Take a tax hike

Lots of newspaper editorial writers in California (including at this newspaper) want Governor Arnold Schwarzenegger to raise taxes, a poll shows voters support certain limited forms of tax hikes, and the level-headed chief legislative analyst in Sacramento says Schwarzenegger still needs to find another $6 billion in taxes or cuts for 2005-2006.

In fact, you’d have to say there’s been a veritable groundswell of pressure mounting on Schwarzenegger and the Republicans to accept fate and finally raise taxes in California.

But not so fast. I had a chat with some of the best-informed Democratic and Republican strategists and consultants in California during the past few days. Despite their many differences on policy and politics, they do not paint a picture of the governor or the Republicans bending on taxes in 2004.

There are many reasons why neither side believes the Republicans will hike taxes. Both sides believe taxes may be raised if the governor’s bond issue fails on the March 2 ballot, because that failure would put California in much more severe financial straits. But most of the experts say Schwarzenegger will prevail on March 2 once he begins campaigning for his twin measures.

Those two March measures include a budget spending cap and a $15 billion bond that is mostly a refinancing of $12 billion in previous, Davis-era debts that the Legislature and Davis borrowed by selling legally dubious bonds that should have been approved by voters. Schwarzenegger is trying to make that transaction right so that the state doesn’t spiral into further crisis. Despite a recent poll showing that only 35 percent of voters support the bond, the truth is that most voters don’t even know what it does.

The governor is so popular in current polls—with half of Democrats saying they like him and with much bigger numbers from independents and Republicans—that once he explains what the intent of the bond is and appeals to Californians for their help, he’s likely to get it.

Bill Carrick, a Democratic consultant advising the Dick Gephardt presidential campaign, predicts that the bond will pass and that Republicans won’t bend on taxes unless Schwarzenegger does.

“Schwarzenegger is in a pretty special place because voters feel like he was elected to fix the budget and straighten out the fiscal mess, and as a consequence, they are willing to invest a lot of capital in Arnold and what he wants to get done. If Schwarzenegger says we need to raise taxes, then you will see a coalition of Republicans and Democrats working together to get that done. But I don’t think you will see any movement at all on raising taxes unless he supports it,” Carrick said.

Dan Schnur, co-founder of Command Focus, a leading Sacramento Republican consulting firm, sees no scenario in which Schwarzenegger or the Republicans will decide to raise taxes. “They will hold firm. They demonstrated last year they were able to hold it together when Gray Davis needed only a few of their votes to raise taxes. He wasn’t able to pry away one. With the governor on their side and the political wind at their back, it is awfully tough to see a scenario in which they’ll raise taxes. When Schwarzenegger came to an agreement with the teachers union [to accept $2 billion instead of $4 billion in school funding increases], the Dems lost the education issue. And that means they lost the middle class—and every political battle is a fight for the middle class,” he said.

Parke Skelton, a Democratic consultant, thinks the March 2 bond faces a tougher sell than Carrick thinks it does. But he, too, sees the Republicans refusing to raise taxes. “I don’t see how Schwarzenegger moves from no taxes to taxes,” Skelton said. “The Republicans have vowed not to raise taxes and dug themselves in so deep on that issue they would have real difficulty turning around. There are certain things they could do instead that are like tax increases but are not really, such as sunsetting the manufacturing tax credit, which would bring in $400 million in revenue. But that kind of thing tends to gore the friends of the Republicans. … I don’t know what they will do to fill the hole.”

Allen Hoffenblum, a Republican consultant, says that unless the bond issue fails, Schwarzenegger will hold firm against taxes. “Schwarzenegger told voters he would not do that. There was a compact with voters that, when it comes to fiscal policies, he said, ‘I will be with you.’ He said to voters, ‘You may not agree with me on environment or on social issues, but I will be with you on fiscal restraint,’ and he cannot violate that compact without voters’ permission,” Hoffenblum said.

Democratic political strategist Ben Austin, a former aide to Bill Clinton and now an aide to Rob Reiner, says Democrats can win on taxes only if they alter their approach. “The bad news is that Republicans are much smarter than they are given credit for and have a history of outflanking the Dems on taxes. The good news is that when it’s an intellectually honest debate over services the public wants and the taxes needed to pay for them, the Democrats can win. … Yes, tax increases are unpopular, but Democrats who are strategic and smart can win this argument. It will be interesting if Democrats in Sacramento hold their ground and insist on new taxes, because they have not shown this backbone in the past,” Austin said.

The recent poll showing that only 35 percent of voters back the governor’s March 2 bond was done by the Public Policy Institute of California (PPIC). The PPIC poll also showed voters are willing to accept limited new taxes—for the rich and on cigarettes.

A budget expert involved in internal Democratic fiscal talks told me, “Taxing the rich won’t fly. We have the most progressive tax in the nation. Probably too progressive.”

You might think that’s blasphemy coming from a liberal Democrat, but it’s mathematical reality. California got into its current crisis by relying too heavily on the rich to fill the state’s budget coffers. When the highly unreliable rich lose their companies or leave California, as has happened here, the state treasury goes bare fast.

As Sacramento Bee journalist Dan Weintraub discovered when he crunched the numbers last year, 44,000 Californians were millionaires in 2000. They earned 21 percent of the state’s income but paid nearly twice that percentage in taxes: 37 percent of state income taxes, or $15 billion. In 2001, the dot-com bust slashed the millionaire pool down to 29,000 people, who earned 12 percent of the state’s income but paid more than twice that: 25 percent of state income taxes, or $8 billion. Thus, in one year, California’s treasury lost $7 billion when the millionaires disappeared.

Yet, California still relies on a highly unstable crowd the size of the town of Needles for a quarter of its income taxes. Scary stuff.

That’s why the tax system needs an overhaul to make the budget less reliant on personal income taxes, not more reliant on them. Only a fool would seek legislation to make us even more reliant on the rich, but watch somebody try. It makes for a cute sound bite.

Voters are willing to accept new taxes on cigarettes, but that poses another problem. California doesn’t have enough smokers, so cigarette tax hikes don’t bring in enough money. Also, cigarette taxes encourage state bureaucrats to hope for more tobacco sales in California instead of fewer tobacco sales. Not good.

Another tax hike of 50 cents per pack would bring in bring in only $500 million a year, yet California faces several billion in deficits this year and next.

If taxing the rich even more invites instability and chaos, and if taxing cigarettes doesn’t make much of a dent, why isn’t the Legislature fixing the entire tax structure so that California has a steadier income—like so many states have done? In 2002 and again in 2003, Davis and the Legislature promised “structural reform”—and then didn’t do a damned thing.

Instead, I predict Republicans will oppose taxes, as will the governor, and Democrats will demand taxes for the rich and on cigarettes, baby diapers and so on.

The Democrats enjoy a majority in the Legislature, but they need several Republican votes to get the two-thirds vote necessary to raise taxes and pass a budget. Just like last year, it will take the Democrats until about July to realize the Republicans aren’t budging on taxes.

Schnur, the Republican consultant, says legislative Democrats “are like Wile E. Coyote in the old Road Runner cartoons. They run into walls, they run off cliffs, they blow themselves up. They don’t learn. Right now, they are probably ordering their menu package from Acme products, and it will be July before they figure out they are on the wrong end of the tax issue.”

Austin, the Democratic strategist, says Republicans “who want to dismantle programs that are very popular with swing voters, in order to avoid a tax increase because the right wing won’t let them, do so at their political peril.”

Déjà vu, anyone?