Opinion

California's Swamp Is Equally Deep

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Posted: Apr 19, 2018 12:01 AM
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California's Swamp Is Equally Deep

The Sacramento Bee reported yesterday that the California Franchise Tax Board (CFTB) has reported that about one million Californians will pay about $12 billion more in federal income taxes because of the new tax bill. It further reports that of the $12 billion, the top 43,000 earners will pay a combined $9 billion of additional federal income taxes. This, they say, is from the loss of state and local tax deductions over $10,000.

Likely preposterous. 

What is entirely accurate is that if the California legislature and the governor pass legislation to work around the non-deductibility of state and local taxes over $10,000 that the California legislature would be making a gift of perhaps $9 billion of federal money to those 43,000 top earners.

Before explaining why the CFTB’s numbers are suspect, there is an interesting history to these numbers. I live in California and I am an accounting professor. The first day I saw there was an initial CFTB report on the impact of the new federal tax bill on Californians, I printed the report and took it with me to read during lunch. That report is only about a dozen pages. It did not take fifteen minutes to conclude that the report had serious errors. At a glance, I could see that each of the four examples provided an incorrect answer with respect to the impact of the new tax bill. 

The Washington Post’s analysis of the new tax bill showed that well over 90% of all taxpayers earning between $149,400 and $732,800 would have significant federal tax benefits from the new tax bill. Yet, here were three out of four examples showing significant tax increases and the fourth dramatically understating the benefit.

I went back to the office and using readily available tax software found on the internet, confirmed that every example was wrong. In one example showing a married couple with income of $201,000, the CFTB reported a federal tax increase of $1707 while the correct result was a tax decrease of $4294. 

I contacted my state senator and we sent a professional memorandum to the CFTB showing the calculations to be incorrect. At that point, the CFTB had determined 1.6 million Californians would pay more federal tax under the new tax bill. 

On March 20th, a revised report was released by the CFTB. This report reduced the number of California taxpayers who would pay increased federal taxes from 1.6 million to 1 million. 

This time, the CFTB examples were of taxpayers with highly unusual tax/financial situations rather than just average folks. One example depicted a single head of household with one college age dependent earning $125,000 per year owning a home with an assessed value of $1,463,000 with a home mortgage of $160,000. This is the type of fact pattern needed to show an increase in federal taxes. Most of the examples are comical.

So, again we contacted the CFTB. This time, I pointed out that the examples were not realistic and the caveats to their calculations indicated they really did not have sufficient data to make any realistic estimates. This based on the CFTB’s statement that: "We have no way of knowing how much income reported by taxpayers on federal schedules C and E qualifies for the new federal deduction applicable to 'qualified' income from certain small businesses. Therefore. the portion of taxpayers' business income that is eligible for the new deduction is modeled on state averages. We do not have all of the data necessary to accurately calculate federal AMT under the new law". 

We asked to see the model and were informed that it could not be shared publicly. Terrific. This despite the fact that California provides an incredible amount of data from individual tax returns on the CFTB's own website.

Based on the CFTB's public data, the top 70,437 California earners in 2015 earned about $246 billion. Netting the benefit from the new tax rates, the loss of the state and local tax deduction over $10,000 and assuming only one-half of business profits and partnership income qualified for the 20% qualified income deduction, the total cost of the new tax bill to these folks would be about $4 billion. This is no more than an educated guess based upon publically available data. But let’s remember, the CFTB’s first report projected 1.6 million Californians having increased federal taxes and their second report showed that 1.0 million Californians would have increased taxes. Maybe their third report would reduce the number another 200,000 or 300,000 which this author thinks would be about right.

Yes, some high wage earners without investments in small businesses or real estate will see their federal income taxes increase. But, the Washington Post points out that the average taxpayer with over $732,800 of income will see their federal taxes decline by an average of $51,140 and only 9.3% will see their taxes increase. That is the nature of any tax reform effort.

It is the corollary issue that should get everyone’s attention. If California went forward with their plan to try to change tax deductions to charitable contributions, those 70,437 high income taxpayers, including the 90.7% who are already getting a significant decrease in their federal taxes, will gain an additional tax deduction in the range of $27 billion and see their federal taxes reduced very significantly beyond the Washington Post projected current average benefit of $51,140.

What is going on here? I will let your inner cynic get to its own conclusions except to wonder about why California is focusing on 70,437 high income taxpayers rather than 15 million other taxpayers who, for the most part, are pretty well benefitted by the new tax bill. Maybe, just maybe, homelessness or other issues are a bit more important.