Monday, February 27, 2012

Brown's Taxing Headace

California Governor Jerry Brown is dealing with a "taxing" headache these days. Within the last week, Brown has taken a jarring one-two punch.

[1] The state is projected to run budget deficits for years to come. Despite rosy economic assumptions, Brown's 2012-13 budget was expected to result in a $9.2 billion deficit. A report issued today by the nonpartisan Legislative Analyst's Office concludes that Brown's forecast is overstated by approximately $6.5 billion.

Brown was looking at roughly a $9 billion budget gap. Now he's looking at $15 billion. To quote another governor wunderkind: "Oops"!

Silicon Valley is experiencing a "mini-bubble," and Facebook's pending IPO is expected to create hundreds of new millionaires. Brown's revenue estimate assumes that "social networking" entrepreneurs and investors will pay billions in state taxes on capital gain income. The LAO report emphasizes that capital gain income is highly variable and notoriously difficult to project. California has been down this road before. Those who cannot remember the past are doomed to repeat it.

California is lurching down a path towards Greek-style insolvency. Here's the basic formula. Politicians create an expansive state bureaucracy. The state employees organize into dues-paying members of public employee unions. The unions funnel dues into political elections to support candidates who promise to keep the gravy train running. The politicians become pawns of union bosses. They borrow money to cover budget deficits as state employees become increasingly detached from the public sector.

In the long run, the cycle is unsustainable and doomed to implode. California cannot afford to pay its recurring bills and satisfy its health and pension commitments to retired state employees. However, that's a problem for the next generation. Brown is a political careerist, and he has no interest in disrupting the cozy relationship between Democratic politicians and public employee unions in California.

[2] Brown wants to solve the $9.2 billion budget gap with a two-pronged tax increase. He wants state voters to approve an initiative to raise tax revenue. The "Brown Tax Initiative" would raise the sales tax by half a cent and raise tax rates on families who earn more than $250,000. In a savvy -- but disgusting -- political move, Brown would link a failure of his initiative to automatic cuts in the K-12 education budget.

Does the income threshold sound familiar? Yes, another Democratic politician defines a working family with $250,000 in income as nouveau riche. To give Brown some credit, his initiative would at least "spread the pain around." Everybody pays sales taxes; a vote to increase the sales tax is a vote to tax me and the "man behind the tree." I'm more disgusted by Brown's decision to hold K-12 teachers and students ransom for his tax increase proposal. (Full disclosure: my wife is an elementary-school teacher.)

The LAO report complicates Brown's overall strategy. The Brown Tax Initiative will not cover the LAO's projected revenue shortfall. Brown will have to go back to the drawing board. Or play games with the numbers, which is usually the "solution" to problems in Sacramento.

[3] Meanwhile, recent poll data suggests that the Brown Tax Initiative may be caught in the crossfire among competing initiatives. Someone pass the Tylenol!

Brown is not the only advocate for higher taxes on the "wealthy." Public employee unions are pushing a "Millionaire Tax Initiative." They want to increase tax rates by 3% for incomes over $1 million, and by 5% for incomes over $2 million.

A wealthy lawyer (Molly Munger) and the state PTA is pushing the "Munger Tax Initiative." The Munger Tax Initiative would progressively raise taxes on all taxpayers, and would funnel the revenue into education.

According to the recent poll, likely voters express support for the Millionaire Tax Initiative (63%) and the Brown Tax Initiative (58%). More likely voters oppose (48%) than support (45%) the Munger Tax Initiative. No big surprise. The first initiative provides a "free lunch" courtesy of the highest-income taxpayers. The second initiative echoes Team Obama's drumbeat to raise taxes on the top 3%. The third initiative would require increased taxes for everybody, which triggers some soul-searching among voters.

If you need to guard the entrance to Hades, I'd recommend a three-headed monster named Cerberus. However, a three-headed tax initiative may confuse and fatigue California voters. Team Brown conducted an unofficial poll suggesting that voters will play "knock out" and select one plan while rejecting the others. If so, voters may fragment their support for the initiatives and tank the entire process. (Team Munger disputes Brown's logic.)

A final remark on the California initiative process. Why exactly do we elect state politicians, when they put any tough decision on the ballot?

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