California Can’t Give Up Tax Increases

State Tax

California is awash in plans to raise taxes.

An under-the-radar piece of legislation will functionally increase the top marginal income tax rate by 1.1 percent in 2024 (with administrative authority to bring it to 1.5 percent), while a pending ballot measure would add a new 1.75 percent surcharge on the income of the highest earners, and Governor Gavin Newsom (D) is proposing a windfall profits tax on top of everything else. If the ballot initiative passes, the state’s top individual income tax rate would soon be 16.15 percent, with the potential to increase to 16.55 percent.

Nationwide, the median top marginal income tax rate will be 5 percent once all currently scheduled rate reductions take effect. Neighboring Arizona will have a 2.5 percent flat tax next year, while Nevada forgoes an individual income tax altogether, though it does have a modest—and, most importantly, capped—payroll tax. Nearby Washington now taxes capital gains income, but not earned income. Other regional competitors like Colorado, Utah, and Idaho have competitive rates and have each adopted multiple rate reductions in recent years. But in California, the only direction is up.

This despite the fact that the state entered the most recent budget cycle with an unprecedented $97.5 billion surplus. The state’s budget is 35 percent larger than it was pre-pandemic—and that’s after adjusting for inflation. And while the record growth has surely stalled as the stock market falters, these new and proposed taxes have nothing to do with revenue challenges.

The Golden State has had a taxpayer-funded disability insurance program since 1946, the second state (after Rhode Island) to adopt such a program. It is currently funded by a State Disability Insurance payroll tax of 1.1 percent on the first $145,600 in wage income, yielding a maximum withholding amount of about $1,602. This payroll tax—like those for Social Security taxes at the federal level and unemployment insurance taxes at the state level—has a taxable wage limit, consistent with its design as an insurance program with capped benefits.

With the enactment of SB 951 earlier this month, however, the taxable wage limit has been eliminated, so the 1.1 percent payroll tax applies to all employment income. And while 1.1 percent is today’s rate, that rate is subject to adjustment every year based on program need and is currently authorized to go as high as 1.5 percent. Even at 1.1 percent, eliminating the taxable wage limit means that, as of 2024, California will have a 14.4 percent top marginal rate on wage income.

And it will go a lot higher if California voters approve Proposition 30 this November.

California Proposition 30, which creates a 1.75 percentage point surtax on income above $2 million, would bring the top marginal rate on wage income to 16.15 percent (and 15.05 percent on non-employment income). The tax is projected to raise $3.0 to $4.5 billion per year, with the bulk of the revenue earmarked for zero-emission vehicle infrastructure and purchasing incentives. The proposal has divided those who might normally advocate for additional electric vehicle (EV) infrastructure, as the tax has been championed by Lyft, which would benefit from EV rebates funded by the new tax as it transitions to a zero-emission fleet. Opponents, like Gov. Newsom, have characterized the tax as benefitting a special interest at the expense of the state’s economy.

Notably, like the existing surtax on income above $1 million (which yields the current 13.3 percent top rate), brackets would not be doubled for married filers, creating a marriage penalty. The tax would kick in at $2 million for both single and joint filers. And this bracket’s kick-in, like the existing surtax but unlike other brackets, would not be adjusted for inflation.

With 21 states cutting individual income tax rates since last year, such increases set California at even greater odds with its state competitors.

To top it all off, Gov. Newsom is responding to California’s gas prices—the product, at least in part, of California’s high gas taxes and costly regulatory environment, as well as refinery issues—by calling for a windfall profits tax on the oil industry.

According to recent AAA price data (October 12th), the average price for a gallon of regular gasoline is $6.25 in California, compared to a national average of $3.92—a premium of about 60 percent over prices elsewhere. Newsom has alleged that oil companies are price gouging California consumers, chalking California’s higher prices up to corporate greed, though he has not offered much by way of an explanation of why every oil company would be greedier in California than in the rest of the country.

If anything, a windfall profits tax on the oil industry would raise prices even higher, while creating further supply problems down the line. Across the country, refinery capacity is already stretched, and this appears to be a particular issue in California. But investing in new refineries is risky: a refinery must be in operation for many years to justify the initial capital investment. And with states, led by California, demanding that all new vehicles be zero-emission by 2030, investors may doubt that they can recoup their investments even if there’s more than adequate demand right now. A tax on “windfall” or “excess” profits would make investment prospects even more dubious.

The oil industry is notoriously high risk and high reward. Large profits in some years help carry companies through lean years that could devastate other industries. The industry’s profit margins are staggeringly high right now, but one doesn’t have to go back very far to see the opposite, and on average, oil industry profits have been below those of many other industries. In fact, the energy industry’s 10-year equity return was negative until the upswing in 2021, and profits remained low until 2022. A windfall profits tax that hits hard in 2022 after a decade of lean years makes it much less likely that the necessary investments will be made in the future. And consumers will pay the price.

A windfall profits tax is not without precedent. In 1980, President Jimmy Carter unveiled a windfall profits tax on the oil industry, resulting (according to the Congressional Research Service and other researchers) in reduced domestic production. 

California is no stranger to high taxes, and the state has enough going for it that its economy can withstand higher tax burdens than would be viable in other parts of the country. But there’s always a tipping point. The growing exodus of businesses and individuals from California to more taxpayer-friendly climes should be an encouragement to pump the breaks, not hit the accelerator.

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