Budget Update: Cuts or Taxes?

Edelstein Gilbert Robson & Smith

As we have reported previously, Governor Newsom released his May Revision to the Budget on May 14, announcing that the state is facing a $54 billion deficit.  The May Revise proposes to balance the budget with a mix of reserves, internal borrowing, federal funding, and short-term revenues.  However, the backbone of the Governor’s May Revise is $14 billion in “trigger cuts” to health and human services, K-12 education, state universities, and other state services.  If adopted these cuts would take effect on July 1 and be in place unless the Federal government provides funding to backfill the cuts.

As we predicted, these trigger cuts have become a major sticking point in negotiations with the Legislature.  The Assembly met as a “Committee of the Whole” this week, a procedure which allows all Assemblymembers to meet but take testimony from outside witnesses. 

The meeting allowed Assemblymembers to review the Governor’s budget and provide feedback and criticism.  The proposed trigger cuts drew bipartisan criticism.  Some members argued that if enacted the cuts would be devastating to California’s most vulnerable populations.  Others pointed out that the budget was too reliant on the Federal government, meaning that a structural deficit would persist in future years when funding dries up.

The Senate took things a step further this week and crafted their own alternative to the Governor’s May Revise.  The Senate plan is similar to the Governor’s but makes a number of adjustments to the trigger cuts.  First, the Senate’s cuts are not “triggered” until October 1.  From there, most of the Senate’s cuts are not cuts at all, but increased reliance on reserves, internal borrowing, and deferred payments.  The Senate Budget Committee adopted their version of the budget yesterday.  If passed by the Legislature and signed by the Governor, the Senate Budget would leave a lasting structural deficit and fewer reserves for future years.

While it is not surprising that the Governor’s proposed trigger cuts are unpopular, finding a $14 billion alternative is challenging.  The only other real option is increasing taxes. In theory, Democrats have more than enough seats in the Assembly and Senate to meet the 2/3 vote threshold to pass a new tax.  Another avenue is the ballot. In fact, a major tax proposal is has just qualified for the November ballot.  Taxes are tricky though, especially in a recession.  Many of the Democrats who would need to vote for a new tax in the Legislature are moderates who took their seats from Republicans in swing districts.  It is also unclear how voters will react to a new tax.  On the one hand, the economy is in shambles due to COVID-19.  On the other hand, that has left more Californians vulnerable and reliant on social safety net programs which are in need of funding.

There are a number of revenue proposals on the table in 2020.

Split Roll

The California Teachers Association (CTA) and the Service Employees International Union (SEIU) are championing a split roll tax initiative that is expected to qualify for the November ballot.  If passed by voters in November 2020, the initiative would remove the existing Prop 13 property tax protections for commercial and industrial properties and require such properties to be reassessed at current market values and then be reassessed at a minimum of every three years.  By treating commercial and industrial properties different from residential property, county assessors would be “splitting” the property tax roll.

It is estimated that the split roll property tax would generate an additional $10-12 billion in new revenue, of which approximately 60 percent would go to local governments and 40 percent to schools.  The economic crisis created by the COVID -19 pandemic creates a greater demand for new revenue, but also presents a greater threat to business property owners who have also been ravaged by the effects of the pandemic.

Prior to COVID-19, the initiative’s union backers were expected to spend between $40 million and $60 million to pass the initiative in November.  However, labor will also be opposing another ballot measure intended to exempt the gig economy – Uber, Lyft, Doordash – from laws classifying their drivers as employees entitled to certain benefits rather than sub-contractors.

It remains to be seen whether the unions will have the resources needed for both fights.  Similarly, it is unclear whether the business community’s ability to raise money against the split roll initiative will be impacted by the economic downturn.

Sports Wagering

Even before the COVID-19 pandemic, there was a push to allow California’s gaming tribes to conduct regulated and taxed sports wagering.  During this week’s Assembly hearing, Assemblymember Adam Gray, who Chairs the Committee with purview over gaming law, raised the proposal as a partial budget solution.  Yesterday, Assemblymember Gray and his counterpart, Senator Bill Dodd, introduced a constitutional amendment (SCA 6) to make sports wagering legal for federally recognized tribes and racing tracks.  To appease California’s card rooms, who are left out of the proposal, the constitutional amendment would also enshrine their right to operate in the constitution.  SCA 6 must be passed by a 2/3 vote of the Legislature by June 25 in order for voters to consider the amendment in November.

AB 398 – Employee Tax

This week, Assemblymember Kansen Chu introduced AB 398, which would levy a $275 per employee tax on all businesses in California with more than 500 employees.  The bill would split revenue from this proposal between local governments and schools to help them backfill their budget deficits.  However, there will be robust opposition from the business community, who are already making the logical argument that the bill will effectively tax any new hire at a time when unemployment is skyrocketing.  As with all tax measures, AB 398 needs a 2/3 vote to pass.

In addition to the proposals above, the Governor has proposed adjustments to revenue including suspending net operating losses for corporate income tax and limiting the use of tax credits.  He is also proposing a new tax on electronic vaping products.

We will keep you apprised of further developments as all of these proposals move forward.

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