10/06/2014 by Jim Mayer

What you can do for California

In the good times, it is important to remember the bad times.

One of California’s most serious governance challenges is the volatility of General Fund tax revenue.  No other state has a revenue system that produces higher booms and bigger busts. As a result, everything from schools to services for the elderly are subjected to fiscal hardships, and Californians to the heartache.

This volatility is predictable, but the consequences are avoidable. Proposition 2 on the November ballot is the best solution developed after a generation of debate. The measure is not just a “rainy day fund.” It will require lawmakers to manage revenues to provide stable funding for essential public services, especially K-12 schools and higher education, community health, public safety and social services.

If this makes so much sense, why has it taken so long to fix?

In more polarized times – just a few years ago – fiscal conservatives insisted on a hard spending cap: Any revenue over a modest growth curve should be returned to taxpayers.

Meanwhile program advocates resist this kind of “fiscal discipline.” They think it sends the message that government has enough money in the good times to save for the bad times – when they believe government doesn’t have enough money in the good or bad times.

Proposition 2 is not a spending cap: The state could still spend all of the revenue it receives.  It just couldn’t spend those spikes in revenue from a surging stock market – what budget writers call “non-recurring revenue” – as if the revenue will be there in the future.

Proposition 2 also does not preclude the important debate about investing more – particularly in education to close the achievement and income gaps, and in infrastructure so California will be competitive and sustainable.

Proposition 2 does, however, solve a big problem: The Legislature historically has spent all of the revenue it anticipates.  Advocates for worthy programs believe in their hearts that in bad times taxes will be increased to prevent cuts – or at least they will be able to defend their programs.

But in the end, history repeats itself. Programs that Californians value most (education) are cut more than programs they value less (corrections), while programs for poor Californians are cut the deepest.

This craziness leads to protests, lawsuits, and angry battles between the State and local governments.  

Consider the numbers:  Between 2004 and 2007, General Fund revenue increased from $82 billion to $102 billion. About $7 billion of the $20 billion came from “spikes” in capital gains income. Then in 2008 General Fund tax revenue dropped by $20 billion.

This is not just a Great Recession problem.  Between 1998 and 2000, General Fund tax revenue increased from $58 billion to $76 billion. Again much of the increase was capital gains. When the recession hit in 2001, tax revenue dropped by $12.8 billion.

In both cases, spending was increased and then slashed to match revenue.  

The underlying challenge: The State is highly reliant on the personal income tax, which is structured to rely heavily on wealthy taxpayers, who make more money from investments, which go up and down.  

One solution would be to broaden the sales tax on goods to include services (such as attorneys, accountants, entertainment, etc.). Another would be to shift taxation from volatile income to more stable wealth. Both ideas are controversial, and while that debate matures, a little discipline will reduce the long-term chaos from short-term budget thinking.

Prop 2 essentially does what smart organizations and individuals do:  manage the peaks and avoid borrowing. Under Prop 2, 1.5 percent of General Fund revenue would go into the reserve. In years when revenue from capital gains exceeds 8 percent of tax revenue, the excess also goes into the reserve.  Of the annual set aside, half will be used to pay down debt and half saved for lean years.

This rollercoaster is so steep and scary that it has consequences in all years, not just lean ones.  2007 was the most prosperous year in modern California history. Per capita income hit an all-time high of $44,446.  State revenue and spending had grown in each of the three previous years – but the State still had an operating deficit.

California went through an entire business cycle without paying off operating debt from the previous recession or even truly balancing the budget.  Then the Great Recession hit.

September 2014 is the 63rd month of economic recovery.  The average time between the last six recessions was 63 months.

Proposition 2 was championed by the Governor and battle-worn legislative leaders.  It was backed overwhelmingly by lawmakers in both houses, both parties.  That political consensus was encouraged in part by recent political reforms that that reward compromise.  That compromise is now on the ballot – a fiscal reform to provide stable funding for critical public services.

What you can do is vote for it.

Jim Mayer is the President and CEO of California Forward, a nonpartisan organization committed to bolstering democracy and improving government performance.

This article was originally published on The Davis Enterprise's website.

Categories: Fiscal Reform, Budget Reform, Rainy Day Fund

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