This Is a Good Time for a Tax Cut : Economy: By the end of the next fiscal year, California’s debt should be fully extinguished.


Last week, Gov. Pete Wilson issued a dramatic call for an across-the-board income-tax cut for all Californians. Critics have responded, arguing that the governor’s tax cut--a 15% reduction in marginal tax rates to be phased in over three years--would make the state’s still-precarious finances much worse. Even many of those who agree that a tax cut would help restore California’s competitiveness are critical of the governor’s timing. A tax cut might be a good thing for the future, they argue. But given the state’s woes, now is not the time.

I believe that a tax cut now is both proper and prudent. The state’s finances are rapidly improving, along with the state’s economy. Indeed, by the end of the coming fiscal year, the state debt, which has been accumulated from past annual budget deficits, will be fully extinguished. At that point, Wilson’s tax cut will become not only a measure that the state can afford, but also one that is critical to its economic health.

Critics raise two objections. Hasn’t California run huge budget deficits in each of the past two years? And just this past July, didn’t California go to Wall Street to borrow $7 billion to finance this year’s budget deficit?

The answer to the first question is no and to the second question yes, but none of the $7 billion was for financing a current budget deficit.


The explanation is somewhat complicated because of the confusing way in which the state reports its finances.

In the early 1990s, California experienced its severest recession in 50 years. When the state government closed its books on the 1992 fiscal year, it was $2.8 billion in debt as a result of past years’ budget deficits. In 1993, contrary to recent assertions, revenues equaled expenditures; the state’s budget was balanced. At the end of fiscal year 1993, the state still had an outstanding debt of about $2.8 billion. Last fiscal year (completed June 30), the state actually ran a surplus of about $1 billion. This surplus was used to reduce the outstanding net indebtedness to just under $2 billion.

In the current fiscal year with tight spending controls already in place, virtually all forecasts show that the state budget will run another surplus. According to the legislative analyst, a surplus will occur even if the state does not receive any additional federal funds to reimburse the state for our illegal immigration costs. This surplus will permit the state to reduce its indebtedness to $1 billion by the end of next June, before any tax cuts take place.

In coming years, the state’s finances will continue to improve. In fiscal year 1996 (which begins next July 1), this improvement will enable the state government to eliminate the remaining debt at the same time the first part of the tax cut becomes effective. After that, the tax cut’s second and third stages would become effective. State spending would be permitted to grow by about 5%. This would require tight controls on state-government spending, but nothing like the severe measures that have been required over the past three years.


What about the reported $7 billion the state borrowed in July? If it is running a surplus, why is the state borrowing? One billion dollars of the $7 billion is being used to refinance the existing outstanding debt. Since it is replacing one type of debt for another, it does not increase the state’s indebtedness. It is simply refinancing the existing debt.

A second part of the $7 billion, $4 billion, is being used for short-term cash management. Since early in the fiscal year expenditures typically exceed revenues, extra cash is needed to pay the bills. The $4 billion of seasonal borrowing is for this purpose. It will be repaid later in the fiscal year when revenues typically exceed expenditures. This seasonal borrowing is part of the state’s normal operating procedures and does not represent an increase in the state’s annual indebtedness.

The third part of the $7 billion, roughly $2 billion, has been used to refinance debt issued in previous years for the purpose of making loans to school districts. The school districts are statutorily required to repay these loans. Hence, this $2 billion of refinanced debt is matched by an asset-loan repayment from school districts--and is not a net increase in the state’s long-term indebtedness. Thus, none of the $7 billion is deficit financing.

California is returning to financial health. In calling for a tax cut, the governor is not being rash or hypocritical. He is simply proposing that a portion of the state’s surpluses should go back to California’s taxpayers.