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Current Crisis Should Pave Way For Real Budget Reform

(Reprinted from the February 2008 issue of the Controller's Monthly Cash Report Summary Newsletter)

By John Chiang
California State Controller

(Reprinted from the February issue of the Controller's Monthly Cash Report Summary Newsletter)

Real budgetary reform is now among the most important issues pending in Sacramento. The Governor and our Legislature are making it a top priority to find positive solutions to our increasingly painful fiscal and economic problems. As the State Controller responsible for making sure the State can pay its bills, I believe we must put in place a workable, long-term plan to ensure a brighter – and steadier – fiscal future for California.

The time is now. The need for long-term reform has been made painfully clear by the terrible financial toll proposed by the Governor’s new budget. To bridge a projected $14.5 billion budget gap, the Governor has proposed a 10 percent across-the-board cut, which I do not believe is a fiscally prudent or responsible way to cut State spending. Public service and program cuts would be felt throughout the state and in our communities. California’s school funding would be slashed and our most vulnerable residents, including low-income families, foster children, seniors and the disabled, would face the loss of critical services on which they depend. Public safety, health programs, higher education, our State park recreational jewels – you name it, all would be dramatically and painfully affected.

You’ve seen the numbers: For our schools alone, the Governor plans on cutting $400 million mid-year, followed by $4.4 billion dollars more in education funds next year. That is the equivalent of showing more than 107,000 California teachers the door. Proposed cuts in health care would be equally debilitating, including chopping $1.1 billion from Medi-Cal. The specific fall-out would include elimination of hearing and vision services for adults, and $11 million in reductions from AIDS programs that would take medications out of the hands of the neediest patients.

Mere numbers and statistics cannot adequately illustrate the horrific fiscal toll this proposed spending plan would exact from our great state and its people.

California’s budget relies heavily on the personal income taxes paid by our wealthiest residents. In 2005, the richest 13.5% of California taxpayers earning more than $100,000 paid 83% of all income tax revenues. However, revenues derived from capital gains rely even more on our richest taxpayers. That same year, capital gains from the top five percent of taxpayers comprised $100 billion out of the $111 billion in total capital gains reported – an extraordinary 90%. Those revenues rise and fall dramatically with the stock market, resulting in California’s unstable and volatile revenue stream.

To illustrate this volatility, in 2000, state revenues derived from capital gains amounted to $10.7 billion. Two years later, in 2002, capital gains only delivered $3 billion to the State’s coffer, a drastic decline of more than 70%.

To address California’s many public needs, lawmakers historically have used unexpectedly high revenues to justify new and expanded programs during good years, and then are forced to slash spending when a bear market dries up revenues. That volatility may be expected on Wall Street, but it should not play a role in California’s budget process. We must find a way to capture non-sustainable revenues in the flush years to tide us over when the economy sours.

I have long supported a rainy day fund for use in tough fiscal times. But we must target what makes the budget flush with cash one year, and drowning in red ink the next.

While the Governor’s budget stability proposal is on the right track, I believe we should target the core cause of the volatility and tap and store excess capital gains revenue during good years for use in the next economic downturn. Programs may not get as big a bump during the flush years, but they would less likely face the huge cuts the governor is now proposing.

As both Controller and Chairman of the Franchise Tax Board, I have asked my staff experts to work closely together to detail how we can hold these volatile funds in the good years for use as an insurance policy in times like this.

Although my plan would address California’s future budget problems, we must also immediately face the current crisis. The Governor has declared a fiscal emergency, and I believe the special legislative session is helping to bring the budget problems into focus. Everything should be on the table. But if we talk about raising taxes, we must ensure the State’s spending plan is accountable to the taxpayers who are footing the bill, and that Californians are confident they are getting at least a dollar’s worth of service for every tax dollar they pay.

We also should look at tax breaks. Five years ago, the Department of Finance reported that California provided $24 billion in tax breaks. This year, tax breaks total $50 billion. Many of the tax breaks are found in the personal income tax, with costs increasing from $18.5 billion if the 2002-2003 fiscal year to $37 billion in the 2006-2007 fiscal year.

While many of these breaks may be fiscally sound, I propose that we conduct periodic reviews of all new tax breaks. We need to determine whether they are indeed producing the intended benefits and whether they should be continued, cut or expanded.

For example, is a tax break creating new jobs or another tangible economic benefit, or is it obsolete and simply adding to someone’s financial bottom line with an insignificant direct benefit to everyone else? Making government accountable to the public it serves will go a long way in inspiring taxpayers’ confidence and their support during these tough fiscal times.

All of this illustrates why we need not just short-term “quick fixes” to our fiscal house, but long-term budget reform.

I’ll say this as succinctly as I can: We need to put an end to California’s boom-and-bust budgeting. As painful as the current situation may be, I will do everything I can to help turn it into an opportunity for consensus on real, long-term solutions.