California’s Economic Recovery Efforts Could Be Hurt By More Tax Increases


California’s Economic Recovery Efforts Could Be Hurt By More Tax Increases

Proposals to implement a wealth tax and increase the state's top marginal tax rate seem especially ill-advised right now.

The COVID-19 pandemic and recession are, thankfully, dealing a somewhat smaller blow to California’s state revenues and public employee retirement systems than originally feared. The stock market’s rebound from its lows in March, combined with the strength of California’s tech companies, may have reduced some of the need for immediate budget cuts and the state’s desire for huge federal bailouts. Now, state lawmakers need to avoid raising taxes on the workers and companies keeping the state afloat.

In May, California Gov. Gavin Newsom projected that the coronavirus crisis would blow a $54 billion hole in his January budget. The hit was expected to come from reduced revenues this year and next, as well as increased state spending on unemployment benefits and other social services. Although unemployment has indeed been dire, the revenue hit thus far has been much less than expected. According to the Legislative Analyst’s Office (LAO), tax collections between April and July exceeded budget projections by $4.3 billion. Although there is no guarantee that the revenue outperformance will continue, at least some of the underlying trends remain in place.

As the LAO also noted, job losses have disproportionately impacted lower-income workers who pay relatively little state income tax. For married couples, the first $100,000 of income is taxed at rates of between zero and six percent. The state’s highest marginal income tax rates, ranging up to 13.3 percent, are reserved for the higher-income taxpayers, most of whom have been able to work remotely during the pandemic. As a result, personal income tax withholding revenues are well ahead of projections.

State sales tax revenues have also outperformed expectations and LAO found that consumer spending recovered more quickly than the governor anticipated. Although continued uncertainty over the path of the COVID-19 pandemic this fall could reverse this trend, the strength of online commerce should continue to help bolster state sales tax receipts. And with the stock market’s bounce back, capital gains tax revenue should remain strong. Although estimated tax payments were running below expectations through July, wealthy taxpayers should begin paying more as the resale value of their equity holdings rises.

The stock market performance has also helped the state’s public pension systems, the California Public Employees’ Retirement System (CalPERS) and California State Teachers’ Retirement System (CalSTRS), recover the large loss in asset values they sustained in March. For the fiscal year ending June 30, the two systems earned 4.7 percent and 3.9 percent respectively. Although those investment results are well short of the 7 percent annual returns expected by the pension systems, they are far above the worst-case outcomes that seemed inevitable just a few months ago.

Now state legislators should take care not to drive out high-income Californians, who are contributing an ever-larger proportion of the state’s budget resources. Proposals to implement a wealth tax and increase the top marginal tax rate from 13.3 percent to 16.8 percent seem especially ill-advised right now.

While it is true that California has been able to retain large numbers of wealthy taxpayers despite its high tax rates, recent events raise questions about whether this can continue eternally. The rise of remote work in response to the coronavirus pandemic suggests that software engineers and other highly-trained professionals can work from anywhere—including low-tax, low-cost states. For tech entrepreneurs and venture capitalists, especially those in the Bay Area, the ability to personally network has fostered a willingness to accept the region’s high cost of living and quality of life deficiencies.

But with the world adapting, and in-person interactions increasingly giving way to Zoom calls and video conferences, there may be some tech workers upper-income tech workers who are free to permanently work remotely and may revisit their place of residence if the state pursues further tax increases. California has thus far avoided the dire pandemic-related budget deficits that state leaders predicted. But that doesn’t mean state lawmakers can’t mess it up with more tax increases.

A version of this column originally appeared in the Los Angeles Daily News