Californians vote tomorrow on six ballot measures addressing their state’s perennial budget problems.  If nothing passes, California will face a $20 billion budget shortfall. If everything passes, the deficit drops to—drum roll, please—$15 billion. Big numbers but not unusual for the Golden State. The bigger issue is whether California, or any other state, should budget by initiative.

 

While California is hardly alone, it remains the poster-child of state budget dysfunction. Its highly volatile tax system follows the economic cycle through boom and bust. Recessions mean collapsing revenue collections collide with spending mandated by earlier ballot measures, making it hard to get a balanced budget.  Using the ballot box to address these problems seems only to make matters worse.

 

It may have all started with Proposition 13, the 1978 initiative known mainly for limiting property tax assessments and rates. Prop 13 began the cycle where the state controlled most spending decisions and the ballot box often earmarked funds.  While most people know about its effect on local revenues, Prop 13 also changed state budgeting rules, requiring a two-thirds majority to pass the state budget and any tax increases.  This supermajority requirement, combined with hyperpartisan politics, makes it extraordinarily difficult for the state to pass a budget, even when the economy is relatively healthy.  In a poor economy, when revenues fall short, the budget process becomes a circus.

 

Asking voters to approve propositions that temporarily increase revenues but limit future spending growth isn’t new—California has done it before with numerous initiatives and three special elections just since 2000.  The state set up a rainy day fund and tried to limit spending in 2004, during the last fiscal crisis. You remember that recession: the dot.com boom busted, the governor tried to reinstate a tax that had been temporarily cut when times were good and got recalled and replaced by a Hollywood star.  The new governor made up the shortfall through borrowing but proposed (and voters passed) a new rainy day fund and balanced budget rules that would fix the state budgetary process and keep the state from going off the rails again.  That was 2004.

 

What would this year’s ballot measures do? Measure 1A would increase taxes for a couple of years, promise to limit future spending, and expand the rainy day fund.   The other ballot measures mainly change formulas established in prior elections that  allocate funds to specific programs in a bid to free up money now for the general fund. While easing the current fiscal crisis, they will clearly fall short of erasing the current shortfall and make budgeting decisions more difficult down the line.

 

One ballot measure is unrelated to prior budgeting-by-ballot-box initiatives.  Prop 1F would prohibit raising elected officials’ salaries during recessions.  That’s a feel good measure that doesn’t really solve the state’s fiscal problem or really do much of anything.  But it’s the only measure predicted to pass. I feel so much better knowing elected officials’ salaries won’t go up during recessions.

 

Rather than further complicating the ballot, maybe its time for California to start over by enacting a new constitution that handles the big issues and possibly lets legislators legislate.  Lawmakers may not want this power but tweaking finances through the ballot box doesn’t seem to work. And there’s still that pesky $15-20 billion shortfall.

Last month I posted depressing state revenue data showing that total state tax collections fell in the last quarter of 2008 for the first time since 2002. I predicted that the situation was “going to worsen before it gets better,” a pretty safe bet given the continuing deterioration of state economies.

So how bad is it in the provinces? Pretty bad. A new report from the Nelson A. Rockefeller Institute of Government showed that, compared to 2008, state revenues in the first quarter of this year fell nearly 13 percent—from $154 billion to $135 billion. Personal income taxes accounted for half of the drop, plunging 16 percent. Sales taxes fell nearly 8 percent.

I’m going to go out on a limb here and predict that state tax collections will fall again this quarter. With unemployment still rising and retail sales falling, the limb feels pretty sturdy. Check back in the fall to see what actually happens.

State revenues are collapsing with the economy. A new study from the Nelson A. Rockefeller Institute of Government reports that state tax collections fell in the last quarter of 2008 for the first time since 2002 (see graph). Not only did the volatile personal and corporate income tax revenues drop but so did the usually more stable sales taxes—declining by 6 percent before adjusting for inflation.    more »

The compromise stimulus bill likely to win Senate approval attracted a handful of Republican votes by adding tax cuts and trimming spending. Most of the spending cuts came in programs intended to aid states directly, including education assistance. However, with 46 states now in the red, and states expected to run cumulative deficits of more than $350 billion through 2011, that choice seems odd. Keeping state and local governments from raising taxes or laying off workers to meet their balanced budget requirements should be a top priority of any stimulus. Keeping income and sales taxes from rising in the heart of the recession would, at the very least, keep things from getting worse. When the New York Times surveyed economists in December, about two-thirds of economists across the political spectrum endorsed the idea of increasing federal spending to maintain current state budgets or expand education.    more »

After close to three months of debate, California finally passed its $103.4 billion general fund budget last week. While other outrageous fiscal events trump the state’s fiasco, it is worth noting that no one in California actually thinks the state’s budget problems are solved. Rather, they’ve plastered over a mess that will worsen with economic conditions next year and make it even tougher to balance the budget after that.    more »

When it comes to taxes, Sarah Palin turns out to be an intriguing mix of Barack Obama and John McCain. Like Obama, she favors a tax rebate for consumers funded by a windfall profits tax on energy companies. But, like McCain, she also backs a gas tax holiday.    more »

On Monday, the Supreme Court ruled that states may offer special tax breaks to residents for investing in municipal bonds issued by them and local governments within the state. The 7-2 decision, in Kentucky Department of Revenue v. Davis was widely expected. But even if the Court wanted to bar states from preferring their own bonds over those from other jurisdictions, the current troubles of the $2.6 trillion municipal bond market probably made that impossible.    more »

While TaxVox and others have disclosed the folly of a federal tax holiday, some have suggested that temporary state gas tax relief might work better. Some New York State legislators are already pushing for such a plan. But before cash-strapped states jump on the bandwagon, they might consider how a previous experiment in Illinois and Indiana worked out. In 2000, Indiana announced that it would be suspending its 5 percent gasoline sales tax for 120 days beginning July 1. In response, Illinois also suspended its levy for six months that July.. Quaint as it seems today, the changes were spurred by a spring spike in Midwest gas prices to (gasp) $2.00 – a level drivers would now gladly embrace.    more »

think I need a drink. Yesterday at TPC, a panel of experts looked at what the credit mess means for state and local governments. The answer is: Nothing good. I felt like I was watching the final minutes of the Super Bowl with a room full of New England Patriots fans.    more »

California's health care reform may be the first victim of the economic downturn. Governor Arnold Schwarzenegger's ambitious $14.9 billion plan to reform the state's health insurance system has crashed, in part because it was unclear proposed funding sources would raise enough revenue to ensure the program's viability in the face of a deteriorating budget environment. The state is facing a $14.5 billion deficit.    more »

Six months ago, states were predicting balanced budgets and surpluses. Virtually all had surpluses at the end of fiscal year 2007 and more than half had ending balances equaling at least 10 percent of their general funds. Governors and legislatures were happily talking about property tax relief and expanding medical coverage to the uninsured.   more »

Bloggers have had a field day ridiculing a year-old decision by the Iowa Department of Revenue that would subject certain pumpkins to state sales taxes. True, the decision was worthy of a Halloween chuckle, but the gigglers are missing the point.   more »

An awful lot of Democrats suddenly seem to think that senior citizens are overtaxed. Presidential hopeful Barack Obama wants to exempt seniors making less than $50,000 from paying any federal income tax. House Ways & Means Committee Chairman Charlie Rangel (D-N.Y.) has tucked a new $700 above-the-line deduction for real estate taxes into his proposal to extend Alternative Minimum Tax relief for another year. While Rangel doesn’t say so, seniors who have paid off their mortgages and no longer itemize would be big beneficiaries of the new tax break.    more »

The wildfires in Southern California should have taught us two major lessons: State and local governments need to be better prepared for predictable disasters and, when it comes to emergency services, you get what you pay for.   more »