Legislative Analyst's Office
February 22, 1995

The Governor's Tax Proposal

How Will Individual Taxpayers Be Affected?

Because the dollar amount of the tax reduction is based upon income levels and tax rates, the dollar amount of tax savings that individuals and businesses would receive varies widely. In general, by 1998, the higher an individual or corporation's tax liability, the greater the dollar amount of tax reduction they will receive under the tax proposal. How much specific taxpayers would benefit is addressed in the following sections.

About Half of All Corporations Will Benefit

According to the FTB's most recent annual report, nearly one-half of all corpora tions in California reported either a net loss or no income for the 1992 tax year. Such corporations would receive no tax savings because they do not have any tax liabili ties. Of the 50 percent of corporations that did file with a positive net income, one-tenth of one percent had incomes over $10 million and paid nearly 60 percent of the total tax liability. Thus, most of the tax savings would be going to these corpora tions because of their high tax liabilities.

Benefits to Individuals Will Differ

Figure 3 shows how individual taxpayers with different income levels would be affected in 1996 through 1998, as the tax proposal is phased in. For illustrative purposes, the examples used in this section are for a married couple filing jointly, with two children and tax deductions equal to the average of California taxpayers having the same income level. The figure displays both the state tax savings from the rate reduction, and the net tax savings after adjusting for higher federal income taxes. Federal income taxes are increased because, in most cases, lower state tax liabilities reduce the amount of itemized deductions a taxpayer can claim for federal income tax purposes. This is because state income taxes are an allowable itemized deduction on federal tax returns. Thus, except for high- income individuals in 1996 and 1997, the taxpayers' federal income tax increases. This federal tax increase from current-law levels is deducted from total state tax savings to arrive at the net amount. In the case of B&C taxpayers, their state taxes also are deductible, but as a business expense; thus, they also would generally see their federal taxes rise.

Figure 4 displays the aggregate impact of the federal offset. About one-fourth of the state tax savings for individuals and businesses is offset by an increase in federal income taxes because of lower deductions. In the case of the PIT, however, this proportion differs by income level. By 1998, taxpayers with income over $1 million have over one-third of their state tax savings offset by higher federal income taxes, compared to less than one-tenth for those individuals with income levels under $25,000. This reflects the progressive nature of the federal PIT bracket structure. Figure 5 (see page 118) shows how the tax proposal distributes savings over the phase-in period taxpayers.

Low-Income Taxpayers Receive No Benefits. Individuals that have no tax liabilities, as with corporations having no liabilities, do not receive any tax savings under the proposal. Thus, a married couple with income of $20,000 or below would not receive any tax reduction from the tax proposal. Such taxpayers have no current-law liability, either because they have little taxable income or what taxes they do have are eliminated because of their personal and dependent credits. High-Income Taxpayers Will Initially Pay More. A married couple with income over $1 million would initially pay more under the tax proposal because of the retention of the high-income tax rates. Specifically, a married couple with income of $1 million would have net tax increases of $3,067 in 1996 and $106 in 1997. Under certain conditions, high-income individuals may end up paying more under the proposal even after it is fully phased in. This is because their Alternative Minimum Tax (AMT) could increase.

All Other Taxpayers Will Eventually Benefit. In 1996, all taxpayers with income levels under $500,000 (except those low-income taxpayers mentioned above) would receive some tax savings. By the time the proposal is fully-phased in, high-income individuals would also realize a reduction in their taxes.

Tax Structure Slightly More Progressive

The tax proposal would produce a slightly more progressive PIT structure for California, largely due to retaining the high-income rate brackets. Under both current law and the tax proposal, taxpayers with higher levels of income bear a proportion ately greater share of total tax liabilities than do lower-income taxpayers. Under the proposal, this effect increases.

Figure 6 shows the distribution by adjusted gross income (AGI) of tax liabilities under both current and proposed law, compared to the distribution of taxpayers. It shows that taxpayers with income over $200,000 as a group would pay a larger share of total tax liabilities--about 2 percent higher under the proposal, whereas all income levels below this would experience slight drops in their shares of total tax liabilities. The figure also shows that under current law, high-income taxpayers, who represent less than one-tenth of all taxpayers, would pay almost 60 percent of the total tax burden. This proportion would increase slightly under the proposed system. Thus, the PIT structure becomes more progressive under the tax proposal because a greater share of the tax liabilities is borne by higher income individuals.

The average tax rate is another indicator of how the distribution of the tax burden changes under the proposed tax plan. Figure 7 shows that, for 1998, there is over a half a percentage point drop in the total average tax rate under the tax proposal. The average rate drops the least in percentage terms for individuals with income levels over $1 million (1.8 percent) and the most for individuals with income less than $20,000 (22 percent). Thus, the average tax rate structure becomes more progressive under the proposal.

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