Will California Take the Low Road?

Economic development strategists contrast “high road” and “low road” paths towards building a healthy economy. It appears the recently announced budget agreement once again opts for the low road, choosing tax cuts and spending limits over high road investments in schools and public structures. While details remain extremely scarce and detailed language of the proposal discussed below is not available to the public, reports suggest that the agreement would:

  • Place a measure on the November 2012 ballot that would create a “reserve on steroids”/spending cap largely based on Proposition 1A of May 2009, which was resoundingly defeated by the voters. While proposed language is not yet available, it appears that the proposed cap would require a reserve equal to 10 percent of state spending, require annual deposits into the reserve equal to 1.5 percent of state spending, transfer “unanticipated revenues” based on a 20 year statistical calculation using linear regression analysis into the reserve, and limit the conditions under which the reserve could be used. One significant change from the structure of the cap proposed in Proposition 1A appears to be a provision that would limit the use of the balance in the reserve in the event of a budget shortfall. Reports suggest that only 50 percent of the balance could be used in the first year of a budget crisis, followed by half of the remaining balance in the second year of a budget crisis, and the remainder in the third year.
  • Eliminate certain anti-abuse provisions included as part of the February 2009 tax deal commonly referred to as “cost-of-performance” rules. This provision would primarily benefit out-of-state corporations and will, by some reports, cost the state $140 million or more per year at full implementation. Advocates for cable television and certain out-of-state technology companies have argued for the proposed change.
  • Modify the corporate underpayment penalty included as part of the September 2008 budget agreement. It is unclear whether the proposed change would also modify the “strict liability penalty” included as part of the 2008 budget agreement.
  • Provide a tax break estimated at $20 million to a single pulp mill project. Reports suggest that this would be accomplished through some type of exception to the Net Operation Loss (NOL) suspension described below.
  • Suspend businesses’ ability to claim NOL deductions for two years and delay the implementation of NOL carrybacks for the same period. Businesses would be allowed to claim these deductions in future years. This provision is reportedly scored as a $1.2 billion revenue increase in the budget year, but will be offset by larger revenue losses in future years.

In contrast to narrowly targeted tax breaks, the budget agreement also includes a reported $7.5 billion in spending reductions including substantial cuts to public schools that would come on top of the cuts documented in the CBP’s “Race to the Bottom?” published earlier this year.

The proposed agreement does reject the most extreme cuts proposed by the Governor, such as the elimination of the CalWORKs Program and state support for child care. However, it also relies on extremely optimistic estimates of federal assistance and state tax collections that will likely result in large shortfalls before the close of the fiscal year.

— Jean Ross