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Tax Inequities Stymie California

Structural flaws in California's antiquated tax system explain why the state is always chronically short of funds to invest in the economy, a new study says

FROM coast to coast, economists are beating their drums over the first hints of good news about the California economy - two months of jobs gains, home sales up, and business failures down.

The news comes after this state's longest and deepest recession in 60 years. California alone represents the world's seventh-largest economy; the Golden State also represents 13 percent of the United States economy.

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But even if - or when - the economy moves into a stronger recovery mode, a new study says the state will face a long-term fiscal crisis unless it starts spending more to provide a better-educated labor force. In order for businesses here to compete globally, California also must build more public works, according to this out-of-state study that is causing wide debate here.

The Washington-based Center on Budget and Policy Priorities criticizes Republican Gov. Pete Wilson for propagating the idea that California is besieged with immigrants, choked by too many school children, and has too many people on its welfare rolls.

The center says the state's recurring, multibillion-dollar budget deficits could be erased and higher spending on infrastructure could be achieved by eliminating inequities in Calfornia's antiquated tax structure.

``It's not just the state economy that's hurting,'' says Iris Lav, director of state and local issues for the center. California's last three budget deficits have been the largest in American history: $14.5 billion, $11 billion, and $8 billion respectively.

``There are structural flaws in the tax system that explain why California chronically has insufficient funds to make the investments it needs to support its economy,'' she says. ``Those flaws existed before the recession and will remain afterward.''

Through the 1950s and 1960s, Ms. Lav says, California and its local governments demonstrated a serious commitment to investing in public services. ``They created outstanding elementary and secondary school systems; made unprecedented efforts to develop high-quality, accessible higher education systems; and made substantial investments in roads and other infrastructure,'' she says.

Starting in 1970, the state began squandering these advantages, the center's study says:

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r The average amount California spent on each elementary and secondary school student declined from 21 percent above the average of other states in 1959-60, to 14 percent below the average in 1992-93. California classrooms are on average the second largest in the country. California has the ninth-lowest high school graduation rate in the country.

r The rate of investment in roads, schools, and other infrastructure between 1960 and 1988 was lower in California than any other state. Total infrastructure investment fell from 40 percent above the average of other states in 1960 to 11 percent below the average in 1988, ranking 36th in the nation that year. Investment in roads and highways per resident in California was next to last in the nation in 1988 - more than 40 percent below the average in other states.

r Over the last eight years, the cost of subsidies provided through the tax system has grown an average of 7.8 percent a year. These tax-based subsidies grew at nearly twice the rate of on-budget general fund spending, which rose at a 4.1 percent average rate. Had tax expenditures been held to the same rate of growth as on-budget spending since 1986, California would have an additional $4.2 billion to allocate to key investments and programs in 1993-94.

The center recommends raising at least $9 billion more annually by broadening the sales tax to cover more services (reflecting a noted change in consumer purchasing from goods to services) and to more frequently reassess both residential and business property. Since the passage of Proposition 13 in 1978, property value has not been assessed at full-market value, but rather at its value upon changing hands, costing an estimated $3.3 billion per year.

Response to the report has been generally divided along partisan and ideological lines. ``Whether or not anyone agrees with its recommendations, this study is valuable for focusing attention beyond the cyclical nature of California recessions,'' says David Booher, a consultant for the California Council for Environmental and Economic Balance in San Francisco. ``It highlights that if we just sit back and let these cycles play out, the prospects to this economy remain cloudy.''

H. D. Palmer, assistant director of the state Finance Department, has denounced the recommendations as ``coming from an out-of-state, liberal interest group.''

``When you have an economy like ours which has been through the ringer, it's `Economics 101' that you don't strangle recovery by saddling people with more taxes,'' he says.

But Lynn Reaser, chief economist for First Interstate Bank, says several recommendations are correct if they are achieved in the right way.

``I would agree that we need a simpler, flatter tax system so that there are not a lot of exemptions,'' Ms. Reaser says. Noting that California's long-term economic health is tied to maintaining a business climate competitive with other states, she adds: ``I would want to see a reduction in overall loopholes so that we could have a lower, overall tax rate.''

Steven Levy, chief economist for the California Center for the Continuing Study of the California Economy, says he agrees with the study's central prognosis. ``There is no doubt that lack of public investment has done major damage to California's competitive edge,'' Mr. Levy says. ``How to go about attracting private investment to that end is the deeper question this state must grapple with.''