California mishandled budget surplus
California's state budget has gone from a surplus of $29 billion to an estimated deficit of $23 billion within the course of six months.
In 2021-2022, California experienced an unprecedented rise in revenue from capital gains which, unlike the federal government, our state government taxes at the full level of ordinary income.
The stock market took off as we recovered from COVID-19. So did capital gains. Now, that's reversed. Start-ups are plummeting. Fewer early investors are cashing in their founders' stock. Land values are no longer skyrocketing. The flood of federal COVID money into the state's treasury for two years has now ceased. Gov. Newsom's January budget proposes to deal with this problem using several different fiscal steps. The general fund will increase borrowing from special state funds that had been designated for other purposes. We will stop redeeming California bonds early. Building at Cal State University campuses was being subsidized by the general fund; now, payments on those construction bonds will be assigned back to the Cal State system. Extra deposits to the state rainy day fund proposed when revenue was plentiful have been cut to zero.
Many of these steps are sensible.
For instance, California should not repurchase its bonds that pay a very low interest rate, when California would have to float new bonds at today's much higher rates. Other steps, however, will not be easy.
Before we got into this crisis, were there steps we could have taken but didn't? Of course.
We could have been more frugal in every increased category as California's government expenditures went from $166 billion to $243 billion in one year, from 2021 to 2022, an increase of $77 billion, or 46%. That growth in expenditure exceeded the growth in population and inflation, triggering a required rebate of $9.5 billion under the 1979 California Constitutional amendment called the Gann Limit.
The $23 billion dollar deficit in this year's budget could have been cut almost in half if we still had that $9.5 billion available. Instead, it was distributed last year to California residents in inverse proportion to their income. Individuals making more than $250,000 received no rebate at all, even though they paid far more than half of the entire state income tax.
The Gann Limit requires distributions of a surplus in the form of “refunds of taxes.” Gov. Newsom and the California Legislature interpreted that phrase into meaninglessness, saying in their “Better for Families” Act that tax funds could simply be given to residents, even those who did not pay taxes.
Grammatically, it's hard to see how a payment to someone who did not pay taxes can be a “refund of taxes.”
Politically, however, it's obvious. Gov. Newsom was able to distribute billions of dollars to middle- and lower-income Californians during an election year; he, and the Democratic party-controlled Legislature, took credit for it.
A refund of taxes should be in proportion to the amount of taxes an individual paid. That's what was done in 1987, the only other time when the Gann Limit was applied. Taxpayers received a rebate of 15% of the tax each person paid. Even then, however, a political compromise put a cap on the overall size of any one person's rebate. The prospect of millionaires receiving hundreds of thousands of dollars in state checks was unpalatable even to Gov. George Deukmejian, even though it could logically be explained that the millionaires were only receiving back a small portion of the taxes they had already paid.
Since returning to the spirit (and actual words) of the Gann Limit is politically impossible, we should restructure California's laws so that any budget surplus goes into the rainy-day fund instead — for just the kind of situation we're now experiencing. California state budgets come in cycles, much like our rain. It's raining now, and we wish we had stored up a bit more of a reserve when it was sunny.
Tom Campbell is a professor of economics and of law at Chapman University. He was California's director of finance under Gov. Arnold Schwarzenegger. He was also a California state senator and a five-term congressman. He left the Republican Party in 2016 and is working to establish a new political party in California, the Common Sense Party.