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Prop. 30 fact check: Will higher taxes push businesses to leave California?

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44331 full

With less than a week to the Nov. 6 election, there's a lot of information - and misinformation - out there about Prop. 30. The measure, supported by Gov. Jerry Brown, would raise sales and income taxes in order to avert $6 billion in primarily education cuts.

Prop. 30 is written into the enacted 2012-13 California budget, which presumes that the measure will be approved by a majority of voters Tuesday. Over the next several posts, we'll try to break down the proposition and examine the big questions that have been raised in political ads over the last weeks.

What Prop. 30 does: Increases personal income tax for seven years on people making more than $250,000. It would be implemented retroactively, starting Jan. 1, 2012. People making between $250,000 and $300,000 would pay 1% more (up to $3,000). People making between $300,000 and $500,000 would pay 2% more and people making more than $500,000 would pay 3% more in taxes.

Sales tax would be increased by 1/4 of a penny for four years starting in 2013. This works out to one cent on a $4 latte or 25 cents on $100.

If it fails: The budget provides a contingency plan called "trigger cuts"; the bulk of these would impact education. K-12 education and community colleges would be hit by $5.4 billion in cuts, the UC system by $250 million, and CSU by $250 million. Other areas impacted by cuts include city police department grants ($20 million), CalFire ($10 million), the Department of Fish and Game ($4 million) and the Department of Parks and Recreation ($2 million).

Arguments against Prop. 30: The arguments fall under four main categories: no new taxes, the measure is flawed, the money would be wasted, and schools are a mess. These positions are primarily supported by the Howard Jarvis Taxpayers Assn., the National Federation of Independent Business California and Small Business Action Committee.

We examine each claim. First up --

1) No new taxes

Claim: Higher taxes are bad for business. They force companies to leave the state. California already has the nation's highest sales-tax rate.

Facts: California actually has the nation’s 12th highest average sales tax rate at 8.13 percent, according to a report by The Tax Foundation, a nonpartisan tax research group based in Washington, D.C. This figure is calculated as a population-weighted average that takes into account local surtaxes on services, which can push the basic state-level rates to 10 percent or higher.

Although the total statewide rate of 7.25 percent is the highest state-level tax rate in the country, The Tax Foundation compares states via their average state sales tax rate because of states like Colorado, says Scott Drenkard, an economist for The Tax Foundation. Colorado's statewide rate is 2.9% but the average local rate is about 4%. "The tax rates consumers actually see checking out is closer to 7% so it's important to think about both," he says.

Sales taxes are "a less bad tax" than income taxes and are generally favored by public finance experts, Drenkard says.

"Here’s why," Drenkard says, "If you’re taxing income you’re disincentivizing the creation of new wealth, or the creation of value. If you’re taxing consumption, you're promoting savings or at least you're not disincentivizing savings, and that savings is associated with long-term growth."

Sales tax in California was also higher until quite recently. Sales tax in California dropped by 1% in July 2011 after the Legislature allowed the temporary half-cent sales tax to sunset.

In terms of personal income tax, many businesses -- especially small ones -- file through the personal income tax code, Drenkard says. According to Drenkard, anecdotal evidence shows increasing taxes does affect business negatively. In 2011, Illinois raised its corporate income tax and personal income tax rates and "there was an exodus of various businesses to other low-tax neighboring states, and some of them even left for faraway states," Drenkard says.

"The capital of businesses is very mobile," Drenkard says, "so if taxes become prohibitive, people will move."

Drenkard says there aren't conclusive studies on this point. Two recent studies come to "two totally different conclusions," Drenkard says. A recent study by Stanford University sociologists looked at California's "millionaire tax," which was introduced in 2005 and levies 1% of additional tax on people who make more than $1 million to pay for mental health services. It found that the "highest-income Californians were less likely to leave the state after the millionaire tax was passed." 

"Most people who earn $1 million or more are having an unusually good year. Most 'millionaires' earned less in years past, and they are not likely to earn this much again. A representative 'millionaire' will only have a handful of years in the $1 million + tax bracket. The somewhat ephemeral nature of very high income is one reason why the top-income taxes examined here generate no observable tax flight. It is difficult to migrate away from an unusually good year of income."

However, what did make high-earners leave California was divorce. The study found that in the year of divorce "the migration rate more than doubles, and remains slightly elevated for two years after the event."

"This shows that there are circumstances that do generate millionaire migration. The tax policy changes examined in this report are very modest compared to the life-impact of marital dissolution."

The second recent study came out of Maryland, and concluded that millionaires will leave if you tax them at higher rates.

"Taxes do matter," Drenkard says. "They’re not the only thing that matters though. Things like climate, things like proximity to other businesses, if it’s another natural resource you’re after you want to be close to natural resources."

A problem with relying too much on personal income tax  for general fund monies though can lead to revenue volatility at the state level, Drenkard says.

"Most of the time [the revenue is from] capital gains and dividends, which can be especially affected by economic swings," Drenkard says.

"And this leads to an unstable revenue stream...When times are good, government revenues are coming in heavily and government services are being provided. But when times are bad, because there's such a reliance on high income levels, you tend to have a real big scoop in revenues that are available for running government services. And this has been a fiscal administration problem that California has had to deal with in the past decade."

Another issue is that the personal income tax increase is retroactive, which means it applies to the 2012-13 calendar year. "People have not had the opportunity to appropriately economically plan," Drenkard says. "That's one of the fundamentals of sound tax policy."

Next, we will look at the second argument -- "The measure is flawed."

Correction: This story initially said in one spot that education would be hit by $5.4 million in cuts -- it's $5.4 billion.

Tami Abdollah can be reached via email and on Twitter (@latams).

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