1) how the tax burden is distributed by income level and (2) how it is eventually shared by consumers, workers, and business owners once the effects of taxes on prices and wages are considered.
Expenditure Impacts. A last issue involves how to interpret and use tax burden information. To the extent that a "high" or "low" tax burden simply measures amounts spent for public services, it says nothing about whether taxes are "too high" or "too low" in the minds of taxpayers. Thus, tax burden comparisons do not address the expenditure side, including how such expenditures benefit different income groups or regions.
There are a number of specific criteria that economists commonly cite as elements of well-designed tax systems.
Although California's system scores relatively well in many areas, substantial challenges exist in other areas. As discussed in later sections, these challenges include capturing the "new economy's" increased reliance on intangible activities and E-commerce, addressing local revenue issues, and ensuring that tax expenditures are effective and efficient uses of taxpayers' money.
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