Putting California’s LAO Surplus Warning in Context

The California flag in a file photo on Aug. 25, 2021. (John Fredricks/The Epoch Times)

Commentary

Catching up to my warnings on bad budget times ahead, despite the expected $45.7 billion surplus Gov. Gavin Newsom imagines, a recent report by the state Legislative Analyst’s Office cautions the state faces tough budget times ahead. This is in preparation for the budget wrangling that will begin in the Legislature in May.

As I have been warning, the Federal Reserve Board is on a course to keep increasing interest rates until it gets inflation under control. Currently, reported Newsweek, “U.S. inflation surges 10 percent, but latest report doesn’t include gas.” And that report was for February, not March, when gas surged even higher.

Then there’s the Ukraine War that’s scrambling global supply chains possibly more than the Covid pandemic did.

The United Kingdom just reported it’s suffering the biggest drop in its standard of living since records started being kept in 1956. Adjusted for inflation, it’s a 2.2 percent drop. America’s economy is somewhat different, so it might not be that bad. But it’s not going to be good.

According to the LAO, California faces budget problems not only if the economy sours, but even if it continues to do well. Let’s first look at what could happen if the economy heads into a downturn, as seems most likely.

The LAO sees “significant operating deficits” if revenue slows, averaging around $11 billion a year from fiscal year 2022-23 which begins on July 1, 2022, through fiscal year 2025-26. The total deficit would be around $44 billion for those four years. Although state Rainy Day Funds currently amount to around $30 billion.

Of course, as we’ve seen in recent years, the budget numbers swing wildly and unpredictably. Two years ago the governor and legislature were expecting massive deficits from the pandemic lockdowns. Instead, surpluses resulted from the large increase in wealth of tech companies that profited from people staying home and binge-watching Netflix (headquarters in Los Gatos) while ordering food on DoorDash (San Francisco).

Another big uncertainty that could slam the state is if the dollar’s position as the world’s reserve currency is reduced from Russia, China, India, Saudi Arabia, and other countries banding together to trade in non-dollar currencies. Reported Asia Times, “Russia and India took a small but important step towards non-dollar trade financing and investment on March 25, when the Reserve Bank of India allowed Russia to invest the proceeds of its arms sales to India in local-currency corporate bonds….

“That is another small but indicative crack in the framework of the US dollar reserve system. Saudi Arabia reportedly will accept RMB in payment for oil shipments to China, its largest customer.”

I’m not an expert in that area, but it seems to me the dollar largely will remain the reserve currency, with only some defections. Our property rights, despite some depredations, remain the strongest in the world, certainly more so than in China, where the Chinese Communist Party arbitrarily steals property whenever it wants to. The Ukraine War is not going to last forever. And the congressional elections this November should bring some balance to the actions of the federal government.

SAL Requirements

The “SAL Requirements” brought up in the LAO report are not about a friend of mine named Sal. It stands for the State Appropriations Limit. As the LAO describes it, “Amounts the state is required to allocate to meet its constitutional requirements under Proposition 4 (1979). In short, a SAL requirement arises when the state’s appropriations subject to the limit are expected to exceed the limit itself.”

For some reason, they don’t refer to this requirement by its well-known name, the Gann Limit, even in passing, which might confuse some people unfamiliar with the state’s budget process. It was named after Proposition 4’s main sponsor, Paul Gann. He was a close ally to the better-known Howard Jarvis, who the year before pushed through the Proposition 13 tax limitation measure.

Gann, or Prop. 4, passed with a huge 74 percent of the vote in 1979. It limited the amount of spending increases to the increase in population plus inflation. Any money collected above the limit was supposed to be returned to the hard-working taxpayers who earned it in the first place.

It was modified by Proposition 111 in 1990, which, according to an earlier LAO analysis, “created more room for state and local appropriations.” That is, it made it harder to meet the Gann Limit requirements.

But the huge surpluses of recent years triggered Gann anyway. The only other time Gann was triggered was, briefly, in 1987.

Last year, Newsom arbitrarily gave the Gann refund to those making less than $75,000 a year. Supposedly those making more than that were “rich.” Even though in California, you have to make at least $150,000 a year to afford a mortgage even on a shotgun shack.

Despite that, the overspending coalition continues to attack Gann. The California Budget Project griped, “The Gann Limit challenges California’s ability to maintain current service levels. The cost of many public services—from health care to support for seniors and people with disabilities—can easily increase faster than the spending cap is allowed to rise each year. If we don’t allow growing revenues to meet the cost of basic services, policymakers could be forced to make major cuts to spending outside of K-14 education, such as for health care, child care, and housing assistance.”

Except every time spending goes too high, the next recession restores reality, as $40 billion deficits strike. Then huge budget cuts hit hard, along with yet more tax increases. That happened in 1991, 2001, and 2009.

Turning back to the new LAO report, it notes theoretically the SAL Requirements can be triggered even if the state doesn’t have a surplus. That means “if revenues grow faster than the median … the state is very likely to face large—and growing—SAL requirements, reaching somewhere between $20 billion and $45 billion by 202526.”

The LAO report proposes several remedies not worth detailing here. But here’s the real point: Regardless of how much is spent, or overspent, on the state budget, the point of the Gann Limit/SAL Requirement was to limit spending so taxes don’t keep going up to pay for the excess spending. If spending goes too high, then spending ought to be cut, with the money saved going back to the taxpayers.

Comprehensive Reform

What’s really needed is comprehensive reform of California’s labyrinthine tax code. Best would be the adoption of some form of the flat tax, which imposes a single rate on income; 5.5 percent has been proposed for California as revenue-neutral, meaning it still would raise enough revenue to pay for all the government programs. Indeed, if done right, a flat tax reduces tax rates, but increases tax revenues because it encourages more investment and jobs creation, boosting the tax base overall.

Objections come from the usual suspects on the Left complaining how “the rich” should pay more, such as the current 13.3 percent top rate that’s driving so many wealthy people and their businesses from the state. In reality, a flat tax would encourage rich people and businesses to return and contribute to the tax base, instead of paying nothing because they left.

In March, Georgia became latest state to adopt a flat tax. Reported the Wall Street Journal, “The bill collapses six brackets into a single 5.25 percent rate beginning in 2024, scrapping the current top rate of 5.75 percent. That will make Georgia the 13th state to adopt a flat tax, following Iowa’s 3.9 percent rate this month.”

Every attempt at reform I’ve seen for 35 years of writing on California budgets has come to naught. Jerry Brown might have had a chance at reform. He understood the flat tax, and in his 1992 run for president even advocated one at the federal level. But he chose to skip reform, instead pushing through the Proposition 30 income tax increase in 2021 and the $5 billion yearly gas tax boost in 2017.

With Democratic supermajorities running the Legislature, no reform will get passed. An initiative would get shot down by the powerful public-employee unions.

A complex and outdated tax system is just another punishing cost of living in California, like $1 million median price homes and the country’s worst public schools. Well, at least we still have great weather.

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.