Economic Theory Meets Political Reality in Think Long Proposal

Joel Fox
Editor and Co-Publisher of Fox and Hounds Daily

The Think Long Committee proposal to change the governance structure in California is centered on a change in the tax system. The committee proposes lowering and flattening the income tax, lowering the sales tax, and creating a new tax on services. In theory, the proposition is sound, although the tax increase that accompanies the restructuring is counterproductive. In execution it may be difficult if not impossible to accomplish.

There is no doubt that California’s economy has changed. As the Think Long report notes, “California’s $2-trillion economy is no longer dominated by manufacturing and agriculture, but is primarily composed of services and information activities.” A tax system to match the economy is worthy of discussion. A tax structure that lowers rates and widens the tax base is good economics.

Theoretically, lowering the tax rates could help spur the economy, which is one of the committee’s goals. Such a plan would also take some of the volatility out of the tax system, which is now so heavily reliant on high-end income taxpayers.

However, the committee’s proposal undercuts that effort by insisting on raising an additional $10-billion in new revenue. If the $10-billion were not built into the tax plan, the rates could be even lower and the incentive to grow the economy that much greater. Revenue then would increase through economic growth.

Even if the committee strengthened its economic hand by creating a revenue neutral plan of lower rates and widening the base, there would still be political hurdles to cross.

For small businesses, the idea of collecting a new tax that they never before had to collect will meet resistance. Consumers paying the tax will likely not be happy either, even if they get a reduction in their income taxes.

Details of how the tax will be applied can also be troublesome. While the Think Long Committee advised that exemptions from the service tax go only to education and health care services, different businesses will seek exemptions as they have in other states that have tried to apply a service tax thereby creating infighting and jealousy.

Lots of questions and few answers exist on how the service tax will work and how much money it will actually raise. Does a baseball coach, paid by parents to teach his young players how to pitch have to collect a service tax or is he exempt under the education exemption? A few coaches just might not add the tax to their invoice.

Such taxes could promote a growing underground economy.

As in most other public matters, no matter how sound a policy, details and politics will determine the outcome.

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