What not to do if big budget surpluses return to California

California’s Legislative Analyst’s Office predicted Wednesday that the state’s recovering economy would generate a windfall for state coffers in the coming two years, resulting in a surplus of $5.6 billion in a year and a half and $9.6 billion by July 2018.

Woo hoo! Time to beef up state programs and cut taxes!

Or not.

The Democrats who dominate the Legislature have a nasty habit of confusing temporary and potentially unreliable increases in revenue with permanent ones, and of blithely ignoring long-term problems until they become crises. Republicans, meanwhile, already consider the state’s income and sales taxes to be confiscatorily high, so big surpluses only increase their demands for tax cuts.

In the current instance, revenues are being boosted by Proposition 30, the initiative voters approved in 2012 to temporarily raise sales and income taxes (the quarter-cent sales tax hike expires at the end of 2016, and the 1% to 3% increase in income taxes expires at the end of 2018). The hope was that the state’s economy would grow enough to make up for the revenue lost when the temporary increases expired. That hope is predicated, however, on the dangerous assumption that lawmakers will keep spending in check.

Legislative Analyst Mac Taylor wrote in the budget report released Wednesday that the state no longer has a structural deficit; for the foreseeable future, it expects to raise more money than it is obligated to spend. But the billions in surplus revenue he predicted come from one notoriously volatile source: the stock market.

According to Taylor, taxes on capital gains and other stock market earnings should bring in $5.2 billion more in the current fiscal year than lawmakers assumed. He makes a similarly optimistic projection for fiscal 2014-15 and beyond, predicting significantly higher income tax revenue than previously thought. Sales and corporate tax revenue won’t keep pace, meaning that the state will become even more dependent on personal income tax receipts.

Another challenge for the state is something Gov. Jerry Brown has dubbed the “wall of debt” -- IOUs to investors, the schools and special funds that lawmakers ran up over the last decade and a half to make ends appear to meet without cutting programs or raising taxes. As of the end of June, that debt amounted to nearly $27 billion. Significantly, that money doesn’t include the huge unfunded liabilities in state pension funds such as CalSTRS, whose assets fell $70 billion short of its future obligations.
To their credit, lawmakers refrained from launching a slew of new programs this year, despite Taylor’s projection in May that revenues would be $3.2 billion higher than previously anticipated. They wisely heeded Brown’s call to base the budget on his more conservative assumptions.

If Taylor proves to be right about the big surpluses to come, though, advocates of every program that has been trimmed in recent years will be pressing the Legislature to restore their budgets. And the push to “invest” more in education, healthcare and other social needs is understandable, considering the penny-wise, pound-foolish nature of some of the previous cuts. For example, the cuts to Medi-Cal (the state’s version of Medicaid, a health insurance program for the poor) have driven many healthcare providers out of the program. An insurance policy that doctors won’t honor is worthless.

Nor is there much doubt that the state’s taxes are too high. The top marginal rate is the highest in the country, making California unattractive to some entrepreneurs.

Yet the state won’t be out of the fiscal woods until it pays off the debts accumulated through budgetary gimmickry and puts its pension funds on a sustainable path. That’s especially true for CalSTRS, which wasn’t affected by some of the core reforms Sacramento adopted last year.

No matter what the Legislature does, public schools and community colleges would be big winners if revenues grow as much as Taylor projects. By law, roughly half of the dollars that the state collects go automatically to K-14 education.

One other X factor is a proposed amendment to the state Constitution that would limit the growth of the state budget and dedicate surplus dollars to a rainy-day fund. The measure, proposed in 2010 as part of then-Gov. Arnold Schwarzenegger’s final budget deal with legislative Democrats, was originally slated to be voted on in June 2012, but lawmakers postponed the vote until November 2014. The delay means that the state’s fiscal picture is likely to be notably better when voters go to the polls than it was last year.

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