California’s tax code is a complex system that has been reformed numerous times over the course of its history. Currently, California has some of the highest overall taxes in the United States. Politicians in California argue about taxes during every election cycle as well as when they determine the state’s budget. Democrats advocate for increasing taxes over time to help the state pay for increased spending. On the other hand, Republicans advocate for fewer taxes and less spending. One must ask whether California’s taxes are fair and equitable for its citizens? To answer this question, there must be an evaluation of the tax system in place. When evaluating the California tax system, there are several criteria outlined by Brimley et al. (2012) that can be used as indicators within this evaluation. The indicators outlined by Brimley et al. (2012) include fairness and equity, adequacy of yield, cost of collection, tax shifting, neutrality, and predictability. Within this evaluation, the indicators provided by Brimley et al. (2012) will be defined and applied to the major state tax categories of personal income, sales and use, corporate, and property. Then, based on these criteria, each tax category will be evaluated and ranked. Finally, there will be a discussion regarding what is the best tax available to fund education in California based on the evaluation provided.
The 6 Criteria for Evaluating California’s Tax System
In this section, there will be a brief description of Brimley et al. (2012) tax evaluation criteria. Read through these explanations of each criterion. While reading, think about how each criterion can be used to evaluate the personal income, sales and use, corporate, and property taxes levied by the State of California on its residents and individual’s doing business in the state.
Fairness and Equity: Per Brimley et al. (2012), “this indicator determines whether the tax system is fair by how it treats individuals, particularly the rich and the poor” (p. 115). What this means is if the tax burden falls more so on the poor than the rich, the tax is considered unfair. In addition, taxes are deemed fairer when they contain progressive features, which means a larger percentage of the tax falls upon individuals with higher incomes. It must be noted, when a tax system is developed, progressive, proportional, and regressive tax measures must be discussed. Ultimately, all taxes should be constructed “to reduce their regressive features as much as possible,” which means individuals with high income will never pay lower taxes than those with lower incomes (Brimley et al., 2012, p. 115).
Adequacy of Yield: Per Brimley et al. (2012), government’s must have enough revenue to maintain their current services. As a result, as long as there is enough funding, there should not be additional taxes that provide “little individual potential for yielding revenue in substantial amounts” (p. 115). Thus, there should not be nuisance taxes that provide only small amounts of revenue because it could complicate the tax system without providing much yield to make it worthwhile.
Cost of Collection: Per Brimley et al. (2012), “taxes should have a relatively low collection and administrative costs for both the government and individual” (p. 115). Thus, taxes should cost the state very little to collect or locate in order to have the highest yields possible.
Tax Shifting: Per Brimley et al. (2012), tax shifting occurs when certain groups are undertaxed or overtaxed. What this does it puts the tax burden on a certain group of individuals who may not ultimately be able to pay the tax or unfairly taxing of a group who can pay the tax. Government tax systems should avoid tax shifting possibilities as much as they can (Brimley et al., 2012).
Neutrality: Per Brimley et al. (2012), “tax patterns should not unduly restrict an individual in determining their economic behavior in earning a living or in choosing the goods or services desired to satisfy their wants or needs or restrict the production of economic goods and services by individuals or organizations” (p. 115). This means taxes should not overburdened individuals or business entities from completely changing how they earn a living or produce goods or services. Taxes should not have a negative effect on someone or somethings lifestyle of the citizens or entities contributing. Rather, taxes should be used to “create the greatest possible positive effect in developing and achieving the goals of the agencies and institutions it is intended to serve” (p. 115).
Predictability: Per Brimley et al. (2012), “governments should utilize revenues that are consistent and dependable than those that change from year to year” (p. 115). Governments want predictable and stable revenues to ensure all expenditures are paid for as well as for debt to be paid off. Also, in times of economic downturn or upturn, there are effects on the tax revenue gathered. For example, when the economy is good, the tax funds raised increase. However, when the economy is bad, the tax funds raised decrease. Thus, an ideal tax system ensures there is “a steady revenue stream regardless of the changes in the economy” (p. 115).
Evaluating the California Tax System Using the Six Criteria: Ranking California’s Tax System
In California, there are a variety of different revenue streams that pay for government services and infrastructure. There are four main revenue streams that residents of California pay through taxes: personal income, sales and use, property, and corporate. However, there are local and state levels taxes such as the gasoline tax and the lottery as other means of collecting tax revenue among many other smaller tax initiatives. Since personal income, sales and use, property, and corporate are the largest revenue generating taxes, they will be evaluated through the six criteria provided by Brimley et al. (2012).
Personal income tax is the largest revenue stream collected by California (California State Controller’s Office, 2018). Personal income tax are the funds collected from the yearly income of residents of the state. This tax is dictated by how much an individual makes over the course of the fiscal year. According to the California Franchise Tax Board (2018), tax rates of a single individual or married couple range from 1% for income of less than $8,223 to 12.30% for an income of $551,473 or above. Generally speaking, over the last few years personal income tax amounts to about 65% of the tax revenue raised in the state (California State Controller’s Office, 2018).
- Fairness and Equity: Based on the definition of this evaluation criteria, the wealthier residents of California are paying more state income taxes than the poor residents. Even with deductions, wealthy individuals still pay more than residents with lower incomes. Therefore, personal income tax passes the fairness and equity criteria.
- Adequacy of Yield: Over the last four years the revenue from personal income taxes has helped fund over 60% of California budget. Given that the economic conditions have improved over the last few years, the yield of personal income taxes has gone up (California State Controller’s Office, 2018). Also, even in times of economic downturns, personal income tax has amounted for over 50% of California’s total tax revenue. Thus, personal income tax passes the adequacy of yield criteria.
- Cost of Collection: The cost of collection of personal income taxes are low since most mechanisms for collecting these taxes are automatic. Each individual or corporate entity must provide documentation of their yearly income regardless of whether they are an employee or a contracted employee. Overall, per the California State Controller’s Office (2018), the cost of collecting personal income taxes is low. As a result, personal income tax passes the cost of collection criteria.
- Tax Shifting: Over the last few years, there have been a number of Propositions passed that have raised taxes on California’s wealthiest individuals. Proposition 55 has increased income tax rates by 1 to 3% depending on how much an individual makes. Many opponents of Proposition 55 stated it establishes an unfair burden on California’s wealthiest individuals to pay for this new tax hike on their personal incomes (Ballotpedia, 2016). Therefore, due to the concerns of opponents of Proposition 55, the criteria of tax shifting is not met.
- Neutrality: The neutrality criteria assesses whether a tax has changed the behavior of the individuals or entities being taxed. Based on the number of wealthy California’s staying and moving into California, tax increases on personal income taxes has not scared wealthy individuals from moving to the state (Gomez, 2018). In terms of lower income Californian’s leaving the state, it is mostly attributed to the high costs of living (Gomez, 2018). Therefore, the criteria of neutrality is being met by personal income tax. But, it is somewhat questionable when discussing how higher taxes have increased the costs of living across the state, which has resulted in lower income Californian’s to leave the state.
- Predictability: Predictability refers to whether the revenue from this tax will be reliant regardless of the economic conditions. While during the Great Recession, revenues from personal income tax decreased, it did not decrease lower than providing 50% of the states tax revenues (California State Controller’s Office, 2018). Therefore, personal income tax passes the predictability criteria.
Sales and Use: Sales and use tax refers to the rates of tax levied on the purchase of goods or tax applied to a product or service when it is used. Within California, the sales and use tax amounts for the second highest tax revenue stream, which has amounted between 20% to 30% of the states general fund revenue (California State Controller’s Office, 2018). Each county in California dictates its own sales tax rate above the state rate of 7.25.% As a result, the sales tax rate fluctuates between 7% and 10.25% depending on what city the product or service was purchased in (California State Controller’s Office, 2018)..
- Fairness and Equity: The more wealthy an individual is the more they typically spend on goods or services. In many cases, wealthier individuals buy more goods and services. Also, sales tax across the state is typically higher in wealthy communities than poorer communities (California State Controller’s Office, 2018).. While this is generally the trend, there are cities like Los Angeles that have the highest sales tax rate of 10.25%, which encompasses both wealthy and lower-income individuals (California State Controller’s Office, 2018). However, for the most part, the sales tax rate in California relates to the wealth associated in the city its levied. As a result, the sales and use tax passes the fairness and equity criteria.
- Adequacy of Yield: Based on the sales tax consistency of amounting for 20% to 30% of California’s general fund, it is a reliable tax that offers similar yields yearly. While economic booms and busts may affect the purchasing power of residents, revenues have not tipped dramatically even during low economic years (California State Controller’s Office, 2018). Thus, sales and use tax passes the adequacy of yield criteria.
- Cost of Collection: California businesses must collect sales and use tax on every purchase of a good or service and send those funds to state. Businesses declare these earnings monthly and then yearly through their business taxes while filing their business tax return. In order to file a business return, it costs $420 dollars; which is much higher than a personal tax return (California City and County Sales and Use Rates, 2018). Therefore, small businesses are hurt more by the costs of collecting taxes than are the larger businesses. As a result, due to this disparity in cost, sales and use tax does not pass the cost of collection criteria.
- Tax Shifting: Sales and use taxes differ in each county and city in the state. Therefore, buying a good or service can cost more or less depending on where it was bought. Some areas of the state have higher sales tax rates, which hurt local small businesses because buying a good or service from them can
- Neutrality: Since sales and use taxes differ in each county and city, it can cause the individual or entity to change their habits. If the sales and use tax differ by 1% to 3% on a purchase of a good or service, it could amount to a large dollar amount on big purchases. For example, if the sales tax is 2% different in one city or county, individuals would save large amounts of funds on large or small purchases. Therefore, sales and use tax do not meet the neutrality criteria because it changes the behavior of consumers and businesses.
- Predictability: The predictability of California’s sales and use tax has been fairly consistent over the last ten years (California State Controller’s Office, 2018). Only during two years of the last ten years has the sales and use tax revenue differed by more than 8% as a percentage of the total general fund. As a result, due to this consistency, the sales and use tax satisfy the predictability criteria.
Corporate: Corporate tax rates are used to levy the total income of a corporation during a fiscal year. Depending on the type of corporation of the business entity, the rate fluctuates from 1.5% to over 10.84% (California Franchise Tax Board, 2018). As a result, corporate taxes have amounted to 10% of the revenue going into the general fund for over the last five years (California State Controller’s Office, 2018).
- Fairness and Equity: California corporate tax varies depending on the type of business entity. Since most corporations are C-Corporations, their tax rate varies between 8.84% to 10.84% (California Franchise Tax Board, 2018). Most of the largest corporations will pay the highest tax bills like the wealthy do for personal income taxes. However, since businesses large and small have a variety of different costs associated with their operations, these tax rates can be a burden on their ability to do business. As a result, across the board, the corporate taxes in California do not pass the fairness and equity criteria.
- Adequacy of Yield: Outside of property taxes, the yield produced by corporate taxes is third in tax revenue generation for the states general fund. This amounts to around 10% of the entire general fund. Therefore, corporate taxes in California produce a significant yield, which allows it to pass this criterion.
- Cost of Collection: The cost of collection of corporate taxes is low but individual businesses must pay upwards of $800 dollars yearly to file their taxes in addition to other state fees associated with their business entity (California Franchise Tax Board, 2018). All business entities must declare their yearly earnings and pay their taxes along with any fees associated with their business. Depending on the size of the business, it may be a significant cost, which may inhibit them from growing. Thus, the California corporate tax does not pass the cost of collection criteria because it can hurt small businesses because of the high tax rate and fees associated with filing the return.
- Tax Shifting: In terms of tax shifting, the businesses struggling under California’s corporate taxes are small businesses. While much of the revenue is collected by large businesses, small businesses are burdened with a relatively high tax rate in comparison to the rest of the nation as well as fees they have to pay the state. Therefore, the corporate tax does not pass this criterion simply on the notion it squeezes small businesses, which inhibits their growth.
- Neutrality: California’s corporate tax can cause businesses to change their behavior. Since California has one of the highest corporate tax rates in the country, various companies have moved their headquarters or entire businesses out of the state (Gomez, 2018). As a result, the California corporate tax does not fulfill this criterion.
- Predictability: The predictability of revenue collected from California’s corporate tax rates has been steady. Over the last five years, corporate tax state revenue has remained very stable by only deviating by one or two percent per year (California State Controller’s Office, 2018). Therefore, the California corporate tax passes this criterion.
Property Taxes: Property tax is a tax levied on the total net value of property owned by an individual. In California, the average property tax is 1.25% of the net value of an individual’s property. Each county in California has a different property tax rate because each city within a county has different property tax rate, which is voted on by voters in local elections. According to the Legislative Analyst’s Office (2012), the property taxes collected in the state only amount to about 1% of the entire general fund.
- Fairness and Equity: In terms of fairness and equity, some cities and counties have properties that are much more valued than in other places. For example, coastal communities have higher home values in relation to houses inland. Therefore, in the more desirable communities and locations, the amount of property taxes will be higher because of the value of those properties will be higher. Typically, the wealthier pay much more in property taxes since they own more property that is of a higher value than poorer individuals. As a result, based on the definition of the fairness and equity criteria, property tax fulfills this criterion because the wealthy pay a higher proportion of these property taxes than do individuals with lower incomes.
- Adequacy of Yield: In terms of property taxes yield, it only raises 2 to 3 billion tax dollars per year (California State Controller’s Office, 2018). Therefore, this only equates to 1% of the entire tax revenue fund. As a result, based on the low amount of revenue generated from property taxes, it does not meet the adequacy of yield criteria.
- Cost of Collection: Cost of the collection of property taxes is low. All property owners must declare their properties net value on their yearly tax return.
- Tax Shifting: Property taxes in California have not changed from the 1% of the net value of property in years (Legislative Analyst’s Office, 2018). However, it is the largest tax payment for many Californian’s. Those with the property that is worth more than others are hit with this tax. Therefore, while tax shifting does not occur in this instance with the rate itself, individuals with a higher net property value are hit more than with this tax than others who do not have as much net property value. As a result, property taxes passes the tax shifting criteria.
- Neutrality: In terms of the neutrality criteria, individuals who buy property understand that the more the property is worth, the more property taxes they will have to pay. Therefore, this tax does change the behavior of residents buying property because the more valuable the property is, it will cost that individual more in property taxes. As a result, property tax does not fulfill the neutrality criteria because it changes the behavior of residents living within the state when making property purchases.
- Predictability: The predictability of property taxes is debatable because home prices fluctuate when the economy is good or bad. As seen in the 2008 financial crisis, many home values depreciated upwards of 25% to 50% of their total value. In times of economic growth, home prices can soar upwards to 25% of their value over a 5 year period. As a result, the predictability of property taxes is volatile because the housing market determines the value of each home. Therefore, property taxes do not fulfill the predictability criteria.
Part Three: Ranking California’s Four Major Taxes
Based on the analysis in the previous section, the ranking of the following California state tax mechanisms is listed below.
- Personal Income Tax
- Sales and Use Tax
- Property Tax
- Corporate Tax
Personal income tax is ranked the highest out of the four highest tax revenues for the state of California because each criterion (besides tax shifting is being met) in its analysis. Of the four taxes mechanisms listed above, personal income taxes raises the most funds consistently and predictably on a yearly basis. In addition, the personal income tax is the fairest and equitable of each of the taxes analyzed because those who pay at the highest levels can afford the tax because they have high incomes. However, it must be noted, over the last few years, the wealthiest Californian’s income tax rates have increased disproportionately to the lower tax brackets of those making lower wages. Therefore, while personal income taxes has many strengths as a tax, it still is not a perfect tax because it does place the tax burden on a smaller population carrying a greater proportion of the tax bill (Ballotpedia, 2016).
Part 4: What’s the Best Tax to Pay for Education in California?
The best tax to pay for the education system in California is through personal income taxes. Education requires a consistent and predictable revenue stream. Over the course of the last five years, the revenue raised through. In addition, personal income taxes are sent directly to the general fund and do not go through any localities before reaching Sacramento. This allows the money raised from this tax revenue to be distributed to school districts across the state based on their needs through the Local Control Funding Formula. Lastly, personal income taxes amount for the largest revenue-raising tax in the state of California California State Controller’s Office, 2018). Therefore, as long as much of the education budget is taken from personal income taxes, the education system in California should not experience many budget deficits if districts manage and spend their allocated funds wisely.
Brimley, V., Verstegen, D. A., & Garfield, R. R. (2012). Financing education in a climate of change. Boston: Pearson.