California voters on November 8 passed Proposition 55, which is an initiative constitutional amendment which took effect on November 9. This ballot measure was the successful effort to extend the Prop. 30 highest marginal tax rates promoted by Governor Brown and others in 2012 as a “temporary tax” to help stabilize the state’s General Fund. Prop. 55 was opposed by some segments of the business community, but no serious opposition effort was mounted against this ballot measure.
Pursuant to the Attorney General’s Title and Summary, Prop. 55 extends by twelve years the “temporary” personal income tax increases enacted in 2012 on earnings over $250,000 (for single filers; over $500,000 for joint filers; over $340,000 for heads of household). Prop. 55 allocates these tax revenues 89% to K-12 schools and 11% to California Community Colleges, as well as up to $2 billion per year in certain years for healthcare programs.
While the ballot measure also prohibits the use of education revenues for administrative costs, it provides local school governing boards with discretion to decide, in open meetings and subject to annual audit, how revenues are to be spent. These are among the required audits and disclosures under Prop. 55.
According to the revenue estimates prepared by the Legislative Analyst and the Director of Finance, the enactment of Prop. 55 “will result in increased state revenues annually from 2019 through 2030—likely in the $5 billion to $11 billion range initially—with amounts varying based on stock market and economic trends. These increased revenues will be allocated under constitutional formulas to schools and community colleges, budget reserves and debt payments, and health programs, with remaining funds available for these or other state purposes.”
According to the official ballot arguments: “PRO: Prop. 55 helps children thrive! Prop. 55 prevents $4 billion in cuts to California’s public schools, and increases children’s access to healthcare, by maintaining current tax rates on the wealthiest Californians—with strict accountability requirements. We can’t go back to the deep cuts we faced during the last recession.”
“CON: Vote No on 55—Temporary should mean temporary. Voters supported higher taxes in 2012 because Governor Brown said they would be temporary. State budget estimates show higher taxes are not needed to balance the budget, but the special interests want to extend them to grow government bigger.”
As explained by the independent Legislative Analyst Office, over half of California’s budget is spent on education and that portion of the budget has seen a 50% increase in spending since Prop. 30 was enacted just a few years ago. The personal income tax provides a large portion of the State’s General Fund, followed by the sales tax and the corporate income tax.
High-wage earners, as well as thousands of small businesses that pay under the personal income tax, will continue paying an extra 1%, 2% or 3% tax on their income for an additional 12 years. The ballot measure also creates a formula to provide additional funds to the Medi‐Cal program from the 2018‐19 state fiscal year through 2030‐31. Although included in Prop. 30, this ballot measure does not extend the expiring sales tax increase of a quarter percent.
While the proponents repeatedly claimed that Prop. 55 continues a tax on “millionaires,” that clearly is not the case. Many small businesses that gross or net less than one million dollars will be impacted, as well as individuals making $263,000 or more, hardly the definition of a millionaire. At least a quarter of personal income tax revenue in California is generated by small businesses (i.e., sole proprietorships, LLCs, Subchapter S corporations, etc.). Some have estimated that over 80% of small businesses pay under the PIT Law.
To make matters worse, Prop. 55 taxes capital gains as ordinary income. With the continued volatility of the global and domestic stock markets, California will likely see big increases and decreases of PIT receipts with the drops and bumps of those stock markets. Moreover, with over $3 billion in the state budget reserves, some have questioned the need to extend the tax increases under Prop. 30 until they expire in 2018.
Prop. 55 extends the following income tax brackets, the highest marginal rates in the nation:
For individual filers (double the figures for joint filers):
Over $263,000 – 10.3% tax rate
Over $316,000 – 11.3% tax rate
Over $526,000 – 12.3% tax rate
Over $1,000,000 – 13.3 tax rate (includes 1% surcharge for mental health)
As a result of the enactment of Prop. 55, thousands of individuals and small businesses will be saddled with additional taxes over the next dozen years and California will continue to have the highest base rates in the nation for those paying taxes under the state’s personal income tax law. While a highly progressive tax system is desired by some interest groups in California, the current rates are at such a level that some believe they are fundamentally unfair and result (along with the highest federal income tax bracket) in more than 50% of income being taxed by the state and federal governments.
Chris Micheli is an attorney and legislative advocate with the Sacramento governmental relations firm of Aprea & Micheli. He can be reached at (916) 448-3075.