State Budget Is a Fiscal Time Bomb, Critics Say : Government: Plan counts on rosy economic picture. Short-term measures are being used to balance it.

The $55.7-billion budget Gov. Pete Wilson signed Tuesday is filled with fiscal time bombs that can only be defused by a robust economic recovery that lifts tax revenues and reduces the state’s obligations to the poor, according to interviews and Wilson Administration documents.

Wilson has accused the Legislature and his predecessor, former Gov. George Deukmejian, of “papering over” past deficits with temporary spending cuts and bookkeeping maneuvers. But Wilson, in a bid to win legislative majorities that included a mix of liberal Democrats and conservative Republicans, resorted to a similarly pragmatic approach, balancing his first budget with more than $8 billion in short-term measures.

Some lawmakers and private economists fear that the record tax increase Wilson has embraced will slow economic growth and drive the government back into the fiscal morass from which it is only now emerging. If so, Wilson and the Legislature will almost certainly face another budget deficit 12 months from now.

Even if times are good, the governor’s own number crunchers concede that within five years, the $7.6-billion tax increase that the Republican chief executive proposed and signed will not be enough to keep the budget balanced.

“I predict we will have another shortfall next year,” said Republican state Sen. Frank Hill of Whittier, a member of the Senate-Assembly conference committee that crafted the spending plan. “There are a lot of onetime fixes in this budget.”

Assemblyman Tom McClintock, a harsh critic of the Wilson Administration, said the governor’s budget was balanced with “flights of fancy.” McClintock last summer was one of a handful of lawmakers to warn that the state’s fiscal situation was going to worsen after the Legislature and governor agreed on a deal to close a budget shortfall. Now he is repeating his message.

“This is the first day of the next budget crisis,” the Republican from Thousand Oaks said in an interview as several pieces of the budget-balancing package cleared the Assembly floor.

This pessimistic view is not shared by Wilson.

“Our purpose was not simply to close the gap in this year’s budget, but to avert crises in future years,” Wilson said. “This crisis could not be papered over.”

Bill Livingstone, Wilson’s press secretary, said: “We don’t have smoke and mirrors in this budget. We’re not cooking the numbers to make everything balance.”

Finance Director Thomas Hayes acknowledged in an interview that the plan that took effect Wednesday will carry the state for at most four years--if the Administration’s economic projections hold true. Hayes conceded that Wilson did not accomplish his goal of restructuring state government to bring expenditures into line with anticipated revenue. Wilson and the Legislature will need to make additional cuts or raise taxes in the years ahead to keep the budget balanced, he said.

“It won’t make it five years unless we make continuous adjustments,” Hayes said. “We are going to have to adjust our programs to stay within the revenue we’re going to have. It’s going to be a multi-year process.”

Those adjustments will be more difficult if the economy’s performance fails to match the state’s expectations.

Department of Finance figures show that Wilson’s revenue-raising package, which includes higher levies on income, sales, cars and other items, will bring the state’s tax burden to historic highs when measured as a percentage of personal income. The department’s forecasters do not expect that heavy load of taxes to dampen economic growth. They expect the economy to expand so that state revenues will climb 3.5% in the fiscal year that began July 1, and by an additional 10% the next year, before counting the money raised by new taxes.

Ted Gibson, principal economist for the department, defended the Administration’s economic projections as “reasonable.” He noted that they were reviewed by several economists from private business and academia and found to be realistic.

Gibson acknowledged that even by his estimate, there is a one-in-three chance that the recent signs of economic recovery will be false--what Wall Street calls a “dead-cat bounce”--and that the economy will erode further. Gibson said he has yet to analyze what effect such a stall would have on the budget. “It’s not good,” he added.

Although the state’s budget crisis has been building for years, it came to a head a year ago when lawmakers were faced with what then was a record $3.6-billion shortfall. The gap was closed with a combination of narrowly targeted tax increases and spending cuts and a large measure of accounting shifts and onetime remedies.

Within months, the problem surfaced again as tax revenues plunged with the economic downturn, and health, welfare, education and prison costs continued to soar. Soon it became clear that the state would end the 1990-91 fiscal year awash in red ink, with a deficit of more than $1.3 billion.

By the time Wilson took office, he disclosed that there was a $7-billion chasm between what the state was expecting to take in and the amount needed to continue all services through June, 1992, at their current levels while paying off the deficit and rebuilding the reserve to $1.2 billion. This projected deficit later grew to more than $14.3 billion.

After months of bargaining and trade-offs, Wilson and the Legislature have erased the shortfall with a deal that has been widely described as half cuts and half revenue. But that description is misleading.

More accurately, the package includes $7.6 billion in taxes and fees, plus another $3.6 billion in revenue raised by getting more from the federal government, borrowing from special funds, shifting money from the pension system and altering bookkeeping procedures. Only $3.1 billion in true program cuts are part of the package--and those are reductions from projected spending. Overall, spending from the state’s general fund is growing 7%.

Why the discrepancy? Part of it is politics. The governor and lawmakers want to appear to be dishing out the pain in equal doses of taxes and spending cuts. Part of it is because of the peculiar vocabulary used by the people who put the budget together. The state Capitol may be the only building in California where you can walk upstairs and come out on a lower floor. It also is the only place where you can call a tax increase a budget cut and get away with it.

Take the renters’ tax credit. By limiting the credit to single tenants making less than $20,500 a year and couples earning under $41,000, the budget package increased the net taxes to be paid by thousands of Californians who rent. But the governor counts this move as a $135-million budget cut because it lowers the amount that the state will have to pay to those filing for the credit.

Similarly, higher fees to be charged by the University of California and the California State University systems are considered a budget cut because they will relieve the state’s general fund of $96 million that would have gone to higher education.

Also, while the state plans to make the full payment required this year to the public employees retirement system, the money will come out of pension reserves rather than the general fund. So it counts as a $560-million “program reduction.”

Wilson bargained for a $1.2-billion reduction in the budget needed for public education to maintain current levels of services. But he also took credit for another $500-million “reduction” that was a paper shift resulting from the changing economy. This $500 million represents an amount budget analysts once thought voter-approved Proposition 98 was going to require for education, even though the schools are not entitled to the funds.

In addition to these phantom budget cuts, the package includes more than $8 billion in temporary measures that are designed to last from one to five years.

Although the $1.2-billion education cut is real, it is a onetime reduction; the money is to be restored a year from now. The pension fund shift of $560 million could be repeated for two years but not after that. Other temporary measures include a $700-million change in accounting procedures and $300 million in federal funds that lawmakers believe they can obtain for the state even though receipt of the money is not assured.

Another $300 million almost certainly will be lost in 1993 with the automatic reinstatement of a business tax break that has been suspended for two years, and the losses will be greater in future years. The provision will allow companies to carry forward operating losses and use them to offset income for tax purposes in future years.

One-half cent of the sales tax increase is temporary and will be repealed automatically in 1992 or 1993, depending on the condition of the state’s coffers. With it will go another $1.4 billion a year.

Finally, in 1996, the income tax increase enacted Tuesday for individuals earning more than $100,000 and couples making $200,000 will be automatically repealed unless extended by the Legislature. That tax increase accounts for $1.1 billion in the current budget.

The Wilson Administration defends these short-term measures by pointing out that two-thirds of the $14.3-billion gap can be considered temporary because it was caused by the recession. Yet, the Administration’s figures show that the changes that are permanent are not enough--even in good times--to bring state spending into line with revenues.

The Finance Department projects that the state will spend more than it takes in every year after 1992. Even assuming that there are no unforeseen expenses--for floods, fires, earthquakes and the like--the reserve rebuilt in this year’s budget would disappear by 1994-95, leaving a $1-billion deficit in 1995-96. The year after that, the income tax increase on the wealthy and the suspension of cost-of-living increases for the poor will automatically expire--driving the state deeper into the hole unless spending and taxing policies are changed before then.

All this assumes that the state’s economy performs up to expectations. Anything short of that will move up the day of reckoning.

Although the state’s economic forecasts for 1991 and 1992 are in sync with most private economists, the Wilson Administration predictions for 1993 and beyond appear rosier than independent experts say can be expected. Many private forecasters do not bother to look that far ahead because the health of the economy is so hard to predict.

The state expects the economy to pick up steam toward the end of 1991 and to grow at a faster rate each year through 1994. In that year, the state expects personal income to grow by 8.6% and non-farm employment to climb 4.3%.

In contrast, First Interstate Bank expects economic growth to be strong as the recession ends this year, then to moderate after that. By 1994, the bank’s economists see a 6.4% increase in personal income and a 1.9% increase in employment--both far below the state’s estimates.

Economist Arthur Laffer, known for his opposition to increased taxation, predicts that the state’s new taxes will hamper economic growth as businesses choose to move or expand to neighboring Oregon, Nevada and Arizona, which have lower taxes. Laffer forecasts that real estate prices will be down 20% by 1994, unemployment, relative to the rest of the nation, will be higher by 2.5%, and that personal income will fall 6% relative to the country as a whole.

“Raising taxes on the last two guys working does not make your state healthy,” Laffer said in an interview.

Assembly Speaker Willie Brown (D-San Francisco), the only legislative leader to agree with Wilson’s positive assessment of the budget solution, predicted that the deal will be long lasting.

“I cannot see any need for reattention to the financing of the state of California, at least through 1996,” Brown said.

Closing the Gap

Here is how Gov. Pete Wilson and the Legislature closed the state’s $14.3 - billion budget gap. The program cuts represent reductions from what would have been required to continue state services at their current levels for another year, given inflation and population growth. PROGRAM CUTS 4% across-the-board cut: $1.153 billion Public schools: 1.368 billion* Higher education: 204 million Welfare grants: 87 million Welfare cost-of-living increases: 85 million Local government support: 35 million Workfare: 30 million Prisons: 18 million Homeless program: 13 million Other: 183 million Total program cuts: 3.176 billion HIGHER STATE AND LOCAL TAXES AND FEES Increase sales tax rate: 3.554 billion** Tax candy, snack foods, newspapers, magazines, bottled water: 557 million Increase top personal income tax rate and raise minimum alternative tax rate: 1.212 billion* Increase vehicle license fees: 769 million Suspend some business deductions: 560 million* Conform to federal tax code: 338 million Raise alcohol taxes: 201 million Limit renters’ credit to lower-income filers: 135 million Delay tax credit for businesses providing health insurance: 100 million* Raise UC and Cal State fees: 96 million Total tax and fee increases: 7.522 billion ACCELERATED TAX COLLECTIONS Withhold taxes on supplemental wages: 80 million* Require payment of estimated taxes on estates: 35 million* Total accelerated tax collections: 115 million OTHER RESOURCES AND TRANSFERS Borrowing from special funds: 644 million* Increased fines and forfeitures: 515 million Other: 141 million Total other resources and transfers: 1.3 billion INCREASED USE OF FEDERAL FUNDS Reimbursement for aid to immigrants: 300 million* Funds for county probation: 14 million Total increased use of federal funds: 314 million OTHER Bookkeeping changes: 1.24 billion* Shift pension funds, delay pension payments: 680 million* Total other: 1.92 billion TOTAL: $14.347 BILLION * Temporary reduction or revenue ** $1.4 billion of the sales tax revenue is temporary