We asked Chris Hoene, the executive director of the progressive California Budget and Policy Center, and Joshua Rauh, a Stanford economist and scholar at the conservative Hoover Institution, how the state could avoid the whiplash of budget surpluses and shortfalls in the future.
By Chris Hoene
California’s leaders are negotiating a serious budget shortfall. They must balance the budget, fund essential services that keep the state and its infrastructure running and protect the well-being of Californians through investments in education, healthcare, child care and more.
Volatility in state revenues is normal. The rapid shift from a budget surplus to the shortfall we face today is both predictable and manageable. But structural reforms to the tools policymakers can use to balance the budget would make the process even more manageable.
California’s progressive income tax structure, which taxes higher earners more, is an equitable approach to taxation that has long been supported by voters. However, this structure yields revenue volatility because high earners tend to receive more of their income from capital gains and stock-based compensation rather than wages. When economic conditions tighten and the stock market fluctuates, so do California’s resources. That’s why we find ourselves facing a sizable shortfall this year.
Compared with what happened during the Great Recession, when the state had no available reserves, California is much better prepared to handle the shortfall challenge. Thanks to a decade of prudent budgeting and efforts by former Gov. Jerry Brown, Gov. Gavin Newsom and state legislators to build up rainy day funds, today’s leaders can tap into nearly $30 billion in reserves. Those funds will allow them to avoid deeply harmful cuts in services and to sustain investments in critical programs and infrastructure, especially for Californians with low incomes and communities of color.
Despite the progress made in managing changing budget conditions, state leaders need a freer hand when it comes to making meaningful investments, raising revenues and adding to California’s reserves.
For instance, a two-thirds supermajority in the Legislature is required to raise taxes, hindering reasonable policy changes such as reducing or eliminating unnecessary and inefficient tax breaks for corporations and wealthy households, which persist even in a state as progressive as California. The looming Taxpayer Deception Act, a ballot measure backed by big business and real estate interests that would make it harder for local governments and the state to raise taxes and other revenues, would further hamper the state’s ability to adapt to economic challenges, jeopardizing critical community services.
Although state leaders have maxed out California’s primary reserves over the past decade, they would have preferred to save even more during prosperous years. However, poorly structured spending limits mandated by voters in the 1970s treat putting money into reserve funds the same as expenditures. That blocks efforts to further build state reserves and, not incidentally, reflects the dangers of short-sighted ballot initiatives.
If we want our leaders to be able to govern and spend in the best interest of Californians — in good times and in bad — we need to approve structural reforms that empower them to freely use all the tools available to protect and fund vital programs, prevent shortfalls and manage the budget. This includes making the tax system more fair, ending caps that prevent saving more during prosperous times and rejecting efforts to restrict the options state and local leaders have to manage budget decisions to prioritize the well-being of all Californians.
Chris Hoene is the executive director of the California Budget & Policy Center.
The coming budget cuts are just the beginning
By Joshua Rauh
Facing a massive budget deficit for the coming fiscal year, Gov. Gavin Newsom’s revised state budget for 2024-2025 addresses a $45-billion gap. Even as the Legislature debates the governor’s proposals, which include significant cuts to such priority areas as homelessness spending, the question remains whether California can reset itself on a sustainable fiscal path.
Unfortunately, the cuts will do very little to shore up the long-term fiscal health of the state.
Newsom’s proposal includes drawing billions from state reserve accounts. Furthermore, most of the long-term spending plans enacted two years ago, when the government projected a $97.5-billion surplus for 2022-2023, remain in place, including investments meant to tackle homelessness and climate change and to establish universal prekindergarten and healthcare for undocumented immigrants.
California’s budget problems at their root come from increasing expenditures significantly while depending on flimsy revenue assumptions, which is further exacerbated by a volatile revenue stream.
Half of personal income tax revenue in California comes from the top 1% of earners, whose incomes fluctuate along with stock market gyrations. In 2021, the fluctuations and federal pandemic funds played a strong role in the future surplus forecast. But in 2024, the surpluses have vanished.
To avoid these boom-and-bust problems, the state must change its budgeting process to ensure that more of the revenues resulting from sudden and clearly unsustainable increases go into reserve accounts. But it must also permanently reduce spending.
Public employee pensions remain an expanding money sink for the state. State contributions to California’s defined-benefit pension plans — which guarantee lifelong salaries and benefits to public employees regardless of the state’s ability to actually pay — amounted to $26 billion in 2022. That’s a hefty 9% of the governor’s $288-billion revised budget, and using reasonable assumptions about state retirees, $26 billion significantly underestimates the real government costs.
To protect future budgets, new state employees should be brought in on defined-contribution plans, like the private sector’s 401k plans, rather than defined-benefit plans. Even if these plans were more generous than private sector’s, they would save the state considerable money, prove desirable to many public employees and stop the defined-benefit Ponzi scheme.
Similarly, retiree health benefits for state employees cost the state more than $7 billion per year. In many cases, these are duplicative of benefits available to retired public employees through Medicare and the Affordable Care Act exchanges, and thus they could be eliminated.
While budget cuts may seem scary for citizens who depend on public services, the bottom line is that the state’s spending is unsustainable. Perhaps no group is a more egregious representation of the state’s wasteful approach than correctional officers. Their total compensation rose by 16% from 2021 to 2022, even as the prison population remains 25% lower than it was in 2018.
Even in the area of K-12 education, do we really think the problem is that the level of spending is too low? All-source per pupil spending in California public schools is projected to be $23,878 for the 2024-2025 fiscal year, although satisfaction with public schools is low and enrollment is down.
The 2024-2025 California budget will require painful cuts. Taxpayers need more accountability in public spending and a better deal for their tax dollars.
Joshua Rauh is a professor of finance at the Stanford Graduate School of Business and a senior fellow at the Hoover Institution.