California's Fiscal Delusion, and America's

Josh Barro is the lead writer for the Ticker, Bloomberg View's blog on economics, finance and politics. His primary areas of interest include tax and fiscal policy, state and local government, and planning and land use.
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I spent most of the last week in Los Angeles. And when I discussed Bloomberg View's recent editorial on California -- the one that argues Californians should relax their property tax limits instead of raising taxes again on high incomes -- with the locals, they generally did not receive it well.

The three most common reactions I heard were these:

1. California's government is wasteful and already taxes enough.

2. We need more tax revenue but I, personally, pay enough.

3. Yes, Proposition 13 (which limits property taxes) should be reformed, but because so many people believe (1) or (2), that's impossible.

The most frustrating of these complaints is (2). Middle-class Californians tend to think they're overtaxed, but they don't know how good they have it. When the Institute on Taxation and Economic Policy last estimated the distributional impact of state tax codes (in 2009, using 2007 data), they found that California had a somewhat lighter middle-class tax burden than the average state, and a much lighter one than politically comparable blue states like Illinois, New York and Massachusetts.

I live in New York, where the fourth quintile of non-elderly taxpayers (that is, those with incomes from the 60th to 79th percentiles, with an average income of $73,100) paid 3.8 percent of their income in property tax and 4.7 percent in income tax. In California, the fourth quintile was slightly wealthier (averaging $75,700) but paid just 3.1 percent in property tax and 2.0 percent in income tax.

Overall, California's fourth-quintile families paid 7.7 percent of their incomes in state and local taxes in 2007. That compares to a national average of 8.5 percent, 8.8 percent in Massachusetts, 9.2 percent in Illinois (since which time Illinois has enacted a major middle-class tax increase) and 11.0 percent in New York.

Numbers are similar for the cohort of taxpayers from the 80thto 94th percentiles of income. I focus on those two groups because, aside from the rich, that's where the money is. Setting Republicans’ "47 percent" rhetoric aside, there isn't much revenue to be raised from the bottom half of the income distribution.

The key tax policy questions a state faces are how much to tax people in these groups and how much to tax people at the top. And in California, Republicans and Democrats have reached consensus that taxes on the 60-to-94 cohort must be low, leaving only taxes on the rich as a topic for debate.

Of course, some states choose a low-tax, low-service model. But that's not what California is trying to do. In electing their legislature and voting on ballot measures, Californians show their preference for a large and active government. The state jockeys with New York for the country's highest teacher salaries. But unlike in New York, there is no political will to tax the middle class to pay for big government.

California's attempt to do high services with low middle-class taxes has led to three bad outcomes. One is a permanent budget crisis, where the state and its municipalities patch their budgets together with gimmicks, borrowing and one-time revenue sources, burdening taxpayers with debt and leading to more spectacular budget crunches when recessions hit.

The second is a tax system that leans heavily on income taxes on the rich. This has led to highly volatile tax receipts and boom-and-bust budgeting. Such a system can also raise only so much revenue: At 10.3 percent, California already has one of the highest top income tax rates in the country, and yet is strapped for cash. Proposition 30, backed by Governor Jerry Brown on next week's ballot, would try to fix California’s budget by taking that top rate to a whopping 13.3 percent.

The third is an erosion in employee headcounts in order to cope with insufficient revenues. California manages high teacher salaries with modestly below-average per-pupil spending by having the country's second-highest student-to-teacher ratio. San Jose spends about $180,000 per full-time equivalent employee on compensation for its police force, but has just 1.1 sworn officers per 1,000 residents, half the national average for a city its size.

Californians lament the deteriorating quality of government services in their state but they are not, by and large, prepared to pay for improvement. People here laugh in your face when you suggest revising Proposition 13.

Yes, Proposition 30 would impose a small sales tax increase on the broad public, but about three-quarters of its revenue would come from taxing the rich. And it looks increasingly like voters will defeat it anyway.

What worries me most about California’s fiscal delusion -- the idea that you can have a big, active government without making the middle and upper-middle classes pay for it -- is that it is increasingly America’s fiscal delusion, too. Both Mitt Romney and Barack Obama have committed to the idea that we can fix America’s vast fiscal gap without a middle-class tax increase.

That idea is nutty, and, if we commit to it long enough, we will do serious damage to the quality of services provided by the federal government. But as California demonstrates, conditions can deteriorate for a long time before the public admits that it will have to bear the burden of paying for what it gets.

(Josh Barro is lead writer for the Ticker. E-mail him and follow him on Twitter.)


This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.