August 20, 2007
Pursuant to Elections Code Section 9005, we have
reviewed the statutory initiative relating to state taxation (A.G. File
No. 07‑0031).
Background
Major State Taxes
The state raises about $115 billion in tax
revenues each year, primarily through three main sources. The state
levies a personal income tax (PIT) on the California income of
individuals. A variety of exemptions, deductions, and credits are used
when calculating taxable income and liabilities. Regular tax rates under
the PIT range from 1 percent to 9.3 percent, depending on a taxpayer’s
income. Under Proposition 63, adopted in 2004, an additional 1 percent
rate (or 10.3 percent total rate) is levied on the portion of one’s
income above $1 million. Revenues from this additional 1 percent rate
fund mental health programs. Individuals are also subject to an
alternative minimum tax (AMT) at a rate of 7 percent.
The state also levies a corporate income tax (CT)
on the net earnings of corporations operating within California that are
earned in the state. The regular tax rate is 8.84 percent, but
corporations are also subject to an AMT at a rate of 6.65 percent.
Corporate entities with a limited number of shareholders—called
S-corporations—have a tax rate of 1.5 percent.
In addition, California levies a sales and use
tax (SUT) on taxable purchases. The current state SUT tax rate is 6.25
percent, including 5 percent for the General Fund, 1 percent for
specified local purposes, and 0.25 percent to pay off the state’s
deficit-financing bonds. Local governments also levy a SUT, with local
rates currently ranging from 1 percent (a uniform local rate) to 2.50
percent (which includes the maximum-allowable 1.5 percent optional rate
primarily used for transportation-related purposes). Thus, the combined
state-local SUT rate among counties varies from 7.25 percent to
8.75 percent, with a statewide weighted-average rate of 7.94 percent.
Proposition 42 Funding
Proposition 42, passed by the electorate in 2002,
permanently directs to transportation purposes SUT revenues from
gasoline sales, which previously had been deposited in the General Fund.
Provisions of the Initiative
This measure makes several changes to
California’s existing tax laws. Specifically, it:
·
Repeals PIT.
·
Reduces corporate tax rates, as follows: (1) the regular
tax rate would be reduced by 1.84 percentage points to 7 percent and the
AMT rate would be reduced by 1.13 percentage points to 5.52 percent; and
(2) the tax rate for
S-corporations would be reduced by 0.3 percentage points to 1.2 percent.
·
Increases the SUT rate by 5.5 percentage points. Thus, the
combined SUT rate would range from 12.75 percent to 14.25 percent. The
measure would also create an exemption from SUT for personal property
purchased for use in the manufacturing process.
Fiscal Effects of the Initiative
State Government Fiscal Effects
Revenues. If approved by the
voters, this measure would:
·
Reduce PIT General Fund revenues by $23 billion in
2008-09, $60 billion in 2009-10, and increasing amounts thereafter. It
would also reduce PIT revenues to the Mental Health Fund attributable to
the 1 percent levy on high incomes by about $1 billion in 2008-09 and $2
billion annually thereafter.
·
Reduce CT General Fund revenues by approximately $1
billion in 2008-09 and by more than $2 billion annually thereafter.
·
Increase net state SUT General Fund revenues by
approximately $15 billion in 2008-09, and by more than $30 billion
annually thereafter. This net amount reflects increased revenues due to
the higher SUT tax rate partially offset by reduced revenues from the
exemption for manufacturing-related property. The exemption would also
result in reductions in state special fund SUT revenues of $100 million
in 2008-09 and $200 million in 2009-10 and thereafter.
Thus, the state would experience a net annual
revenue loss of over $30 billion a year.
The above estimates assume no behavioral
responses from taxpayers as a result of the measure. These impacts,
however, could be substantial. For example, the elimination of the PIT
and the large net reduction in state taxes could spur investment and
in-migration to California, resulting in increased revenues to state and
local governments. In addition, the large increase in the sales tax
rate—making it the highest in the nation—could induce greatly increased
purchases of out-of-state goods. This would lower the revenue gain from
the state sales tax increase and reduce local government sales tax
revenues. Finally, the large net loss in state revenues would result in
major reductions in state spending and/or lead to increases in other
state revenues. The impacts of these behavioral effects are unknown but
likely major.
Costs. The measure
would affect state costs in the following ways:
·
Proposition 42.
Increased transfers would occur from the General Fund to
transportation-related funds per Proposition 42 of about $1 billion in
2008-09 and more than $2 billion per year annually thereafter.
·
Tax Agency Administrative Costs. The
Franchise Tax Board, which administers the PIT and CT, would experience
major cost reductions due to the elimination of the PIT. These savings
would be offset somewhat by increased administrative costs to the Board
of Equalization, which administers SUT. The net impact—once fully
implemented—would be savings, potentially in the low hundreds of
millions of dollars a year.
Local Government Fiscal Effects
The measure’s manufacturing-related exemption
would reduce local SUT revenues by an estimated $100 million in 2008-09
and $300 million in 2009-10 and thereafter. (These reductions are in
addition to the above-discussed reduction in state SUT revenues to the
Local Revenue Fund and Local Public Safety Fund, which are distributed
to localities.)
Summary of Fiscal Effects
This measure would have the following major fiscal effects:
·
Net reduction in state General Fund revenues of over $30
billion annually, primarily due to the elimination of the PIT and an
approximate doubling of the state sales tax rate.
·
Major behavioral effects in response to the measure,
resulting in unknown impacts on state revenues and expenditures.
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