Despite Prop. 30, CA revenues likely to miss the mark – again

Feb. 4, 2013

By Josephine Djuhana

Will Gov. Jerry Brown get all the revenue increases he wants from Proposition 30, which voters passed last November?

Brown recently said in an interview with Jeremy Hobson of Marketplace Morning Report that Prop. 30 was the main reason California was able to achieve a “balanced budget after years of deep deficits.” The initiative would inject “billions of dollars into our budget” and bring California “its first balanced and sustainable budget in 15 years.” His administration estimated the proposition would “increase state revenues by $6.9 billion by the end of 2012-13, and generate billions of dollars per year until its taxes expire at the end of 2016.”

That’s assuming the tax revenues actually will come in. Yet it’s no secret California’s January budget numbers perpetually miss the mark. The problem is the governor makes a laundry list of optimistic assumptions:

* The state will continue to receive hundreds of millions in federal funding.
* The state and national economy will improve.
* The stock market will continue to rise.
* Personal incomes and home values will continue to increase.
* Corporations will see higher returns (despite cap-and-trade).
* Individuals and businesses will stay in California despite the high tax rates.

These are only a handful of suppositions the governor makes, even though all the changes that we’ve seen in California’s demographics reflect a different scenario.

Historical differences

In a recent California Common Sense study, Autumn Carter highlighted the differences between governors’ historical January General Fund revenue projections and projections included in budgets enacted in June (although sometimes “June” has meant a later month when the Legislature has delayed enacting a budget). She wrote:

“Since 1997-98, actual revenues have been within 2% of January’s projected revenues only two times. By comparison, June’s projections have been within 2% of actual revenues six times. The median error for January’s projections is 4.7%, compared to June’s median error of 1.6%.”

California experienced a budget shortfall of $10.7 billion in fiscal year 2009-10, and another $2.9 billion in 2011-12. In 2008-09, that shortfall went as high as $20.1 billion. Carter wrote that such overly optimistic projections “further drive uncertainty and unexpected cuts.”

Overestimating revenue isn’t the only problem with the California budget. Brown has played with the numbers in the California budget in order to attain the “balanced books” that he has been showcasing over the past few weeks. As Sacramento Bee columnist Dan Walters reported:

“The tendency has been to shift expenditures from the general fund to new special funds and that has the effect – intended or coincidental – of flattening out general fund numbers and thus making the growth of state spending look smaller than it has been.”

So even though it looks like that General Fund has been balanced, much of the spending has been shifted from the General Fund to “special funds,” thus lowering the expenditure projections in the General Fund and creating the illusion that the General Fund is balanced. In fact, between 2010 and 2012, the total dollar amount of loans, transfers and loan extensions from special funds was $1.4 billion. And in 2011, in order to balance the General Fund budget, Brown delayed more than $630 million in loan payments to special funds.

The governor’s budget also did not address the root causes of the financial problems, which are the exploding pension and retiree healthcare costs. The Legislative Analyst’s Office noted in its overview of the 2013-14 budget, “[U]nder the Governor’s multiyear plan, the state would still have no sizable reserve at the end of 2016-17 and would not have begun the process of addressing huge unfunded liabilities associated with the teachers’ retirement system and state retiree health benefits.” Even the Los Angeles Times said California’s debt problem had spiraled out of control:

“Sacramento is legally obligated to pay many billions of dollars withheld from schools, local governments and healthcare providers as lawmakers struggled repeatedly to balance the books. It owes Wall Street more per resident than almost every other state. And it has accumulated a crushing load of debt for retiree pensions and healthcare, now totaling more than taxpayers spend each year on all state programs combined.”

So how can Brown proudly proclaim at the beginning of his State of the State address that we have wrought a “solid and enduring budget,” when it appears that there remains a plethora of problems?

Overly optimistic revenue projections

The Manhattan Institute’s 2012 study on the Great California Exodus said the data suggest “many cost drivers—taxes, regulations, the high price of housing and commercial real estate, costly electricity, union power, and high labor costs—are prompting businesses to locate outside California, thus helping to drive the exodus.” Spectrum Location Solutions reported 254 companies left California in 2011; that included major tech companies, such as Twitter, Adobe, eBay and Oracle, which all packed up for Salt Lake City. It’s no wonder, considering the state of Utah has a 5 percent flat state income tax for both its personal income and corporate tax rates, and 5.95 percent for sales taxes. Compare that with California, which has an 8.84 percent corporate tax rate (and 10.84 percent for banks and financial institutions), a 13.3 percent tax rate for folks with an income over $1 million and a 7.5 percent state sales tax rate.

With such high tax rates, what’s stopping Californians from jumping ship and moving to other states? And companies aren’t the only ones high-tailing it out of the Golden State. Prominent individuals, such as the Williams tennis sisters and Tiger Woods, all have left the state in favor of states with lower tax rates. Phil Mickelson has talked about it.

Considering all these factors, it is virtually impossible to know for sure if the tax revenue from Prop. 30 will be as robust as promised. “Federal tax rates are going up as well, and many people have backed their income into the 2012 year, as is the case with high-net worth individuals,” Steven Frates told me; he’s the director of research at Pepperdine University’s Davenport Institute. “California has a highly progressive income tax set up, and the revenue may not be there.”

Just a brief perusal of the monthly financial reports published on the state controller’s page will make any reader aware of the continually fluctuating revenue experienced month-to-month. In April 2012, the state experienced a $2.44 billion shortfall—that’s 20 percent off-mark—with income tax, sales tax, and corporate tax revenues all well below their projected amounts. State finances in September 2012 missed revenue projections in sales and corporate tax revenue by 5.6 percent and 8.8 percent, respectively, resulting in a $162.5 million shortfall. Income tax revenue in November 2012 was off by 19 percent, resulting in a shortfall of $842.5 million.

It is precisely the optimistic revenue projections that cause preliminary budget numbers to be so off-target. Brown cannot expect to tackle our pension and benefits costs properly with so much fluctuation and inconsistency in his proposed budget.

Performance-based budgeting

A real solution to the California budget problem could be found in performance-based budgeting. Traditional line-item budgets hold agencies accountable only for what they spend based on their inputs; performance budgets hold agencies accountable for what they achieve. A Kentucky Legislative Research Commission released a memorandum in 2001 outlining the basics of performance-based budgeting:

Objectives. Agencies should develop strategic plans of what they intend to accomplish. These plans should contain objectives based on outcomes that the public values.

Performance measures. Based on their strategic plans, agencies should develop specific, systematic measures of outcomes that can be used to determine how well agencies are meeting their objectives. Examples: student test scores for education programs; mortality rates for health programs.

Linkage. Objectives and performance measures are integral parts of the budgetary process. Appropriations are linked to agencies’ results: how well they are meeting their objectives as indicated by performance measures.

The underlying essence of the role of government must be driven by constituent desires and needs, not laws and regulations—and the budget should reflect those needs. If the government could truly provide results, not just promises or efforts, citizens would be less skeptical of those in power.

As Geoffrey Segal and Adam Summers wrote in a 2002 Reason Policy Study:

“Performance goals and measures play a vital role in public budgeting.  They are powerful tools that can lead to the efficient and effective provision of public programs and services.  By providing program managers and employees with what they are expected to achieve and how well they are doing, they paint a more realistic and accurate picture of agency performance.  Most importantly though, citizens are given the means to evaluate, understand, and participate in their government.”

Not all government programs are bad, but the state could do without a lot of the sprawling bureaucracies and agencies that control so much of our lives. Ask any Californian if they’ve ever benefitted from AB32, the Global Warming Solutions Act of 2006; or if they feel their air has gotten cleaner since the implementation of cap-and-trade tax-credit auctions. Ask any Californian if they’ve enjoyed waiting in endlessly long lines at the DMV. Ask any Californian if they’ve ever enjoyed sitting in traffic for long hours, traveling a distance that is grossly disproportionate to the amount of time it takes to get their final destination.

Citizens need to be the priority of government—not unions, not special interests, and certainly not agencies that hide $20 million in state funds (California Department of Parks and Recreation, that’s you).

With performance-based budgeting, we could fix the expenditure side of the budget. And in order to fix the revenue projection side, a flat tax rate would do well to be rid of all the ills of overly optimistic assumptions.

Flat tax

In “Eureka! How to Fix California,” commissioned by the Pacific Research Institute, CalWatchdog.com’s parent think tank, economist Arthur Laffer called for a flat tax for the state of California. It would enact one simple tax on net business sales, and another on personal unadjusted income. There would be no other taxes. He outlined his plan:

“One tax base would be personal unadjusted gross income from all sources, with only a few deductions: charitable contributions; interest payments, including on home mortgages; and rent on one’s primary residence, to remove the current system’s preference for homeowners. A single tax rate would apply across the board, from the first dollar earned to the last. The other tax base would be businesses’ net sales, or “value added”—that is, the difference between sales and production costs, which equals the state’s gross domestic product when aggregated across California. The low 6 percent rate would reduce the incentive to avoid earning taxable income in California, and the very broad base would reduce the number of places where people could hide their income to avoid taxation.”

To top it off, this tax system would yield as much revenue as all of California’s current state and local taxes. Imagine that! No more missed revenue projections, a real balanced budget and a fully functioning government catering to its constituents’ actual needs.

A budget cannot be considered balanced if its revenues are too volatile to predict accurately. Frates told me of the January estimate, “It’s just an opening shot, a sort of kabuki dance between the governor and the Legislature.” Brown called for celebration in his State of the State address, “California is back, its budget is balanced, and we are on the move. Let’s go out and get it done.”

But perhaps it is time to consider a total restructuring and reform of the California budgetary process, and fix it before we go by the wayside.