Cal-Tax Research Bulletin


February
1996


Governor's 1996-97 Budget

Planning for Prosperity

Budget Highlights

Introduction

Amid a somewhat brightened fiscal setting, Governor Pete Wilson submitted his 1996-97 budget proposal in January, contemplating expenditures of $61.5 billion, including $45.2 billion from the state's general fund. The budget, as proposed, cites a net general fund surplus June 30, 1997 of $404 million.

As he proposed last year, the governor again suggests a major tax reduction, reduced spending for welfare, full funding for corrections and increases for education. Increased economic growth is projected, but general fund revenues would grow more slowly, due primarily to a "phased-in" 15 percent reduction in income and bank and corporation taxes.

To achieve balance, the budget is predicated on legislative changes in a number of program areas. In health and welfare programs alone, more than $2 billion in proposed savings are dependent on federal statutory changes.

Revenue projections in the budget are somewhat conservative, given forecasts of a continued moderate economic recovery in California. Overall general fund revenues are projected to increase only slightly more than one percent, a figure that includes reduced personal income tax receipts from the first phase of the tax cut and the transfer of trial court funding from the general fund.

Governor Wilson describes his budget as "his continuing commitment to invest in education, public safety, preventive programs and economic growth."

This research bulletin, by Cal-Tax Director of Research Stephen Kroes and researcher Les Howe, describes important components of the governor's budget plan.

Governor's Key Budget Goals and Programs

Table 1

Fiscal Discipline

Investment in California's future

Public safety

Preventions

California infrastructure

California competitiveness

Tax Reduction

As in last year's proposed budget, the governor seeks major tax reductions for 1996-97 and beyond. The most prominent part of the tax cut package is a 15 percent reduction in all personal income tax rates and the bank and corporation tax. The governor also proposes additional tax reductions targeted to specific industries or types of taxpayers. Table 2 shows all the elements of the tax reduction package, and Table 6 shows the expected state revenue reductions from these changes. Actual taxpayer savings would be less than the state revenue loss, because taxpayers would have less state income tax to deduct from their federal tax returns. The Legislative Analyst's Office estimates that the resulting increase in federal income tax would reduce net taxpayer savings by an average of 25 percent.

Governor's 1996 Tax Reduction Proposals

Table 2

Personal income tax: Reduce rates by 15 percent over three years, to range from 0.85 to 7.91 percent by 1999, from the current 1.0 to 9.3 percent rates

Bank and corporation tax: Reduce rate by 15 percent over 3 years, to 7.91 percent by 1999, from the current 9.3 percent rate

Research and development tax credit: Increase to 12 percent from 8 percent (24 percent from 12 percent for university research contracts)

Unitary: Exclude 75 percent of foreign source dividends under the water's-edge formula

Semiconductor equipment manufacturers: Expand manufacturers' investment tax credit to special purpose buildings

Biopharmaceutical start-up companies: Allow 100 percent net operating loss carryover for 8 years and allow manufacturers' investment tax credit carryover for 9 years

Aerospace: Increase the hiring tax credit for workers in the Long Beach enterprise zone

Commercial aircraft parts and repairs: exempt from sales tax

Small business expensing: Conform to federal law raising the threshold to $17,500 from $10,000

Home sale capital losses: Allow limited deduction on the sale or exchange of a principal residence for first-time home owners

Gross premiums tax on annuities: Reduce to 0.5 percent over three years from 2.35 percent

Source: Governor's Budget Summary


Note: This table is not numbered in sequential order because it appeared in a different position in the printed publication. For reference purposes, we are keeping the same table numbers that appeared in the printed bulletin.

The income tax rate reduction is very similar to the proposal Governor Wilson included in his 1995-96 budget, following his Council of Economic Advisors' 1994 study recommending means of improving California's competitive position with other states. Currently, California's top personal income tax rate is 9.3 percent, beginning at about $63,000 of taxable income for a married joint tax return. The bank and corporation tax is also 9.3 percent, which applies as a flat rate to corporate income. The governor's proposal would phase in a 15 percent reduction in these rates as follows:

Income Year    Top Rate
   1997         8.84%
   1998         8.37%
   1999         7.91%
Personal income tax rates for taxpayers in lower income brackets would also be reduced 15 percent, providing proportional tax reductions for all California taxpayers. Opponents to the tax cut have characterized it as providing much greater benefit to higher-income Californians, but their claims ignore the progressive nature of this tax. California's income tax has been labeled the most progressive in the nation. High-income taxpayers pay a much greater percentage of the income tax because of the progressive brackets; therefore, they would receive a greater dollar benefit from the reduction. But all taxpayers would benefit in equal proportion to what they now pay.

The Legislative Analyst's "Overview of the 1996-97 Governor's Budget" estimates that the governor's tax proposal would reduce state general fund revenue growth by about one half over the next four years - from an average of about 4.6 percent annually to about 2.3 percent.

California's Tax Burden

Opponents of the governor's tax reduction plan claim that California does not need to reduce taxes because this is not a high-tax state. They cite Cal-Tax data, from the "California Taxing and Spending" research bulletin, showing that California's tax burden ranked 22nd highest in the nation when measured per $1,000 of personal income.

Focusing solely on this measure of tax burden can be deceptive, because it is biased against high -income states. Table 3 shows this measure of tax and fee burden for the ten highest-income states. Note the dramatic grouping of most high-income states at the bottom of the tax burden ranking. Some of those states have reputations as high-tax states, and their tax burdens are lower than California's.

Conversely, some low-income states rank very high on the list of tax burden per $1,000 of personal income. For example, New Mexico, North Dakota, Iowa, Utah, Arizona, Louisiana, Idaho, and South Carolina all rank higher than California. Why? Because personal income and population density in those states are low, and it takes a higher proportion of their incomes merely to provide basic infrastructure and services. More densely populated and higher income states, like California, spread those costs over a greater tax base, allowing a slightly lower tax burden per $1,000 of personal income. California policymakers should not feel pressure to "keep up" with states that rank higher on this measure of tax burden simply because they are poorer and less populated.



Competition in Government

The governor's budget proposes more competition between the public and private sectors to achieve further efficiencies and cost savings in the delivery of public services.

The governor has directed agencies to conduct a top-to-bottom review of their functions and activities and to submit plans for divestiture "when feasible." The plan is expected to be ready by April 15 this year.

Governor Wilson also has designated the State and Consumer Services agency to provide guidelines for top administrators to prepare them for more competitive management.

In addition, a task force of state leaders, with private sector input, will provide policy oversight on competitive state projects and proposals.

Making Temporary Cuts Permanent

During the past several years, some state programs were reduced, and Cost of Living Adjustments (COLAs) and the renters' tax credit were eliminated on a temporary basis. Those reforms are scheduled to expire in the budget year, causing a $1.7 billion increase in state spending.

The governor has called a special session of the Legislature to attempt to make those reductions permanent by April 1 of this year to avoid the $1.7 billion added cost. Table 8 shows the reductions that will expire unless made permanent.

According to the Department of Finance, if these reductions are allowed to lapse, and if state taxes are increased to cover the costs, about $4 billion in new taxes would be needed, because Proposition 98 education spending would take 60 percent of the tax increase.

Local Diversion of Income Tax

Another important and possibly controversial change proposed by the governor is to allow taxpayers to choose to earmark one percent of their total state income tax to the local government where they reside. The funds would be available for local public safety costs. The budget estimates that about $150 million could be diverted in the budget year.

Federal Reimbursement

As in his budget last year, the governor's 1996-97 proposal includes some savings that will depend upon favorable action by the federal government, either through legislation or administrative waivers. According to the Legislative Analyst's Office, these total about $2.6 billion, including:

Retiring The Deficit Debt

During the beginning of the 1990-93 recession, the state general fund incurred several large operating deficits. Two years ago, the state borrowed several billion dollars from banks and other sources to finance cash flow. A strict repayment scheme was adopted, providing for triggered spending reductions if revenues fell short of projections. The projections proved accurate, and the triggers were never invoked. Those loans will be fully paid as of April this year, and the state has completely erased any carryover deficit. As shown in Figure 1, the general fund has run operating surpluses since 1993-34. The budget projects a surplus fund balance of about $400 million at the end of the 1996-97 fiscal year.


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