California Budget Fails to Address Long-Term Fiscal Stability

California’s newly enacted budget for 2015-2016 falls short of properly addressing the institutional budget troubles the state has faced for years.  The California budget shows some steps in the right direction, like adding to the state’s Rainy Day Fund.  However, it fails to deal with the elephant in the room: California is drowning in debt and heavily relies on the personal income tax to pay the bills.

The recession has taken its toll on the economic stability of the state, which has relied on a strategy of debt and tax hikes on high-income earners to stay afloat. As the state enjoys a budget surplus of $6.7 billion, spurred by a recovering economy, now is the time to address long-term financial ailments.

The Golden State has a “wall of debt” to the tune of $443 billion, according to California Common Sense, a non-partisan think tank dedicated to opening government finances to the public. This number includes $64.6 billion in delayed infrastructure repairs and $218.6 billion in unfunded liabilities like pension obligations.  The state has made a meager effort to confront this wall of debt by paying off $1.9 billion through the new budget and increasing the rainy day fund to $3.5 billion by year’s end. It is worth noting, however, that lawmakers only took these actions after the people mandated them through a recent proposition aiming to stabilize the budget process that has been in turmoil for years.

Efforts to pay down debt and build up savings during times of prosperity are good practices, but they treat the symptoms rather than the cause of continually unbalanced budgets.  What drives these wild swings from poverty to prosperity and back again is the reliance on high-income earners and the personal income tax to fund the majority of the state’s spending.  California’s desire to “tax the rich” has led to a tax system where half the state’s revenue comes from the top 1% of residents.  This dependence is problematic, because the income of top earners fluctuates with the performance of investment income in the market. This toxic reliance is demonstrated by the exceptionally harsh budget situation during the recession and the recent unexpected surplus coinciding with a strengthening stock market.

This boom and bust revenue effect is not a new phenomenon for California or other states that rely heavily on personal income taxes to fund state government. In the most recent edition of Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index, the authors track the revenue volatility for state personal income taxes, corporate income taxes, and sales taxes (see chart below). Corporate income taxes are the most volatile source of revenue, followed by personal income taxes. Sales taxes are the least volatile source of government revenues.

CA tax & revenue volatility - Ben W

Governor Jerry Brown should be applauded for recognizing this risky reliance on high-income earners and the personal income tax, but the new budget was a missed opportunity to address the structural problem with the way lawmakers finance government in Sacramento.  While politically difficult, especially in California, it is vital for the state to reduce the dependence on personal income tax revenue by lowering personal income tax rates and relying more on predictable consumption taxes to create a more stable source of revenue.  If California enacts such reform to its tax code, the state will not only become more sustainable for the future, but also more economically competitive.


In Depth: Cronyism

Cronyism in tax policy stifles innovation, hinders competition and introduces a deep temptation for corruption. The 2014 ALEC Center for State Fiscal Reform study, The Unseen Costs of Tax Cronyism: Favoritism and Foregone Growth, found that in the most recent year in which states published their respective tax expenditure…

+ Cronyism In Depth