California's taxes are already bad enough -- with an income tax rate of 9.3 percent on incomes above $38,291, a 10.4 percent tax on financial institutions and a 7.25 percent sales tax. California's problem is runaway spending, and the right thing to do about that is to do the right thing. A "Citizens Budget" produced by the Reason Foundation and Performance Institute offers a perfectly sensible list of $18.2 billion in spending cuts, in addition to the governor's modest proposal -- enough to balance a two-year budget and leave room for a badly needed reduction in the state's punitive income-tax rates.
The Tax Foundation ranks states according to their tax climate for business. By their impressively rigorous analysis, states with the very worst tax systems are Mississippi, California, Arkansas, Ohio, Nebraska, Hawaii, New York, Maine, Minnesota and Louisiana. At least three of those 10 -- Arkansas, Nebraska and New York -- have been busily making the worst state tax systems even worse. Ohio, too, if you count an increase in the sales tax (both income and sales taxes were raised in New York and Nebraska). California is close to making the same mistake.
No amount of federal aid could deter the legislators of these four or five states from their determination to tax their economies into oblivion. On the contrary, those state officials are among the most likely to use their slice of the newest $20 billion of federal slush funds (a payoff in the tax bill) to sustain unsustainable spending plans until after the next election.
The best tax systems on the Tax Foundation's list include those of Wyoming, New Hampshire, Nevada, Colorado, Alaska, South Dakota, Florida, Washington, Oregon and Tennessee. Note that six of these 10 have no tax on individual income and four have no tax on corporate income.
How states collect taxes can be nearly as important as how much they collect. Sales and excise taxes, so long as they are not uncompetitive with neighboring states, are somewhat less harmful than income taxes because you can delay the tax by saving. User fees, such as college tuitions and road tolls, make sense. Steeply progressive income tax systems, by contrast, seriously wound state economies because they repel skilled mangers and professionals and the companies that depend on them.
In 1998, The Journal of Public Economics published a critical study by Martin Feldstein and Marian Vaillant, asking, "Can State Taxes Redistribute Income?" The answer is "no."
States like California, New York, Oregon and Vermont that try slapping high tax rates on high income just end up exporting people with unusual talent and skill (that's why Tiger Woods moved from California to Florida). Remaining managers and professionals become scarcer and therefore more valuable. Before-tax salaries and fees are higher in high-tax states, Feldstein and Vaillant found, to attract and retain qualified executives, physicians and the like. State taxes supposedly aimed at the rich end up being a burden on everyone else. State consumers end up paying more for professional services, and state businesses become less competitive because they have to pay higher managerial salaries than states with little or no income tax.
The fundamental "crisis" of the states is that government spending in most states has increased far more rapidly than the incomes of taxpayers. States that face the problem by cutting spending and tax rates are certain to prosper, just as Ireland did after slashing national spending and tax rates. Higher tax rates are no solution to the unaffordable spending schemes of overtaxed states like California and New York. On the contrary, high tax rates are a symptom of excess spending and a major cause of inferior economic performance.