When the rich aren't getting richer, state's in poorhouse

By Daniel Weintraub -- Bee Columnist

Published 2:15 a.m. PST Sunday, January 18, 2004

The rich are no longer getting richer in California. And the rest of us, oddly enough, are suffering from their misfortune. That's the story from the latest report on tax returns filed for the 2002 tax year. The preliminary figures, which I obtained from the Franchise Tax Board last week, show that the number of returns reporting incomes exceeding $1 million dropped again, to about 25,000. The combined income earned by those fat cats also shrunk, by more than 20 percent.

Why should we care? Because California's skewed income distribution, combined with progressive tax rates, means that the people at the very top of the income heap pay a very high percentage of the personal income tax collected in this state.

Their extraordinary, onetime income surge at the end of the last century provided most of the new tax revenue that legislators and former Gov. Gray Davis used to raise teacher salaries, increase welfare benefits and expand eligibility to state-provided health care. But the decline that followed also accounted for most of the revenue drop that contributed to the state's fiscal crisis. And as of the most recent tax year, they hadn't hit bottom yet.

The million-dollar earners peaked in 2000, when 44,000 of them -- about enough to fill your average baseball stadium -- reported incomes totaling $172 billion and paid more than $15 billion in taxes. The tax take from that relative handful of returns accounted for more than one-third of all income tax paid in the state.

The next year, the number of returns reporting incomes that high slumped to 29,000. Their combined income also declined, by nearly half, to $95 billion. And here was the killer: Their tax liability dropped from $15 billion to just under $8 billion.

The money lost to the treasury that year would have been enough to pay for the state's entire commitment to higher education, or most of the cost of the Medi-Cal system that provides health care to six million of California's poorest residents.

The income, much of it generated by profits on dot-com stock options, simply vanished, as quickly as it had appeared. The latest figures show that the downward trend, while it slowed in 2002, continued.

The remaining 25,000 million-dollar earners took in a combined $75 billion, down from $95 billion the year before. And the tax take from that crowd declined again, to just over $6 billion. The super-rich, and the state's treasury, are basically back to where they were in 1998.

The implications of these numbers for social policy are a bit sobering.

Normally, an unequal distribution of income is considered bad for society. Flattening the income distribution curve, on the other hand, is supposed to be a good thing. But California's experience since 1999 shows that what might be desirable as social policy is not so good for the state's fiscal health, at least given the current structure of the tax system.

Since 2000, when the high-tech bubble was concentrating income at the higher end of the scale, the share of California income reported by those highest fliers -- the million-dollar earners -- has been cut in half, from 20 percent to just 10 percent. More broadly, all of those earning more than $100,000 in California saw their combined income drop from 54 percent of all the money earned in the state to 46 percent.

The middle-class, meanwhile, saw its share of the income expand. Those earning between $50,000 and $100,000 increased their share of the income from 23 percent to 27 percent. But people in that income category pay relatively little income tax in California. Combined, they pay a bit less today than they did in 2000.

In fact, those earning between $50,000 and $100,000, while they took in 27 percent of the income in 2002, paid 19 percent of the income tax. People earning more than $100,000, while earning 46 percent of the money in the state, paid 73 percent of the income tax.

These ratios are somewhat balanced by sales tax and property taxes paid by the various groups. But the income tax figures demonstrate anew something most close observers of the state's fiscal condition already know: California's treasury is highly dependent on taxes from the state's most affluent residents. When they do well, their wealth is shared with the rest of us. When they do less well, we also pay the price.

Raising tax rates on this small group of highly successful Californians will undoubtedly be part of the mix of deficit-closing policy proposals debated in the Capitol this year. But the tax return data suggest that a more fruitful and more stable approach to balancing the budget over the long term would be to somehow figure out how to make more Californians wealthy, and keep them that way.

Reference Documents from CA Legislative Analyst Office

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Last modified: Janaury 25, 2004

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