Deduct Tax Code’s Special Breaks : By Conforming With Federal Law, State Could End Inequities

It’s time for a real reform of California’s income-tax law.

The passage of the 1986 federal Tax Reform Act has set the stage for the state Legislature to pass a comprehensive tax-reform bill of our own. We have a singular opportunity to lower state income taxes, achieve greater equity and make the state’s income tax simpler and more understandable.

For four years I have authored tax-reform legislation designed to achieve these objectives. This year Assemblyman Dennis Brown (R-Long Beach) and I introduced a comprehensive tax-reform measure that passed the Assembly in June and now awaits action by the Senate. It is supported by Gov. George Deukmejian and a wide-ranging group of business and civic groups.

This bill would make California’s tax law nearly identical to that of the federal government. Such diverse items as sub-chapter S corporations, Individual Retirement Accounts, the alternative minimum tax and the standard deduction amount would be handled the same way on both state and federal forms. In addition, the bill proposes a three-tiered tax-rate schedule, with the top rate lowered from 11% to 9.6% and a personal-exemption credit increased from $44 to $200. It also provides a joint filing status for heads of households.

If this measure becomes law, more than 600,000 taxpayers will no longer pay any state income tax, and more than 6.1 million Californians will be paying less. Less than 1% of taxpayers will have increases of $1,000 or more. A family of four with an annual income of $22,600 will pay no state income tax, and households with incomes of $30,000 to $50,000 will be paying, on the average, 8% less. All this would be done without increasing or decreasing the state’s general fund revenues.

If this is possible, why hasn’t the state already conformed its tax code?

Actually, California’s tax law conforms quite selectively to the previous federal tax code. This has been our state’s traditional approach. It is a system influenced largely by political considerations and the need for revenue, rather than being based on fairness. Consequently, California’s income-tax law is rife with special benefits, exemptions and rules that have been designed to help one special-interest constituency or another.

Some provisions could be justified as purporting to solve a unique California problem. But special benefits cost both the state and local governments revenue. They cause everyone else to pay higher taxes. They contribute to a justifiable feeling that the system is unfair and inequitable. Moreover, there is no evidence that any special state benefit alters taxpayer behavior or stimulates economic growth. The fortunate few who qualify for special tax breaks receive a windfall that is paid for by everyone else.

Legislators are quite aware of these facts. We also recognize that most taxpayers are more conscious and concerned about their federal taxes than about state income taxes. Because of the dominant role played by federal taxes, only a handful of states have income-tax laws substantially different from federal law. But California’s tax laws continue to be the most nonconforming of any state’s.

The bill proposes that our state tax form begin by having taxpayers simply copy the taxable income amount from their federal tax form onto the state form. The taxpayers would then make minor adjustments, determine their tax liability from the tax tables and, finally, subtract their personal and dependent exemption credits to determine what they either owe or will receive as a refund. All this could be done on a postcard.

This proposal for simplicity, equity and fairness is opposed by interests that have gained special benefits in existing California law. In particular, various interest groups seek special treatment for capital gains, political contributions, oil and gas exploration and production, and meal and entertainment expenses. Even more audaciously, one proposal would eliminate the state’s minimum tax, thus allowing taxpayers who qualify the ability to avoid paying any state tax whatsoever. Just as Congress did, the Legislature will have to say “no more.”

Some legislators fear that they would subject themselves to political attack for supporting a bill conforming to a federal law that has eliminated loopholes favored by narrow constituencies.

For example, for four years the federal government has included as taxable income one-half of Social Security payments when couples have earned more than $32,500 from other sources. Yet legislators are concerned about the image of “taxing Social Security.” But the image is not reality. The fact is that only the wealthy Social Security recipient is ever subject to this provision of law.

We believe that the bill, taken in its entirety, would reduce taxes for most Californians even though special loopholes would be eliminated. Everyone pays less when we can expand the definition of taxable income and lower tax rates.