BILL ANALYSIS                                                                                                                                                                                                    



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          Date of Hearing:  May 16, 2011

                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
                                Henry T. Perea, Chair

                     AB 1130 (Skinner) - As Amended:  May 2, 2011
           
           2/3 vote.  Tax levy.  Fiscal committee.

           SUBJECT  :  Personal Income Tax:  tax rates. 

           SUMMARY  :  Establishes a 10.3% personal income tax (PIT) bracket 
          for taxable income in excess of $500,000.  Specifically,  this 
          bill  :  

          1)Establishes a 10.3% PIT rate for the following:

             a)   Single filers whose taxable income is over $500,000;

             b)   Joint filers whose taxable income is over $500,000; and, 


             c)   Head of household filers whose taxable income is over 
               $500,000. 

          2)Requires the Franchise Tax Board (FTB) to recompute the 10.3% 
            income tax bracket for taxable years beginning on or after 
            January 1, 2011.

          3)Applies to taxable years beginning on or after January 1, 
            2011. 

          4)Takes effect immediately as a tax levy. 

           EXISTING FEDERAL LAW  :

          1)Imposes six different income tax rates on individuals, 
            estates, and trusts ranging from 10% to 35%.

          2)Provides an AMT rate of 26% on AMT income up to $175,000 and 
            28% on AMT income exceeding that amount.  

           EXISTING STATE LAW  :

          1)Provides for six different PIT rates ranging from 1% to 9.3%, 








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            and for five different filing statuses, including single, head 
            of household, married filing separately, married filing 
            jointly, and surviving spouse.  Each rate applies to a 
            different range of income, known as a "tax bracket." 
            Individual tax liability is dependent on one's taxable income 
            and one's filing status.   For taxable years beginning on or 
            after January 1, 2009 and before January 1, 2011, each of the 
            six tax rate percentages was increased by an additional 0.25%. 


          2)Requires the Franchise Tax Board (FTB) to recalculate the tax 
            brackets each year based on the change in the California 
            Consumer Price Index.  

          3)Imposes an additional 1% tax on the portion of a an individual 
            taxpayer's taxable income that exceeds $1 million and 
            dedicates the funds received to provide mental health services 
            to children and adults, approved by the voters as Proposition 
            63 in 2004.  Disallows any reduction of this additional mental 
            health tax liability by tax credits.  (R&TC Section 17043). 

          4)Imposes an AMT in order to ensure that a taxpayer who can use 
            preferential tax benefits, such as deductions, exemptions, and 
            credits, does not escape taxation completely.  California's 
            AMT rate for individual taxpayers equals 7%.  Unlike the 
            federal government, California indexes AMT exemption amounts 
            under the PIT Law.  

          5)Provides for an AMT rate of 7.25% for taxable years beginning 
            on or after January 1, 2009, and before January 1, 2011, and 
            for an AMT rate of 7% for taxable years beginning on or after 
            January 1, 2011. 

           FISCAL EFFECT  :  The FTB estimates that this bill would increase 
          General Fund revenues by $2.3 billion in fiscal year (FY) 
          2011-12, by $1.7 billion in FY 2012-13, and by $1.8 billion in 
          FY 2013-14.  

           COMMENTS  :   

           1)Author's Statement.   The author has provided the following 
            statement in support of this bill:

          "The richest one percent of Californians are making an average 
            of $1.7 million dollars.  Novel-winning economist Joseph 








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            Stiglitz states 'the upper 1 percent of Americans are now 
            taking in nearly a quarter of the nation's income every year.  
            In terms of wealth rather than income, the top 1 percent 
            control 40 percent. The recently approved federal tax cut 
            extension gave California's wealthiest citizens $14 billion in 
            tax cuts.  The top 1% of Californians received an average of 
            $90,000 in tax cuts.

          "Recent polls reveal that an overwhelming majority of 
            Californians believe that richest Californians should pay more 
            taxes.  Seventy-eight percent of likely Californian voters 
            support a 1 percent increase in the income tax rate for 
            Californians earning more than $500,000 a year.  This includes 
            60% of Republicans.

          "Historically, even our most fiscally conservative Governors 
            have increased the tax rate in times of major deficits.  
            Governor Pete Wilson increased taxes on the top 1% by 
            including a 10 and 11 percent tax rate.  Governor Reagan did 
            the same in 1973. 'This bill would add a 1% tax increase of 
            the richest Californians.  Those that make over $500,000 
            constitute less than 1% of taxpayers but could contribute an 
            estimated $2.3 billion in additional revenue.  The proposed 
            tax rate schedule is as follows:

                         --------------------------------- 
                        |Tax Rate    |Taxable Income      |
                        |------------+--------------------|
                        |1.0         |Up to $7,124        |
                        |------------+--------------------|
                        |2.0         |$7,214 to $16, 890  |
                        |------------+--------------------|
                        |4.0         |$16,890 to $26,657  |
                        |------------+--------------------|
                        |6.0         |$26,657 to $37,005  |
                        |------------+--------------------|
                        |8.0         |$37,005 to $46,766  |
                        |------------+--------------------|
                        |9.0         |$46,766 to $500,000 |
                        |------------+--------------------|
                        |10.3        |$500,000 and over   |
                         --------------------------------- 
           
          2)Argument in Support.   Proponents of this bill state, 
            "California currently faces a $15.4 billion budget deficit, 








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            even after the $11.2 billion recently made cuts" to higher 
            education and social services provided to the sick, poor, and 
            elderly.  The proponents assert that recent polls reveal that 
            "seventy-eight percent of California voters support a 1% 
            increase in the income tax rate for Californians earning more 
            than $500,000 a year."  The proponents also argue that even 
            "our most fiscally conservative governors have increased the 
            tax rate in times of major deficits."

           3)Argument in Opposition.   Opponents of this bill assert that 
            the "tax increase on higher income tax brackets ? will hit 
            California's small and medium sized businesses especially 
            hard, as many of them do not organize as corporations and 
            therefore pay personal income taxes in lieu of corporate tax." 
             The opponents state that California already has the most 
            progressive income tax structure in the United States, with 
            the top 1% of earners paying more than 75% of state's income 
            tax revenues.  Opponents argue that progressive income tax 
            structures "cause individuals and small businesses to change 
            their income-earning and tax-planning behavior "the create "a 
            drag on the economy and may ultimately result in fewer tax 
            revenues."  Finally, the opponents believe that this measure 
            will further harm the economy, will contribute to the 
            increased revenue volatility, and is unlikely to generate the 
            estimated revenues. 

           4)Background.   Throughout California's history, governors and 
            the Legislature have imposed progressive tax brackets on the 
            highest income earners.  Beginning with Governor Ronald 
            Reagan, a 10% tax bracket was enacted in 1967, and later 
            raised to 11% in 1971.  In the early 1990s, California faced a 
            severe recession, which resulted in significant shortfalls in 
            the state budget.  In response, the State acted to increase 
            revenues and reduce expenditures.  The Legislature and 
            Governor Pete Wilson, in addressing the issue, increased the 
            PIT rates by adding a 10% and an 11% tax bracket for the 
            State's highest income earners and increasing the AMT rate 
            from 7% to 8.5% SB 169 (Alquist), Chapter 117, Statutes of 
            1991].  In 1991, the 10% rate was imposed on filers with 
            incomes over $100,000 (single) and $200,000 (married filing 
            jointly).  The 11% rate was imposed on filers with taxable 
            incomes over $200,000 (single) and $400,000 (married filing 
            jointly).  These income thresholds were increased for 
            inflation each year, so that by 1995, the 10% rate was imposed 
            on filers with taxable incomes over $109,936 (single) and 








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            $219,872 (married filing jointly), and the 11% rate was 
            imposed on filers with taxable incomes over $219,872 (single) 
            and $439,744 (married filing jointly).  In 1995, supporters of 
            a permanent extension of the tax bracket rates placed 
            Proposition 217 on the ballot.  The measure would have 
            continued the 10% and 11% tax rates permanently and allocated 
            revenue from the increase to schools and local governments.  
            Proposition 217 failed narrowly by 2/10ths of one percentage 
            point.

          In February of 2009, in an effort to deal with a $20 billion 
            budget deficit, the California Legislature voted to add 0.25%, 
            or twenty five basis points, to the tax rate for all brackets 
            for the 2009 and 2010 tax years.  ABx3 3 (Evans), Chapter 18, 
            Statutes of 2009].   The Legislature also proposed to the 
            voters to extend this 0.25% increase to the 2011 and 2012 tax 
            years, but the voters did not approve Proposition 1A (2009) in 
            the May 19, 2009 special election.  

           5)Progressive Taxation.   California currently has a progressive 
            taxation system.  A progressive tax is one where the tax rate 
            increases as the taxable base amount increases.  As explained 
            earlier, California has six different tax rates, each 
            increasing as the base increases.  There are several schools 
            of thought addressing this issue.  Generally speaking, there 
            are those who believe in a progressive system of taxation, and 
            those who do not, preferring other methods of taxation, like a 
            flat tax.

          The argument against a progressive tax system is similar to the 
            one espoused by Austrian economist and author, Eugen Von 
            Bohm-Bawerk.  Addressing the concept in his work, Karl Marx 
            and the Close of his System, Von Bohm-Bawerk focuses his 
            argument on the consumption of goods versus the consumption of 
            capital.  Applying the concept of diminishing returns, as 
            income rises, a smaller portion of that income will be used 
            for consumption of goods.  By default, a larger portion will 
            be used for capital investments, which will generate more 
            income for more capital investments.  By purchasing more and 
            more capital goods, the cost of production begins to fall and 
            begins to elevate the standard of living.  A progressive 
            system of taxation would increase the tax rate on higher 
            income individuals, reducing the amount of income available 
            for capital investments and thereby reducing improvements to 
            the standard of living. 








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          This argument against a progressive system of taxation, however, 
            fails to address the issue of a growing gap between those who 
            have capital investments generating an exceedingly greater 
            amount of income and those who are just able to pay for life's 
            necessities.  Because low income earners spend a larger share 
            of their income on necessities, they have a much smaller 
            portion of income left over to make their own capital 
            investments.  The argument also fails to address the 
            elimination of jobs from increased capital improvements.  For 
            example, a company employing 10 workers may decide to purchase 
            large capital equipment, eliminating the need for those 
            workers.  The machine can perform the same amount of work, but 
            the business will become more efficient by reducing its labor 
            costs in subsequent years.

          The idea of a progressive tax system has gained acceptance from 
            a wide range of individuals. Writing in The Wealth of Nations, 
            Adam Smith outlined the hardship and burden that lower income 
            individuals have in society.  Specifically, Smith focused on 
            the necessities of life, on which low-income individuals spend 
            a much larger percentage of their income.  In recognizing the 
            disproportionate impact on the poor, Smith stated, "it is not 
            very unreasonable that the rich should contribute to the 
            public expense, not only in proportion to their revenue, but 
            something more than in that proportion."  Other arguments also 
            encourage the use of a progressive taxation system because 
            individuals with greater capital are also more likely to take 
            advantage of societal benefits supported by taxation, such as 
            defense, infrastructure, and the protection of property 
            rights.  Individuals who control larger sums of capital are 
            also able to take advantage of economies of scale, a wider 
            range of investment opportunities, and are able to more 
            directly participate in shaping government.  By providing a 
            progressive tax system, democracies are better able to enhance 
            economic opportunity for the lower and middle classes.  

           6)The Recent Temporary PIT Increase  .  As part of the budget 
            agreement enacted in February of 2009, California increased 
            the burden of PIT that made the state's income tax system less 
            progressive.   By increasing each rate by 25 basis points, the 
            Legislature ensured that all taxpayers with income tax 
            liabilities shoulder the burden of a tax increase.  In 
            contrast, this bill proposes to make the PIT Law more 
            progressive.  Instead of increasing the tax burden for all 








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            taxpayers, it shifts the costs of financing public services 
            from taxpayers with less income to those with more income.

           7)The Recent Public Policy Institute of California's Poll.   The 
            survey released by the Public Policy Institute of California 
            (PPIC) on April 28, 2011, found that 68% of Californians 
            believe the quality of K-12 education will suffer if cuts are 
            made (PPIC Statewide Survey, Californians and Education, April 
            2011).  The majority oppose increases in the state sales tax 
            (61% all adults, 62% likely voters) or overall state personal 
            income tax (62% all adults, 66% likely voters) to maintain 
            funding for schools.  However, 68% of adults and 62% of likely 
            voters favor raising the top rate of the state income tax paid 
            by the wealthiest Californians to maintain K-12 funding.  

           8)Revenue Volatility.   Revenue volatility is related to both 
            California's economic cycle and its tax structure.  As noted 
            in Revenue Volatility in California by the Legislative 
            Analyst's Office (LAO), California's economic cycle has 
            historically been more volatile than the nation's economic 
            cycle due to the presence of high-paying cyclical 
            technology-related industries and the housing sector.  In 
            addition to the historic volatility of California's economic 
            cycle, revenue volatility has also been an issue because of 
            California's increased dependency on the PIT.  The percentage 
            of state revenue coming from the PIT has increased from 37% in 
            FY 1979-80 to a peak of 57% in FY 2000-01, although it receded 
            to 53.4% in FY 2007-08.   Because of the progressive structure 
            of the PIT law, 88.5% of PIT revenue comes from the top 20% of 
            taxpayers by income, with the top 1% of taxpayers - 144 in all 
            - pay almost half of total income tax receipts.  Since the 
            income of these taxpayers include a large share from capital 
            gains, which are much more volatile than wages, California has 
            seen changes of 10% or more in total income tax receipts in 10 
            of the last 13 years.  

           The LAO's report mentioned several ways in which California 
            could reduce the volatility of its revenues.  One of the 
            proposed approaches was reducing the progressivity of the 
            basic PIT structure, which would involve flattening the PIT 
            structure by increasing the tax rates on lower and moderate 
            income earners and reducing the tax rate on high-income 
            earners.  Other suggestions included increasing the State's 
            reliance on alternative tax revenues.  Specifically, the State 
            may be able to reduce its dependence on the PIT by extending 








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            taxes to services, which tend to be relatively stable during a 
            business cycle, or by increasing property taxes.  

          With regard to property tax, revenues generated from the levying 
            of taxes on property tend to be the most stable of the major 
            state and local sources.  According to the Commission on the 
            21st Century Economy, property taxes are more stable because 
            property tends not to fluctuate as much as other tax bases in 
            response to the business cycle, most notably the PIT.  Prior 
            to 1978, property tax was assessed at the market value.  
            However, in 1978, voters passed Proposition 13, which limited 
            assessments to the property's acquisition value, plus an 
            annual increase capped at the lesser of 2% or the rate of 
            inflation.  Proposition 13 also added a two-thirds vote 
            requirement for raising taxes.  After the passage of 
            Proposition 13, there was a dramatic drop in property taxes 
            relative to personal income.  Property tax as a share of 
            personal income dropped from 5% in FYs 1977-78 to 2.4% in FYs 
            2005-06.  In terms of preventing volatility in the state's 
            revenue, Proposition 13 made it incredibly difficult to raise 
            revenue from one of the most stable sources.  

          Of course, it is also important to note that volatility is not 
            inherently undesirable; it is only a problem if state 
            government operates with an expectation of stability.  If the 
            Legislature properly addresses the issue of volatility within 
            the budget, state funded programs and other costs could be 
            properly managed without having to restructure California's 
            tax system.  

           9)A "Marriage Penalty:   An Unintended Consequence?   This 
            measure proposes to increase the highest PIT rate from 9.3% to 
            10.3% to apply to taxable incomes greater than $500,000, 
            regardless of the taxpayer's filing status.  In other words, a 
            single individual with a taxable income over $500,000 would be 
            subject to this new tax as well as a head of household or a 
            married couple with the same amount of taxable income of 
            $500,000.  As such, it would encourage married individuals and 
            registered domestic partners to file separately to avoid the 
            so-called "marriage penalty" and to reduce their overall tax 
            burden.  The marriage penalty refers to the higher tax 
            liability of married two-worker couples, compared to their 
            non-married counterparts.  As explained by the FTB staff in 
            the analysis of this bill, the "marriage penalty" was an 
            unintended consequence of the Revenue Act of 1948, when 








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            Congress abandoned treatment of the individual as the taxpayer 
            unit and adopted the split-income plan of joint returns for 
            married persons.  (Public Law No. 471, Chapter 168, 301-305, 
            62 Stat. 110, 114-16).  The author may wish to consider 
            amending this bill to equalize the tax treatment of married 
            individuals and registered domestic partners filing separately 
            and those filing jointly. 

           10)Related Legislation.   

          AB 1239 (Furutani), introduced in the current legislative 
            session, temporarily establishes 10% and 11% personal income 
            tax brackets for high-income taxpayers and increases the 
            alternative minimum tax rate to 8.5%.  AB 1239 is set to be 
            heard in this Committee on May 16, 2011.

          AB 1836 (Furutani), introduced in the 2009-10 legislative 
            session, was similar to this bill.  AB 1836 failed passage out 
            of this Committee. 

          SB 96 (Ducheny), introduced in the 2009-10 legislative session, 
            would have added four higher tax brackets with higher tax 
            rates.  SB 96 was held by the Senate Committee on Revenue and 
            Taxation. 

          AB 2897 (Hancock), introduced in the 2007-08 legislative 
            session, would have established two additional tax brackets 
            with higher rates, similarly to this bill.  AB 2897 failed 
            passage out of this Committee.  

          AB 6 (Chan), introduced in the 2005-06 legislative session, was 
            similar to this bill.  AB 6 failed passage on the Assembly 
            Floor. 

           11)FTB's Suggested Technical Amendments.  

          On page 3, line 6, replace "2011" with "2012"

          On page 4, line 24, replace "2011" with "2012"




           REGISTERED SUPPORT / OPPOSITION  :   









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           Support 
           
          Alliance of Californians for Community Empowerment (ACCE)
          American Federation of State, County and Municipal Employees 
          (AFSCME), AFL-CIO
          California Federation of Teachers
          California Nurses Association
          Coalition of California Welfare Rights Organizations
          Congress of California Seniors
          CREDO

           Opposition 
           
          California Chamber of Commerce
          California Taxpayers Association
           
          Analysis Prepared by  :  Oksana Jaffe / REV. & TAX. / (916) 
          319-2098