California’s Budget Problems Are Far From Over

It’s good that the budget for the fiscal year beginning July 1, 2009 has a $2 billion reserve and that the Senate Appropriations Committee has said it will not approve any legislation with a price tag, no matter how small. 

The state of the state’s economy is worsening and there is the strong probability the budget enacted on February 19 is moving toward becoming out of balance. 

Revenues from the state’s main taxes – sales, income and bank and corporation – were $900 million below estimates in February, according to State Controller John Chiang. 

When Governor Arnold Schwarzenegger created the budget he unveiled December 31, it was based on November forecasts. The next cash forecast won’t occur until late this spring. 

In the meantime, economic conditions have changed – for the worse. 

Nationally, the federal government has revised its estimate of the growth of the Gross Domestic Product from a minus 3.8 percent to a minus 6.2 percent. 

In November, California’s unemployment stood at 8.2 percent, which was 2.5 percentage points higher than the 5.7 percent rate in October 2007—the largest year-over-year jump since December 1982. 

The state’s unemployment rate is now 10.1 percent. 

Here is just one of the disturbing trends contained in Schwarzenegger’s Department of Finance Bulletin for December: 

“California lost 26,400 non-farm jobs in October, following a revised loss of 10,900 jobs in September. Job losses have accelerated as the year has progressed. 

“In the five months ending with October, the state lost an average of 15,700 jobs each month. During the first five months of the year, the average monthly loss was 5,200.  

The administration does not publish a bulletin in January since traditionally that is when the governor releases his proposed budget. 

Higher levels of unemployment and a more depressed economy make it less likely he state will collect the revenue it expects to gain form the budget’s tax increase, particularly the 1 cent boost in the sales tax and the .25 percent income tax surcharge

Similarly, bad economic conditions usually drive up the number of Californians on welfare and Medi-Cal, the state’s health care program for the poor, driving up state operating costs.      

Some of the contents of the new budget and its September predecessor can also be expected to exacerbate the state’s fiscal problems. 

The fiscal best case, at least for the state’s coffers, is those taxes will remain in effect for four years. If voters reject measures on the May 19 ballot, the increases expire after two years, creating a double-digit billion-dollar revenue drop. 

While the taxes are temporary, the newly enacted budget contains a tax cut that initially will cost the state $700 million in lost revenue annually. That increases to $1.5 billion over time.

Currently, businesses that do business in multiple states are taxed based on a methodology that averages its proportion of sales, property and payroll in California. For most businesses, the sales factor is double-weighted.

Under the budget, in determining what income is subject to taxation by California, most multi-state businesses could choose the current method or just base it on a percentage of sales.

One category of California business might benefit from this law change — those with lots of property and employees in California but with most of their sales outside the state.

While the budget passed in September limits tax credits used by businesses to 50 percent of a company’s tax liability in the 2008 and 2009 tax years, in 2010 affiliated companies or subsidiaries will be allowed to transfer their credits to other corporations.

California has various business tax credits. The most significant one is a credit for research and development, which costs the state nearly $1 billion annually. Another expensive credit for the state is doing business in economically depressed areas. That costs $290 million. In addition, there is a credit for employer contributions to childcare, hiring of persons in so-called enterprise zones, creation of low-income housing or hiring prison inmate labor. There are others.

The change in law, starting in 2010, would create a marketplace in which companies could sell their unused credits to one another – a sharp departure from current tax practice. The state estimates that it will cost $365 million in lost revenue starting in the fiscal year that begins July 1, 2011.

In return for prohibiting businesses from taking net operating loss deductions for two years, the September budget allows businesses in the third year and thereafter to carry back the losses they were previously unable to deduct.

In 2011, those carry backs would be limited to 50 percent of losses and to 75 percent in 2012. After that, back to 100 percent.

California currently allows net operating loss deductions to offset all of a taxpayer’s income. Unused deductions can be carried forward up to 10 years.

In addition, many of the spending and taxation decisions made in the recent budget cancel out some of the benefits to California of the American Recovery and Reinvestment Act.

The federal package provides an estimated $13.1 billion in refundable income tax credits for middle to low-income Californians at the same time the state budget includes $12.2 billion in tax increases, only some of which are deductible. And only half of taxpayers deduct. 

The federal bill includes a one-time $250 payment to the state’s aged, blind and disabled poor at the same time the state is reducing the maximum grant for an individual by $37 a month, $444 annually. 

“California is roughly an eighth of the nation. The impact of this is sufficiently large that it could affect the prospects of recovery for the nation as a whole,” said Jean Ross, director of the California Budget Project, who has been examining how the state’s budget interacts with the federal stimulus package. 

-30-