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Send Them a Message! 'Taxes,' said Justice Holmes, 'are the price we pay for civilized society.' If that be true, Californians were in a downright uncivilized mood this week, for they voted overwhelmingly for a ballot proposal (the Jarvis-Gann initiative) which promises to reduce lo cal property taxes 57 percent and to curb future tax increases of either the state or local variety. over, five successful initiatives —anti busing, anti-pay TV, political reform, anti-open housing, and the death pen alty —were totally or partially over turned by the courts. Specifically, the electorate voted to limit taxes on all property —residential, commercial, and industrial —to one percent of the 1975-76 market value, and to limit increases in assessments generally to no more than two percent annually. Property taxes now run about two to three percent of market value, so this means a reduction of roughly $7 billion annually in local-gov ernment revenues. The initiative henceforth will require a two-thirds vote of the legislature to increase state taxes, and a two-thirds vote of the lo cal electorate to raise local levies. The same may happen in this case, be cause legal questions have been raised about the ambiguous wording of the brief (389 word) initiative. One section states that the lowered property taxes would be distributed 'according to law' within the counties —but as yet there is no such law. Another section limits annual increases in the 'fair mar ket value' base to two percent on property that does not change hands, but it allows full reassessment of prop erty when sold —which could violate the equal-protection clause of the U.S. Constitution. And another section says that special taxes may be imposed only by two-thirds of 'qualified elec tors' —which is ambiguous because it could mean those voting, those regis tered to vote, or those of voting age. Next step What happens next? The winning side expects the millennium, while the los ing side predicts total chaos. The reali ty, however, may be closer to the purgatory long familiar to taxpayers, expecially since legislators throughout the state may now try to increase rev enues from other sources in order to maintain accustomed levels of gov ernment services. One possibility is that the initiative will never become law, as has happened so frequently in the past. Between 1960 and 1976 alone, 148 proposals were submitted for the state ballot, but only 26 even tually qualified and only seven of those were approved by the voters. More Opposing views But assuming the legal challenges are overcome, what will actually happen next? According to University of Southern California Professor Arthur Laffer, the favorable vote on the initia tive will go a long way toward revital izing the California economy, by reducing the heavy tax load on the state's residents. Moreover, he claims that harsh spending cuts are unlikely, because of the state's ability to borrow in capital markets and, in particular, utilize its now towering surplus. As of June 30, the surplus will approach $3.4 billion, and it could reach $4.8 billion at the end of fiscal 1979 if no calls were made upon it. (continued on page 2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. Again, Laffer argues that revenues will fall by considerably less than the wide ly-quoted $7-billion figure, simply be cause property values will rise, encouraging more new construction and an expanded tax base. Also, tax revenues from other sources will ex pand. With property taxes lower, businesses will expand their activities within the state. This expansion will create more jobs, more investment, and higher real wages, so that sales and income taxes eventually will rise, cre ating future opportunities for tax relief or essential spending increases. levels to make up for the missing prop erty-tax revenues. The result might in clude a mixture of spending cutbacks, increases in fees for certain govern ment services, increases in business taxes, and hikes in sales and individual income taxes. (But tax-increase pack ages may be hard to put together, giv en the Jarvis-Gann requirement of a two-thirds majority to pass tax mea sures.) Paradoxically, this result might go against the views of those, like Laffer, who argue that an optimal tax structure includes higher taxes on property than on income or sales. State Director of Finance Roy Bell takes a more skeptical view, arguing that the economic stimulus gained from lower property-tax rates will be con siderably less than the $7-billion rev enue loss. First, individuals will net only $1.5 billion of that $7-billion figure, be cause home-owners will receive only one-third of the tax cut and will exper ience higher federal and state income taxes as a result of reduced deduc tions. (According to a recent UCLA study, the U.S. Treasury will benefit from a $2.2-billion increase in Califor nians' income taxes, as well as a $500million reduction in Federal payments to California local governments for jobs that will now be abolished.) Again, Bell claims that wage-and-salary losses associated with spending cuts and layoffs will amount to about $6 bil lion in 1979, leading to a potential re duction in consumer incomes of $4.5 billion ($6 billion minus $1.5 billion.) Why the message? Californians rejected several earlier (and milder) attempts to reduce their tax and spending burdens, so why did they vote so overwhelmingly this time to 'send a message' to their govern mental leaders? One reason may be the growing size of the state's burden of state-local taxation. California is outranked only by New York in this re gard, with a per capita tax burden 30 percent higher than the U.S. average. One thing is certain - the next several months will be rather chaotic for state and local legislators, as they attempt to change tax structures and spending2 2 The tax burden has actually worsened because of the impact of several re form measures passed during the last decade. In 1966, the state legislature moved to standardize assessment practices by setting the assessment ra tio at 25 percent of market value for all property throughout the state, with that goal to be reached by 1971. But when the 1970's brought its unique combination of several recessions, several housing booms, and rampant inflation, California experienced skyrocketing increases in home values but lagging increases in commercial and industrial property values. Thus, home-owners found themselves pay- ing much higher property taxes, both absolutely and in relation to other property owners. They also found themselves paying much higher state income taxes, as inflation kept pushing them into higher and more graduated tax brackets, following 1971 tax legisla tion (Library —1971 law?) designed to make the income-tax structure more progressive. Today every 10-percent rise in personal income leads to at least a 17-percent rise in state income-tax revenues. The initiative still might not have tri umphed, however, if state and local authorities had moved more expedi tiously to return to the taxpayers the surpluses amassed during the inflation ary boom of the past several years. Late in its last session, the legislature passed and placed on the ballot a mea sure (the Behr bill) to reduce home owner and renter tax burdens. How ever, this complex measure failed to attract much support, in part because it could be read as threatening sharp tax increases in the future. A national message Jarvis-Gann has a message for more than Californians, and not simply be cause of California's role in setting na tional trends. (Actually, Tennessee voters approved a budget-limitation measure earlier this spring, and other states are also getting into the act.) The broader message may be a growing dissatisfaction with inflation and with what the voters perceive as govern ment's contribution to that problem. Consumer prices have almost dou bled over the past decade, and more and more voters have come to be lieve that the problem would be less severe if federal, state and local gov-3 3 emments had demanded less of the economy's resources. Government spending has increased more than ten-fold since 1950 —and has grown more than two and a half times in the past decade alone —to reach a total of $621 billion in 1977. Governments accounted for 21.4 percent of GNP in 1950, but their share has now risen to 32.9 percent of the total. Expenditures have soared at all levels, but state-local government spending has grown most rapidly of all, and now accounts for 14.0 percent of GNP —partly because more than onefourth of those funds now come from federal grants. Between 1950 and 1977, employee compensation at the federal level dropped from 12.0 to 10.7 percent of total government spending, while fed eral purchases of other goods and ser vices dropped from 18.7 to 12.7 percent of the total (see chart). Mean while, employee compensation at the state and local level —especially for teachers —jumped from 16.7 to 22.5 percent of total government spend ing, while the state-local share of other spending for goods and services also increased. Most importantly, govern ment transfer payments (primarily fed eral) jumped from 23.6 to 31.9 percent of total spending, to a total of $198 bil lion in 1977. Voters in California and elsewhere apparently are now reacting unfavorably to these figures — especially the rapid expansion of items such as transfer payments and teach ers' salaries. As time goes on, we are likely to hear even more the question: How much government spending is enough? William Burke uojSuiqsPM • M l • uoSaJO • ppPA9|sj • oi|pp| elf iieMPH • eiujo^ip^ • puozijv • P>|SP|v © S S D T C J J S([T < i Og •JI|P3 'ODSjDUEJJ UPS ZSL ON llWH3d m JS > © S > ^ OlVd 3ovisod sn |^ J 3 ) p S ) j] 1IVW SSVTD 1SMIJ BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Selected Assets and Liabilities Large Commercial Banks Loans (gross, adjusted) and investments* Loans (gross, adjusted) —total Security loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities Other securities Deposits (less cash items) —total* Demand deposits (adjusted) U.S. Government deposits Time deposits —total* States and political subdivisions Savings deposits Other time deposits} Large negotiable CD's Weekly Averages of Daily Figures Member Bank Reserve Position Excess Reserves(+)/Deficiency (— ) Borrowings Net free(+)/Net borrowed (— ) Federal Funds—Seven Large Banks Interbank Federal fund transactions Net purchases (+)/Net sales(— ) Transactions with U.S. security dealers Net loans (+)/Net borrowings (— ) Amount Outstanding 5/24/78 Change from 5/17/78 110,803 88,759 1,980 27,186 29,916 15,677 7,975 14,069 107,758 28,467 224 77,526 7,182 31,661 35,747 17,470 — 264 111 118 + 36 + 163 + 96 132 21 + 212 471 103 + 1,037 + 50 + 120 + 862 + 782 Week ended 5/24/78 + Change from year ago Dollar Percent + + + + + + + + + + + + Week ended 5/17/78 - + 60 44 16 + + 14,732 14,348 194 3,469 6,463 3,008 423 807 13,001 1,812 104 11,337 1,288 220 9,101 7,801 + + + + + - + + + + + + + 15.33 19.28 8.92 14.63 27.56 23.74 5.04 6.09 13.72 6.80 31.71 17.13 21.85 0.69 34.16 80.68 Comparable year-ago period - 8 50 58 + 62 18 44 509 + 367 - 197 26 + 120 - 143 + ♦Includes items not shown separately. {Individuals, partnerships and corporations. Editorial comments may be addressed to the editor (William Burke) or to the author____ Information on this and other publications can be obtained by calling or writing the Public Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 544-2184.