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Thursday, June 14, 2012

Flatten California!

Art Laffer
A proposal to fix the state’s business-killing tax regime

Six years ago, I decided to leave Rancho Santa Fe, California, for Nashville, Tennessee. That’s a major undertaking for anyone, but particularly for a 25-year resident of Southern California, dragging his whole family and company along with him. I still remember decision day: January 5, 2006. I’d been disappointed in November by the defeat of Governor Arnold Schwarzenegger’s ballot initiatives, which aimed at reining in state spending, but I was utterly aghast as I read the transcript of the governor’s State of the State speech just days into the new year. Clearly, he had resolved to move in a big-government direction, making proposals that included issuing billions of dollars’ worth of new bonds to pay for statewide infrastructure projects. The last thing California needed was more government spending. It was time for me to go.

I’ve had a lot of company of late. Firms, people, investments, and tax revenues are fleeing California, repelled by the most onerous antigrowth business environment in the United States. California’s after-tax rate of return for doing business lags so far behind other states’ (especially zero-income-tax competitors such as Texas, Tennessee, and Florida) that the exodus shouldn’t surprise anyone. Yet the state’s Democratic leadership is pushing a November ballot measure aimed at raising income and sales taxes in order to make up for lost revenue.

Tax hikes, especially during trying economic times like these, make no sense. Economies don’t tax themselves into prosperity. What California needs is a radical tax overhaul—to be precise, a single, low-rate flat tax. Such a reform would spur a renewal of economic activity and investment while continuing to raise the revenues that the state needs.

The upcoming fifth edition of Rich States, Poor States, a publication that I coauthor annually with Stephen Moore and Jonathan Williams, will show just how antigrowth California’s business environment is. Our study uses 15 pro-growth attributes to rank the states’ economic competitiveness. In the first four years of the index, California never ranked outside the bottom ten states; this year, it will probably manage that feat—just barely—thanks to the expiration of numerous temporary tax increases (several of which Democrats want voters to reinstate in November).

Taxes are indeed a big part of California’s economic problem. At 10.30 percent, the state’s top marginal personal income-tax rate is the fourth-highest in the country, and its top marginal corporate income-tax rate of 8.84 percent is 25 percent above the national average. Excessive taxation is an equal-opportunity tormentor, afflicting labor and capital, poor and rich, men and women, old and young. In the short run, higher taxes on labor or capital will reduce after-tax earnings. Some people will violate the law and fail to report taxable income; others will use legal options, including tax deductions and credits, to reduce their payments. In the long run, residents—those who can afford to, anyway—will vote with their feet and leave the state, shifting the tax burden to lower-wage workers, as well as to immobile land and property.

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