How would federal tax overhaul hit California?
As we weigh the impact of the federal tax overhaul, now being wrought by President Trump and the Republican Congress, on California, we should keep in mind the first and foremost axiom about taxation.
What and who are taxed and the levels of those levies are purely arbitrary decisions that are completely divorced from logic, consistency or even rudimentary fairness.
Tax decisions are driven by ideological biases, special interest influence, political expediency and momentary passions. And those who are newly taxed usually complain loudly — until, of course, they have the opportunity to shift levies to someone else.
California saw a tax rebellion of its own four decades ago over large and seemingly arbitrary increases in property taxes, driven largely by out-of-control inflation. Voters overwhelmingly passed Proposition 13, which capped increases in those taxes and also made it more difficult to enact replacement increases in sales and income taxes.
The new federal tax overhaul sharply reduces corporate income tax rates — aimed at stimulating job-creating investment, advocates say — and partially pays for it by reconfiguring personal income taxes to generate new revenue.
It’s certainly not the tax simplification that was promised. In many respects, it makes federal tax law even more complex. And it has particularly pointed effects on California and other states with high state and local taxes, as demonstrated by the wailing coming from Democratic politicians in those states. Gov. Jerry Brown even likens Congress to the Mafia.
Most noticeably, the federal tax bill limits deductions for mortgage interest and state and local taxes, which would hit those in upper-middle and upper economic classes the hardest, because they are most likely to bump up against those limits.
California political leaders, and those of other hightax states, say that’s unfair and smacks of arbitrary punishment for blue states that vote Democratic. And they may be right about its political motives.
However, what worries them the most — although unspoken — is that they are losing indirect federal subsidies for their high state and local taxes and, therefore, their high-income taxpayers would feel the full impact of those taxes.
Despite a small reduction in federal tax rates, those losing their state and local tax deductions might rebel by moving to lower-taxing states, or changing investment strategies to minimize taxable capital gains.
California is particularly vulnerable to such a rebellion because its state income tax rates are, by far, the highest in the nation, its state budget is inordinately — and perilously — dependent on revenue from a relative few high-income taxpayers, and Nevada, which has no income tax, is next door.
It also has the nation’s highest housing prices, so the new limit on deducting mortgage interest will make buying homes with mortgages over $750,000 more costly, and will indirectly make buying homes in states offering more bang for the buck more attractive.
For the umpteenth time, coincidentally, a coalition of liberal groups is proposing to modify Proposition 13 by removing its limits on taxing commercial property, thereby, they hope, raising billions of additional dollars for schools and local governments.
If successful, it would be a counter-rebellion of sorts, reinforcing California’s reputation for blue politics and high taxation with another arbitrary change in tax policy.