Legislative Analyst's Office
February 22, 1995

The Governor's Tax Proposal

What About California's Tax Levels?

High tax rates were cited by the Governor's Task Force as a key problem for California's business climate and the state's economy. The following section compares California's tax levels to other states to see how we rank in terms of tax levels.

Marginal Rates Are High

California's tax rate for corporations is generally a flat 9.3 percent under current law. Compared to other western states, it is among the highest, being surpassed only by Alaska. Arizona has the next highest rate at 9 percent. Among major industrial states, California's tax rate is more comparable. Pennsylvania and Massachusetts have higher rates than California, and New York, New Jersey, and Ohio are currently at or near 9 percent. Figure 8 shows the 1994 marginal PIT rate schedule for individuals. While the example is for a married couple filing jointly, the structure is the same for single tax filers but all dollar values are halved. The marginal tax rates for high-income individuals are above those for other western states. Lower-income Californians, however, face lower tax rates than in many other western states. For example:

Marginal rates, however, are only one part of the tax structure. Other factors that should be considered when making interstate tax comparisons include deductions, exclusions, exemptions, and credits. Two studies that have attempted to include such elements (completed by the Minnesota Department of Revenue and the consulting firm of KPMG Peat Marwick for the Governor of North Carolina) arrive at conclu sions similar to those illustrated above. That is, low-income taxpayers face lower tax liabilities and high-income taxpayers pay more in taxes in California than many other western states. While these studies make several generalized assumptions that may not reflect specific tax conditions for all taxpayers in each state, they give a sense of California's ranking relative to other states.

California About Average in Terms of Average Revenue Burden

Average revenue burden is another measure that can be used to make interstate tax comparisons. Most comparisons below are made in terms of revenues or taxes relative to personal income rather than in per capita terms. Many economists believe that expressing taxes relative to personal income is the better measure because per capita comparisons do not standardize for income level differences across states.

Figure 9 shows that, according to U.S. Department of Commerce figures for 1991-92 (the most recent data available), California is about average in terms of revenue burden per $100 of personal income. California is about 1 percent above the national average in total own-source revenues, while its total state and local tax revenues are less than one-half of a percent above the average.

If we focus strictly on tax revenues per $100 personal income, Figure 10 shows state taxes are about 11 percent higher than the average of other states, while local taxes were about 14 percent below the average.

Figure 11 (see next page) compares California state and local tax burdens to the average of other western states (excluding Alaska) and the average of other major industrial states. California's total state and local tax burden per $100 of personal income is about 2.5 percent lower than the average of western states and about one-fourth of a percent lower than industrial states. California ranks between western and industrial states in terms of both state taxes and local taxes.

Figure 12 (see next page) shows that, in per capita terms, California is slightly higher than western and industrial states for state-local taxes combined and state taxes alone. By most measurements, California is about average in terms of average revenue or tax burden. This is a common view amongst economists who follow such data.

The Impact of the Proposal on Average Tax Burden

How does the tax proposal affect the comparisons made above? Figures 13 and 14 show the level of California tax revenues under current and proposed law compared to average tax revenue levels in other states (again, as of 1991-92). (We calculated the impact of the proposed tax cut by applying the fully phased-in percentage tax reduction to 1991-92 California tax levels.) California state and local taxes per $100 of personal income with the proposal in place would have been 4.1 percent below the average of other states, and state taxes would have been 3.3 percent (instead of 11 percent) higher than other states. In per capita terms, California would still have higher tax levels, though the gap between it and other states would narrow. Even adjusting for the tax proposal, however, the drop in relative tax burden is fairly modest, and California still appears to be an average state.

Other Factors Influencing the Business Climate

California's state and local tax burden clearly does play a role in affecting the state's business climate. There are other elements, though, that should be considered when evaluating the state's competitiveness and comparing it to other states. Figure 15 lists some key factors that economists agree influence the business climate.

The effect of each factor on business location decisions varies, depending on the particular industry and taxpayer involved. However, taxes are sometimes focused more heavily upon in discussions and debates about the business climate than are some of the other elements in Figure 15, because taxes are one factor that is change able in the short-run. Changes in other factors, such as infrastructure, usually require time to evolve, and some factors, such as climate, can not be altered by policy decisions at all.

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