California Has An On-Time, Balanced Budget; Sales Tax Drops

July 06, 2011

While I was in college in California in 2000, I read a newspaper article about my state government's struggle on how best to spend an $8 billion budget surplus. As at the federal level, the surpluses were based on phantom profits and disappeared as the economy tumbled into recession and spending soared unsustainably above revenues.

In the decade since, the Golden State's budgets have been written in red ink. It was a given that each year California would put off the final reckoning—move a payroll into the next year, borrow to pay operating expenses, do a one-time tax increase, issue IOUs—anything but solve the structural imbalance. Each year, the accumulated deficits grew larger, making the ultimate resolution that much harder.

California has now done the improbable: they confronted their structural imbalance and solved it, passing an $85.9 billion general fund budget. More surprisingly, they did it nearly completely by reducing planned spending and even let a sales tax reduction go ahead as planned. (Governor Jerry Brown (D) seeks to extend expiring increases in income, sales, and vehicle taxes, but accepted that it wouldn't happen this time. Brown also vetoed a more gimmick-laden budget, pushing the Legislature to actually cut.) While the budget does expect billions in extra tax revenues from growth that may not occur, it requires additional cuts to occur automatically if the money doesn't materialize.

The Sacramento Bee listed the largest cuts/service changes, which I summarize below:

  • Medi-Cal (the state's Medicaid program): Patients will now pay a $5 co-pay for doctor visits and a $50 co-pay for emergency room visits, doctors and hospitals will see a 10% cut in payments, adult day health care is eliminated, and recipients are capped at seven doctor visits per year and $1,510 in hearing aid expenses.
  • Healthy Families Program (formerly children's health care program): Premiums for families between 150% and 250% of the poverty level are increased, as are co-pays for emergency room visits.
  • Developmental services are cut through cost-containment procedures; mental health services see an $861 million transfer from county programs to state programs.
  • CalWORKs (welfare): Time limit is reduced from 60 months to 48 months; cash grants are reduced 8 percent; more work income is counted for qualification criteria; child care and employment services are cut $369 million.
  • In-Home Support Services will now require medical certification (this will save an estimated $67 million); more federal funds; installation of medication-dispensing machines in homes (saving $140 million).
  • For education, my alma mater of the University of California will see a $650 million cut, as will California State University ($650 million) and community colleges ($400 million). Cal Grants will see stricter verification requirements. K-12 education receives the same funding as last year, the minimum under a state proposition, but will be reduced if taxes are not raised by November 2012. Preschool and child care will see stricter income eligibility enforcement.
  • State employee compensation will be reduced $471 million through efficiencies, and prison rehabilitation and medical care services will be cut. Courts see a spending cut and a reduction in new construction funding. Rural property owners will pay an annual fee for fire protection services.  
  • The vehicle tax is shifted to pay off accumulated debt, although it dropped from 1.15% to 0.65% as of July 1. The sales tax also dropped one percentage point on that date.
  • The state expects to raise $900 million through a tax amnesty, repeal of the state child tax credit, and the new "Amazon" tax.
  • Counts on $8.3 billion in unexpected revenue growth and $2.9 billion in borrowing and other changes.

Also, California legislators forfeited $800,000 in pay for passing the budget after their required deadline, although it went into effect before the beginning of the July 1 fiscal year.

No one observing California's fiscal situation has suggested that its enormous short-term budget deficit results from a reluctance to tax. Rather, it is a result of trying to keep spending commitments that were based on naïve assumptions about tax revenue growth from the boom. California has taken a big step in reprioritizing those commitments instead of continuing to put off the hard choices. Governor Brown deserves strong praise for forcing everyone's hand on this.

However, his proposed tax extensions are on top of what were already high taxes, especially for the individual income tax, corporate income tax, and sales tax. The high rates and collections from these taxes harm California's long-term competitiveness and economic growth. With respect to the so-called millionaires' tax on individuals, the idea of paying for broadly available public services through disproportionate taxes on high-income earners raises serious equity questions. More pragmatically, such taxes are highly volatile and contribute to the boom-and-bust cycle of California's state budget.

Policymakers and stakeholders in California and other states considering reform of their tax systems should raise these concerns and resist efforts to substitute damaging short-term fixes for real long-term, pro-growth tax reform. States with such systems will be best positioned for investment, entrepreneurial activity, and job growth as the economy recovers.

More on California here. Read here about Michigan repealing its destructive MBT gross receipts tax on business, another improbable thing that has happened this year. Do these things happen in threes?

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