California families commit to salting away a share of their income when they can, just in case the roof springs a leak.
But state lawmakers have learned that saving for the proverbial “rainy day” can be a challenge, given the competition for dollars and wildly fluctuating tax revenues.
“The state is a dysfunctional family with a number of relatives demanding services, demanding a piece of the nest egg,” said Ruben Barrales, a San Diego Chamber of Commerce executive who was part of a 2009 commission that vainly argued for tax reforms to reduce the state’s revenue swings.
The dilemma is magnified by California’s over-reliance on volatile personal income tax revenues, inflated mostly by capital gains that state residents realized after cashing in real estate or stocks during bull markets.
“When revenues were riding the rocket, that’s what fueled it,” said H.D. Palmer, a spokesman for the state Department of Finance.
But when the housing bubble bursts and the bulls turn into bears, “those receipts sink like a rock in the water,” said Barrales.
For example, taxable capital gains dove to $56 billion in calendar year 2008. That represented a 43 percent free-fall from the $132 billion realized in 2007.
That drop in the value of investments sold by Californians was quickly translated into a decline in tax revenue for the state.
At its 2000 pinnacle, the dot.com industry helped produce $10.19 billion in capital gains taxes. The next year, after the market crashed, capital gains taxes collapsed to just $3.96 billion.
More recently, the hot real estate market helped deliver $10.87 billion in capital gains taxes in 2007. In 2008, that cash to the state dwindled to just $4.55 billion.
And there was no reserve to speak of to cushion the fall.
For the past few years the state has struggled to maintain a savings account barely breaking 1 percent of general fund expenditures. Brown has proposed a 2011-2012 contingency of about $1 billion in a general fund budget of $84.6 billion. Lawmakers have passed along budget plans of their own with reserves ranging from $300 million to $600 million.
Even during good times, lawmakers have a hard time saying no so the money can be tucked away for future emergencies.
“When a surplus builds there is extraordinary pressure to spend it or cut taxes,” explained Brad Williams, a former policy expert with the nonpartisan Legislative Analyst’s office.
Indeed, legislators and governors love to send money back to the taxpayers. Ronald Reagan in 1969 mailed checks of up to $200 and in 1987 George Deukmejian approved rebates of between $32 and $136 for each taxpayer depending on income. Gov. Pete Wilson cut the car tax and Gray Davis temporarily reduced the state car tax. At the time, few argued for setting more money aside for the next downturn.
“Money in reserve is red meat,” continued Williams, now a partner in the Sacramento-based Capitol Matrix Consulting which advises private clients on fiscal issues.
Gov. Jerry Brown’s proposed 2011-12 budget estimates the state will receive $49.74 billion in personal income taxes, which make up a majority of the state’s general fund. The second largest contributor is the sales tax, which will bring in an estimated $24 billion.
Barrales, like many analysts, believes that the state’s money woes can be partly blamed on its failure to maintain a secure reserve and inability to compromise on tax reforms.
“It’s common sense planning,” he said.
But it’s not for lack of trying. Previous governors moved to establish special contingency accounts, only to see them vanish in the legislative process. For example, Gov. Arnold
Schwarzenegger infuriated Democrats, who filed a lawsuit challenging his move, when he vetoed nearly $500 million in spending 2009-2010 to maintain a reserve.
Several commissions, under governors of both parties, also advanced ambitious, but controversial, recommendations to stop leaning so heavily on transient tax sources.
A major problem in redrawing the tax code is it appears next-to-impossible to avoid having winners and losers if the goal is to keep the same amount of money flowing into state coffers. For example, cutting personal income taxes has been recommended to reduce reliance on capital gains. But to recoup the lost revenue, the sales tax would have to be extended to services, such as lawn care and lawyers.
Others propose a flat tax.
“It’s tough to redistribute the tax burden politically, but economically it would benefit the state,” said Joel Fox, president of the Small Business Action Committee who also edits the “Fox & Hounds” political blog focusing on business and political issues.
Fox said the current unrelenting budget woes present an opportunity to make repairs.
“Someone said ‘very little changes until the status quo is more painful than change.’ I wouldn’t be surprised if there are new attempts (at change),” he said.
There have also been stabs at requiring reserves.
“Once upon a time we did have a cushion,” said Williams. “The cushion was so big the voters took it away.”
Ironically, it was Brown, during his first go-round as governor, who presided during the buildup of a surplus that triggered the Proposition 13 property tax rebellion in 1978. The savings account nearly reached $4 billion, in contrast to $11.6 billion in expenditures. Then-Treasurer Jesse Unruh branded it an “obscene surplus.”
A year later, voters passed what was known as the “Gann Limit” to cap spending growth based on inflation and population. But a series of subsequent ballot measures protecting education funding and transportation revenues basically nullified the reserve requirement.
In 2004, voters approved Proposition 58 and established a “budget stabilization account” capped at $8 billion or 5 percent of the budget, whichever is greater. A share of the account is earmarked to repay deficit reduction bonds issued earlier, but the governor can suspend that requirement during a fiscal crisis, and the reserve has never come close to its projected level.
More recently, Schwarzenegger and lawmakers agreed as part of a package of measures to ask voters to establish a new mandatory reserve formula and give governors new powers to strike spending. But Californians in 2009 rejected Proposition 1A, which was linked to other unpopular measures, such as extending tax hikes. It was also opposed by the influential Howard Jarvis Taxpayers Association and the League of Women Voters.
Given the slim revenues, rebuilding reserves will be a tough sale. Lawmakers would have to leave cash unspent while at the same time slashing spending on schools, health care, parks and the disabled.
“The tradeoffs are too stark,” Williams said.
Voters may get another crack at requiring a healthy reserve in February 2012 – if not sooner. Lawmakers have put on the presidential primary ballot a measure that would impose a bigger commitment to a rainy day fund and make it more difficult to suspend annual contributions to the savings account. It includes language identifying a 10 percent reserve, but only as a “target “ and is not mandatory.
That measure could go to voters sooner, perhaps within a couple of months. The Legislature is debating whether to set a June special election for Brown’s proposal to extend temporary increases in the sales, personal and car taxes.