California dreamin'?

As one of the many who have left California over the past several years, I have been saddened to see what a mess Sacramento has made of the Golden State. California is awash in a tide of red ink, and the intellectual and technical infrastructure that made California the destination for entrepreneurs and fueled its economic growth is fraying: businesses and their high-net worth patrons are fleeing the state for locales that have lower (or no) taxes and less cumbersome regulation. The result is that California is killing the goose that laid its golden eggs.

Today in the Wall Street Journal comes a ray of California sunshine. It seems that Governor Arnold Schwarzenegger, just a year away from the end of his final term, has finally found the backbone he's been missing since he went to Sacramento. On the table? All manner of cuts to services and a the possibility of a flat tax for corporations and individuals -- a central requirement to bringing fiscal certainty back to the state. As the graph below shows, one of the states biggest problems is that state tax revenues rise and fall more excessively than does state personal income:

"From 2003 to 2008, state revenues boomed by 40% as the economy expanded. But in the last year, revenues have fallen by more than 20%. Politicians in Sacramento pile on new spending in the boom years, building in new pension and other commitments that are unsustainable in the downturns. The interest groups furiously oppose any spending decline, so the politicians dutifully raise taxes, and the cycle repeats."


The result is boom followed by bust...a cycle that leaves California scrambling during down times for revenue to support its profligate spending when things are going well. Its as if you create a personal budget for yourself the year you sell your house with a one-time capital gain -- using that year's income as the basis for your new lifestyle. The result is that you start living above your means, with bills that you can't pay down the line. Its no way to run your life -- and its no way to run the state of California, either.

To his credit, the newly disciplined Governator has found the idea of a flat tax as a solution to the state's ills:

The best idea is his semi-endorsement of a flat tax for California. The state's budget problem has two main causes: The first is runaway spending and the second is a tax structure that smothers businesses and entrepreneurs. California's income tax is the most progressive of all 50 states, with the second highest top rate (10.55%) after New York City's 12.62%. The Governor's revenue office calculates that between 50% and 55% of the income tax in the state comes from Kobe Bryant and the rest of the richest 1% of taxpayers.

Mr. Schwarzenegger has appointed a bipartisan tax reform commission and it is exploring a "uniform tax" with a rate of 6% on individuals and corporations with few deductions. This would raise enough revenue to run the government while reducing the sharp revenue shifts from boom to bust and back. More important, it is the kind of tax overhaul that could start to attract business back to the state.

All of which makes perfect sense -- until you factor in the left-wing state legislature, which believes that punishing the rich is part of their progressive mandate, never mind if it actually hurts the state economy. The Democrats in the state Assembly and Senate are ideologically driven to tax and spend, and believe that the wealthy pockets they seek to plunder have no bottom. They also deeply believe that economic incentives are not linked to behavior (meaning that you can keep taxing and the people will keep earning at the same rate as before). A flat tax is thus anathema to their social sensibilities and that tired old mantra that the "rich should pay their fair share".

But what if there aren't any rich left to tax?