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Dean Pete Peterson on "Where Bernie-nomics Goes to Die" | Real Clear Policy

Where Bernie-nomics Goes to Die

November 22, 2016 | By Pete Peterson | Real Clear Policy

The presence of Bernie Sanders in television commercials this fall in support of a California ballot initiative on drug pricing demonstrates the ongoing appeal the Vermont senator has for the Golden State’s many liberal voters, despite his ill-fated presidential campaign. It would be hard to imagine two states more different than Vermont and California, but, politically speaking, invoking Sanders’ support for initiatives in America’s most progressive income tax state makes a lot of sense.

However, in the wake of California’s successful campaign to extend the country’s highest taxes on the wealthy, new studies are warning that the next recession will have a serious impact on the state’s finances.

The recent passage of Proposition 55 over the protests of even the state’s most liberal editorial boards will extend America’s top income-tax rate — which was originally promoted in 2012 as “temporary” — of 13.3 percent on incomes over $1 million through the year 2030. But that doesn’t tell the whole story. The state’s next three top rates — going down to 10.3 percent on Californians making over $263,000 — are the highest in the United States. In 1995, California raised 36 percent of its income-tax revenues from the top 1 percent; in 2014, 48 percent of income-tax revenues came from this same group.

But there’s trouble in brewing in Sanders’ tax paradise. As the Los Angeles Timespointed out in an editorial against Prop 55: “A tax structure that depends too heavily on a small group of people, however wealthy they may be, also presents an insidious social and political problem.”

One of the worst effects of a tax system that depends on the “1 percent” to raise a significant portion of revenues is volatility. Even before the last major tax increases, the fluctuations in California’s income-tax revenue looked like the Sierra Nevada mountain range. Fifteen to 30 percent rises and dips from year to year have been a regular occurrence since 2000.

A larger driver of the volatility is another Bernie-nomics staple: capital gains taxes. The golden state taxes those nefarious earnings from “Wall Street” and land sales the same as it does income, adding grease to the tracks of the state’s revenue train whenever there’s a downturn.

Analysts of California’s plight are beginning to notice. In the governor’s May budget revision, the state’s own Department of Finance modeled the prospect of a recession of “average magnitude” in 2017. Such an event would result in a $55 billion drop in state revenue over three years — that’s billion with a “b”— out of a total state general fund that reached $122 billion this past year. In other words, they predict a 15 percent drop in revenues each year until the next presidential election. 

In April, Moody’s gave a “fiscal stress test” to the country’s four most populous states to help determine each state’s ability to withstand a recession in the next two years. California finished fourth “due to its revenue volatility, weak financial flexibility, and lower reserve levels.” These factors contribute to California’s bond rating — the lowest in the country.

The state’s financial officers are not unaware of these impending storm clouds. In June, State Controller Betty Yee, a Democrat, issued a report running over 80 pages, “Comprehensive Tax Reform in California: A Contextual Framework,” that reviews the myriad proposals offered over the years meant to bring stability to the state’s revenues. In an interview about the document, Ms. Yee began by saying, “I wanted to give the public a lot to chew on,” and concludes, “what I’m trying to do is have this conversation before the whole thing collapses.”

While the Controller’s report is comprehensive, the options have been well known for years. All have been discussed at one point or another — from extending sales tax to services and moving from current corporate taxes to a Net Receipts Tax, to nearing California’s third rail: property taxes. None addresses the volatility question without looking at the progressive income-tax structure.

Is such a step be possible in deep blue California, populated as it is with so many “Bernie Bros”?

An encouraging prospect can be seen in the bluer state to our west: Hawaii. There — in a primary race won by Sanders with almost 70 percent of the vote — state legislators actually held to their promise of making a recent income-tax increase “temporary,” dropping their three top marginal rates and reducing the highest from 11 percent to 8.25 percent. In refreshing words from the office of Hawaii’s Democratic Governor David Ige, “the governor is committed to working within the state’s means, examining ways to become more efficient as a way to increase revenues as opposed to raising taxes.” 

In other words, “Aloha, Bernie-nomics.” 

Pete Peterson is dean of Pepperdine’s School of Public Policy.