California's Dirty Little Withholding Secret

How the Golden State "borrows" money from taxpayers -- interest free.
November 12, 2009 AT 3:00 AM
Girard Miller
By Girard Miller  |  Finance Columnist
The finance columnist for Governing.

A lifetime award for the sleaziest budgetary gimmick of all time goes to the state of California. As part of the legislature's patchwork of budgetary Band-Aids to support the fiction their budget was balanced, the state will begin to deliberately over-withhold taxes from its citizens.

Employers are now required to deduct an additional 10 percent from each employee's income tax withholdings -- even though it's more than the employee owes. It's an interest-free cash-flow loan to the state treasury until next April 15 when a refund will then be due. For a worker making $50,000 a year, the involuntary loan works out to $200 each year. To the state, that's reportedly $1.7 billion of annual "savings," although that number looks dubiously high to me. And of course, the state will find a way to account for these tax receipts in its current fiscal year, so this just kicks the can of budget-balancing further down the road of infamy.

As California municipal officials already know, the state has discovered all sorts of ways to "borrow" from others. It has imposed an involuntary drawdown on state aid from dedicated tax sources. Now, municipalities lose interest on their cash reserves and in some cases must become borrowers in order to tide the state over.

Rather than address its real, structural budget deficits, the legislature resorted to a dozen similar gimmicks in 2009, and it's reasonable to expect them to find even more in 2010, because their deficits are accumulating.

Nobody in California wants to see service reductions, and voters have refused to increase their already-high income and sales tax rates any further. In a recession, it's the pro-cyclical spending cutbacks caused by state and local government revenue reductions that aggravate the national economy the most, so I have intellectual sympathy for the problems facing state leaders. But fiscal gimmickry is not the answer. In this case, the state is clobbering its retailers and municipalities who depend on retail sales taxes. As household paychecks shrink, holiday spending will be reduced by this ploy, which only aggravates the local financial situation.

What is even worse about this withholding tax surcharge is that it probably doesn't end in a year. Fiscal watchdogs expect this ruse to continue as long as the state is running in the red. This year's budget is already $1 billion below original projections, and the state has run out of one-time revenue sources. So, next year's budget chasm will be even deeper.

Taxpayers could, of course, change their withholding declarations at the workplace to reduce the over-withholding, but the math is too complicated for the average person to figure out and bother with. Employers would face a paperwork blizzard, so they will not alert employees to this deception. And of course, the state would then have a legal right to impose stiff penalties on the poor souls who mistakenly miscalculate their deductions on their W-2 form. "Heads we win, tails you lose" would be the clear message state officials have delivered to their citizens.

This is the stuff from which taxpayer-revolt ballot initiatives are born. Stay tuned to see if any of the populist groups, outraged over this over-withholding scam, can compel the salons of Sacramento to straighten up and fly right.

Girard Miller
Girard Miller | Finance Columnist |