California’s state and local governments collect a quarter-trillion dollars in taxes each year, equivalent to about 12 percent of the state’s personal income.
However, were California to eliminate all of its “tax expenditures” – special tax treatment for certain kinds of income or transactions – it could collect about $70 billion more, according to the latest annual report on such provisions.
That’s not about to happen. The biggest of the tax expenditures, such as the tax-free treatment of employer-provided health care and pensions, the home mortgage interest deduction, or the sales tax exemption for food, are widely enjoyed and politically sacrosanct.
But many of the tax expenditures, so-called because they have the same fiscal effect as direct appropriations, are very narrow, benefiting just one economic activity.
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Take, for instance, the sales tax exclusion for custom computer software. It subsidizes certain high-tech companies, which lobbied strenuously to get it enacted nearly three decades ago, but doesn’t apply to off-the-shelf software ordinary consumers buy.
The tendency is for legislators and governors to enact new tax expenditures – or loopholes – ostensibly because they will have some beneficial impact, but only rarely review them to determine whether they’ve had the promised effects, much less repeal any found to be lacking.
One recent example is the corporate tax credit for Southern California’s movie industry, a subsidy aimed at persuading producers to do their business here, rather than in other states or nations.
Thus, the total amount of forgone state revenue tends to expand over time. The current $70 billion estimate is about 10 times the annual revenue that the state would receive from extending a temporary surtax on high-income Californians – an issue that voters will decide in November.
A recent report from State Auditor Elaine Howle represents a rare effort by the Legislature to examine tax expenditures, in this case a few, including the movie tax credit, that represent about half of the $5 billion in corporate income tax breaks.
Howle is appropriately critical of the Capitol’s long-standing practice of enacting tax expenditures and then largely forgetting about them. She said that five of the six her office examined need tighter oversight to determine whether they are having the promised beneficial effects and cites what other states are doing to police their particular tax expenditures.
Howle notes, for instance, that state taxation of multinational corporations doing business in California, dubbed “water’s edge,” could encourage corporations, through creative accounting, to avoid taxation in California.
It’s odd that each year, governors and legislators wrangle over even the minutest direct appropriations in the state budget, yet they ignore $70 billion in tax expenditures that are just as important as any item in the budget in terms of both fiscal and economic impact.
If they ever get around to truly reforming California’s convoluted and dangerously imbalanced tax system, they should start by cleaning up tax expenditures.