Brown’s Tax Plan Comes With Double Dose of Uncertainty

By: - January 18, 2012 12:00 am

With a revenue system that’s heavily dependent on income taxes on the wealthy, California’s budget has a history of unexpected booms and busts that reflect the vagaries of the national economy. In that context, it’s notable that the state Legislative Analyst’s Office (LAO) has declared that “revenue estimates are an even bigger question mark than usual for the Legislature this year.”

The source of the uncertainty is Governor Jerry Brown’s tax plan. Brown’s proposal includes both a sales tax increase and an income tax increase on individuals making at least $250,000 a year or joint filers making at least $500,000.

One question, of course, is whether Brown’s plan will pass. That will likely be decided by California’s voters in November. This year, Brown is proposing the tax increases as a ballot initiative, after Republicans in the legislature blocked his tax plan last year.

Even if the tax initiative passes, though, the LAO’s report raised doubts about whether it will be bring in as much money as Brown hopes. Brown’s budget says the initiative will bring in $6.9 billion by the end of the 2012-13 fiscal year, but LAO put the number at $4.8 billion.

The reason for the disparity, explains Justin Garosi, an LAO analyst, is different forecasts for the income tax portion of Brown’s plan. Those forecasts reflect different views on how much income Californians will claim in capital gains. Overall, the Brown administration thinks that Californians’ capital gains will hit $96 billion in 2012, while the LAO places the number at only $62 billion.

Forecasting capital gains is notoriously difficult. That’s partially because all economic forecasting is imprecise, but also because capital gains can rise and fall suddenly, independent of the expansions and contractions of the economy as a whole. One reason the Brown administration and the LAO came to different numbers, for example, is that the Brown administration assumes the Bush tax cuts will expire as scheduled at the end of this year. If that happens, investors are likely to claim more capital gains before their taxes go up, leading to a temporary boost in state revenue. 

The very wealthy tend to claim a greater proportion of their income in capital gains. For that reason, the revenue from Brown’s income tax plan depends heavily on the capital gains number. By targeting the rich, Brown’s plan would make California’s tax code more progressive, but also potentially more volatile. “Neither number is going to be right,” Garosi acknowledges. “With forecasting, you try to get close.”

On that point, the LAO and the Brown administration seem to agree. “The Legislative Analyst’s Office report underscores the fundamental uncertainty of our time,” Brown’s office said in a statement , “and, therefore, the financial imperative to be prudent, make the tough cuts now and give the voters a choice on additional revenues.”

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Josh Goodman

Josh Goodman helps lead research on fiscal management and place-based economic development programs as part of Pew’s state fiscal health project. Goodman has served as a primary author for Pew studies that examine how states should evaluate tax incentives and maintain budget discipline when implementing those incentives.