By Lou Cannon, July 1, 2008

                        The tip-off on Governor Ronald Reagan’s unsuspected pragmatism came
                        two days after his inaugural speech on January 2, 1967, in which he
                        promised to “squeeze, cut and trim” the cost of government. On January
                        4, however, he told aides that all the cutting and trimming in the world
                        might not suffice. A tax increase could be necessary, said Reagan, and,
                        if so, he didn’t want to wait “until everyone forgets that we did not cause
                        the problem—we only inherited it.”

Reagan’s comment reflected a practical streak that would serve him well in public life. His
rhetoric was often unsophisticated—“there are simple answers, just not easy ones,” he often
said—but his governance was more nuanced. This pleasantly surprised future Gov. George
Deukmejian, a freshman state senator whom Reagan chose to carry his tax bill. Deukmejian had
campaigned with Reagan and considered him a fire-eater. “A lot of people, including me,
thought he would be ideological,” Deukmejian recalled years later. “We learned quickly that he
was very practical.”

Reagan faced a serious budget shortfall. In 1966, Gov. Edmund G. (Pat) Brown had dodged an
election-year tax increase by changing the state’s accounting practices to count anticipated
revenue. This left Reagan with nine months of revenue to pay for a year of services and
programs. When he took office the budget gap was estimated by the state Department of
Finance at $400 million (more than $2.5 billion in 2008 dollars). Dire as this was, the shortfall
estimate soon increased because of weak economic conditions that further reduced state
revenues. Within a few months, analysts were warning of a potential $700 million shortfall.
Neither Reagan nor his inexperienced aides were prepared for the magnitude of the deficit. “We
were not only amateurs, we were novice amateurs,” said Reagan’s communications director Lyn

This amateurism was compounded by Reagan’s naïve belief that the brightest lights in California
business would be willing to drop what they were doing to serve their state. Then, as now, the
post of state finance director is a California governor’s most crucial appointment. The director is
charged with the task of consulting with the nonpartisan professionals in the finance department
and preparing a budget that in Reagan’s era was supposed to be balanced annually. Reagan
hoped when he was elected that some of the best brains in California’s leading corporations
would volunteer to serve as finance director. When no one in the business community stepped
forward, Reagan offered the post to A. Alan Post, the pioneer legislative analyst who at the time
was considered the leading expert on California fiscal issues. But Post turned down the job, and
the appointment process lagged.

After another highly rated expert also declined the post, Reagan appointed a management
consultant who lacked budget expertise. The budget that the new finance director prepared and
that Reagan submitted to the Legislature sought 10 percent across-the-board cuts in every
agency. As Assembly Republican leader Robert Monagan observed, this “cookie-cutter”
approach would have punished the best-managed departments and rewarded those with slack.
Reagan was disappointed in this lack of support from the legislative leader of his party, but he
withdrew the budget.

Meanwhile, he pursued symbolic economies, including hiring and purchasing freezes, that one
analyst of the Reagan transition called “ludicrous diseconomies.” As an example, the analyst
observed that the Department of Public Works had purchased cabs for 40 trucks before the freeze
and was prohibited from buying the rest of the vehicles. Reagan also sold the state airplane and
cut down on out-of-state travel by government employees. Although the savings of such
squeezing and trimming were small, the effort enabled Reagan to make the case to the public that
he had done all he could to economize and needed to raise taxes.

In March, along with a new budget that proposed controversial cutbacks in the Department of
Mental Hygiene, Reagan sent the Legislature a wide-ranging menu of proposed tax increases
carrying a price tag of $946 million. It was the largest tax increase ever sought by a U.S.
governor and four times as large as Gov. Brown’s previous record in 1959. By the time the bill
cleared the State Senate the price tag was $1 billion, more than $6 billion in 2008 dollars.

The Reagan tax proposal put Jesse Unruh, the powerful Democratic speaker of the Assembly, in
a quandary. Unruh, who made no secret of his ambition to become governor (and would run
unsuccessfully against Reagan in 1970), had long championed property tax relief. At the time
local property taxes were rising so rapidly that seniors and others on fixed incomes were being
forced from their homes. Eventually, in 1978, property taxes would produce the populist
backlash known as Proposition 13. But in 1967, Unruh was far ahead of the pack on this issue.
That is, he was ahead of the pack until Reagan became governor. Novice though he was, Reagan
paid attention to the people and sensed the potency of property tax relief. In his first meeting
with Unruh after becoming governor, Reagan agreed that such relief would be part of the tax bill.
Unruh wasn’t totally happy about this, for he didn’t want to share political credit for obtaining
property tax relief. But he nevertheless pushed the bill through the Assembly, and then teamed
with Reagan to get it narrowly through a State Senate that was nominally under Democratic
control, but was in practice a bipartisan and conservative institution.

The tax bill was also bipartisan, but its content might have been the work of a New Deal
Democrat: overnight it changed California’s revenue-raising structure from a regressive one to a
progressive system. During Gov. Reagan’s administration, with most of the changes coming in
the 1967 tax bill, corporation taxes nearly doubled, from 5.5 percent to 9 percent. The tax on
banks went from 9.5 to 13 percent. The maximum on personal income taxes increased from 7
percent to 11 percent. The bill also included $190 million of property tax relief. Both Unruh and
Deukmejian suspected that a Democratic governor—and indeed many Republican governors—
would never have been able to get such a thing approved. “It was sort of like (Richard) Nixon
going to China,” Deukmejian said.

The tax increase did not diminish Reagan’s belief that government spent too lavishly and that
Americans were too highly taxed. In 1973, he sponsored a state tax-limitation ballot initiative
that was rejected by the voters. As president of the United States in 1981, he persuaded
Congress to cut income taxes; overall, the Reagan presidential administration reduced the
marginal tax rate from 70 to 28 percent. In nearly all of his undertakings, including a
monumental bipartisan welfare bill that he crafted with Assembly Speaker Bob Moretti, a

Democrat, in the second term of his governorship, Reagan demonstrated a pragmatism that is the
essence of successful governance. It was a pragmatism that served him well as president.

The mists of history tend to obscure the bitterness of the past. On the road to bipartisan
achievements, Reagan and his adversaries exchanged many harsh words and engaged in dubious
acts of partisanship. But they also kept their eyes on the ball. In 1967, when Reagan threw his
weight behind the largest tax increase any state had ever enacted, Democrats and Republicans
alike tended to share the view that California should recognize reality and face up to its fiscal
problems. That is what Reagan did, and the state was better for it.

Lou Cannon has written five books about Ronald Reagan, including the acclaimed President
Reagan: The Role of a Lifetime.

By Beacon Economics, July 1, 2008

Confronting a major fiscal crisis in 1967, the newly elected Reagan Administration and the
legislature agreed on a set of tax increases that totaled $948 million. What would that increase
mean today? There are several ways of approaching an answer to this question. Perhaps the
most straightforward is to adjust the Reagan tax increase for inflation. This calculation indicates
that the Reagan tax increase was equivalent to $6 billion in today’s dollars.

This, however, is but one way of thinking about the size of the tax increase. Through rising
incomes and population growth, the size of the California economy has also increased
dramatically in the last 40 years.

Therefore, a second way of thinking about the tax increase is that in 1967 it increased revenues
equivalent to 1.1 percent of state output. In 2006, California’s GDP was $1.7 trillion. A tax
increase imposing an equivalent burden on the state’s economy today would therefore be in
excess of $19 billion.

A final way of contemplating the Reagan tax increase in today’s terms is relative to the state
budget. In 1966-67, the state’s General Fund totaled $3.3 billion. The $948 million tax increase
was equivalent to just under 29 percent of the budget. The 2007-08 General Fund was $102
billion. A comparable tax increase would be on the order of $29 billion.

The difference in these metrics results from the fact that the economy has grown significantly
faster than inflation and the state’s General Fund has grown significantly faster than the overall

By any reasonable metric, the Reagan tax increase raised significant revenues. Indeed, were
such a tax increase implemented today, it would likely cover the state’s current budgetary woes.


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