Tax Shortfall May Cut State Spending : Take Could Be $800 Million Under Projections, Wiping Out Reserve

State Finance Director Jesse R. Huff disclosed Tuesday that state income tax receipts are as much as $800 million below projections, a development that is expected to wipe out much of the budget reserve and cause cutbacks in both current and anticipated spending.

After a year in which the state handed out income tax rebates of $1.1 billion because of an unexpected budget surplus, the dramatic drop-off in income tax receipts took Deukmejian Administration officials and lawmakers by surprise.

“We are in the range of several hundred million short, perhaps as much as $800 million,” Huff said. “It is something that has caught us by surprise.”

Checks ‘Smaller Than Expected’

Linda Proaps, executive secretary of the Commission on State Finance, which tracks revenues and expenditures, said in a letter to legislators that the shortfall could be $800 million to $900 million.

Huff, a member of the commission, said the shortfall turned up when the Franchise Tax Board began counting tax payment checks mailed to meet the April 15 tax deadline.

“The checks are smaller than we expected,” the finance director said.

Huff and other officials speculated that a major reason for the drop-off in tax payments could be unexpectedly large losses reported by taxpayers as a result of the Oct. 19 stock market crash.

Another extraordinary development in 1987 that could have contributed to the shortfall was the overhaul of state income tax laws to make them conform with federal tax codes, which were rewritten in 1986.

The tax conformity bill approved last year by the Legislature and signed by Gov. George Deukmejian was supposed to be revenue neutral, meaning that overall tax receipts were not expected to increase or decrease.

Huff and other state officials had been counting on the April tax payments to help finance the current $41.9-billion budget. The budget was based on projections that personal income taxes would generate $14.1 billion this year. The latest projections, if they hold up, could drop that figure to $13.2 billion or less.

Despite a $1-billion reserve that Deukmejian has set aside for emergencies, Huff said cuts in both the current year’s budget and the $44.3-billion budget being proposed for the fiscal year that will begin July 1 are likely. “We’re going to be working overtime,” Huff said.

Assemblyman John Vasconcellos (D-Santa Clara), chairman of the Assembly Ways and Means Committee, said, “I am looking to Gov. Deukmejian to advise us on how to modify the budget he gave us based on revenues that no longer exist. The ball is in his court.”

Vasconcellos said he considered the state budget, even before the drop-off in revenues, to be “bare bones,” without adequate funding for education, health services, programs to halt the spread of AIDS, and control of toxic substances.

“What this means is that we might have to take as much as $1 billion out of next year’s budget. That to me is frightening and threatens California’s capacity to assure quality education and good health for our people,” Vasconcellos said.

The lawmaker noted that Huff has already predicted that he will have to cut the budget by at least $200 million if Proposition 72, an initiative that would raise the state spending limit and transfer general tax revenues to transportation programs, is approved by voters in the June primary election.

Other legislative leaders were in Washington on their annual trip to meet with federal officials and members of Congress to discuss issues of concern to California.

Huff, who is responsible for preparing forecasts of state revenues and expenditures that are used as the basis of preparing state budgets, said it is still too early to determine the exact cause of the shortfall. He said tax officials have had time to count only the checks, not do a thorough examination of returns.

He ruled out the possibility that the drop-off in income tax revenue was related to the economy. He said employment remains high and the economy is strong.

Huff said his office had been unable to get a clear fix on how investors reacted to the crash.

“The question all along has been: When people cashed out of the market, did they cash out in net loss or net gain positions?” Huff said.

If investors sold stocks and took losses in 1987, then it would reduce taxable income, resulting in lower state income taxes. Capital gains, of course, would produce profits and higher levels of taxable income.

The state budget contains a reserve fund of nearly $1 billion, which is enough to meet immediate cash shortages. But it is unlikely that Deukmejian will agree to use it all to make up for the shortfall, meaning he likely will propose emergency cuts in current spending, as he has done in the past. And based on his policy of maintaining the reserve, Deukmejian likely will insist that the $1-billion rainy-day fund be restored for the new fiscal year, meaning cuts in other programs.

The budget picture could improve if the Legislature, as expected, approves proposed legislation to conform the state corporate income tax code to revisions in federal tax codes made in 1986. If that legislation is passed, it could bring in an additional $210 million to $240 million, but it is not known whether it can be passed in time to affect the current shortfall.

Just Monday, Huff told a joint Senate-Assembly Tax Committee hearing that state tax revenues were only $79 million short of projections, not enough to cause serious concern.

Asked why, a day later, that figure would jump to $800 million, Huff said, “It’s developing rather quickly.” He said the $79-million figure was based on revenues as of the end of March and did not reflect April tax payments.

About this time last year, Huff was widely off the mark on his revenue projections when he surprised the Legislature by reporting an unexpected surplus of $1.1 billion, the amount that was ultimately returned to taxpayers in rebates.

At the time, Huff attributed the bonanza to changes in federal tax law in 1986.

Assistant Finance Director Lois Wallace said that while the off-the-mark projections are “something we don’t hold up with pride,” the revenue forecasts in fact reflected the experience of many other states in trying to predict taxpayer behavior in the way of the far-reaching tax changes.

“This is the first year we are having to live with the changes in the state tax law. The first year we lived with the federal tax law changes we got an extra $1 billion. This year we are short. Taxpayers are behaving differently than they ever have before. It’s a whole new ballgame,” she said.

The same phenomenon does not seem to be occurring at the federal level.

U.S. government revenues totaled $412 billion for the first six months of fiscal 1988, according to the Treasury Department, up more than 7% from the $383.8 billion for the same period in fiscal 1987.

The Treasury Department has not reported how much of that revenue stemmed from personal income tax. Fiscal 1988 began Oct. 1.