California Governor Jerry Brown’s initial state budget was Sacramento’s first on-time budget in years, and the first “majority vote” budget in decades for the Golden State. Since June 2011, Governor Brown has signed three more on-time and balanced budgets. In fact, in January 2014, Governor Brown proposed a budget with a projected surplus of over $5 billion! Under current estimates, the year-to-year gaps between spending and revenues have been erased for the foreseeable future in California. Governor Brown’s fiscal record is quite a contrast from his predecessors. To be fair to Governor Schwarzenegger, many of the tough cuts in education, health and welfare programs he was forced to make while in office, and take the political hit for, helped Governor Brown balance the state’s General Fund. Governor Brown also has benefitted from three other significant events, including one largely of his own making: (1) the end of the great recession; (2) strong stock market performance that has increased capital gains and is driving a tax revenue bonanza for the state; and (3) passage of Proposition 30, a general tax increase that raised both sales tax and personal income tax rates in California.

Governor Brown said repeatedly during his election campaign that he would neither sign nor support a general tax increase without a vote of the people. In uncharacteristic fashion compared to many politicians, he kept his word. Proposition 30 passed in the November 2012 election on a 54 percent to 45 percent vote margin. It raised top personal income tax (“PIT”) bracket payers in California by 3 percent to a full 13.3 percent on personal income. It also raised the state’s general sales tax by 0.25 percent to a full 7.5 percent. The sales tax increase sunsets after four years, at the end of 2016, and the PIT tax increase doesn’t sunset until the end of 2018. Seven billion in annual revenues are attributed to the temporary Proposition 30 tax increases. After passage of Proposition 30, California is among the highest taxed states in the country.

Time to Pop Champagne Corks and Celebrate Fiscal Stability?

Despite the recent improvements in California’s budget situation, there remain a number of major risks that threaten the state’s new found fiscal stability. These include billions remaining in short-term budgetary debt, hundreds of billions of dollars in longer term liabilities for unfunded public employee retiree health care and pensions, as well as demands for new program spending. The threat of the next recession and changes in federal policy could cost the state billons in higher costs and reduced revenues. Also, the temporary spike in capital gains primes the pump of the spending lobby. The pressure to increase state general fund expenditures is enormous and legislators are inclined to expand existing programs and create new ones. Many in the state’s capitol tend to see this temporary budget surplus as an opportunity to achieve their policy and spending agendas. As if these threats were not enough to cause panic at the California Department of Finance, the quarter‑cent sales tax increase under Proposition 30 will expire at the end of 2016, and the higher income tax rates on the state’s wealthiest residents will expire at the end of 2018. This is just in time for Governor Brown’s successor to be sworn into office.

California’s fiscal history is riddled with budgets that made permanent obligations of both spending increases and tax cuts based on temporary revenue increases driven by capital gains. After these spikes in revenues disappeared, as they always do, the state was forced to cut programs and raise taxes. This danger is exacerbated by the fact that two thirds of all general fund revenues come from the PIT and 50 percent of all PIT collected in the state come from the top 1 percent of taxpayers (an important, but small population). So when this handful of highly affluent individuals gets a financial cold, the state budget gets a severe case of influenza – or worse. And that is what happened to previous governors when the capital gains tax bubble burst – they had a fiscal roller coaster on their hands. So, the combination of the fleeting capital gains surge and the temporary Proposition 30 revenues should leave no doubt that the state’s modest surplus must be carefully guarded or fiscal ghosts of budgets past will haunt California. It should be clear to see that maintaining the new found fiscal stability will require considerable restraint, smart policy and economic momentum.

How Does California Avoid Repeating Budget History? 

There is one big “new” factor that could save California services and taxpayers the pain of more fiscal instability. The new factor is Proposition 2 on the November 2014 ballot. California voters have the very important opportunity to approve a bipartisan solution to the “boom-bust” budget cycles of budgets past. Governor Schwarzenegger fought hard most of his administration for meaningful budget reform that would prevent over-commitment of temporary state capital gains tax revenues. He finally reached an agreement with the Legislature in 2010, but that vote was put off and delayed until now. With the help of strong leadership by Governor Brown, and both Democrats and Republicans coming together this year, Proposition 2 was drafted as a significant improvement on the 2010 plan negotiated by the former Governor.

Proposition 2, the Rainy Day Budget Stabilization Fund Act, is a legislatively-referred constitutional amendment. The measure, upon voter approval, would alter the state’s existing requirements for budget reserves and have the effect of smoothing out the spikes of “peak revenues” by putting them away in a budget stabilization (rainy day) fund that could only be tapped when critically needed. It also includes an education stabilization component to make sure Proposition 98 education funding guarantees are protected as well. The actual fiscal mechanism is a bit Byzantine to describe for this article, however, analysts in the Governor’s Department of Finance, the Legislative Analyst’s office and the legislative budget committees all agree that if it is enacted, it will make a positive difference in future budget stability. In addition to smoothing out year-to-year revenue spikes, it would accelerate the state repaying existing budgetary borrowing and debt, increase funds for infrastructure projects, and the additional cash reserves it creates would reduce the need for external borrowing and thereby cut financing costs associated with operating state government on a day-to-day basis. It is truly a win-win situation for all California residents and taxpayers.

Conclusion

California has made really impressive progress the last three years on its fiscal situation. Governor Brown and the Legislature deserve a lot of credit for making smart fiscal moves. They have also benefitted significantly from national and state economies rebounding from the great recession, as well as taxpayers’ willingness to increase their own taxes – albeit with a sunset. If policy makers can resist the temptation to “spend it all” in one year, and instead plan for the future, and if voters approve the Proposition 2 rainy day fund, California can experience balanced budgets and fiscal stability into the future. Governor Brown’s successor will still have to manage fiscal challenges when both sales tax and PIT increases sunset under Proposition 30; however, with the budget under control and a rainy day fund in place, he or she will be in a much better position to manage the state affairs at that time.