California Nightmare

Jerry Brown's Tax Cliff

The second most important election next Tuesday.

WSJ Editorial, November 1, 2012

The most important single vote in America next Tuesday, after the Presidential race, is Governor Jerry Brown's attempt to stick Californians with another giant tax increase. Mr. Brown and his labor allies say Proposition 30 will fix the state's budget deficit and ward off education cuts. But the real choice before voters is whether to issue Sacramento's incorrigible spendthrifts another blank check.

Two years ago the Governor staged a bow to democracy by pledging that he wouldn't raise taxes without a vote of the people. The truth is he couldn't pick off enough Republicans in the legislature for a tax increase without delivering significant pension reforms, which government unions won't allow. Thus the last-ditch resort to the ballot box.

The Brown-union plan includes a "millionaire's tax" that kicks in at $250,000, three new income brackets for high earners and an increase in the top rate to 13.3% from 10.3% for individuals and many small business owners making more than $1 million. This would give California the highest income tax in the country, leaping over Hawaii's 11%. Oh, and by the way, these higher rates would be retroactive to this year.

Mr. Brown's initiative would also increase the state sales tax by a quarter-of-a-cent to 7.5%, though this is principally to foster the illusion of "balance," to quote the Zen-master Governor. The sales tax would generate only about $1 billion of the $6 billion in new revenue that the Legislative Analyst's Office projects for the tax increase.

As the Analyst cautions, due to huge swings in the investment incomes of top earners and "the uncertainty of their responses to the rate increases, the revenues raised by this measure are difficult to estimate."

No kidding.

Nearly everyone who has examined California's chronically unbalanced budget has recommended flattening its steeply progressive tax code to create a more stable revenue stream. 

Mr. Brown himself campaigned for President in 1992 as a flat-taxer. But Democrats in the legislature won't lower tax rates because they love the revenue windfalls they get when times are good and they can boost spending.

Then when markets crash, they can cry havoc and lobby for still-higher taxes. That's what the teachers unions did as recently as 2008, claiming that cuts that would have merely returned education spending to pre-bubble levels would cripple schools. Caving to the union pressure, a handful of Republican legislators in 2009 walked Governor Arnold Schwarzenegger's plank and voted for a $13 billion sales and income tax increase. Schools received less money over the next two years anyway—while spending on entitlements and union retirement benefits grew.

Democrats are now back at the same stand. Mr. Brown has threatened to "trigger" $5.9 billion in education cuts if his initiative fails, but he'd make less than $100 million in other trims. How's that for balance?

Such "trigger cuts" could easily be re-configured with a modicum of political will in Sacramento. Instead of slashing $500 million from higher education, Democrats could kill their quixotic bullet train, which will cost about $360 million this year alone in debt service, and chop $100 million in tax credits to their Hollywood friends (who are bankrolling the tax campaign).

Or they could restructure retirement benefits, which cost $6.5 billion this year—up from about $1.4 billion in 1999. There's millions more to be found in modifying current workers' pensions and retirees' cost-of-living adjustments as nearly a dozen states have done. In Rhode Island such reforms have cut the state's pension liability by half.

Barring such reforms, pension costs will continue to balloon and eat up all new revenues. The California State Teachers' Retirement System has projected that it will need between $3.5 billion to $10 billion annually over the next 30 years to stay solvent. So any money allocated to schools will merely backfill the teachers' pension fund.

Illinois's laboratory of kleptocracy provides an instructive lesson. In January 2011 Democrats in Springfield raised the state's income tax by 67% and corporate rate by 46%. Over the next eight months unemployment surged to 10.2% from 9.4%. So in December lawmakers handed out tax breaks to their corporate friends who were threatening to flee to more business-friendly states.

Springfield last year spent all $7 billion in new revenues on retirement benefits and closed out the last fiscal year with another $8 billion deficit. Lawmakers increased the cigarette tax in May to raise an additional $400 million for Medicaid. Meanwhile, Governor Pat Quinn is wondering why lawmakers haven't moved on his pension reform plan.

The only way California can escape its recurring fiscal Frankenstorms is through reform and economic growth. The former would stimulate the latter while the Governor's tax initiative would squelch both. Raising taxes on small business owners when one in five Californians is out of work or employed part-time because he can't find a full-time job is the definition of insanity.

Once more cash starts flowing to Sacramento, taxpayers can forget about budget and regulatory reforms that the Governor has suggested are on his agenda after the election. The only thing Democrats in Sacramento have planned after November is more spending.