July 2002

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Cal-Tax Commentary 

David R. Doerr,
Cal-Tax’s chief tax consultant, is the author of “California’s Tax Machine, a History of Taxing and Spending in the Golden State,” published in 2000. Before joining Cal-Tax, he was chief consultant to the Assembly Revenue and Taxation Committee for 24 years, until mid-1987.

“If the tax bills pending before the Legislature are passed, it is likely that the temporary taxes will be around a lot longer than people realize.”

Temporary tax increases are part of this year’s proposed tax package. They include a one-year increase in the vehicle license fee, a two-year suspension of net operating loss carryforwards and a one-year suspension of the teachers’ tax credit.

There is significant danger that once a temporary tax increase is on the books, it will be continued beyond its original expiration date. As history has shown, keeping a tax in effect can be the point of least resistance when state legislators try to balance budgets.

Because of the structure of this year’s proposed budget, that danger is magnified. Pending before the Assembly is a budget that shifts the “budget gap” significantly to future fiscal years and, as has been reported, could fall apart if the state’s economy dips ever so slightly.

In a recent Sacramento Bee column, Daniel Weintraub observed that the next spending plan will leave state finances in a “highly leveraged and precarious condition. The only question is whether postponing the eventual day of reckoning will give the state’s economy a chance to catch up with its budget or make matters worse. And things could get much, much worse.”

The Legislature’s budget analyst has projected fiscal crises recurring over the next four years, including a nearly $10 billion problem next year. In a July 9 memo, Legislative Analyst Elizabeth Hill said that even if the pending state budget and tax package passes, there will be ongoing gaps of $9.8 billion for 2003-04, $12.3 billion for 2004-05; $11.2 billion for 2005-06; $9.6 billion for 2006-07, and $8.7 billion for 2007-08.

Much of the “budget gap” is covered for this fiscal year by borrowing, one-time spending reductions and temporary tax increases. If this budget and accompanying tax increases are passed this year, how will the “budget gap” be filled next year and the year after that and the year after that?

Borrowing options will be significantly reduced and some of the borrowing for 2002-03 will be required to be paid back from current revenues. There will be upward pressures on spending because of the significant pay and benefit increases granted in long-term state employee contracts negotiated by the governor.

The likely scenario for future years will play out in the same manner as this year’s debate: Major legislative forces will say spending cannot be cut any further without jeopardizing vital services and therefore tax increases are necessary to balance the budget.

If these pending budget and tax increases (AB 433, AB 3000 and AB 3009)are passed, guess what will be most at risk in the next few years?

Obviously, it will be an extension of the temporary tax increases, primarily the vehicle license fee (a.k.a. car tax) increase and the suspension of the NOL, for these are the big-ticket revenue raisers. Politically, proponents will claim the extensions are not really tax “increases” because taxes will be no higher than in the prior fiscal year. The suspension of the NOL will be particularly vulnerable because the portion of the amount that can be carried forward will be increased from 65 percent to 80 percent.

Recent tax history gives little comfort that continuation of the temporary tax increases will not be the first option to deal with predicted future budget gaps.

In 1991, part of Governor Pete Wilson’s tax package was a “temporary” 0.5 percent sales tax increase. Because of continuing fiscal problems and the property tax shift to schools, voters made the temporary tax increase permanent in 1993. Additionally, the small business health care tax credit that had been enacted in 1988, and scheduled to take effect in 1991, was suspended. In 1992, it was again suspended. It was finally repealed without ever having gone into effect.

Even when the fiscal crisis had passed, a major effort was launched to make the temporary income tax increase enacted in 1991 permanent. In 1996, the spending lobby placed an initiative on the November ballot to keep the 10 percent and 11 percent brackets. It got 49.1 percent of the vote. Proponents argued that it was not a tax increase but was simply keeping taxes at the level they had been for several years.

The results of local elections also confirm that the public is much more likely to extend a temporary tax than to vote to impose a new tax.

If the tax bills pending before the Legislature are passed, it is likely that the temporary taxes will be around a lot longer than people realize.