How California budget process became a quagmire

Drafting state budgets in California was once a fairly straightforward exercise in fiscal politics.

The governor’s budget gnomes could fairly accurately predict how much tax revenue would be generated over the forthcoming fiscal year, particularly since most of it would come from taxes on retail sales, a stable base.

An initial budget was issued in January and it would be revised in May after the April 15 deadline for personal income taxes provided more specificity. Legislative leaders of both parties huddled, sometimes with the governor, and a final budget emerged.

Yes, there were some conflicts. Budgets took two-thirds votes of both legislative houses so the final product needed bipartisan support. Republicans, usually in the minority, would sometimes withhold votes until their demands were met.

Over time, however, the budget process became a political quagmire, in part because the ideological divisions in the Capitol became more pronounced. As Democrats drifted to the left and Republicans to the right, what once was collegial sparring became holy war. But that was not the only factor.

As California’s array of services expanded, so did the number of budget stakeholders seeking larger pieces of the pie or protecting what they had. The field of play became immensely larger after voters passed Proposition 13, the iconic property tax limit, in 1978 and the state became the basic financier of schools and a big factor in local government budgets.

The pie itself changed. The importance of sales taxes in the revenue stream gave way to dominance by personal income taxes, which are inherently less predictable, particularly since most are paid by relatively few taxpayers in upper income tiers.

As Gov. Gavin Newsom’s latest budget proposal, unveiled last week, notes, “California’s progressive tax system, where nearly half of all personal income tax in the state is paid by the top 1% of earners, has contributed to extreme budget volatility over the years.”

That volatility is the chief reason for the budget’s projection of a $31.5 billion deficit just 12 months after Newsom declared that the state had a $97 billion surplus and bragged that “No other state in American history has ever experienced a surplus as large as this.”

Not only have revenues become structurally less predictable, but they also have become subject to changes in national and global economies.

The revised budget’s deficit is projected even without a recession, but were there an even modest downturn – which many economists expect, due to the Federal Reserve System’s sharp hikes in interest rates to battle inflation – the state would take a big hit.

“Based on a moderate recession scenario in fiscal year 2023-24, revenues could decrease by $40 billion in 2023-24 alone, largely driven by losses in personal income tax,” the budget declares. “Revenue declines relative to the May Revision forecast could reach an additional $100 billion through 2026-27.”

Revenue declines of those magnitudes would quickly consume the state’s seemingly hefty “rainy day” reserves.

Budgets no longer require two-thirds legislative votes and Democrats have overwhelming legislative majorities, but that, ironically, is another complicating factor.

Periodic revenue surges, such as last year’s $97 billion paper surplus, whet appetites of Democrats’ allies, such as unions and social welfare and medical care advocates, for additional spending and generate resistance when times get tough.

Newsom’s budget would put the brakes on spending, including clawing back some appropriations from last year. Advocacy groups are leaning on friendly legislators to do whatever is necessary to keep the money flowing, including tax increases and/or tapping into the reserves.

One-party control of the Capitol may change the specifics of fiscal politics, but doesn’t make them any simpler.