What should California do with the $4.6 billion in extra tax revenue?

150 150 James Mayer

The Rainy Day Budget Stabilization Fund Act would shape the future of the state. (Photo: Doug888888)

The internet was humming last week with the news that the California economy has generated $4.6 billion more in state tax revenue than budget writers had anticipated.

Now comes the big question: What to do with it?

Californians in November 2014 are scheduled to vote on a constitutional amendment, the California Rainy Day Budget Stablization Fund Act, that would restrict what state officials can do when revenues jump above the 20-year average growth line.  In fact, Californians were supposed to vote on that amendment – which had been championed by Gov. Schwarzenegger and agreed to by the Legislature – in November 2012.  But with Schwarzenegger back in Hollywood, the Legislature moved the measure to the 2014 ballot.

And so now, state leaders are confronted with two important decisions:  First, without limitations in place, how much self-discipline will they apply to the $4.6 billion “bonus.”  And second, what to do about the “rainy day” proposal on next year’s ballot.

First things first: Lawmakers should treat the $4.6 billion as “one time” money, as opposed to a permanent growth in revenue. Why? Because that’s probably what it is.

Fiscal analysts are always challenged in real time to sort out with precision how much of revenue growth should be attributed to underlying economic growth and how much should be attributed to one-time events.  In this case, the safe bet – and given everyone’s nausea from the fiscal rollercoaster, let’s be safe – is that much of this money can be attributed to changes in the tax code that encouraged investors to take gains last year.

There is general agreement on how to deal with one-time money, and this year most of it will go to satisfy the Proposition 98 minimum funding guarantee for K-14 education. And if that is the case, how much of it should go to paying down the debt owed to K-14 education or pay for one-time investments such as infrastructure or technology?

In the past, state officials have often given in to the pressures and temptations to restore budget cuts or create new programs that cannot be supported when revenues flatten out.  That’s why in 2008, California Forward identified the imperative and has advocated for reforms that would better manage the state’s volatile revenue.

The other alternative is “tax reform” that will produce a more stable funding stream for the General Fund.  California relies on a progressive income tax and a sales tax largely limited to goods rather than services, and as a result the state’s revenue stream is far less stable than most other states.

Most tax reform proposals, however, require spreading more of the burden to middle and low-income taxpayers or taxing something that is not currently taxed.  Both choices are really hard – and should not be as hard as agreeing on a mechanism that provides stability for important, but politically vulnerable programs, like elder care services.

That brings us to the second issue:  Will the Legislature keep the constitutional amendment on the ballot?

California Forward has supported the rainy day proposal, but there is more than one way to solve the problem. What’s most important is that it actually be solved.  If not this amendment, then the Legislature should make it better, not eliminate it.

The proposal on the 2014 ballot would increase the state’s “rainy day” fund from 5 percent to 10 percent of the General Fund. It would require 3 percent of General Fund revenue to be deposited each year into the reserve – unless revenue is declining – until the 10 percent is achieved.

In general, it also would limit base spending to the growth in revenue, averaged over the last 20 years.  The formula is much more complicated than that, which is one of the concerns.) For the most part, revenue north of the average can be spent, but on “one-time” expenditures, such as debt reduction or infrastructure projects.

Today’s Legislature may think there is a better answer. But Californians – and the hundreds of local governments that rely on state funding and the millions of people who rely on quality and stable services – need an answer.

Fiscal instability impacts all state programs, but some programs more than others.  In the past, public safety spending has grown faster than higher education or social services. During tough economic times, the Legislature is faced with difficult choices, and the cuts have often been deepest in higher education and social services, impacting low income Californians the most.

Given the tremendous political pressures and a revenue stream that is increasingly volatile as the economy evolves, California needs some guard rails.

This year, however, Californians are going to find out what state lawmakers do without them.


James Mayer

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