California is in the Black
Governor Jerry Brown’s initial state budget was Sacramento’s first on-time budget in years, and the first “majority vote” budget in decades for the Golden State. Since June 2011, Governor Brown has signed three more on-time and balanced budgets. In fact, in January 2014, Governor Brown proposed a budget with a projected surplus of over $5 billion! Under current estimates, the year-to-year gaps between spending and revenues have been erased for the foreseeable future in California. Governor Brown’s fiscal record is quite a contrast from his predecessors. To be fair to Governor Schwarzenegger, many of the tough cuts in education, health and welfare programs he was forced to make while in office, and take the political hit for, helped Governor Brown balance the state’s General Fund. Governor Brown also has benefitted from three other significant events, including one largely of his own making: (1) the end of the great recession; (2) strong stock market performance that has increased capital gains and is driving a tax revenue bonanza for the state; and (3) passage of Proposition 30, a general tax increase that raised both sales tax and personal income tax rates in California.
Governor
Brown said repeatedly during his election campaign that he would neither sign
nor support a general tax increase without a vote of the people. In
uncharacteristic fashion compared to many politicians, he kept his word.
Proposition 30 passed in the November 2012 election on a 54 percent to 45
percent vote margin. It raised top personal income tax (“PIT”) bracket payers
in California by 3 percent to a full 13.3 percent on personal income. It also
raised the state’s general sales tax by 0.25 percent to a full 7.5 percent. The
sales tax increase sunsets after four years, at the end of 2016, and the PIT
tax increase doesn’t sunset until the end of 2018. Seven billion in annual revenues
are attributed to the temporary Proposition 30 tax increases. After passage of
Proposition 30, California is among the highest taxed states in the country.
Time to Pop Champagne Corks and Celebrate Fiscal Stability?
Despite
the recent improvements in California’s budget situation, there remain a number
of major risks that threaten the state’s new found fiscal stability. These
include billions remaining in short-term budgetary debt, hundreds of billions
of dollars in longer term liabilities for unfunded public employee retiree
health care and pensions, as well as demands for new program spending. The
threat of the next recession and changes in federal policy could cost the state
billons in higher costs and reduced revenues. Also, the temporary spike in
capital gains primes the pump of the spending lobby. The pressure to increase
state general fund expenditures is enormous and legislators are inclined to
expand existing programs and create new ones. Many in the state’s capitol tend
to see this temporary budget surplus as an opportunity to achieve their policy
and spending agendas. As if these threats were not enough to cause panic at the
California Department of Finance, the quarter‑cent sales tax
increase under Proposition 30 will expire at the end of 2016, and the higher
income tax rates on the state’s wealthiest residents will expire at the end of
2018. This is just in time for Governor Brown’s successor to be sworn into
office.
California’s
fiscal history is riddled with budgets that made permanent obligations of both
spending increases and tax cuts based on temporary revenue increases driven by
capital gains. After these spikes in revenues disappeared, as they always do,
the state was forced to cut programs and raise taxes. This danger is exacerbated
by the fact that two thirds of all general fund revenues come from the PIT and
50 percent of all PIT collected in the state come from the top 1 percent of
taxpayers (an important, but small population). So when this handful of highly
affluent individuals gets a financial cold, the state budget gets a severe case
of influenza – or worse. And that is what happened to previous governors when
the capital gains tax bubble burst – they had a fiscal roller coaster on their
hands. So, the combination of the fleeting capital gains surge and the
temporary Proposition 30 revenues should leave no doubt that the state’s modest
surplus must be carefully guarded or fiscal ghosts of budgets past will haunt
California. It should be clear to see that maintaining the new found fiscal
stability will require considerable restraint, smart policy and economic
momentum.
How Does
California Avoid Repeating Budget History?
There
is one big “new” factor that could save California services and taxpayers the
pain of more fiscal instability. The new factor is Proposition 2 on the
November 2014 ballot. California voters have the very important opportunity to
approve a bipartisan solution to the “boom-bust” budget cycles of budgets past.
Governor Schwarzenegger fought hard most of his administration for meaningful
budget reform that would prevent over-commitment of temporary state capital
gains tax revenues. He finally reached an agreement with the Legislature in
2010, but that vote was put off and delayed until now. With the help of strong
leadership by Governor Brown, and both Democrats and Republicans coming
together this year, Proposition 2 was drafted as a significant improvement on
the 2010 plan negotiated by the former Governor.
Proposition
2, the Rainy Day Budget Stabilization Fund Act, is a legislatively-referred
constitutional amendment. The measure, upon voter approval, would alter the
state’s existing requirements for budget reserves and have the effect of
smoothing out the spikes of “peak revenues” by putting them away in a budget
stabilization (rainy day) fund that could only be tapped when critically
needed. It also includes an education stabilization component to make sure
Proposition 98 education funding guarantees are protected as well. The actual
fiscal mechanism is a bit Byzantine to describe for this article, however,
analysts in the Governor’s Department of Finance, the Legislative Analyst’s
office and the legislative budget committees all agree that if it is enacted,
it will make a positive difference in future budget stability. In addition to
smoothing out year-to-year revenue spikes, it would accelerate the state
repaying existing budgetary borrowing and debt, increase funds for
infrastructure projects, and the additional cash reserves it creates would
reduce the need for external borrowing and thereby cut financing costs
associated with operating state government on a day-to-day basis. It is truly a
win-win situation for all California residents and taxpayers.
Conclusion
California
has made really impressive progress the last three years on its fiscal
situation. Governor Brown and the Legislature deserve a lot of credit for
making smart fiscal moves. They have also benefitted significantly from
national and state economies rebounding from the great recession, as well as
taxpayers’ willingness to increase their own taxes – albeit with a sunset. If
policy makers can resist the temptation to “spend it all” in one year, and
instead plan for the future, and if voters approve the Proposition 2 rainy day
fund, California can experience balanced budgets and fiscal stability into the
future. Governor Brown’s successor will still have to manage fiscal challenges
when both sales tax and PIT increases sunset under Proposition 30; however,
with the budget under control and a rainy day fund in place, he or she will be
in a much better position to manage the state affairs at that time.
Tom
Sheehy is the former Chief Deputy Director of Finance
and
Acting Secretary / Undersecretary of the State and Consumer
Services
Agency under Gov. Arnold Schwarzenegger. He joined
Greenberg
Traurig's Sacramento government affairs practice
