California’s economy may not be booming, but it’s definitely on the mend. The Bay Area is churning out high-tech profits and high-wage jobs. In other parts of the state, unemployment is inching down toward full-employment levels.
And as always when the economy improves, tax revenues are soaring. With an income tax system highly dependent on the wealthy and their investment income, the state treasury typically sees a windfall whenever times are good.
But this time, something is different.
A new “rainy day” reserve approved by voters a year ago is already working as intended. The law is forcing the state’s politicians to set money aside to prepare for the inevitable cooling of the economy or even a recession, and the resulting slowdown in tax revenue.
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This change was long overdue.
Since at least the early 1990s, California’s economy and tax system have conspired to create a boom-and-bust revenue stream, leading to cycles of big budget surpluses followed by crushing deficits. As the revenues gushed in good times, legislators and governors either cut taxes or committed the money to new programs, as if the good times would roll forever.
But the good times always ended. And when they did, the state was forced to slash public services or raise taxes, or both, to balance the budget.
Liberals hated the budget cuts, and conservatives hated the tax hikes, but neither side could control their impulses or agree on a law that would impose discipline for them. Former Gov. Arnold Schwarzenegger recognized this problem and tried to fix it. His first attempt to create a mandatory reserve fund, shortly after he took office in 2003, was poorly written and toothless. But he kept trying, and in 2010, he sponsored another measure that promised to be much more effective.
Democrats, though they had agreed to place that measure on the ballot, never liked it, and they later amended the plan into Proposition 2, which went to the voters in 2014. That constitutional amendment won the support of Gov. Jerry Brown, his Republican opponent, Neel Kashkari, and both major political parties. Nearly 70 percent of voters approved the measure.
And it’s working. The law sets aside 1.5 percent of all general fund revenues plus any capital gains taxes that exceed 8 percent of the state’s revenues. Half of that money must go to pay down debt and pension obligations, and half is kept in the reserve for a fiscal emergency.
By the end of this budget year, the rainy day fund is expected to hold more than $5 billion. That balance will likely grow to more than $7 billion next year. And if the economy grows as expected, the state will still have billions more to spend on new programs or keep in short-term reserves.
At some point, the good times will end again. That’s never pleasant. But this time, the state will have repaid billions in debt and built a prudent reserve as a cushion to reduce the need for service cuts and tax increases.
So while it’s always easy to criticize the state’s political and governmental dysfunction, we should acknowledge this example of bipartisan cooperation among political leaders and the voters to do something smart. With any luck, it will save us all a lot of pain the next time the state’s tax revenue roller coaster hits its peak and starts back down again.
Daniel Weintraub is editor of the California Health Report. He can be contacted at firstname.lastname@example.org.