No Clear Answer Presented by Other States’ Budget Strategies

By LAURENCE DARMIENTO

Staff Reporter

Do other states have better ways of raising money?

Yes, but that doesn’t necessarily mean they will work here. And it doesn’t even mean they work there.

While Californians debate how to cure the state’s enormous fiscal ills, there are a host of revenue-enhancing ideas being pursued elsewhere, from the establishment of a more balanced revenue stream to formal rainy day reserve requirements to an expanded sales tax base.

“A one-size-fits-all approach to tax reform is doomed for failure, but that does not mean there are not a great many valuable lessons states can learn from one another,” said Richard Greene, an editor with Governing Magazine, which recently concluded a year-long study of state tax practices.

With California’s heavy reliance on individual income taxes, perhaps the most basic reform involves simply balancing the revenue stream, which Iowa does enviably.

Individual income taxes made up 49 percent of California’s state tax collections in 2001, while sale taxes were below 27 percent a reliance that came back to bite the state with the collapse of the dot-coms and the near evaporation of capital gains.

By contrast, Iowa’s individual income taxes comprised 37 percent of tax collections in 2001, while sales taxes made up a healthier 34 percent. So when the economy slowed, Iowa was subject to far less of a drop in revenue than California. Iowa, in fact, was one of the few states that did not face service cuts or fiscal trickery in order to balance its budget.

“You are better off having a good mix of sales and income taxes,” said Ray Scheppach, executive director of the National Governors Association.

Obtaining that balance can be difficult because it would likely mean raising sales taxes. Which leads to the next option: extending sales taxes to professional services.

As the economy becomes more service oriented, payments for services now account for 58 percent of dollars spent by consumers, up from 41 percent in 1960, according to Scheppach.

Yet many states have been wary of a backlash from lawyers, doctors and other powerful professional groups. In Florida, a services tax in the late 1980s caused such a ruckus that the state legislature rescinded the law.

Hawaii does have a 4 percent tax that covers a wide range of sales and services and makes up two-thirds of total collections beneficial, many say, in limiting the amount of cost cutting required to balance the budget. Still, many consider Hawaii an unusual case since it’s not easy for a professional there to pick up and go anywhere else.

Of course, the same could be said of California, with its large number of professionals who would be reluctant to uproot families and clients for another state.

Another possibility is a gross receipts tax that would slap very low taxes, generally below 1 percent, on just about every exchange of goods, rather than just at the final purchase by consumers.

That tax generally hits smaller businesses harder because they get taxed on most everything unlike, say, a large corporation that is more vertically integrated and thus not subject to taxes along every step of the transaction process.

Last year, New Jersey tried to level the playing field by implementing a limited gross receipts tax aimed at corporations that do not pay any corporate income tax.

Besides generating revenue, there’s also socking money away to fund tough times. Several states, including Massachusetts and Michigan, had rainy day funds that exceeded 10 percent of their budgets before the economy soured.

The catch? Crafting dual requirements for building up the funds in good times while giving the legislature enough flexibility to withdraw from the funds in bad times. “That is kind of a tricky balance,” said Nicholas Johnson, director of the state fiscal project for the Center on Budget and Policy Priorities.

California has a rainy day fund called the “Special Fund for Economic Uncertainties,” but it lacks stiff laws requiring the legislature to pump it up when the economy is growing.

Finally, there are revenue and expenditure limits that states have imposed in a dose of forced fiscal discipline. Conservative groups, such as the Cato Institute, promote these approaches, contending that irresponsible spending is what is at the heart of the states’ fiscal crises.

The poster child for fiscal restraint is Colorado, which passed a Taxpayer Bill of Rights that requires voter approval for any tax increases while tying annual revenue growth to inflation and population growth. Any revenue collected over that must be refunded to taxpayers.

Critics say the approach has tied the hands of state government, especially as Colorado tries to grapple with rising health care expenditures that have increased faster than the general inflation rate.

Another approach is a more informal budget process limit taken by the Maryland Legislature, which tries to tie budgetary growth to underlying economic growth. But critics point out that Maryland was still left with a record $1.2 billion budget gap last year.

Voices

Kathleen Connell

Los Angeles-based investment advisor

Former California Controller

‘No question we need to change our overwhelming dependence on the income tax. We need a more even tax structure.

“First, we need to do a swap. We take a portion of the income tax and route that to local governments. Then we need to take an equivalent portion of the sales tax that now goes to local government and keep that portion in Sacramento. This swap lessens the dependence of state government on the income tax and it lessens the dependence of local government on the sales tax.

“Second, we need to broaden out the sales tax to business services. We are no longer a manufacturing state, we are a service state. We should be looking at taxing hairdressing salons and accounting services.”

Stephen Levy

Director

Center for the Continuing Study of the

California Economy

‘Longer term, I think it’s worth looking at reassessing commercial property and considering reassessing residential property by changing the 2 percent annual increase to 4 or 5 percent. Not the rate, but the assessed property. The intent of Prop 13 was to lower property taxes. I would try to have the assessments a little closer to market.

“I would favor perhaps, a property tax/sales tax swap, to get cities and counties to have more incentives to make land use decisions that are sensible. Some kind of swap that gave communities more property tax revenue. Share more sales tax revenue so the businesses in the cities have to share it with everyone else. I would start with the commercial property reassessment with the revenue going to local government.”

Patty DeDominic

Chief Executive

PDQ Personnel Services

‘I’m not sure that we can fix the revenue stream, but we can have a base rate of income. In boom times, we will obviously have more income. I think we need to fix our expenditures to some base rate and not exceed them unless we have them coming out of reserves. That requires making some tough decisions, but I believe there are a number of ways the state shuts itself off and is more bureaucratic and spends more money than it needs to.

“It is important to revisit all tax rules and regulations in the next five to 10 years, but I like Prop. 13 and I would not want to change it.”

Janna Braun, Howard Fine