Commentary on Election

California Education And Business Climate – Post-Prop. 30

By Blake Christian
Certified Public Accountant

November 20th, 2012 – As the political adage goes, “Elections have consequences,” but the most recent election may require modification to more accurately state that, “Elections have both anticipated and unanticipated consequences.”  The governor, educators, students and other pro-Proposition 30 voters may soon find out the full extent of these unanticipated consequences.

On November 6 the California voters spoke loudly and clearly that education is critically important for our kids’ futures (a point I fully agree with), and the imposition of the highest income and sales tax rates in the country appears to be the most acceptable method for fixing our broken education system (a point I strongly disagree with).

As a result of Prop 30’s passage, California’s individual tax rates retroactively increased to January 1, 2012, from a prior high of 9.3% (10.3% for those having California taxable income in excess of $1 million), to rates ranging from 10.3% to 13.3% for taxpayers with state taxable income in excess of $250,000 (http://vig.cdn.sos.ca.gov/2012/general/pdf/30-title-summ-analysis.pdf). This represents a 32.2% increase in the highest marginal rate. State sales tax rates are also increasing another .25%, up to a new base-level sales tax rate of 7.5% (before county/city tax) for every California taxpayer beginning January 1, 2013 – so even the poor get drilled with this portion of Prop 30.

Voters are just now realizing the full horror of Prop 30’s passage.

The income tax increases will be borne by individuals (not businesses) for the next seven years; the sales tax hit will impact both business and individual taxpayers on all taxable purchases for a mere four years. These increases will make California the most costly state in which to operate, but the legislators continue to believe that businesses and workers will “stay here for the weather.”

The following link will allow you to compare other states’ tax structures and why California is consistently rated towards the bottom (#48 in 2012) of the worst states in which to operate (according to the State Business Tax Climate Index: http://taxfoundation.org/sites/taxfoundation.org/files/docs/2012_tax_foundation_index_bp62.pdf). And that’s before these new tax hikes kick in!

The unintended consequences relate to the inevitable business and worker exodus from California, which will very likely follow the full realization from taxpayers that their cost of making and spending their California-sourced income has gone up by a very significant amount. This will include business owners, corporate executives, retirees, software developers and inventors, artists and others. The day after passage, our CPA firm received a flood of calls and e-mails from clients and other taxpayers asking the magnitude of Prop 30 on their operations and how they can relocate or (in some cases) sell all or parts of their California business operations so they can move to another state. Time will tell how many make the move, but at this point, the frustration level is the highest I have seen in my 32-year career.

Gov. Jerry Brown and his Prop 30 supporters are understandably elated at the passage of a $42 billion tax increase, which is imposed on higher earners who represent less than 2% of the voting public – ironically a group that generally does not support the governor’s policies, so their votes are seldom needed by the governor.

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The week following the election yielded one of the more amazingly defiant political quotes by this life-long public servant. While responding to questions regarding the possible exodus of California taxpayers looking for lower tax states, Governor Brown boldly stated: “High-income earners have more to fear from their spouses than they do from taxes in California,” he said. “Usually it’s because they are going through a nasty divorce. So as long as they take care of their relationships, we will take care of spending their money wisely.” Based on history, “spending” and “wisely” have seldom been used in the same sentence to describe California budget policy.

While I am a big supporter of education, a tax hike of up to 33.2% on upper income individuals in the midst of a four-year economic downturn is perplexing – especially since virtually none of the fundamental flaws in the California education system (unions, pensions, tenure, etc.) have been addressed in the past several years and Prop 30 does nothing more than throw more money down a bigger hole. This myopic focus on the revenue-side of the state budget process, rather than education reform and cost controls, reminds me of a great political cartoon from the 1980s where a man is standing next to his car with a flat tire. There are coins and dollar bills lying around the flat tire (which he has not even bothered to remove from the car) and the man continues to throw more money towards the tire. The caption reads: “Another liberal throwing money at a problem.”

With a combined California education budget of more than $69 billion, this is apparently not enough money to improve California’s education system from its 30th overall (2011) and dismal 47th place (2012) science ranking amongst other states. Even though Long Beach has some bright spots, including well-respected school superintendents and college/university presidents, California’s educational system is THE poster-child for fraud, waste, abuse, greed and mismanagement.

Proposition 30 was championed by Governor Brown and various chambers of commerce, since the business community was threatened with severe business tax reforms if they did not let Prop 30 squeeze more dollars out of those “wealthy” California individuals making more than $250,000. The Long Beach Chamber and Cal Chamber rolled over and took a “neutral” position on Prop 30 due to extreme pressure from the school superintendents, community colleges and university leadership.

The pro-Proposition 30 lobbyists assured Californians that passage would silo – for the benefit of students and teachers – virtually all of the $6 billion-plus of annual income and state tax receipts associated with the Prop 30 increases. However, even a cursory review of the Prop 30 text (http://www.sos.ca.gov/elections/vig-public-display/110612-general-election/prop-30/prop-30-text.pdf) reveals this is a very inaccurate representation, which is why I encouraged people who really cared about education (and believed a tax hike was in order) to support Prop 38, which would have raised $10 billion per year for 11 years for a total of at least $110 billion (http://vig.cdn.sos.ca.gov/2012/general/pdf/38-title-summ-analysis.pdf).

Another nice feature of Prop 38 was that the tax increase would only become effective in 2013.For those of you who voted “yes” on Prop 30, I am very hopeful that you will carefully monitor the flow of tax funds and hold your elected officials and educators fully accountable for making sure that every dollar actually goes to classroom education for the full seven-year period. The college students who overwhelmingly supported Prop 30 should make sure that their tuition does not increase during the seven-year period – but that already looks bleak since the CSU system only waited two days after the election before discussing hikes. Berkeley students are already protesting and demanding roll-backs in tuition – so nice to see that accountability is already being worked into the mix.

For those who voted “No” on Prop 30, I highly recommend that the personal and long-term economic impact of these rate hikes be kept front and center in every transaction you undertake for the next seven years. Please let those job applicants that you are forced to turn away know that you wish you could hire more, but are being forced to do more with less. Let your waiter know you would like to give more than 15%, but after-tax profits are down; when the schools ask for money for a special project, take a very hard look and ask if that project should really be funded with the $42 billion in new taxes; when your kid’s tuition jumps, be vocal with the school leadership; when you are shopping, let the business owner that the combined federal and state tax hikes are leaving you with less spending money. And when choosing a vacation destination (assuming you have the funds), choose a state with reasonable sales tax, hotel rates and business climate.

In meetings between California legislators and the governor over the past decade, it is clear that they have very little concern regarding business and worker exodus. Only brick and mortar retailers and certain service providers need to be physically present in the state –and those that must keep some physical presence here in California will continue to move their headquarter offices, call centers and other divisions to more business-friendly states, as they have been for the last decade – and there are currently 47 be states from which to choose.

As long as the governor and majority of the state legislators continue to believe that, “Oh – they will never leave, but if they do they will come back for the weather,” the California business community will continue to have slower growth and the best and the brightest will find friendlier and less taxing states to grow their businesses and retire.

Governor Brown, the Prop 30 supporters and the other tax-and-spend politicians have won this battle, but will very likely lose the coming war between states luring away our businesses, workers and retirees. A state infrastructure that relies on raising taxes and fees on a very narrow slice of taxpayers, and a shrinking income base, is unsustainable. When the dust settles, there may not even be enough people left in the state who can afford to ride on the governor’s high-speed rail boondoggle. Now I understand why the legislators have been resistant to include a high-speed rail line that goes to Las Vegas – everyone would be buying a one-way ticket to Nevada.

(Blake Christian is a Long Beach certified public accountant and a former chairman of the Long Beach Area Chamber of Commerce.)