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California has a legally dubious proposal to bypass tax reform

California has a legally dubious proposal to bypass tax reform
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California State Senate Leader Kevin de León recently unveiled a legislative tax evasion scheme to thwart recently passed federal tax reform. Here’s how the scheme would work. Taxpayers could elect to make “charitable” “contributions and gifts” to a newly created California Excellence Fund. In exchange, the state would issue tax credits of an equivalent amount.

The taxpayers could then claim this charitable deduction on their federal income tax return. A $1,000 “donation” to the fund diminishes state income tax liability by $1,000, so there would be no state tax benefit due to reclassifying this tax payment as a charitable contribution. However, the reclassification could lower federal taxes by $370. California legislators are openly scrambling to enable this massive tax evasion.

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Forcing hardworking Americans thousands of miles away to fund a large part of the California government amounts to taxation without representation. Taxpayers elsewhere would shoulder much of these costs in courtesy of an effective rebate up to 37 cents of every dollar paid in California state income taxes. An electrician in Iowa, an accountant in Tennessee, a bar owner in Florida and others around the nation will be paying for the boondoggles in the Golden State, such as Gov. Jerry Brown’s bullet train to nowhere.

These individuals in faraway states have no input whatsoever on the shenanigans plaguing the West Coast. Compounding matters and residents in many other states, including Wisconsin, Indiana and North Carolina, are reaping the benefits of prudent decisions involving state government. Lower taxes and robust economic growth have followed. These individuals are now being asked to bear the burden of a bloated Sacramento regime that refuses to enact similar prudent reforms.

Compounding the injustice to fellow citizens across the nation is the misappropriation of federal tax law intended to benefit actual charitable causes. But don’t be fooled because this California Excellence Fund is by no means a charity. No distinction exists between how tax dollars are spent and how dollars from this fund are spent. The legislature would choose how to spend the dollars collected by the fund just as it determines how to spend capital classified as tax revenue.

In fact, the legislation itself clearly specifies this bill is “a tax levy.” León attempts to contort tax provisions meant to aid the poor, enhance culture, provide education, and strengthen faith communities into a tool to funnel tax dollars in greater abundance to his political base. This tax scheme is unlawful, in addition to being unfair. Although donations “for the use of state” may qualify as a charitable deduction, the IRS clearly specifies qualification only applies to a donation if “voluntary and is made without getting, or expecting to get, anything of equal value.”

Unfortunately for advocates of this tax evasion scheme, receiving a dollar for dollar reduction in income taxes owed to the state in return for this “donation” fits the very definition of “equal value.” A $100 contribution equals a $100 reduction in income tax owed to fund government services the taxpayer will still benefit from. In addition, the donor receives up to $37 in federal income tax liability reductions. For every $100 contribution, the taxpayer receives up to $137 in benefits. Because taxpayers will “donate” to the fund with the expectation of receiving financial benefit exceeding their contribution, such payments will not count as a federal charitable deduction.

Of course, some have pointed to states awarding state tax credits and federal tax deductions for donations to educational scholarships as an example of the validity of this scheme. But these preexisting programs were created at a time when state and local taxes were fully deductible. Federal tax avoidance was not in play since a donor could deduct an identical amount of from his federal taxable income whether he chose to simply pay his standard state tax bill or to divert some of these dollars to a private charity. This is important because charitable intent is requirement for federal charitable tax deductions. Furthermore, these donations fund private sector entities rather than government operations benefiting the donor. Tax evasion rather than charitable intent drives this current scheme.

The new $10,000 cap on state and local tax (SALT) deduction prevents politicians from masking the true impacts of their spending. For instance, plans to enact higher income taxes in New Jersey have been placed on hold. Both governor-elect Phil Murphy and State Senate President Steve Sweeney are being forced to grapple with the fact that dramatically restricting the SALT deduction makes state tax hikes politically far more difficult. This inability to hide the costs of bloated government is a boon for taxpayers.

Californians already suffer from the highest top marginal personal income taxes in the nation at 13.3 percent combined state and local, along with the eleventh highest corporate income taxes at 8.84 percent. This slew of taxes supports the sixth largest per capita government workforce in the country and the fifth highest state and local spending expenditures per capita at more than $13,100 annually, which is more than $52,000 per family of four.

Despite the gusher of spending, Californians endure crumbling infrastructure, failing schools, and agricultural plains shriveling through man-caused water shortages. At the same time, the state funnels provides hundreds of millions to a handful of politically favored businesses to purchase items such as agricultural equipment and heavy under the guise of combating climate change, burying the instructions amidst hundreds of pages of legislative text. Californians have been swindled. León claims the 2017 tax reform will “line the pockets of the Trump family, hedge fund managers, and private jet owners.”

But after-tax earnings increase across all income levels under the reform. It’s the senator and his colleagues in the California State Assembly who have seemingly declared war on the middle class by repeatedly increasing taxes, most recently hiking the base excise tax on gas by 12 cents per gallon, a whopping 43 percentage point increase in the total gas tax, along with more than doubling the base excise tax on diesel. Not to mention, his friends continue to advocate for anti-growth draconian environmental measures driving up the costs of televisions, food, housing and electricity.

The California legislature is trying to keep two core groups of constituents happy: the ultra-rich who want to pawn off nearly half of the sky high California tax rate onto the rest of the nation and the public sector unions ambivalent as to who shoulders the costs of mismanaged government so long as they receive their share of the booty. Rather than attempt to foist these costs on unsuspecting Americans far away from the West Coast, perhaps California’s public servants should at last enact the reforms required to lift the crushing tax burden. Why should the farmer in Kentucky be forced to pay for Gov. Brown’s bullet train to nowhere?

Joel Griffith is director of the Center for State Fiscal Reform at the American Legislative Exchange Council.