Please realize that a 1,000 word oped cannot cover everything I want to say. A special thanks to Robin Rauzi, who did a great job cutting down the length of my proposal and keeping a lot of what I wanted to say. Besides, she added some good points in the process, too, clarifying a lot of my attempt.

On this page, I am adding a collection of thought points that I would have added if I had had another 1,000 words:

  • I have zero conflict of interest. I do not receive money from anyone. The tax reform I am proposing would likely leave me personally worse off.
  • My key proposal is not even to implement this tax change right now. It is to study it and implement it (or parts of it) only if it turns out that it is likely to greatly improve California.
  • Tax policy is hard. No one will agree to every aspect of it. It is a matter of finding livable workable compromises. There is a bad tendency to do knee-jerk policy, often based on self-serving arguments.
  • CA has to make tax policy for 38 million people, not just for you and me. It will always be unfair to some.
  • Nobody likes to pay taxes. We tax because we have to. If we could provide the same services—infrastructure, school, police, streets, Vets, CA guard, prison, public sector unions, public sector contracts—then someone needs to pay for it. My oped is not making an argument that we should be taxing more or less. It is making an argument how we should tax, given that we have decided to fund a specific amount of public spending.

    • It is very important to make tax reform in all of our interests, rich and poor. Thus, we need to disentangle the taxation principle reform from our more common redistributive tinkering with the tax code as much as possible. We can continue to squabble about how to take from one group and give to another in a year or two.

    However, if we do not delay the distribution argument, then our disagreeing views will derail any reform that benefits us all in the aggregate. Therefore, I would strongly suggest that we should set as our explicit goal to keep the average taxation in each (income) class not to increase (except for the very poorest who should no longer be tax payers). Again, we should not use the reform to increase the tax burden. My argument is that reform should just change the formula for how tax is assessed, calculated, and avoided: We should no longer penalize work and the poor.

  • Although I want to balance winners or losers, especially by (income) class, it is inevitable that in such a large change, some individuals will come out worse (though many more will come out better). If all your money is in low-basis Prop-13 real-estate today, then you will come out for the worse. If most of your money is in real-estate, you are likely not coming out for the better (though any reform will reduce the income tax on your net earnings). For most others, the reform should likely be a push or better.

    The tax code could allow for hardship reductions. It could allow for phase-in. It could allow for opting into a code you prefer. You could chose to be grandfathered in under the old code, possibly with a modest 2% increase in income tax to make up for the missing sales tax. However, once you do this, you could be locked into the old code forever—though this would be difficult to enforce. We need more study. I don't have it all worked out.

  • States with lower tax rates: areavibes. I want to be clear that I do not endorse what these states are doing or not doing with their tax revenues. I don't know enough about them. I am just stating the facts.
  • The California tax code is not (very) progressive. Income taxes on AGI are (very) progressive; but net-in-net, our poorest seem to be paying the most in CA taxes in proportion to their income, mostly through sales taxes. The last good study of this is dated by about 25 years. Here are the numbers:
    Taxes As Percent of Income and As Fraction of Total Taxes
    Fraction of Income
    Income Income Tax Sales Tax Property Tax Total Income Sales Property
    < $5,000 0.0 % 30.5 % 44.2 % 74.7 % 0% 41% 59%
    $5-10,000 0.0 % 7.7 % 5.4 % 13.1 % 0% 59% 41%
    $10-20,000 0.3 % 5.5 % 2.7 % 8.5 % 4% 65% 32%
    $20-30,000 0.9 % 4.6 % 1.8 % 6.3 % 14% 73% 29%
    $30-40,000 1.5 % 3.5 % 1.8 % 6.8 % 22% 51% 26%
    $40-55,000 2.2 % 3.4 % 1.9 % 7.5 % 29% 45% 25%
    $55-70,000 2.6 % 2.7 % 1.8 % 7.1 % 37% 38% 25%
    $70-100,000 3.5 % 2.5 % 2.0 % 8.0 % 44% 31% 25%
    > $100,000 4.7 % 2.5 % 2.2 % 9.4 % 50% 27% 23%
    All 3.0 % 3.4 % 2.3 % 8.7 %
    Do not consider these numbers to be the gospel. They are only indicative. We need a new and updated study.
  • The overall estimates I used were taken from a more recent study.
  • Even our income tax code is not primarily taxing the rich. It is not. Our code taxes high-adjusted gross income earners. These are not the same as the top 1%, much less the top 0.01%. Larry Elisson, among the richest Californians, has paid only a small fraction of his $50 billion in lifetime wealth gains to the state of CA. Most of it sits in unrealized capital gains—most of which will likely never end up being taxed by California. Meanwhile, those with high adjusted gross income are subject to some of the highest marginal tax rates in the world. It is almost punitive. We need a reasonable middle. Oh, and don't think California will necessarily get capital gains tax from Donald Sterling either.

    It is a fallacy to think that this is good reason to raise taxes (further) on capital gains or wealth. This might work for the U.S. overall, but it does not work well for a single U.S. state. Move for just one year out of state, wait until retirement to move to Florida (as many U.S. residents now routinely do), or wait until you die—and California gets nothing ever!

    A recent analysis by Varner and Young has it right and wrong. The fact that we do not have immediate departures in response to millionaire's taxes is factually correct, but misleading.

    • We have been taxing AGI income, not even real income (incl unrealized capital gain), much less wealth (the millionaire designation is wrong).
    • Then, it takes a while to leave—it is not instant. Again, it takes time to leave, and with good planning, many can and do escape on as-scheduled routine.
    • Studying only those who have paid is like suffering from Wald's Selection Bias. The ones left over are those whose income was too unexpected to properly take care of their tax problem.
    • And the key problem is not even the departures, but the non-arrivals. Who would want to locate their new business and/or live in and/or retire in TX, FL or NV, if CA were almost as good an option from an economic perspective? All that they have over us are better and lower taxes and a friendlier business climate.
  • I do recoil whenever I read that "because the rich are not paying their fair share, they should pay more." There are a lot of people who are paying half of their income in taxes nowadays. It is one thing to tax them. It is another thing to accuse them. We should be appreciative to those who pay. I know of wealthy people who have left the state not primarily because the tax rates were so high for them, but also because they had to endure constant rhetoric in the press villifying them.

  • Prop 13 is not good and fair. There are now guest-houses in Bel Air that pay more toward our schools than the mansions to which they were originally attached. (And many house owner cannot move because they have such a great deal being taxed only on historical purchase value that they are locked in a golden cage.)
  • The key source to lowering taxes is to "steal" taxes that are now paid to other states. Our lousy tax code has left enough money on the table to make almost everyone better off.
  • Zero taxes have a great advantage over 0.1%—no administration effort. If we can, wipe 'em out. However, a modest tax—say 5% on income over $1 million, would be tolerable. I fear greatly, though, that my proposal will be an excuse to raise property taxes without reducing other taxes. Not my intent.
  • Dan Mitchell told me about Henry George, who was a 19th century writer and Californian who argued for a single tax on land.

There will be a great temptation to alter such a tax change beyond recognition. Each party and lobby will want to extract its pound of flesh. For the greater good, our politicians would have to resist the lobbies on all side. Jerry Brown has already shown great spine. A radical tax reform could become his crowning achievement.

If we can do this, then we would finally have a tax system that induces businesses to move to California and employ more Californians—that saves our cities and retailers against unfair no-sales-tax internet competition, that costs the state and its citizens much less to administer, that is fairer to those who need to move, that does not penalize our poorest, and that makes all of us Californians better off, at the expense only of non-Californian states.

I am well aware that I am proposing studying a moon-shot. But it is only a moon-shot because we have made it so difficult.

Spending

  • We need mechanisms to limit spending. Prop 13's primary good aspect was its limits. We could put in limits to what fraction of our GDP government is allowed to spend (or amount per person), perhaps averaged over the last 4 years to buffer recessions.
  • I would be happier to pay more in taxes if our government spent it better. Sadly, when you and I would spend $1 to fix a problem, my impression is that the government roughly spends $5 to fix the same problem. We are wasting a lot of good money. Just look at our schools. Yes, please tax me more to improve our children's education, especially the poorest and most disadvantaged. But then don't waste my money. LAUSD already spends $10,000 per child. It's not that this is so low. We cannot fix the problem until we fire bad teachers and hold bad schools and administrators responsible.

    Teachers' unions serve teachers, not students or taxpayers. Don't blame the unions for lobbying—it's their job. That's why they exist. It's like blaming whales for eating krill. Instead, make it worth the while of the overwhelming majority of teachers to back real reform, where bad teachers can be replaced and good teachers can be rewarded. Many good teachers are not very happy given the current setup, either.

Related Thoughts

Pikety

  • The Pikety book is plain wrong for many reasons, the most important being his conceptual confusion what the perpetuity r-g formula means. (It is impossible to have r<g.) Alas, Pikety points out how little intelligent thinking has often gone into the issues. Besides, I think he is correct about the dangers of dynastic wealth and thinking about the distribution of wealth. But here is what we need to think about:
    • What are the objectives that we are trying to optimize? How can we even start this discussion unless we are explicit here?
    • What are the tradeoffs that we have to make? Don't kid yourself: it is not just dynastic capital, but also your talents that are inherited. Do you really deserve U.S. citizenship more than those born in third-world countries? If hard-working effort were the main criteria, then many of our Mexican illegal immigrants should have the most take-home pay. In the end, we need to trade off economic incentives and efficiency, contribution to the greater good, the ability to escape taxation, and many other objectives. We must compromise some on all of the objectives. A corner solution is not optimal.
    • The best question raised by Pikety in my mind is: what is the appropriate tradeoff between wealth taxes and income taxes? I have some ideas here, but they are just half-baked. This is not a trivial question to answer.

    Jerry Brown

    • Jerry Brown is governor of a hard-to-govern state with few real powers. Given what he is faced with, he has in my opinion done quite a good job. He has balanced public-sector union interests (which greatly contributed to his electoral success) with the interests of California-at-large. Whether you think he has done too little one way or the other, I think everyone must agree that it could have been a lot worse, in either direction. But, do not let my view of Jerry distract you from what is important: fixing our taxation system.