A Tale of Two States

With apologies to Charles Dickens, I’d like to tell a Tale of Two States. Earlier this month, on December 5, California Governor Jerry Brown and New York Governor Andrew Cuomo both announced that, even though state revenues in general were rebounding, they were both facing budget shortfalls.  This isn’t totally surprising since earlier in the recession both states passed temporary tax increases that had expired or were about to, and both depend heavily on progressive income taxes.  Both governors announced a desire to respond to forecast budget deficits with tax changes, including increasing income taxes on high income households.  But that is where their tales part ways.

  Last year, throughout the budget season, Brown couldn’t get the legislature to extend  California’s expiring tax increases He failed both because state revenues were stronger than anticipated last Spring and, more importantly because it took a supermajority of the legislature  to pass tax increases.  The budget the legislature did pass assumed these strong revenues would continue, even though the source of those extra dollars wasn’t totally understood.  Indeed, the budget included an additional $4 billion in unspecified revenues that if not realized would trigger automatic spending cuts.

 Well, after a bumpy summer and even bumpier fall, the Legislative Analyst’s Office projected actual revenues will fall $3.7 billion below forecast and help produce a 2012-2013 budget shortfall of $13 billion. That would trigger the large automatic cuts in higher education, social services, and K-12 education. In response Brown announced that he’ll bypass the legislature and   ask voters to approve a retroactive tax increase in November 2012

 While some spending reductions will still kick in, late-year revenue increases mean these cuts are smaller than originally expected.  However, bigger budget cuts will depend on what voters decide next November, including whether to retroactively raise income taxes and increase the sales tax.  However, the presence of numerous other tax proposals might make passage harder.  In any event, this year’s budget debate will be interesting, with legislators forced to consider what happens if the ballot measure doesn’t pass.

 In contrast, Cuomo proposed comprehensive reform of New York’s tax code.  Although he has cut spending and won concessions from labor unions, the state still spends more per capita than nearly all other states and it faces  a $350 million shortfall for this year and a projected $3.5 billion deficit next  year.  

 With a  temporary surcharge on incomes above $200,000 expiring at the end of this month, Cuomo hoped to make the state  income tax more progressive by permanently increasing top marginal tax rates from their pre-surcharge levels (though importantly they’d still fall from what they are today). At the same time, he wanted to lower rates for middle-income taxpayers, streamline other provisions of the code, and restore funding for some government programs.  Thus, revenues would go up, Republicans could claim that tax rates will be lower than they are now, and Democrats could take credit for a more progressive tax system and some new spending.  Cuomo negotiated his tax reform with just two people – the Republican Senate majority leader (Dean Skelos) and the Democratic Assembly Speaker (Sheldon Silver). The often dysfunctional state legislature approved the whole package within a week.

  Cuomo definitely benefited from the timing of the expiration of the temporary tax increases.  The recovery looks more uncertain now than it did last year, and by revising rates before the surcharge expired he framed the package as a tax cut. In theory Jerry Brown could also negotiate a deal with a subset of legislators, leadership from both parties in both houses – a gang of five, instead of three.  However, in practice often in California, agreement isn’t reached or legislators defect and a deal isn’t kept. Requiring another trip to the ballot box.

 Fiscal institutions and rules matter. But as Cuomo proved, good timing and some legislative hardball are just as important when it comes to budget reform.