By J. Fred Silva, senior advisor, and Kim Rueben, research fellow, Public Policy Institute of
This opinion article appeared in the San Diego
Union-Tribune on January 26, 2003
The state's huge budget deficit, we now know, is in part attributable to its
decision to fund long-term program commitments with relatively volatile revenue
sources. Income tax revenue, for example, declined $10 billion with the
disappearance of the high-technology boom of the late 1990s. That drop has led
to a mismatch between spending and revenues that the nonpartisan Legislative
Analyst says will continue for years unless the state takes corrective
The current crisis would seem to be the perfect occasion for reviewing the
state's tax structure, spending obligations, and fiscal arrangements with local
governments. Although Gov. Gray Davis has proposed many changes, especially in
this last area, his proposal does relatively little to reform California's
quirky public finance system. Consequently, it misses a rare opportunity to
address the state's underlying fiscal problems.
In general, Davis' proposals resemble those made by previous governors facing
budget shortfalls. To close the two-year budget gap, he has proposed major cuts
in state spending, including $10 billion in the current fiscal year; raising
$8.3 billion in new taxes; and rolling a $5.8 billion deficit from this fiscal
year into the next.
Some of the new spending cuts are real, including the elimination of some
state-supported health benefits. Many are postponements of current obligations,
such as the $900 million deferral of state reimbursements for new education
mandates and the cancellation of cost-of-living increases for education
On the revenue side, the governor's budget proposes to increase the general
sales tax, tobacco taxes, and income tax rates for some households. The proposal
seems to spread the pain of the tax increases across income groups. The new
sales taxes will fall most heavily on low-income Californians – at least insofar
as such taxes absorb a larger portion of their income. And the income tax hikes
will target high-income households.
Some would argue, however, that the state already relies too heavily on these
revenues, which rise and fall dramatically with the business cycle.
Because the governor is constitutionally required to propose a balanced
budget, there is little explicit borrowing included in Davis' proposal. However,
the Legislature is not required to pass a balanced budget, and this will mean
substantial borrowing to cover shortfalls. Last year, that shortfall came to
$3.5 billion, which the state will need to cover this year. Next year, the state
will almost certainly need to borrow again to close the remaining gaps.
Luckily for the state, interest rates are low; but it already has floated
large energy and general obligation bonds, and that outstanding debt may raise
its borrowing costs.
The governor's budget certainly satisfies his constitutional obligations; in
many ways, it is the fiscal equivalent of "keeping the lights on." And he has
balanced his proposed budget in the traditional way – by blending program cuts
and tax hikes. The necessary borrowing will be done later, when legislative
leaders and the governor iron out the actual budget.
But the centerpiece of Davis' budget – the so-called realignment proposal –
deserves special attention. It would shift most of the new revenue – about $8.3
billion – to county governments to provide health and human services. (Counties
already administer these services, but the programs are currently paid for out
of the state's general fund.)
At first blush, the realignment seems to address a basic issue in California
governance: the difficult and sometimes contentious fiscal relationship between
state and county government. Much of that contentiousness flows from the dual
nature of county government. On the one hand, county governments are autonomous
political jurisdictions providing various services within their borders. On the
other, they are "creatures of the state," administering state programs, mostly
in health and human services. County officials often complain that the state
requires them to deliver services but does not always provide sufficient money
to do so.
By diverting new revenue as well as program responsibility to the counties,
the governor seems to be addressing that complaint. But there may be at least
two other motives for the proposed realignment.
First, the demand for the affected health and human service programs –
including those for substance abuse, child welfare, mental health and long-term
care for low-income seniors – is growing rapidly, and the state has not been
especially successful in meeting that demand. The handoff to county governments
may leave local officials scrambling for answers that the state itself has yet
Second, the realignment may be a politically adroit way to cope with the
constitutional aspects of the budget process. In 1988, California voters
approved Proposition 98, which guaranteed a certain percentage of general fund
revenue to schools and community colleges. If Davis simply raised taxes to close
the current deficit, a significant share of the new revenue would be allocated
to K-14 education. However, it now seems that he wants to protect some health
and human services programs by diverting new revenue directly to counties, which
already administer them.
When viewed this way, the realignment is not an attempt to reform state and
local responsibilities so much as a way to avoid losing part of the new tax
revenue to K-14 education.
It will be interesting to see how county governments respond to the
governor's proposal. Most will soon realize that the underlying issue is which
level of government controls program standards (including eligibility) as well
as administration and finances. In theory, the government entity that sets the
standards should raise the revenue to meet those standards. But this proposal is
silent on that issue.
So far, counties seem more concerned about the Davis plan to stop reimbursing
them for declines in revenue from the vehicle license fee. The VLF, which voters
earmarked for local governments in 1986, was the third-largest source of
general-purpose revenue for localities. State officials increased VLF revenue
during the budget crisis in the early 1990s; but in 1998, when state coffers
were filling up again, the state lowered the VLF significantly and began
compensating counties and cities for the lost VLF revenue.
Now Davis proposes to eliminate that compensation. Although the VLF has never
provided counties with a major portion of their revenue, that money represents a
large portion of their discretionary revenue – that is, dollars that may be
spent on something besides state-mandated programs. By eliminating that source
of revenue, Davis would make it more difficult for counties to fund programs
that are not covered by his realignment proposal.
Aside from raising these specific issues, the governor's budget reflects a
more general problem: namely, the need to reconcile a high level of public
services with a tax system that can pay for them.
In many ways, voters have helped create this problem. Last year, for example,
voters passed three statewide ballot initiatives that expanded the state's
obligations in transportation and education. Proposition 47, the largest school
facilities bond measure in state history, will cost taxpayers over $800 million
per year in principal and interest. Proposition 49, which increases state
support for after-school programs, will cost anywhere up to $550 million in
2004-05. And Proposition 42 dedicates the sales tax on gasoline to
transportation and transit projects, thereby limiting funds for other
Yet even as voters continue to approve measures such as these, they have put
restrictions on the government's ability to fund them. The passage of
Proposition 13 in 1978, for example, famously capped property taxes and led to
the state assuming more responsibility for funding local services, including
education. By limiting property taxes, a much more stable revenue base than both
sales and income taxes, California has committed itself to a budgetary roller
We now need a serious discussion about the best way to fund public services.
There is no shortage of suggestions along these lines; the question is, who will
provide the political leadership required to champion and implement them?
Because the governor's proposal will frame the budget discussion, we are
unlikely to hear more about underlying problems at this critical juncture. This
may well be a missed opportunity. The governor is not obliged to propose or
implement sweeping solutions to systemic problems. But we should not conclude
that these problems will disappear with the next upswing in the business