Author: Andrew J. Chang and Justin L. Adams Ph.D.

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.

Last
week, Governor Schwarzenegger set as one of the highest priorities for his last
year in office the elimination of California’s status as a "donor state." That
is, the Governor intends to end the current practice of California getting back
only 78 cents for every dollar it pays in federal taxes.

Without question, Schwarzenegger’s goal is important.
According to the Tax Foundation, between 1981 and 2005 California’s donor
status has led to a cumulative donor deficit of almost $490 billion. But as
Joel Fox and John Wildermuth pointed out in their commentaries last week, getting
the federal government to fork over more money isn’t going to be easy. The
federal government is facing its own budget problems and – as Nancy Pelosi confirmed
recently – isn’t inclined to help Californians solve ours.

What we need is a Plan B.