California tax windfall: Spend it or roll back that 'temporary' tax hike?

After years of budget crises with deficits in the billions of dollars, California is suddenly dealing with significantly higher tax revenue – and big questions as to what to do with it.

Tax receipts are running $5.6 billion higher than predicted when Democratic Gov. Jerry Brown signed the state spending plan last June. His revised budget, released last week, projects general fund revenue for the fiscal year starting July 1 to be $6.7 billion higher than anticipated in January.

Why the change of fortune?

“The tech sector is doing well, and as the dotcom bubble demonstrated, tax revenues during tech surges do very, very well in this state,” says Kevin Klowden, managing director of the Milken Institute's California Center in Santa Monica, Calif., and managing economist for the Milken Institute.

The $115.3 billion general fund spending plan that Governor Brown has presented would create an earned income tax credit – the first ever in the state – and would extend health-care coverage to some immigrants living in the state illegally. It also would increase funding for the University of California by 4 percent as part of an agreement between the governor and Janet Napolitano, president of the university.

But Brown has also indicated he's wary of setting levels of spending that can't be sustained.

“One of the things the governor has noted is the average length of economic expansion in California has been five years, and we are one year past that average now,” says H.D. Palmer, spokesman for the state Department of Finance.

“We know another downturn is coming, we just don’t know when," he adds. "So we don’t want to commit to ongoing high levels of spending – which was the mistake we made during the dotcom boom.”

In fact, most of the tax windfall is already spoken for because of two laws: Proposition 98, which requires certain levels of spending on K-12 education and community colleges, and Proposition 2, a mandatory rainy-day fund. Brown's revised budget plan includes a $7.5 billion increase in education spending, and it sends nearly $2 billion to the rainy-day fund.

Another factor in the budget considerations is a temporary tax increase that was approved by voters in 2012 and is set to begin phasing out next year. The measure, known as Proposition 30, raised top income-tax rates to 13.3 percent and hiked the state sales tax from 7.25 percent to 7.5 percent. 

Some Democrats and educators want to extend Prop. 30 – an idea that is not sitting well with others.

“As I’ve observed many times, it’s rare to see a temporary tax go away, regardless of promises made to voters," writes George Runner, vice chairman of the State Board of Equalization, in an op-ed. "Despite our state’s high tax ranking and surging revenues, spending-addicted lawmakers always want more of your dollars.”

In assessing California's fiscal state, some academics note the economic volatility that has socked California over the decades.

“The key word is uncertainty. Nobody really knows what things will look like a year from now,” says Jack Pitney, professor of government at Claremont McKenna College in California. “The economy has gotten better in recent months, but the national economic expansion could sputter out.”

The highest-earning 1 percent of Californians pay half the state’s personal income tax, he says: “In a bull market, these folks have had lots of capital gains, meaning a flood of revenue for California. But as we've seen in the past, the bears can overtake the bulls without much warning, and that would mean a fiscal drought."

The Howard Jarvis Taxpayers Association – a supporter of 1978’s Proposition 13, which reduced property taxes and furthered a national property tax revolt – is siding with those who want to let the taxes expire permanently.

“The high taxes can no longer be justified,” says HJTA president Jon Coupal. “While many wealthy have decided to stay [in the state], we don’t know how many simply resolved to wait out the 'temporary' tax. If it becomes permanent, we believe more wealthy – and the jobs they create – will move out of California.”