Guest Post: Another View of the State’s Grim Fiscal Condition

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(Editor’s Note: This synopsis of the state’s fiscal condition, mildly edited by California’s Capitol,  was sent to clients of Greenburg Traurig, an international law firm. Among the entities Greenburg’s Sacramento lawyers represent are El Paso Corporation, the American Council of Life Insurers, Otis Elevator Company, MillerCoors LLC and Novartis Pharmaceuticals.)

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California’s Fiscal Outlook 2011-2012 —

A $25 Billion Headache

Just one month after the passage of the latest budget in California’s history, the non-partisan Legislative Analyst’s Office finds that the state faces a whopping $25 billion budget deficit.

This is comprised of a $6 billion deficit for the fiscal year ending June 30, 2011, and a $19 billion gap between revenues and expenditures in the 2011-12 fiscal year which begins July 1, 2011.

Despite California’s constitutional requirement for the enactment of a balanced budget, the state finds itself in serious fiscal straits again. In part, this is because $12 billion of the $18 billion in “solutions” in the last budget were temporary or “onetime” in nature.

Add to that the sunset of $8 billion in temporary tax increases that were agreed to two years ago and expire by June 2011.

Additionally, updated expenditure information shows the state spending $4.5 billion more than anticipated just one month ago.

This all adds up to a new $25 billion headache.

The gap between ongoing revenues and expenditures is now approaching 23 percent of the general fund.

So, what can we expect out of Sacramento with a new Legislature and governor taking office in January?

Governor-elect Jerry Brown will be constitutionally required to introduce a state budget on January 10, 2011 — just one week after being sworn into office.

This does not give him and his transition team much time to work out the details of a new fiscal recovery plan.

It is likely that one of the governor’s first official acts will be to declare a “fiscal emergency” and compel the Legislature to take early action on

his budget proposals.

The legislative analyst is recommending a multi-year approach to solving the problem, with a combination of permanent and one-time solutions in year one and then gradually solving the entire problem over four years.

Also recommended by the legislative analyst is permanent revenue increases — higher taxes.

We believe the most likely scenario is that any tax increase would be an “extension” of the tax increases that are scheduled to sunset next year: a 1 percent increase in the sales tax, a .25 percent surcharge on personal income taxes and A 1.65 percent rather than 1.15 percent vehicle license fee.

However, there are likely to be calls for elimination of corporate tax breaks like R&D credits, net operating loss carry forward and back, single sales factor apportionment and related provisions.

Passing a tax increase, including keeping the temporary tax increases in place, will not be any easy task.

California still requires a two-thirds vote of the Legislature to increase a tax and the Democrats’ majorities fall two seats short of that threshold in the 40-member Senate and two seats short in the 80-member Assembly.

Some legislators have suggested asking voters to approve an extension of the 2010 tax increases in a special statewide election but that course is filled with risk if the Legislature defers spending cuts and voters ultimately

reject extending the higher tax rates.

Governor-elect Brown may follow his last two predecessors and call for a special tax commission to review and recommend ways to reduce California’s volatile tax revenue system.

Both Republicans and Democrats agree on the need to broaden the state tax system so that California doesn’t have such a small number of wealthy

households paying most of the taxes. The top 1 percent of taxpayers in the state pay almost 50 percent of thev personal income tax. This makes state tax revenue very vulnerable to future changes in capital gains and related types of volatile income.

Although there is far-reaching agreement on the need to broaden the base, there is much controversy over how to achieve it.

For example, some argue for lowering the state sales tax rate but spreading it to services that are now exempt.

Others argue for widening the tax brackets and ensuring that all income levels pay some tax.

These ideas would reduce volatility but are also quite controversial.

Gov. Arnold  Schwarzenegger’s tax commission, led by political insider Gerald Parske, proposed to reduce state income, sales, and corporation taxes and offset the revenue loss with a “business net receipts tax.”

This proposal did not gain any traction in the Capitol.

Finding a long-term solution to California’s persistent budget shortfalls is further complicated by voter decisions on three initiatives on the November ballot.

While voters passed a measure reducing the legislative vote

threshold to pass a budget bill to a simple majority from two-thirds, they simultaneously made passing a budget more difficult by approving revenue-limiting measures that prevent future borrowing from local governments and

impose a two-thirds vote to pass fees on businesses to mitigate any alleged social or environmental harm associated with the use of a company’s products or services.

On November 11, Schwarzenegger announced that he will call a special budget session starting December 6, that focuses on resolving the $6 billion current-year deficit. The GOP governor said that, “California’s economy appears to be showing signs of stabilizing, our job creation, and revenues are still lagging.”

And: “Changes in Congress and passage of Proposition 22 – (the prohibition on the state borrowing local revenues) — also present significant new challenges to balancing our budget.”

This announcement came just one day after the release of the legislative analyst’s report.

Jerry Brown enjoyed a brief honeymoon after being elected to his first term as governor in 1974.

There will be no honeymoon on January 3 as he begins his third term in the office, this time as California’s 39th governor.

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This GT Alert was prepared by Tom Sheehy and Parke Terry. Questions about this information can be directed to:

· Tom Sheehy — sheehyt@gtlaw.com

· Parke Terry — terryp@gtlaw.com

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