California's annual budget crisis continues unabated this week. Almost two months into fiscal year 2011, the state legislature still has not enacted a budget. Democratic leaders in the state Assembly and Senate recently offered a joint budget-balancing plan that "spreads the pain" between spending cuts and tax increases, but this plan has received only lukewarm support. Part of the problem, as noted in a recent California Budget Project analysis, is that the tax increases in the Democratic plan would impose virtually no tax hikes on the best-off Californians. This is an especially odd choice given that the wealthiest Californians have enjoyed substantial growth in real incomes at a time when middle-class incomes have been stagnant.
Senate President Pro Tem Darrell Steinberg, one of the architects of the plan, explains this free-pass for the wealthiest Californians as a response to the misleading claim, expressed frequently by Governor Arnold Schwarzenegger, that California's tax system is already too volatile due to its reliance on the capital gains income realized by the best-off taxpayers. Yet as the nonpartisan Legislative Analyst's Office has found, reducing volatility by making the income tax less progressive will almost certainly have an unfortunate tradeoff: reducing the long-term growth (and sustainability) of state revenues.
At a time when the state faces a $19 billion deficit that shows no signs of disappearing in the future, hamstringing long-term revenue growth isn't the first solution to this problem one would think of. As we've noted in the past, making state tax systems less volatile can't be the primary goal of a state tax system. Long-term sustainability should be the main goal — and a progressive income tax, coupled with prudent fiscal management of a meaningful rainy day fund, is a sensible tool for achieving this goal.