SAN FRANCISCO (Reuters) - California Governor Jerry Brown was elected in 2010 on a promise to fix the state’s chronic fiscal crisis. His weekend announcement of a much bigger-than-expected shortfall in the state budget signals how far he still has to go.
In an unusual move that underscored the highly politicized nature of the state budget, Brown took to YouTube on Saturday to deliver the bad news: the state’s projected budget deficit for the fiscal year starting July 1 is now $16 billion, up from the $9 billion anticipated in January.
The Democratic governor also warned of further cuts to an already-battered public education system if voters rejected a tax increase in a ballot initiative this fall.
On Monday, Brown will hold a news conference to detail the new budget deficit and how he intends to close it.
California, whose economy is the largest in the nation and would rank ninth in the world if the state were a country, has struggled for decades with a tax system in which property tax increases are limited by law and tax hikes of any kind must be approved by voter initiatives or a two-thirds vote of the legislature.
High income and sales taxes produce plenty of revenue in good times but fall sharply in a recession, while spending on schools, prisons and medical care for the poor and elderly is hard to adjust.
The deeper deficit forecast reflects the state’s uneven economic recovery: tax collections this year have fallen about $4 billion below projections, though many state legislators and economists had warned that the January revenue estimates were far too optimistic.
The deficit also grew because some previously agreed cuts to state social programs, including the Medi-Cal healthcare program for low-income families and seniors, were either delayed by legislators or blocked by the courts and federal officials.
Brown’s video had the air of a campaign call for a tax hike initiative that is the centerpiece of his fiscal plan.
“What I’m proposing is not a panacea. But it goes a long way toward cleaning up the state’s budget mess,” he said. He acknowledged that further budget cuts would be needed as well, but added: “we can’t fill a hole of this magnitude with cuts alone without doing severe damage to our schools.”
The measure would temporarily raise California’s sales tax to 7.5 percent from 7.25 percent and increase personal income tax rates on a sliding scale starting at annual income of $250,000. Incomes of $1 million and above would see a 3 percentage-point bump, pushing the top rate to 13.3 percent. The measure would raise $9 billion for the next fiscal year
Brown faces a June 15 deadline to gain legislative approval for a budget for the new fiscal year. Democrats control the legislature but have been reluctant to go along even with the cuts he proposed in January. Republicans are mobilizing to fight Brown’s proposed tax hikes.
The state will spend about $86.5 billion this year, down from a peak of $103 billion in the 2007-2008 fiscal year. Brown in January proposed $92.6 billion in general fund spending for the next fiscal year.
REVENUE FAILS TO MEET EXPECTATIONS
California’s budget watchdog agency warned in February that Brown’s revenue expectations were optimistic. The more sober forecast this weekend was apparently prompted by lackluster revenue in April, a critical month for collecting personal income taxes.
“It’s a terrible recovery,” said Mike Genest, one of former Republican Governor Arnold Schwarzenegger’s budget directors. “It seems we’re in a cycle of somewhat lower expectations each time people take another look.”
California’s unemployment rate in March was 11.0 percent, well above the 8.2 percent national average for the month.
Some pockets of the state’s economy, notably the high-tech industry, are doing well.
This week’s initial public offering of Facebook stock will make millionaires of thousands of employees and investors. Tax receipts related to the IPO could total billions of dollars but will likely be collected over time and will not be sufficient to change the budget outlook.
Much of the state continues to struggle in the wake of a real estate collapse. The Central Valley city of Stockton is in talks with its creditors to try to avert filing for bankruptcy.
FOCUS ON SCHOOLS
Brown has been warning of further cuts to education since his initial budget proposal in January. Local school districts, barred from raising their own revenue through higher property taxes, are heavily dependent on dwindling funding from the state government in Sacramento. Preliminary layoff notices for the next school year have been sent to more than 20,000 teachers.
State colleges and universities have implemented massive tuition increases in recent years. The University of California has said it may have to boost tuition another 6 percent this year if funding is cut further.
But Brown has little choice but to propose yet deeper cuts to school spending, which is guaranteed the lion’s share of the state’s revenue due to a law approved by voters.
In January, Brown proposed $5.4 billion in so-called trigger cuts should voters snub his proposed tax hikes, with $4.8 billion of the cuts slated for schools and community colleges.
Whether voters take Brown’s warning to heart depends largely on whether they are directly hurt by cuts, said Bill Whalen, a research fellow at the Hoover Institution who was an aide to former Republican Governor Pete Wilson.
“For a decade we’ve been talking about budget deficits and it’s a little of ‘My eyes glaze over when we talk about this,’” he said.
WALL STREET WATCHES
Credit analysts will scour details of Brown’s revised plan, which could affect their outlooks on the state. Standard & Poor’s revised its outlook on California in February to positive from stable, a potential first step to a higher credit rating, which would help ease borrowing costs. At ‘A-’ - six levels below ‘AAA’ - California is S&P’s lowest-rated U.S. state.
S&P’s Gabriel Petek said the agency is keen to see Brown’s new plans for cuts, updated revenue forecasts, projections on how much his ballot measure can raise and contingency plans should voters reject it. Petek also said it will be vital for lawmakers to act quickly to balance the state’s books, without resorting to gimmicks.
The signing of a budget would clear the way for California to sell short-term revenue anticipation notes (RANs). The state is the biggest borrower in the $3.7 trillion U.S. municipal bond market and sells RANs to meet its cash-flow needs. Having a budget in place also allows the state to sell longer-term general obligation debt.
California 10-year muni yields traded last week at an average of 72 basis points over the Municipal Market Data benchmark triple-A scale, the third highest spread after Puerto Rico and Illinois.
Reporting By Jim Christie. Editing by Jonathan Weber, William Schomberg, Tiziana Barghini and Paul Simao
Our Standards: The Thomson Reuters Trust Principles.