California’s State and Local Revenue Structure After Proposition 13: Is Denial an Appropriate Way to Cope?

1. California’s State and Local Revenue Structure After Proposition 13:Is Denial an Appropriate Way to Cope? Robert W. Wassmer Professor and Chairperson Department of Public Policy and Administration California State University, Sacramento

2. Layout of Presentation • Introduction • California’s Revenue Structure: Pre and Post Proposition 13 • Post-Proposition 13 Outcomes • How to Better Cope • “Out of the Box” Revenue Idea State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

3. Introduction • June 1978 approval of Proposition 13 • 60% cut in local property taxes • California’s state and local reliance on property tax • 1977-78: 26% greater than rest of U.S. • 2005-06: 24% below rest of U.S. State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

4. Introduction General Fund State and Local Revenue Reliance for State of California, FY 2005-06 General Fund State and Local Revenue Reliance for all United States, FY 2005-06 State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

5. Introduction • Reasons to pay attention • 2008-09 budget shortfall in 25 states • CA (15.4%) second only to AZ (17.8%) • FL, NV, NJ, and RI > 10% • CA’s relative size in U.S • 14% of GDP • Cautionary tale to other states • Adopted or considering similar fiscal reforms State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

6. California’s Revenue Structure • Sub-national revenue in California and U.S. increased after Prop 13 • Per-capita terms • CA distance from U.S. has shrunk • Personal income terms • CA further distanced itself from U.S. State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

7. California’s Revenue Structure • Greater reliance on personal income taxes • Highly progressive • Top rate of 9.3% at $90K married household • Additional 1% levied on millionaires • Household incomes > $500K yield 1% returns, 39% revenue State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

8. California’s Revenue Structure • California reliance on corporate income taxes still greater than U.S. • California reliance on current charge revenue now greater than U.S. State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

9. California’s Revenue Structure • Consider in context of • Two-thirds, super-majority vote requirements • Pass state budget (elsewhere only in AR and RI) • Any statewide increase in taxes for revenue (11 states) • Serrano v. Priest • Separation of local finances from local schools • An anti-tax and initiative constrained environment • Table 1 in paper lists 12 propositions since Prop 13 • Prop 98 most infamous • 40% of state’s general fund expenditure to public K-14 State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

10. Post-Prop 13 Outcomes • Left: Variable stock option and capital gains tax revenue • Highly pro-cyclical and large percentage of tax revenue • Right: Personal income growth in state more stable than state revenue growth • Bigger percentage decline in revenue when income declines State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

11. Post-Prop 13 Outcomes • Left: Roller-coaster budget stabilization goes negative • Right: Projected operating deficit at start of each recent state budget cycle • Structural deficit now pegged at $3 to $8B on $100B+ expenditure State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

12. Post-Prop 13 Outcomes • BOOM: Late 1990s in CA economy and income tax revenues • Windfall revenues spent on education, health, and human service programs • $4B annual cut in vehicle license fees (VLF) • BUST: 2002-04 operating deficit forecast at $27B • Re-elected Governor Davis raises VLF • After recall: Governor Schwarzenegger lowered VLF, spending cuts, 30% tuition up for UC/CSU • BOOM: 2004-05 operating surplus at $3B and reserve fund at $9B • Deficit bonds paid off early, K-12 expenditure up • BUST: 2007-09 operating deficit forecast at $20B+ State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

13. How to Better Cope • Budget process reforms • Reduce two-thirds voter requirements • 55% or complete removal • Create greater fiscal discipline • Better accounting of tax expenditures • Create more prudent budget reserve fund • Move to multi-year budgeting • Two or three year cycle • Improve the public’s and legislator’s understanding of budget • Simpler presentation of constraints and tradeoffs State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

14. How to Better Cope • Revenue reliance reforms • Increase reliance on more stable tax bases • Less on corporate and personal income tax • Expand sales tax base and/or fees • Raise more state and local revenue • Reinstate 10 and 11% top personal income tax brackets • But need prudent budget reserve method if done • Reduce local govt reliance on state revenue • Touching the “third-rail” of California politics • Split-role property taxation State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

15. “Out of the Box” Revenue Idea • Gov Schwarzenegger's Executive Order S-3-05 • July 2005: Climate change a reality, CA 12th largest emitter of GHGs, time to take action • Global Warming Solutions Act (AB 32) • Sept 2006: By 2010 GHGs down to 2000 level, 2020 to 1990 level, and 2050 down to 80% below 1990 • By 2009 mandatory reporting of GHGs and specific regulatory/market mechanism plan • Creation of Economic and Technology Advancement Advisory Committee (ETAAC) • Report done Feb 2008 State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

16. “Out of the Box” Revenue Idea • ETAAC suggests some form of cap and trade (CAT) • Debate over merits of verses carbon taxes (CT) • CAT offers greater certainty on GHG reduction amount • CT offers greater certainty on GHG tax amount • Debate over allowed GHG credits allocated • Free allocation based on historical emissions or output, or revenue generating auction • ETAAC leans toward later (variable price signal) • “…convene an advisory group, …to prepare a study outlining several sensible options for recycling revenues to businesses or individuals” (p. 56). State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

17. “Out of the Box” Revenue Idea • Recent proposal for Budget Stabilization Act • General fund transfers into (out of) fund when revenue above (below) long-term trend • Built up to 10% of general fund expenditure • Also Dept of Finance required to forecast thrice mid-year budget situation and across board cuts if deficit • Suggestion • Use portion of initial years’ auction revenues to establish budget stabilization fund • Estimated that if price per ton of GHG yearly allocation falls between $5 and $20, annual revenue between $2 and $8 B State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008

18. “Out of the Box” Revenue Idea • Anticipated concerns • Is auction revenue a tax or fee? • Considered fee if nexus between charge/service • “Carbon Share: Because the sky belongs to all of us” • If tax, additional two thirds legislative majority to hurdle • If feds adopt CAT or CT • Auction revenues to state go away State and Local Tax Policy - Out of the Box, Georgia State University, May 14, 2008