California Budget Crisis

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California Budget Crisis

Category : Articles

No Spending cuts v No Tax Cuts

Introduction and Key Issue
This paper focuses on the issue of how to tax implement reform within the next two terms available to Governor Brown.

The important issue I address is how the restrictions imposed on the legislature to increase taxes has restricted the Legislature??™s ability to manage the budget.

Political divide
There is a fundamental divide between the taxation and political views of the two key parties California. The Republican Party follows the Market Liberalist view of the Government (Simmons B, et al, 2006, p 782). Under this view, Government should be limited to defining private property rights and contracts, national defense, basic infrastructure (as little as possible) and protecting those unable to protect their own interests etc, (Dryzek J 2009).

The Democratic Party on the other hand resists the market liberal view. The State has a role to provide service to the community in its own right. They are willing to use taxes to provide government services for the perceived good of the community, regulate the private market.

Table 1: Democrats and Republican policy
|Democrats (CDP, 2010) |Republican (CRP, 2008) |
|Taxes ??“ no statement (but willing to increase) |Taxes are too high |
|Support majority vote for tax increases and budget |Government spending is too high |
|Change Proposition 13 to require business to pay taxes on |Support 2/3 majority requirement for tax increases and budget |
|property |Against unfunded state mandates |
|Support social policies such as Research and Development, |Ban bonded debt to cover operating deficits |
|small business loans, expand parks |Increase government fiscal accountability |
|Provide quality education |Pro Privatisation |
|Support universal health plan | |
|Oppose privatization | |

Democrat controlled governments tend to spend more than Republican governments (Alt J and Lowry C, 1994 (see discussion below) ??“ resulting in ongoing policy tension that must be resolved within the institution of the legislature.

Direct Democracy
The constitution[1] was amended in 1911 to allow citizens to put laws or constitutional amendments to a public ballot. If passed by a simple majority, the proposition will become law. To get on a ballot, at least 5% (for statute) or 8% (for constitutional amendment) of the registered voters at the last gubernatorial election must sign a petition (and meet other requirements) (SOS, 2011).

This reform was driven by a popular drive for social and economic reform in the 1800s and was intended to give power to citizens that could counter the influence large companies (such as the Southern Pacific Railroad) had over the legislature (Fred Silva J, 2000). The power was intended to result in better policy outcomes, more responsive public officials and generally improve democratic involvement (Dyck J, 2009).

The system, is based on distrust of the legislature, and effectively reinforces this distrust over time as they become more aware that without their input, ???elected officials shirk??? (Dyck J, 2009, p 546). Dyck concluded that this resulted in citizens questioning the trustworthiness of public officials. Bowler and Donovan consider that the need to have an initiative power as a ???gun behind the door??? to limit their representatives if required can also generate distrust (Bowler S and Donovan T, 2006).

A significant increase in distrust of government was a major cause of 1978 Proposition 13 that limited taxes on property and required the legislature to have a 2/3 majority to increase tax (Article XIIIA) (Wagschal, 1997). Other limitations have been inserted into the constitution include expenditure limits (Art XIIIB), public debt limits (Art XVI) (Wagschal, 1997). Discontent with government continues, with the legislature having a disapproval rate of 72% (PPIC 2010).

Counter productive outcome

Currently democrats hold 62.5% and 65.8% of the Senate and Assembly respectively. This is enough to pass a budget without Republican support (from 2010) [2] but not enough to increase taxes or call for a constitutional amendment to be taken to voters[3].

The citizen initiative restriction of a 2/3 majority requirement to increase taxes (and previously to pass a budget) has inadvertently made it extremely difficult for political parties with divergent views on government services to resolve their contentions. Rather, as is the current case, one party is able to produce a budget without support of the other. This has resulted in prolonged negotiations, delayed budget processes and increasing community dissatisfaction[4]. Democrats, unwilling to reduce valuable programs are unable to increase taxes without Republican support. Conversely, Republicans cannot reduce taxes without Democrat support.

The cause of the current fiscal crisis is that policy makers failed to adjust spending to reduce revenues or find new revenue (Sheffrin S, 2004, p 216) when the revenues from personal tax substantially fell in 2001.

Tax reform and COTCE Proposals.

California is over reliant on personal income taxes that have shown to be highly volatile over recent years (COTCE, 2009).

To overcome this tax imbalance COTCE proposed the abolition of company taxes, reduction of personal tax rates (mainly at the higher income end) and replacement of current sales tax with a Business Net Receipts Tax (BNRT).

The proposed reforms were intended to be revenue neutral, but appeared doomed to failure on political ideology lines.

The proposals to replace corporate tax and sales tax with NBRT (accompanied by flattening of personal tax rates ??“ favoring high income taxpayers) would be acceptable to the Republicans, as it did not appear to breach market liberal ideals. However, Democrats could easily object to the regressive nature of the NBRT on the basis that income tax compensation is inadequate for lower and middle class workers.

Criticisms that the NBRT had design flaws that could make business non competitive with other States and countries (Pomp R, 2009).

Alternative Approaches

Option A

Voters will be forced to choose to keep services and raise taxes, or follow the Republican approach and lose the services.

Stage 1

The Governor introduces his preferred budget (with mix of tax extensions and services cuts) to the Legislature accompanied by a back up budget showing the brutal cuts to be made if tax increases are not extended.

If the preferred budget is not approved by the legislature, the back up budget will be approved on a simple majority by the Democrats with the Republicans blamed loss of services.

The Governor would either refer the preferred budget to a vote[5] or harness enough votes in a citizen??™s initiative to introduce and ratify the preferred budget[6].

The community are generally supports solving the budget process problem with around 77% calling the budget deficit a big problem and 42% support a mix of cuts and tax increase. There is a reasonable chance that this approach will successfully deal with the current crisis. If the voters reject the preferred budget the Governor would need to carry out threat of cuts. The Democrats would need to re-make their case as to why government services should be retained.

Stage 2
If the voters support the preferred budget, the voters have indicated their preference for services ??“ even with some tax, the Governor will then put forward tax reform proposals that continue the momentum to have reasonable government services with appropriate taxes.

Based on the COTCE the following tax regime changes could be proposed.
1. Net business income tax (based on proposed by COTCE version but revised to address concerns)
2. Lower company tax ??“ but retain it
3. Lower personal taxes with emphasis on lower and middle class (some cuts to upper limits).

The proposed reforms will be broadly revenue neutral, but be designed to maintain a stable revenue mix and grow as the Californian economy recovers over time. Voters will be offered personal income tax cuts, more stable fiscal arrangements and an opportunity increase their trust that the Government can manage the budget in their interests.

This option undermines republican market liberal approach to government services and provides a signal to the voters that the Democrats can deliver what they want effectively.

This option is, however, high risk. The Governor could be accused being cynical and using the crisis for his own political gain[7] and suffer serious political harm.

Option B ??“ Aim for constitutional reform

Step 1

Same as Option A

Step 2

Unlike Option A, the Governor will announce:

1. A proposal to implement the tax reforms set out in Option A;
2. Constitutional reform proposals.

The Constitution proposals would aim to ???clean up??? the Constitution and remove the barriers to effective fiscal management in California. This would build on the 1996 Constitutional Revision Committee (CCRC, 1996), which considered requiring balanced budgets, general reserve funds etc. Specific recommendations to amend the proposition 13 requirements on votes for tax increases as well as how to make businesses liable to property taxes[8]

This approach shares the same benefits and downsides encountered by Option A, however, this Option has the added benefit that it offers a holistic remedy to the core issues confronted by the California legislature.

This option is also high risk.

Proposal

My preferred option is Option B.

Option A has the benefit of potentially achieving the Governor??™s tax reforms outcomes in a more direct manner. The use of the current crisis and changed budget vote rules gives the Governor a chance to force a quick settlement of his proposed budget and at the same time set the scene for tax reforms that will appeal to many democrats and not be highly opposed by republicans (as the taxes will be at least neutral).

Option B offers a holistic solution as it deals with the underlying constitutional restrictions hampering effective government.

Whilst this Option risks constitutional arguments delaying or defeating the tax reform proposals, the gambit of swift intervention in the crisis, followed by swift action on these reforms may allow the measures to get sufficient support voter support to succeed.

Ian Pittard
U3833011

References

Alt J and Lowry R, 1994, Divided Government, Fiscal Institutions, and Budget Deficits: Evidence from the States, The American Political Science Review, Vol 88 (4), 1994, pp 811-828

Bowler S and Donovan T, 2006, Direct Democracy and Political Parties in America, Party Politics, 2006, 12, (5) pp 649-669

CCRC see California Constitution Revision Commission

CDP see Californian Democratic Party

CRP see Californian Republican Party

California Constitution Revision Commission, 1996, Executive Summary: Final Report and recommendations to the Governor and Legislature

Californian Democratic Party, 2010, California Democratic Party 2010 Platform. Viewed 30 April 2011, www.cadem.org

Californian Republican Party, 2008 Californian Republican Party Platform 2008. Viewed 30 April 2011, www.cagop.org

COTCE, 2009 see Commission on the 21st Century Economy

Commission on the 21st Century Economy, 2009, California. Viewed 30 April 2011 www.cotce.ca.gov

Pomp, R, 2009, Correspondence from Richard Pomp, Commissioner, to COTCE Commission RE: Why I Think We Are Heading In The Wrong Direction, 14 September 2009. Viewed 1 May 2011, http://www.cotce.ca.gov/documents/correspondence/staff_and_commissioners

Davidson P, 2000, Tax Reform: A Retrospective [2000] UNSWLawJl 36; (2000) 23(2) University of New South Wales Law Journal 264

Dryzek J and Dunleavy P, 2009, Market Liberalism (Chapter 5) in Theories of the Democratic State, Plagrave Macmillan, London

Dyck J, 2000, Initiated Distrust: Direct Democracy and Trust in Government, American Policy Research, 2009, 37, pp 539-568,

Fred Silva, J, 2000, The California Initiative Process: Background and Perspective, Resource Material for The Speaker??™s Commission for the California Initiative Process, Public Policy Institute of California, California

New M, 2009, Starve the Beast: A further examination, Cato Journal, Vol 29 (3) pp 487-495

PPIC see Public Policy Institute of California

Public Policy Institute of California, 2010, PPIC Statewide Survey: Californians and Their Government ??“ March 2010, PPIC, California.
Extracted 1 May 2011 www.ppic.org/main/publication.aspi=927

Secretary of State, 2011, Statewide Initiative Guide 2011, Secretary of State, California.

Sheffrin S, 2004, State Budget Deficit Dynamics and the California Debacle, Journal of Economic Perspectives, Vol 18 (2) pp 205-226.

Simmons B, Dobbin F, Garrett G, 2006, The International Diffusion of Liberalism, International Oganisation Foundation, Vol. 60, No 4, pp 781-810

SOS see Secretary of State

Wagschal, 1997, Direct Democracy and Public Policymaking, Journal of Public Policy, 17 (3) pp 223-245

———————–
[1] Article II Section 8
[2] See Section 12 of Article IV of the California Constitution (amended by Proposition 25 of 2010)
[3] See Section 12 of Article IV and Article XIIIA of the California Constitution
[4] Evidenced by Proposition 25 that blocks pay to the legislature if budgets are not passed promptly.
[5] requires 2/3 majority under article XVIII
[6] Election promise to take tax increases to the voters was reported on www.ktla.com.news in a video interview viewed on 1 May 2011
[7] Which he is doing.
[8] Aligned to Democratic Party Policy Platform (above)