There are rumors circulating that the Legislature is considering reducing State sales taxes while increasing personal income taxes as part of this year’s budget package. If these rumors are true, then that is unquestionably a good thing. As we described on these pages in January of this year as well as in the San Francisco Chronicle, such a tax swap could save Californians billions of dollars annually and help grow the economy.
Why is this? Because personal income taxes are deductible from their federal taxes while sales taxes are not. Under this tax reform, Californians would keep more money circulating within the State even if the reform was revenue neutral.
That means more economic activity and more jobs in California.
By our calculations, the deductions allowable under such a tax restructuring could support an additional 63,000 jobs in the state. And this figure does not include the additional economic impact that would result from a lowered sales tax – when goods are made less costly, people will buy more of them.
There are three main questions to consider in designing this type of tax swap:
First, what tax should be used to replace the lost sales tax revenue? Although the Legislature is apparently focusing on the personal income tax, it could instead decide to use the corporate income tax. One reason is deductability — we would expect that all of the State’s corporate taxes would be deducted on federal filings, helping ensure that all of the benefits of the tax swap are realized by Californians.
Second, how progressive does the Legislature want to make the tax reform? Theoretically, it is possible to zero out the tax burden for the lowest earners while actually making the tax system less progressive.
And third, what does the Legislature want to do with the savings? It is possible for tax rates to be adjusted so that all taxpayers are made better off while the State government reaps additional revenue.
Those interested seeing more details of our analysis are welcome to download it from our website.
Today is a happy day. It is hard to imagine much good coming out of California’s dire budget situation, but this tax reform should give everyone hope.