Legislative Update: COVID-19, Budget & Taxes

Edelstein Gilbert Robson & Smith

Governor Newsom has walked a political tightrope since March when he issued a first-in-the-nation order for Californian’s to shelter in place.  The shelter in place order was highly effective at reducing the rate at which COVID-19 spread in California.  At the same time, it brought economic devastation on a level that pales in comparison to anything experienced in recent memory.

As we’ve reported previously, Governor Newsom faced increasing pressure from a willful population and defiant counties who were seeking to reopen.  Bowing to this pressure, the state loosened its guidelines enough to allow a more rapid reopening and return to work for Californians.  For a few weeks in June and July, restaurants, bars, salons, and gyms were reopened.

With California’s COVID-19 infection and mortality rates spiking, however, 97% of the state’s population are once again restricted from visiting these businesses.  The virus has made its way into even the most remote of California’s Counties.  Editorial boards, medical professionals, and some in the state Legislature have started encouraging the Governor to pursue a more aggressive shelter in place order, once again limiting activity outside of the home to essential business.

61% of California respondents recently told the Berkley Institute for Governmental Studies that California has reopened too fast.  With those numbers as well as pressure to issue more restrictive orders coming from politicians, the press, and medical professionals it may seem strange that the Governor has not already re-imposed a more severe shelter in place order.

However, in Sacramento it is widely recognized that the path to Newsom’s political future runs through Presidential battleground states.  According to a Change Research poll 57% of likely Florida voters believe their state has reopened too quickly.  Results were lower in Arizona (51%), Wisconsin (48%), North Carolina (38%), and Michigan (28%).  The challenge for the Governor may be finding a path forward that allows him to credibly claim to have found a middle ground for his state that limited the spread of the virus while protecting against greater economic hardship.  That claim must pass muster not just with California’s more liberal electorate, but in middle America.

Budget and Taxes

The Governor must also grapple with the impact the economic crisis has had on the budget.  As reported previously, the Governor and the Legislature closed the state’s $54 billion budget gap with a tenuous agreement that relies on the hope that the federal government will backfill lost revenue for the state.  If federal money is not forthcoming, the enacted budget will likely worsen the state’s finances in future budget years.

Public employee unions and some Democrats in the Legislature believe taxes are the answer to the state’s financial woes.  Even before the onset of the pandemic, these groups were pursuing an initiative to split the property tax roll.  Proposition 15 would carve some commercial properties out of the property tax protections approved by voters under Proposition 13 in 1978.  If passed Prop. 15 would raise $6.5-$11.5 billion in new revenue for local governments and schools.

While Prop. 15 will be on the ballot in November, legislators are also pursuing new taxes.  Assemblymember Miguel Santiago has introduced legislation that would impose an additional 1% tax on those earning more than $1 million, 3% on those earning more than $2 million, and 3.5% on those earning more than $5 million.  Another bill, AB 398 (Chu) would assess a $275 per employee tax on businesses with over 500 employees.

On paper, Democrats have more than enough votes to meet the 2/3 threshold for the Legislature to pass new taxes.  In reality, many of the Democrats who make up the “supermajority” are moderates who won their seats from Republicans in competitive districts.  For these moderates, a vote for increased taxes is a big risk this close to an election.  It is also true that state revenue is extremely volatile because California already relies disproportionately on high income earners.  Doubling down on that means the state will continue to face rapid revenue swings during future recessions.

A competing group composed of moderate and traditional Democrats alike have proposed a “non-tax” alternative to raise revenue.  As we noted last week, Senator Hertzberg and a number of his colleagues have proposed to raise $100 billion through “securitization” of existing revenue streams and incentivizing taxpayers to pay future taxes early.  Though innovative, there are scant details to prove that the proposal could raise so much revenue and no bills have been introduced thus far.  Given that, it seems unlikely that much progress is made on this idea in 2020.  Nevertheless, it represents a non-tax alternative for raising revenue.

Thus far, the Governor has not weighed in on any of the legislative proposals.  He and the Legislature must weigh the politics of imposing new taxes during one of the worst economic crises of modern times against the state’s looming budget crises.