Cutting ‘fatal flaw’ helps budget

Californians can breathe a sigh of relief.

When proponents of a 2016 ballot proposal to extend Proposition 30’s tax rates on wealthy Californians amended their measure this week, they did something that was both politically smart and fiscally sound: They eliminated a provision the governor a few days ago called the measure’s “fatal flaw”, that would have exempted this proposed new revenue from the state’s Rainy Day Fund—created in 2014 when nearly 70 percent of voters approved Proposition 2.

California Forward worked hard to help design and pass Proposition 2, and we are working hard to defend it. Building a stronger budget reserve is one of the biggest steps toward fiscal stability our state has taken in a generation—one of our only bulwarks against the economic downturn spending cuts that devastated communities over the last decade.

When these surges occur, about a quarter of these funds come from people earning more than $500,000 a year.

This new reserve is also inextricably linked with Proposition 30—along with any other major new revenue proposal. Why? Because smart, long-term budgeting requires saving as well as spending.

Thanks to Proposition 2, the state is on track to do both. The governor’s January budget projects the reserve growing from $4.4 billion in 2015 to more than $9 billion by 2018. According to a CA Fwd analysis, however, if Prop 30 revenues were exempted from these transfers, the size of contributions to the reserve would likely be cut in half—severely hampering its ability to serve as a fiscal safety net.

This is due to the formulas for depositing money into the Rainy Day Fund, which gets its revenues from an annual transfer of 1.5 percent of General Fund revenue and—when the stock market is going up—a portion of capital gains revenue. (For wonks: A spike is defined as all revenue exceeding 8 percent of General Fund tax proceeds.) When business is booming, this can mean as much as 75 percent of the money going into the Rainy Day fund comes from episodic, temporary surges in the market.

Here’s the thing: When these surges occur, about a quarter of these funds come from people earning more than $500,000 a year. That is, the taxpayers impacted by Proposition 30.

Take away Proposition 30 revenue, in other words, and you take away an outsize portion of the Rainy Day Fund.

Opponents of Proposition 2 still argue that setting aside money on this scale is only taking away from programs that need it today. But as we move closer to the next dip in the business cycle—it’s clear these reserves will be put to good use.

And on a potentially huge scale. In the governor’s January budget, the Department of Finance modeled what a “moderate” recession would do to the state budget—concluding that revenue losses to the General Fund could “easily total $55 billion over three years.”

A $9 billion Rainy Day Fund would not cover all of these losses, but it would cushion the blow, especially in the first two years. Had such a reserve existed in 2008, schools would have avoided almost 50 percent of the cuts they experienced in the first year of the Great Recession.

Even without the Proposition 2 exclusion, thoughtful deliberation will be required in the months ahead to determine if extension of the income tax provisions of Proposition 30 is the right tax policy for California, but that’s a subject for another day.

For now, voters who supported Proposition 2 because they remember past years of fiscal anxiety can rest more comfortably.
The state has a budget reserve because they don’t want to go through that again. Neither do we. And, thankfully, neither does the governor.
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Ed’s Note: Lenny Mendonca and Pete Weber are co-chairs of the Leadership Council of California Forward, a nonprofit government reform group. This version updates earlier text to restore final three paragraphs that were inadvertently deleted.