Megan McArdle describes one of the biggest problems with a progressive income tax — the volatility of the revenue. This is why California in particular is in such big financial trouble — in boom times the coffers encourage them to create all sorts of programs, needed or otherwise, for which the revenue collapses in a recession. A flat rate would have much less dramatic swings.
11 thoughts on “California’s Problem”
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When tax revenue varies less than economic output it has a net destimulating effect during recessions and stimulating effect during booms, when it varies more it has a net stimulating effect in times of recession and destimulating effect during boom times. As a large collectivist institution one would expect it wise to use government to help average out the economy with regard to recessions and booms. It is particularly inefficient and destimulating when government combines a destimulating recession tax policy with a stimulating spend policy.
When the government seeks less volatile tax revenue the result is to inflict greater volatility upon the tax payer. It seems to me that what the government really should be trying to do is take volatility out of the economy. To do this it should be saving extra during the boom times in order to cover lower tax revenues during recessions.
With these relationships in mind, I suspect government should be adopting a more not less volatile tax system. But this would require a degree of fiscal responsibility which increasingly seems to be beyond the ability of governments to manage. Increasingly the government seems inclined to outsource economic volatility to the private sector – and we wonder why we get bad recessions…
I don’t know about California, but Illinois, which is mentioned in the article as on of the “states that are the most heavily reliant on the taxes of the wealthy” has a flat tax rate.
Also of note is that, mathematically speaking, a flat tax is still subject to dramatic swings. 10% of $200,000 is half as much as 10% of $400,000 – AKA “still a dramatic swing.”
Actually scrub that, it is likely much better to get government fingers out of the economy, the market is much better at deciding how much to cut and how much to borrow/save. Let the market do the stimulating/destimulating and stop the government from doing so. This means putting the government on a fairly fixed revenue and keeping them accountable. Basically, the taxpayer is more competent at dealing with volatility than the government is so it is better to let the taxpayer take the brunt of it.
From the article: “Nearly half of California’s income taxes before the recession came from the top 1% of earners.”
This is pretty much the case for US federal income taxes as well. The top 1% pay a significantly disproportionate share, shown to be more than 38% of all federal taxes according to this article: http://www.davemanuel.com/2010/11/04/what-percentage-of-federal-income-taxes-do-rich-people-really-pay/
Chris, I think your point is not that important. Perhaps a better question would be “Why does Illinois have one of the biggest budget holes when compared to other states?”
The answer is obvious at both the state and the federal level: our elected officials are spending too much money. Wouldn’t it make more sense for Illinois (or any other state) to say: “Our expected revenues for this year are approximately $54 billion. Let’s stack rank our spending, determine how much money each department really needs, and everything below the line will not be funded for the current year. This is unfortunate, and we hope to restore some of those programs at some point in the future, but we have carefully identified our priorities and must take responsible fiscal steps to protect our future.”
Jiminator – the problem was we needed to increase taxes years ago. Illinois previous rate was 3%, the lowest rate of any state with an income tax. The new rate of 5% puts them in the middle of income-taxing states (and below Wisconsin), which is probably where it should be.
when it varies more it has a net stimulating effect in times of recession and destimulating effect during boom times.
Yes but only if you’ve fallen prey to the Keynesian mental illness. If, as a rational man, you understand instead that the entire notion of government “stimulus” is utter bollocks — as much a bogus play on words as calling government purchase of state pensions an “investment” or the non-raising of tax rates a “tax cut” — and one would hope the (null) result of last year’s $1 trillion “stimulus” would give pause to anyone less in the grips of religious frenzy than Paul Krugman — then this logic is all backward.
Because, as perhaps you meant to imply by your second post, a progressive tax structure converts the excess income of boom years from private savings to public consumption, which is just about the opposite of what you want to do, and has the vicious monetary effect to boot of spring-loading the inflation that tends naturally to occur as the boom tapers off.
the problem was we needed to increase taxes years ago. Illinois previous rate was 3%, the lowest rate of any state with an income tax. The new rate of 5% puts them in the middle of income-taxing states (and below Wisconsin), which is probably where it should be.
Interesting. I still believe that both the feds and the states have got to get their spending under control. If they would stack rank their priorities, and not spend any more money than they are taking in, folks would have a much better method to speak out on what programs should be above or below that line. For legislators to insist that everything is important and no significant reduction in spending is even thinkable, we’ve got the wrong folks in office.
In Illinois, we are cutting spending. There are still things we (for values of “we” that include “majority of residents”) want to do that we can’t unless taxes go up.
It’s worth recalling that a significant part of the problem comes from the bad performance of pension funds like CALPERS (which according to Wikipedia is down roughly 80 billion dollars from its peak of 260 billion). This sort of failure creates a huge sudden liability around times of economic downturns.
Well if the legislature hadn’t let those buggers invest in California real estate at the top of the bubble, they might not have that problem, Karl.
the problem was we needed to increase taxes years ago.
Nah, Caterpiller would just have left sooner.