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Can California CFO Betty Yee Get the Golden State to Think Big on Tax Reform?

The last time California enacted comprehensive tax reform, FDR was president, Babe Ruth was still playing baseball and the Golden State was five years away from seeing its first freeway open.

Danny Feingold

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California State Controller Betty Yee

The last time California enacted comprehensive tax reform, FDR was president, Babe Ruth was still playing baseball and the Golden State was five years away from seeing its first freeway open. No wonder, then, that the world’s seventh-largest economy has an antiquated tax system, something many consider a major factor in the fiscal rollercoaster that has defined the state’s economy for several decades.

All this could change if State Controller Betty Yee has her way. California’s chief financial officer is hell-bent on bringing the state’s tax structure into the 21st century, even if it has to be dragged kicking and screaming.

As the state’s chief financial officer, Yee feels a strong obligation to bring fiscal stability to California. But her motivation to overhaul the state’s tax system is also rooted in a desire to see greater and more sustained public investment in one of the epic challenges of our time – reducing economic inequality.

The first step in what will almost certainly be a years-long undertaking was the release last week by Yee’s office of a report entitled “Comprehensive Tax Reform in California: A Contextual Framework,” which makes the case for fundamental change. The report, produced by a ten-person panel of academics, business leaders and government officials commissioned by Yee last year, very deliberately avoids prescriptions for how to overhaul California’s tax system. Instead, it provides historical context, analysis and a wealth of data on why the system is not working – a starting point for what Yee hopes will be a broad, robust public conversation that leads to sweeping changes.

Comprehensive tax reform is a regular subject of focus for editorial boardsacademics, and advocates from the right and left, but isn’t a topic on which many politicians are willing to stick their necks out.

Yee, however, doesn’t mince words about the severity of the problem. “Designed during the Great Depression, California’s tax structure is outdated, unfair, and unreliable,” she writes in the introduction to the report.

Few officials can speak with more authority on the subject than Yee, who spent years developing state budgets with the California Department Finance during a period of extreme economic volatility and served two terms on the State Board of Equalization, which oversees tax administration. “I’ve had a good view of how broken the system is, and we are buying time,” she told Capital & Main in a recent interview.

Public dialogue around taxes in California often begins and ends with Proposition 13, the bombshell 1978 ballot measure that set off a national revolt against taxes. While the impacts of Prop. 13 were profound – in addition to dramatically decreasing property taxes and thus state revenues, it imposed a draconian requirement for two-thirds approval by the state Legislature of any future tax hikes – it hardly amounted to comprehensive tax reform. A better description would be a grenade that shattered part of the backbone of California’s revenue structure, leaving the state fiscally disabled.

In recent years, critics of Prop. 13 have begun the first serious effort to repair the damage. A proposed amendment to the state constitution sponsored by State Senators Loni Hancock (D-Oakland) and Holly Mitchell (D-Los Angeles) would create a split roll system for property taxes, allowing commercial and industry property taxes to increase while preserving the current limits on personal property taxes. The amendment has little if any chance of passing, but supporters hope that it will set the stage for an eventual ballot measure campaign that would rein in the excesses of Prop. 13.

Yee, however, has set her sights on something much bigger. She believes that California must look far beyond Prop. 13 and put everything on the table, from corporate taxes to a potential services tax to a reassessment of the state’s increasing reliance on income tax hikes for the rich. In doing so, argues Yee, we must keep our eyes on the prize: fiscal solvency, economic growth and public investment that addresses the needs of those struggling in a state that is one of the most unequal in the country.

A tax on services would represent a major shift for California, but hardly a novel one. “We are one of the few states that does not have a tax on services,” Yee pointed out. This void is particularly problematic in an era where the sales tax base is shrinking as consumers direct more of their spending to services. A case in point, noted in the report, is digital downloads, which have largely supplanted the purchase of merchandise such as compact discs and packaged software – and are not subject to sales taxes.

If information services, finance and insurance and health care, to name a few examples, were taxed at levels comparable to our current state and local sales tax rate, the state would see a whopping annual windfall of $120 billion. A more modest approach, as proposed in State Senator Bob Hertzberg’s Senate Bill 8, would bring in $10 billion a year (like the split roll tax, SB 8 is not expected to advance in the Legislature anytime soon).

When it comes to personal income taxes, which account for nearly 70 percent of California’s General Fund revenues, Yee is not necessarily advocating that the state deviate from its practice of demanding more from the wealthy. She is a strong backer of progressive taxation, and supports this November’s ballot measure that will extend Proposition 30, the 2012 measure that raised billions of dollars for public education through a combination of increased income taxes for high earners and a sales tax hike. But she is concerned about the volatility inherent in a heavy reliance on income taxes, which in lean years can exact a steep toll on revenues – and the ability of government to provide essential services.

The unpredictability built into the existing tax system earned California a ranking of 44th among the 50 states in an evaluation of fiscal solvency. California is so unstable in its basic revenue structure that just last month, Moody’s determined that the Golden State rates dead last in its ability to withstand a recession.

That is a status quo Yee is unwilling to accept, even as she insists that California not shackle itself to the kind of fiscal austerity approach that some observers believe has become a hallmark of Governor Jerry Brown. Indeed, she sees embrace of tax reform as a litmus test for whoever succeeds Brown. “I will not endorse any gubernatorial candidate that does not take this seriously,” she said.

Yee recognizes the considerable political risks that go along with shaking the hornet’s nest of tax reform, noting that her crusade could put her job in jeopardy. But so be it. In the coming months, she plans to take her case to the public, hoping to stoke a discourse in every part of the nation’s most populous state.

“The time for comprehensive tax reform is now,” Yee writes in her report. “No more kicking the can down the road.”

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