Deukmejian’s View of Law on Tax Rebate Losing Support

To Gov. George Deukmejian, the issue is simple: The California Constitution requires that the state give back to the taxpayers $700 million it received in unexpected revenues.

To use the money in other ways, such as spending it on schools, would break the law, the Republican governor has said. “As the Constitution requires,” Deukmejian said last week, “I have proposed to provide a rebate. . . . “

Around the Capitol however, Deukmejian’s interpretation of the Constitution has become a minority viewpoint.

A variety of lawyers, budget experts and politicians disagree with the governor’s stance on the law, including the business-supported California Taxpayers Assn., the office of Atty. Gen. John Van de Kamp, nonpartisan Legislative Analyst Elizabeth Hill, Legislative Counsel Bion Gregory, State Supt. of Public Instruction Bill Honig and Democratic leaders of both the Senate and the Assembly.

“The state has a number of options if more revenues are collected than can be appropriated,” the nonpartisan Taxpayers Assn. concluded in a study last March. The report identified 10 possible actions available to the state, one of which would be a tax refund.

Constitutional limits on spending, approved by voters in 1979 and known as the Gann limit after its sponsor, anti-tax crusader Paul Gann, came into play at the state level for the first time with the Deukmejian Administration’s discovery in May that the state would receive $1.1 billion in unexpected tax revenues.

The question of what is permitted under the Gann limit has become central to a legislative stalemate over the proposed state budget for the fiscal year beginning July 1. On Monday, Republican lawmakers in both houses sided with Deukmejian and blocked passage of the $41.1-billion spending plan--despite a separate constitutional requirement that the Legislature approve a budget by that day.

Under the Gann limit, incorporated in the state Constitution as Article XIII B, the state and local governments can increase their annual spending at no more than a rate based on the combination of population growth and inflation.

If the state or a local government collects more than it can spend under the limit, the Constitution requires that excess revenues “shall be returned by a revision of tax rates or fee schedules within the next two subsequent fiscal years.” This is the section cited by Deukmejian Administration officials to support the governor’s claim that the money must be returned to the taxpayers.

Another section of the Constitution provides, however, that a variety of expenditures do not count toward the appropriations limit, including money transfered by the state, without strings attached, to counties, cities, school districts, community colleges and special districts.

Other exceptions from the limit include paying off bonds approved by the voters and paying for programs ordered by the federal government or the courts.

The Constitution also provides that the state or a local government can go to the voters and ask that the appropriations limit be raised for a period of no more than four years at a time. There have been at least 189 such elections, roughly two-thirds of them tied to proposed tax increases, according to a March study by the California Taxpayers Assn. Of the 125 elections in which results were compiled by the organization, voters approved raising the limit on 90 occasions.

Another alternative employed by the Deukmejian Administration in previous years has been to change its interpretation of what spending comes under the limit, thereby increasing the amount of money that could be spent.

Chief Assistant Atty. Gen. Richard D. Martland said the Constitution clearly provides the state with alternatives to a tax rebate. “Our view is that there are several ways to deal with the revenues that come in that cannot, in essence, be appropriated,” said Martland, who headed the government law section when Deukmejian was attorney general.

‘Not the Only Option’

Hill and Gregory drew the same conclusion in reports submitted to the Legislature. “While a rebate is a legitimate option for dealing with increased revenues, it is not the only option,” Hill said.

Deukmejian’s finance director, Jesse Huff, defended the governor’s position, pointing out that the Legislature would have to act before June 30, the end of the fiscal year, to appropriate the money for some purpose other than a tax rebate. Anyway, he asserted, a combination of constitutional requirements and related state laws makes a tax refund the only legal alternative.

“There are some expenditures that are permitted under the Constitution,” Huff acknowledged in an interview, adding: “Just because they are permitted under the Constitution doesn’t mean that in the last two weeks of the fiscal year you can do them legally. You can’t.” The governor has proposed giving $700 million of the $1.1-billion windfall back to the taxpayers through a 10% income tax rebate, with a maximum of $95 for individuals and $190 for couples.

Deukmejian proposes to use the remaining $400 million of the surplus to replenish money that has been spent out of the state reserve this year on a variety of programs, including $85 million for public schools and $98 million for Medi-Cal, according to the Department of Finance.

Because the state is already close to its appropriations limit in the current fiscal year, however, it would have to find a way to increase its spending capacity in order to use the $400 million to replenish the reserve.

Transfer Plan

Deukmejian proposes to accomplish this by transferring to the state $400 million in unused spending capacity under the Gann limit that is credited to school districts. Budget analysts agree that this maneuver would be legal because the state is the primary source of school funding and the school districts’ limits are directly linked under law to the state’s limit.

To counter Deukmejian’s rebate plan, the Democratic-controlled Legislature passed legislation to give $700 million directly to the schools and community colleges. The money, under this plan, would count against the schools’ and colleges’ spending limits, not the state’s, Democratic lawmakers said.

Deukmejian vetoed the bill, saying in a veto message that it “violates the state Constitution.”

Later, Administration officials were unable to identify the section of the Constitution the bill would have violated. Huff contended that the bill would be unconstitutional because it would allow school districts to place unappropriated money in escrow accounts while awaiting voter approval to spend it.

Furthermore, Huff said, giving the money to school districts would not be legal because the schools would have no room remaining in their limits once the state takes over the $400 million in their remaining capacity.

The finance director said he based the $400 million estimate of the school’s capacity on a computer model that calculates financial data submitted by school districts.

Accuracy Challenged

Honig challenged the accuracy of the $400-million figure, saying a survey of two-thirds of the state’s school districts indicated that they have a total of more than $1 billion in unused capacity.

Huff and legal experts outside the Administration also clash over the issue of whether individual school districts and other local governments could hold elections to raise their limits so that money collected in a previous fiscal year could be spent.

Although the Constitution does not directly address the question, Huff contends that elections must be held before revenue is collected. Honig, the California Taxpayers Assn., Martland and others argue that the elections can be held as long as the money has not been spent. Some local governments have already held such retroactive elections, according to Rebecca Taylor, research director for the taxpayer association.

Another alternative to a tax refund, according to critics of the governor’s rebate plan, would be to give the $700 million to county governments, many of which have been struggling to provide basic services.

However, Huff contended that some counties would not be able to spend money transfered to them by the state because they have already reached their spending limits. Arguing that these counties also could not legally hold elections to raise their limits retroactively, Huff said giving money to the counties would inevitably result in discrimination against those who were unable to spend it. Such unequal treatment would be illegal, he said, although he acknowledged that some state programs already provide different levels of funding to different counties.

‘Can’t Really Do It’

“I think, and the governor thinks, legally you can’t really do it because you run into the unequal treatment,” he said. “Under existing law, there’s nothing to do but give the $700 million back to the taxpayers.”

Huff also rejected the idea of using the $700 million to pay some of the state’s bond debts in advance. Although money used to pay off bonds approved by the voters does not count toward the spending limit, Huff argued that it would violate the spirit of the law to pay them back early because the voters have not required the state to do so. The governor also has said that paying off bonds early could result in prepayment penalties.

On one point, however, there is common agreement: Unless the Legislature and the governor reach agreement by June 30, all of the $1.1 billion would be subject to a tax rebate.

In that event, Democratic leaders of the Legislature suggest, they would seek a statewide election to permit expenditure of the money. Honig and other politicians have already said they will attempt to put an initiative on the ballot next year to modify the way the Gann limit is calculated, thereby allowing more money to be spent.

Administration officials point out, however, that if the Legislature approves Deukmejian’s proposal by June 30, the governor could be forced to cut up to $800 million from the budget that will take effect July 1.

Without passage of legislation transfering the $400 million in spending authority from the schools to the state, they say, Deukmejian would have to cut $400 million from next year’s budget to replenish the reserve to make up for excess spending this year. And he would have to cut another $400 million from the budget for the coming fiscal year to prevent the state from exceeding its spending limit.

‘Prudent’ Reserve

These potential cuts might be avoided, however, if Deukmejian were to compromise on his longstanding demand for a $1-billion “prudent” reserve--an appropriation that counts toward the state spending limit even if it remains unspent.

This could lead to an awkward situation in which Deukmejian is substantially reducing spending on education and other state programs at the same time he is preparing to return money to the taxpayers.