The Capitol’s politicians have known for years – and should have known for decades – that the state budget’s ever-increasing dependence on personal income taxes, especially those from high-income taxpayers, posed a big problem.
As the state’s overall economy fluctuates – we average one boom and one bust each decade – it has an obvious effect on state finances, but that effect is magnified greatly by having income taxes on the affluent as its major revenue source.
Just the top 1 percent of taxpayers account for a third of the state’s general fund revenues, and their taxable incomes have much wider swings than the economy as a whole. Indeed, plunging revenues from the wealthy accounted for virtually all of the state’s budget meltdown during the last recession.
Since then, moreover, we have become even more dependent on their income taxes because voters raised rates, albeit temporarily, on the highest-income taxpayers in 2012 – a boost that leading Democrats now want to extend or make permanent.
Wide revenue swings are magnified even more by a tendency to spend heavily on upswings and lock commitments into the state constitution, making deep cuts difficult when taxes nosedive.
This syndrome has a name – “volatility” – and when it strikes home, governors and legislators have few choices other than running deficits and borrowing to cover them, leaving what Gov. Jerry Brown calls a “wall of debt” to be repaid when revenues recover.
There are two long-term approaches to the fiscal gyrations – changing tax laws to level out revenues or socking away money during boom times to cushion revenue downturns.
Tax reform is cleaner and has a better chance of working, but is politically unpalatable, as a commission appointed by former Gov. Arnold Schwarzenegger and legislative leaders quickly learned. It recommended a tax overhaul, only to see it trashed because it would’ve reduced tax burdens on the rich and increased them on middle-class Californians.
Building reserves is more palatable, although unions and other pro-spending groups dislike taking funds off the table, and having money in the bank always tempts politicians to spend.
Proposition 2 is Brown’s stab at the latter, calling it “our best defense against an uncertain and volatile future.” It would create a new rainy-day fund that could gradually reach 10 percent of general fund spending – about $11 billion currently – and then be tapped for a “budget emergency.”
It has some supposed safeguards against being prematurely spent, but a governor and Legislature could easily bypass them.
The more pertinent issue is whether even a 10 percent reserve is sufficient when revenue can swing by 20 percent, as recent history indicates.
Tax reform is still a better option, but Proposition 2 is probably the only game in town.