How to Fix the California Budget Deficit Problems

How to Fix the California Budget Deficit Problems

By Alan Derman

January 21, 2011

It should be clear by now that California has an ongoing budget crisis. Education and vital social services have been cut over 20% (over) the last two years. These draconian cuts are devastating public education, safety, and public health.

The really effective and fair way out of this ongoing crisis lies in tax fairness. Over fifteen (15) years ago, those who made at least $250,000/year paid 10%, and those who made $500,000 paid 11%. Currently, both pay 9.3%. This results in chronic, ongoing revenue losses of about $5 – 6 Billion annually. Also, the State Finance Department’s deficit projections can change rapidly and are not very reliable. For example, the media analysts and the Legislative Office advertised a $28 Billion deficit, but since last week, that projection (over 18 months) was cut to $25 Billion. This is a significant variance for any budget, and reduces its credibility!

It is important to note that the wealthiest 1% of the U.S. population owns more than a third (33%) of the country’s wealth which is the most inequitable wealth distribution since before (1920’s) the Great Depression (per Fortune Magazine). The richest 1% averages $1.6 million annual income, which is still growing.

Numerous corporate loopholes and reductions in marginal tax rates enable corporations and wealthy individuals to avoid billions in taxes annually. An example is the oil severance tax, which costs California $2 – 3 Billion in lost annual tax revenues.

For many years, California was the only state in the U.S. to require a 2/3 super majority vote margin to pass any budget and any tax, but it still only requires a Simple Majority to end or reduce an existing tax. All of these unfair Revenue-raising rules helped lead to rising annual revenue losses and deficits.

There are many ways to increase revenues.

  • First, the top income tax bracket should be restored to at least 11%.
  • Second, all corporate tax loopholes enacted during the last twelve years of budget deals must be repealed which will yield at least $5-8 billion annually.
  • Third, the full vehicle license fee should be restored, which will yield $3-4 billion annually.
  • A fourth tax revenue source should be enactment of an oil severance tax on all oil produced in California. This will yield $2 or $3 billion annually.
  • Fifth, all corporate, non-residential real properties should be reassessed, since Prop. 13 (enacted 1978), gave such properties unfair exemptions and Prop. 13 should be revised accordingly to exclude such unfair corporate tax revenue exemptions. California could easily raise billions annually in this category alone!!
  • Sixth, California should enact a small tax on all stock and bond transactions (.005% x the volume of each trade), that potentially will yield at least $3-5 billion in revenue annually.
  • Seventh, California should establish a modest tax on all internet sales transactions, which could yield a minimum of $5-8 Billion annually.

On the expense reduction side, California should:

  • One, cut consulting, Engineering, and legal expenses in the annual budget of CalTRANS by 50%, that would save at least $1/2 – 2 Billion annually. All other State Departments should likewise cut all consulting expenses by 50%, saving at least an additional $1-3 Billion annually.
  • Second, the main State pension systems, CalPERS and CalSTRS, each must cut outside money-managers fees each year by 50%, which would yield almost $500 million in annual savings for CalPERS, and approximately $350 million for CalSTRS. For example, CalPERS recently renegotiated annual fees for the Apollo Private Equity Group Fund, saving over $300 million in 2010!
  • Third, California has lost more than one million jobs since the recession began (2007-8), and continues to lose jobs. Actually, California has the same number of jobs it had ten years ago, when the State workforce had 3.6 million fewer workers!! Tax cuts result in a much smaller “bang for the buck” than spending increases. In fact, each dollar reduction in taxes produces far less than a dollar gain in economic activity. For example, each dollar spent to extend Unemployment Insurance results in increased economic activity of $1.61. For each dollar spent on Food Stamps, economic activity increases by $1.75 – a major increase. More than 2.2 million Californians were unemployed in December 2010, and State jobless rate was 12.4%.

The September 2008 and February2009 corporate tax cuts, if repealed, will boost 2010-11 tax revenues by at least $685 million. The permanent tax cuts, over time, will cost California about $2.5 Billion annually in lost revenues. These tax cuts should be repealed immediately by the legislature. Re-instatement of California’s top 10% and 11% income tax rates would make the State’s tax system more equitable, raising at least $4-6 Billion annually in new revenues!

A ten cent per gallon alcoholic beverage fee increase would yield $1,170,000,000 in added revenues for California per year! Why not do this?

General Fund revenues could be raised by lowering taxes now dedicated to “Special Funds” [define and/or give examples] and raising taxes that support general State services and programs. The State could also require tax withholding on payments to independent contractors, which would boost tax revenues by at least $200 – 300 million annually.

The State of California should also require all corporations to reconcile book and taxable income to increase transparency and corporate income tax revenues. Further, California vigorously pursue collection of transaction and use taxes on all internet sales, which could raise at least $5 Billion annually and [while achieving] achieve greater tax fairness for “brick and mortar; businesses throughout the State.

California should apply tax fairness changes to eliminate all tax incentives to all “off-shore” jobs and profits, per President Obama’s proposed 2011 Budget and to close other corporate tax loopholes per the proposed 2011 Federal Budget. Many billions of dollars in added tax revenues could thereby be achieved.

Also, the Sales Tax could be extended to various services, such as cable satellite T.V., recreation, repair services, pay-per-view sales, etc. The revenue that could easily be raised would be in the tens of billions annually. Reducing taxes at the State level is, at best, a zero sum game. When states cut taxes, usually they must offset lost revenues by reducing spending. Spending cuts tend to reduce positive economic impacts (i.e. jobs).

Actually, combined state and local taxes represent about 2-3% of the total cost of doing business for a corporation. Such small reductions of business’ cost are unlikely to promote significant expansion(s) in business. Tax cuts do not pay for themselves through stronger economic growth, and usually lead to revenue losses that are often, as in California, offset partially by harmful cuts in vital social services. These cuts range from: IHSS (over $486 million in cuts proposed), School (?) and higher education fee hikes (18% in less than two years for the UC and State University systems), $1.7 Billion in Medi-Cal cuts, etc., and over $400 million in more cuts to the State University system, along with a 10% hike in fees for the University of California.

According to Governor Brown’s recent Budget 2011 Forecast, taxable sales taxable sales are projected to increase by 7.1% in 2011, followed by an increase of 8.6% in 2012, but annual personal income is only expected to increase by 3.8% in 2011 and 4.0% in 2012. Currently, Sales Tax and personal income taxes are the two largest revenue sources. Corporate taxes need to be increased significantly for a balanced and fairer system to raise revenues.

The proposed $12.6 Billion in draconian budget cuts are largely unnecessary, since most can easily be offset by revenue increases as suggested in this proposal, which would tend to have more positive impacts on deficits, rebuilding our recession-battered economy. The revenue side of the Governor’s proposed 2011-12 Budget mainly relies on restoration of the .25% personal income tax surcharge, and temporary increases in sales taxes (1%) and vehicle license fees.*

The major cuts to social services proposed (especially to the disabled, elderly, and welfare clients), are especially draconian and cruel. These cuts could easily be avoided by a simple increase in the top corporate tax rate from 9.3% to 11%, and also the ending of numerous unfair corporate tax loopholes. As an example, Google has an effective Federal corporate tax rate of 3.5%! Such tax rates and corporate loopholes are totally unjust, and against the interests of a democracy. Rather, these vicious tax cuts in social services, and absurdly low corporate and individual wealthy (top 1%) tax rates shift most of the tax funding burdens to the California (and U.S.) middle classes. The interests of millionaires and billionaires (hedge-fund managers, corporate CEO’s, etc.), hopefully will not prevail in the 2011-12 state Budget debate and beyond or we risk destroying our fragile, recession plagued democracy, creating a plutocracy, which the Super-wealthy corporate elite (mostly Republicans) now seem to ardently desire. To reiterate, we urge responsible legislators to reject the draconian cuts to social services and use revenue enhancing proposals as described herein.

In addition, we urgently suggest that the Legislature review all consulting and money management expenses for the State University system and the University of California. The Regents of the University of California have been grossly ineffective in reducing both consulting expenses and external fund management fees. Even CalPERS has finally, after decades, has reduced its external fund management by over $300 million in 2010 (see Wall Street Journal, Dec. 14, 2010)! The State University and University of California systems should do likewise. By that method major fund managers’ fees could be reduced up to 50% (by renegotiating their contracts); the systems could save hundreds of millions of dollars annually.

This fund-management fee reduction program would save students and their families hundreds of millions of dollars annually, closer to the to the notions of universal affordability as promised in California’s 1960 Master Plan for Higher Education. Also, the State transfer payments to the two university systems will be more efficiently spent (approximately $5 Billion at present). The State Treasurer will have a stronger basis for more oversight over the non-transparent, imperial Board of Regents (13??) of the University of California. Currently the two State systems pay exorbitant, excessive fund-management fees to dozens of Wall Street fund-managers, an ongoing practice of piracy.

It is long overdue to reform and restructure the grossly excessive fund(s)-management fees paid by the University systems, which drains public education of hundreds of millions of dollars annually. That money should be invested in both the rebuilding of California’s public education institutions, making them both: more affordable for California residents and their families; while helping to rebuild and invigorate the California recession-battered economy.

The State Treasurer and the new head of the Department of Education should immediately work on pushing the Board of Regents to re-negotiate all of their external fund management fees, as CalPERS has started to do (as previously noted with over $300 million of savings in 2010). Taxpayers will save billions potentially while students and their parents will have a reduction of their burden in excessive tuition fees.

State representatives on the secretive Board of Regent should establish with the support of the Governor, a “Higher Education Oversight Division” to review and monitor, on a monthly basis, the current unilateral spending and investment plans and decisions of the University Board of Regents. The State of California currently transfers annually some $5 Billion of taxpayer funds to the State University and University of California systems. It is long overdue to change and improve the spending and investment decisions of the State University Trustees and UC Regents.

Parents of students in both University systems are variously outraged, dispirited and tired of excessive tuition and fees charged to students. Essentially this is a process of privatization of these systems, making them substantially overpriced for an increasing majority of California’s residents. This is increasingly becoming a visible and sharp source of conflict as consultants and administrators become quite wealthy.

In summary, there are numerous ways to deal with the $25 Billion (revised) deficit projection. The best ways included raising the top California tax rate from 9.3% to at least 11% that would yield about $5-6 Billion annually. Second, corporate loopholes of 2008 and 2009 should be repealed, thereby yielding between $5-8 Billion in revenue annually.

The external fund managers’ contracts with the University of California and the State University system should be re-negotiated by 50% annually, resulting in estimated annual savings of approximately $300 million for the University of California and approximately $200 million for the State University system. Also, a State Higher Education Oversight Panel should review all contracts and expenditures of the U.C. Board of Regents and the State University Trustees.

Please consider these options rather than draconian budget cuts. The disabled, elderly, and students should not be victimized by the cumulative revenue losses of an unfair tax system with windfalls for corporations and the wealthy.

Budgets are about priorities, revenue and expense assumptions, and projections about future economic factors, such as inflation, recession, and how to finance basic human support services for a civilized state. We don’t want California to turn into a “third world country” of deprivations and the polarization of growing wealth and tax disparities. Let’s have a humane budget, a fair tax structure, and stop draconian cuts by prudent revenue increases. *See CBP (California Budget Project) CBP January 11, 2010

Alan Derman

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