In a desperate move to balance the budget, Californians opted to raise tax rates on top earners in the last election. Over the next few years, the state will be extracting $6 billion in new tax revenue from individuals and families earning more than $250,000 and $500,000 a year, respectively.The early budget outlook is positive; the state expects to run a $1 billion surplus by fiscal year 2014-2015. But the Financial Times is leery of the long-term outlook:
But in increasing taxes on the top 1 per cent of residents the state has made itself more susceptible to downturns and economic shocks, according to Ross DeVol, chief research officer at the non-partisan Milken Institute.“The top 1 per cent of earners in California accounts for 20 per cent of income but pays 41 per cent of income taxes,” he said. “After Prop 30 the top 1 per cent would pay something north of 50 per cent of income taxes. What we have done is accelerate the volatility of the tax base in California. What if there’s a downturn?”
There are two essential developments to note here. First, California will rely on a tiny group of people to erase $5 billion in debt. From now on, more than half of all the government operations will be funded by less than 1 percent of the state’s residents, who account for less than 20 percent of the state’s total income.Second, the state economy is doing well at the moment relative to the rest of the country, but it is still losing jobs and skilled workers to lower-tax economies in Nevada, Texas, and the Southeast.This tax-funded surplus will allow the state to momentarily ignore the underlying problems that drive the deficit. But the problem of the escalating costs of pensions and public services and the blue social model has not been resolved and will only worsen with time.The Golden State has locked future leaders on a precipitous path. Should another budget-breaking recession emerge, Californians will either have to make unconscionable cuts to social programs and services or attempt to sustain nearly the entire government on a diminishing fraction of residents. Either way, the long-term case for optimism is weak.