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Executive Summary

Greening the Golden State: A Tax Reform for California's Future

By M. Jeff Hamond
With Gary Wolff, Clifford Cobb, and Mark Frame

The Rationales for Change
California's Economic Future
California's Tax System
California's Precious Environment
Options for Tax Reductions and New Revenues
Three Tax Shift Scenarios and Their Impacts

A new report from Redefining Progress, Greening the Golden State: A Tax Reform for California's Future, outlines an innovative approach to fiscal and environmental policy in California. This new approach, called an environmental tax shift (ETS), holds the potential to improve many of the state's most pressing problems while attracting broad support from lawmakers, business owners, and taxpayers alike.

Under an ETS, California would reduce current state taxes on "good" things that it wants more of -- labor, profits, property improvements, and investment -- and replace the revenue with new levies on "bad" things that it wants less of, such as pollution, speculative land holding, resource depletion, waste, and destruction of habitat.

The ETS examples provided in the report would replace a portion of state revenues -- perhaps 5 to 7 percent, or about $5 billion -- with revenues from new environmental taxes or fees. Total state revenue would be unchanged, however, and major shifts in the tax burden up or down the income scale could be avoided. Variations of this idea are being explored or have been adopted in other states and countries.

Such a shift from taxing "goods" to "bads" offers a promising chance to boost the state's economy by reducing taxes on productive economic activity (i.e., labor and investment) while establishing powerful tax-based incentives to reduce pollution or improve land use. What's more, unlike other tax reform proposals, an ETS could attract broad political support. Many different constituencies -- environmentalists, middle-class families, anti-regulatory activists, small business owners, high-tech workers and investors, and so on -- will all find something to like about this policy idea.

Among other benefits, Greening the Golden State finds that a California tax shift could:

  • Create a prosperous business environment for the industries that are leading California's current economic expansion and are likely to continue to do so well into the next century. These include high technology, tourism and entertainment, and professional services.

  • Address a number of important and persistent environmental problems -- such as sprawl, air and water pollution, and inefficient water use -- at lower cost than new government regulations.

  • Spur new development and job creation in low-income areas of the state that need it the most. One reason for this is that energy- and materials-efficient economies tend to employ more people than less efficient economies of the same size.
  • Provide much-needed tax reform that will empower average families to reduce their taxes and result in a tax system that is more in line with other states, thereby improving California's competitiveness. And this tax reform can be achieved without shifting the burden of taxation onto the poor.

The Rationales for Change    (back to top)

Like most tax systems, California's current state tax code sends the wrong signals to virtually everyone. It discourages work, enterprise, and capital formation while it encourages urban sprawl, pollution, waste, and inefficient resource use.

On the other hand, an ETS changes these incentives by taxing "bad" things directly, as opposed to the current approach that seeks only to reduce taxes on particular "good" things. For example, when we want to promote a particular social goal -- say, increasing the number of people with health insurance -- we frequently pass tax credits or deductions that we think will help accomplish that objective. But these numerous special preferences result in a convoluted system that no one understands, and they cost so much in lost revenue that we have to raise rates on everything else.

An ETS asks: What if we could change behavior and accomplish social goals both through what we tax as well as what we "untax"? What if we could accomplish social, environmental, and economic objectives all at the same time? An ETS can meet these objectives, simply by making small changes to what we tax in order to raise the revenue for needed public services.

How would an ETS work? There are many options. California could pass a higher tax on the assessed value of urban and suburban land, thereby providing a market-based tool to limit urban sprawl, and use the revenues to reduce the (larger) portion of the property tax that falls on structures and improvements. It could increase the gasoline tax and use the revenues to eliminate the vehicle license fee or reduce the state sales tax. It could tax energy and materials use a little bit more, and labor a little bit less. The central point is that a portion of state revenues would be raised by taxing environmental "bads," and the revenues would be directed to other tax cuts, rather than new spending.

California's Economic Future   (back to top)

California's economy has made a remarkable turn for the better since the recession of the early 1990s. Since January 1996 alone, the state has added almost 1 million new jobs, and more than 1.5 million since the recession's low point -- a rate of job creation and economic growth that has outpaced the nation as a whole. Income and spending are up; inflation, unemployment, and interest rates are all relatively low.

Still, things could be better. California can do more to accelerate job gains and income growth among its working poor and immigrant populations, and in its inner cities. It can do more to create a business environment that will sustain its key growth industries. It can develop public policies that lead the state toward the economy of the future, rather than maintaining the extractive, wasteful, resource-intensive industries of the past.

The trends in California's economy indicate that an environmental tax shift could:

  • Benefit the industries leading California's expansion, notably high technology, tourism and entertainment, and professional services. The state's economy has changed, and its tax code must reflect these changes by reducing taxes on things the state has a competitive advantage in -- such as labor and brainpower -- while increasing them on things it needs less of, such as pollution and waste.

  • Create new opportunities for those who have been left behind by recent job growth and income gains. An ETS can help accomplish this objective by reducing taxes on labor, encouraging more compact development, and spawning new enterprises based on recycling, reuse, renewable energy, and/or energy efficiency.

  • Provide incentives for businesses to look for profit-making ways to reduce their emissions, as many businesses have already done. Greening the Golden State reviews how 11 large companies in California have both increased profits and improved their environmental performance.

California's Tax System  (back to top)

California's tax system embodies definite strengths and weaknesses. Its personal income tax is the most progressive in the country, and its revenue sources are reasonably varied, ranging from income and sales taxes to property taxes on vehicles and a menu of excise taxes. On the other hand, its property tax entails a number of inequities, its sales tax is regressive, and the system seriously restricts local governments' alternatives for raising revenue. Greening the Golden State examines the major taxes in California's tax code, pointing out the major pros and cons of each tax.

One important problem facing California is the fact that while the state's overall tax burden places it near the middle of the 50 states, its distribution of revenue among the different taxes is troubling. For example, California's personal and corporate income taxes rank near the top nationally, and are much higher than surrounding states, but many of its other taxes rank much lower-particularly the gasoline tax that ranks 43rd in the country. This imbalance should be corrected if California is to continue to compete.

If the state can shift this revenue balance closer to the national median, it might not only improve its competitive position, but also protect itself against future deficits during recessions by reducing its reliance upon income taxes.

California's Precious Environment<  (back to top)

Key environmental problems that can be addressed by an ETS include urban sprawl and traffic congestion, which increasingly are becoming statewide rather than purely local issues, and the continuing problem of air and water pollution.

Current projections show that the state will add 2.8 million new jobs and nearly 5 million residents by the year 2005, but such growth brings problems for communities and the environment because it increases pressure for new development. Such growth is an environmental problem because the state's incentives-low land taxes, low fuel and energy taxes, and the failure to value environmental assets in land-use decisions-all lead down a path of growing outwards, not upwards. An ETS can help in this regard by changing economic incentives in the state without stripping local governments of their land-use decisionmaking authority. It would use the power of markets rather than regulation to encourage compact development and improve the quality of life in many communities-and it can do so without abandoning the tax limitations of Proposition 13.

Finally, there is the continuing problem of pollution, which has significant health impacts and important, wide-ranging effects on the state's economy. California's air and water have improved in many ways in recent years, but problems are still significant and will worsen with continued population growth. Where air pollution is concerned, California is in a uniquely good position to improve because there are no factories or power plants to the west (the direction from which the jet stream transports pollution).

An ETS can help reduce both air and water pollution in the state by driving changes in behavior through the price system, rather than government edict. Firms and individuals would be encouraged to find the cheapest way to achieve the goal of conservation. And by returning the tax revenue to the taxpayers via reductions in other taxes, an ETS provides the opportunity to protect the environment for future generations with reduced concern about economic costs or lost jobs.

Options for Tax Reductions and New Revenues   (back to top)

The tax reductions in Greening the Golden State fall into five categories:

  • Reductions in personal and corporate income taxes, both rate reductions and new tax credits.
  • Tax reductions targeted to labor, such as state tax credits based on a portion of federal payroll taxes paid.
  • Reductions in the state sales tax.
  • Property tax changes, including shifts between the buildings and land portion of the tax (but no outright property tax increase).
  • Reductions in the motor vehicle "in lieu" fee, which currently taxes the ownership rather than the use of motor vehicles-even though the latter activity causes the environmental harm.

The possible revenue increases fall into six categories, listed in the order they appear in the report:

  • Energy and electricity, including a tax on the carbon content of fossil fuels or the repeal of the state sales tax exemption on utilities.
  • Transportation and parking, including higher taxes on motor fuels.
  • Air pollution, water pollution, and toxic waste.
  • Land use, most prominently the buildings-to-land property tax shift (a.k.a., "split-rate property taxes"), but also including new "impact fees."
  • Solid waste.
  • Water, which could include either a tax on the value of water rights, or a tax on water consumption.
Three Tax Shift Scenarios and Their Impacts    (back to top)

Finally, the report presents three different revenue-neutral ETS scenarios and discusses whether the scenarios might be viewed as equitable or fair. Each of the scenarios is designed to replace approximately $5 billion in state revenues, or about 7.5 percent of revenues in 1998. Redefining Progress does not advocate any scenario, or any particular tax change, over any other. The report is designed to spark discussion, and we hope the report and the scenarios will do just that.

The scenarios are summarized below. Please see the report text for more complete information, and for discussions of their likely impact on tax equity and fairness.

Scenario 1: Energy and Transportation Tax Shift

Gasoline tax increase of 17¢ a gallon 2.74
Eliminating the sales tax exemption on utilities 2.06
New sales tax revenue as a result of the gas tax increase 0.13
Total new taxes 4.93
Exemption of the first $2,000 of wages from the federal payroll tax, in the form of a refundable state income tax credit (3.61)
An additional one-third reduction in the motor vehicle "in lieu" fee (0.94)
New state EITC equal to 10 percent of federal credit (0.38)
Total tax reductions (4.93)

Scenario 2: Resources and Pollution Tax Shift

State carbon tax of $20 per ton 1.94
State land surtax (on assessed value) of 0.2 percent 1.49
Tax on water consumption of $20 per acre-foot 0.80
State tax on solid waste of $14 per ton 0.44
A 10 percent tax on fertilizer, lime, and pesticides 0.16
New state sales tax revenue as a result of the carbon tax 0.07
Repeal of several tax breaks for the oil industry 0.05
Total new taxes 4.95
A 10 percent reduction in the state general fund sales tax (1.75)
Reduction in state personal income taxes by $1.0 billion (1.00)
An additional one-third reduction in the motor vehicle "in lieu" fee (0.94)
Reduction in state corporate income taxes by $500 million (0.50)
New state EITC equal to 20 percent of federal credit (0.76)
Total tax reductions (4.95)

Scenario 3: Property Tax Shift

Allow local governments to use split-rate property taxes (i.e., increasing land portion of property tax) 3.00
Additional gasoline tax of 8.5¢ per gallon 1.37
Tax on water consumption of $20 per acre-foot 0.80
New sales tax revenue as a result of the gas tax increase 0.06
Total new taxes 5.23
Allow local governments to use split-rate property taxes (i.e., reducing property taxes on buildings and improvements) (3.00)
A one-half cent reduction in the state sales tax (1.75)
New state EITC equal to 10 percent of federal credit (0.38)
Removing tangible business property from the tax base (0.13)
Total tax reductions (5.26)

Download "Greening the Golden State" (115 pp. / 653 kb)