Noted Economist's Plan to Rescue California: Flatten it!

No, it’s not what you think. When Arthur Laffer (of Laffer Curve fame) says “flatten California,” he’s not talking about steamrollers. He’s talking about the Golden State’s tax rate.

“Firms, people, investments, and tax revenues are fleeing California, repelled by the most onerous antigrowth business environment in the United States,” Laffer writes in City Journal.

“California’s after-tax rate of return for doing business lags so far behind other states’ ... 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,” he adds.

Although Laffer -- himself a member of the California exodus -- has lobbied for a flat tax in the broken state for years, his efforts have been met with little success. However, now that California’s financial crisis has taken on comical proportions (a $16 billion shortfall?), maybe -- just maybe -- state lawmakers will listen to what he has to say.

“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,” Laffer writes, arguing that the idea of taxing oneself into prosperity is absurd.

He explains the situation:

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.

Laffer goes on to prescribe a cure for California’s financial ills. He suggests the state scrap “all its state and local taxes and fees” (except for “sin taxes” because those don’t really have anything to do with revenue) and replace everything with a flat tax of six percent “on two distinct bases.”

“One tax base would be personal unadjusted gross income from all sources, with only a few deductions,” he writes. “A single tax rate would apply across the board, from the first dollar earned to the last.”

“The other tax base would be businesses’ net sales, or ‘value added’ -- that is, the difference between sales and production costs, which equals the state’s gross domestic product when aggregated across California,” he adds.

He argues that a six percent tax rate would not only curb the trend of people avoiding taxable income, but that a broad tax base would also remove possible places for people to hide income to avoid taxation.

California Gov. Jerry Brown

“That’s it. This tax system would yield as much revenue as all of California’s current state and local taxes. At the state level, the taxes on business profits, payroll, gas, capital gains, and stock options would disappear,” he writes. “Locally, property taxes would follow suit. All sales taxes -- state, county, city, and special-district -- would likewise be abolished.”

However, despite the fact that his ideas could save California, state lawmakers seem pretty intent on raising taxes in order to generate revenue. Of course, with an unemployment rate of 10.9 percent, the worst in the country, tax increases could be disastrous for the already fragile economy.

For California’s sake, maybe lawmakers should try something different. Maybe they should try reducing taxes instead of continually raising them.

“Without question, other major reforms are also needed in California. One could get lost for weeks in the state budget, with its vast unfunded liabilities, and come up with innumerable ways to save money that most Californians would find reasonable,” Laffer writes.

“But the tax reform that I’ve outlined would be a big step toward California’s becoming the Golden State again,” he concludes.

Read the full article here.

Front page illustration: Chad Crowe/Wall Street Journal