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How did we get here? California taxes and education funding

A pedestrian walks by an H & R Block office on April 15, 2011 in San Francisco.
A pedestrian walks by an H & R Block office on April 15, 2011 in San Francisco.
Justin Sullivan/Getty Images

With Los Angeles voters facing a parcel tax to raise money for schools, and the governor's initiative to raise sales tax and taxes on higher-income earners this November to avoid cutting $5.2 billion in education funding, some people have wondered what exactly happens to their regular annual taxes.

You know, the ones due today.

People have asked me what the state does with their money. Especially since California has the highest statewide sales tax rate and one of the highest income tax rates in the country. How is it possible that the state is 47th in the nation on per-pupil spending when so much of that money is supposed to go to education?

I spoke with H.D. Palmer, the deputy director for the California Department of Finance today who tried to explain how we got here.

"What happened was the recession," Palmer said. "That's the short-form version of it."

Because education makes up about 40 percent of the state's general fund, it is often greatly affected by the economic health of the state.

According to Palmer, two main things hit California especially hard: the bursting of the housing bubble and the collapse of the stock market. Since California had many more subprime mortgages, particularly in the Central Valley and Inland Empire, compared to other states, it got "hit harder and earlier" than the rest of the nation.

That impact translated into the loss of housing-market related jobs in areas such as construction, durable goods sales, among others.

The other issue had to do with taxes and how the state collects taxes.

"We have a very progressive tax system in the state, and there's a very small band of taxpayers who contribute a significant amount of income in taxes," Palmer said. "And a lot of their income is not so much wage based as based on capital gains and stock options.

"So in the beginning of 2000, when the dotcom boom was in full flower, capital gains made up a substantial amount of the state's income tax."

Palmer said of last year's tax returned filed in California, about 1 percent, or 140,000 represented 40 percent of all personal income tax paid in the state that year.

"Fluctuations in the market place affected that narrow band of taxpayers; it was great when the dotcom boom was going, but not so great when the dotcom boom went bust."

The market collapse in 2008 really affected state revenues. Prop. 98 funding, which guarantees a certain portion of state funding goes to education, is made up of property tax and general fund monies. In 2007-8 that spending was $56.5 billion and it went down by about $9 billion to $47.6 billion in 2011-12, Palmer said.

(General fund monies include personal income, sales and corporation taxes, with personal income making up the largest part.)

"We lost more than a million jobs too in California during the recession," Palmer said. "Fortunately that's behind us, and we're slowly growing our way out, but not as rapidly as anyone would like."

He said it will take time for revenues to bounce back.

"We're not going to see pre-recession employment levels in California until probably the early part of 2016," he said.

The tax returns that are due today will fill in important pieces of the budget puzzle. Those pieces will also trickle down and affect local school budgets across the state.

"Today is the cruelest day for most taxpayers, but the most critical day for the state," Palmer said. "Over the next two week it's going to be most critical. Are we going to hit our targest for personal income tax for the month of April? We've got to revise the budget for mid-May."

In a radio interview last week, the governor said he believed the estimated $9.2 billion shortfall will widen after the returns are tallied, Palmer said. Lower than expected sales tax revenue had already forced trigger cuts to education in January.

The governor's proposed budget unveiled in January included the possibility of $5.2 billion in cuts to education if voters do not pass an initiative on the November ballot to raise taxes. The initiative would increase sales tax by 1/4 a percent for four years starting Jan. 1, 2013 and increase the income tax on people making $250,000 or more for seven years starting in the 2012 tax year.

Correction: An earlier version of this story said California had the highest income tax rate in the country, but at certain tax bracket levels that changes. It is one of the highest in the country.

Tami Abdollah can be reached via email and on Twitter (@latams).