Governor's 1997-98 Budget
Economic Growth Fuels Revenue Growth
Budget Highlights
  • California's economy is growing faster than that of the nation, providing increased state revenues.
  • The budget proposes business tax reduction to be phased in over two years.
  • Education funding continues to increase, and this proposal commits much of the increase to class-size reduction.
  • The budget proposes to expand educational technology, especially in high schools.
  • Welfare reform is needed to adapt to new federal laws, and the budget includes a comprehensive plan to reform the system, focusing on temporary assistance, preventing dependency and helping recipients find jobs.
  • Current-year spending will exceed current-year revenues, tapping some of the budget reserve.
  • The budget year would produce a $360 million operating surplus, allowing a total reserve of about $550 million.

On January 9, Governor Pete Wilson released his proposed $64.6 billion budget for fiscal year 1997-98. As with the current budget, a prominent feature of this budget is economic recovery, resulting in growth in revenues and spending.

Similar to previous Wilson budgets is a focus on welfare reform. However, this year is different because welfare reform must comply with federal reforms enacted by Congress and President Clinton last year. Reform is required, but reaching agreement with legislators is likely to be difficult. A week after this budget was introduced, legislative opponents to the plan held a news conference and sharply criticized Mr. Wilson's welfare proposals. The welfare proposals described in this analysis are probably a starting point, and the final solution is likely to reflect some degree of compromise.

Another key feature of this budget is increased education spending. Last year's enacted budget included a major investment in elementary school class-size reduction. This year, the governor proposes to expand the class-size reduction effort to all kindergarten through third-grade classes.

Also similar to prior budgets is a call for tax reduction, although this year's proposal is focused solely on business taxes, calling for a 10 percent reduction in the bank and corporation tax rate over two years.

Major Policy Changes in the Governor's Budget
(Dollars in millions)
Revenue Changes

  • Reduce the corporate income tax rate 10 percent over two years
  • Eliminate the renters' credit
    • Spending Changes

    Education

  • Increase Proposition 98 funding, to be used to:
  • Fund enrollment growth and increase K-12 per-pupil funding
  • Expand class-size reduction to all K-3 classes
  • Reform special education
  • Increase investment in educational technology
  • Expand community college involvement in welfare job training

    • Health and Welfare

  • Eliminate scheduled AFDC grant increases
  • Other reforms:
  • Reduce grant 15 percent after six months on aid (if able-bodied)
  • Require recipients to work or take job training
  • Expand child care benefits to accommodate work requirements
  • Limit time individuals can receive aid (lifetime and short-term limits)
  • Require paternity to be established or mother will be ineligible for aid
  • Establish permanent ineligibility for fraud perpetrators
  • Make legal immigrants who arrived after August 1996 ineligible for five years
  • Repeal mandate for county general assistance
  • Assist recipients with finding employment
  • Reduce SSI/SSP grants
  • Assume additional federal funds for Medi-Cal for illegal immigrants
  • Eliminate prenatal care for illegal immigrants

    • State-county relationship

  • State assumes greater trial court funding

    		•
    This analysis was prepared by Cal-Tax Director of Research Stephen Kroes.

    The Economy

    California's economic recovery is in full swing, providing healthy growth in employment, personal income, and taxable sales, which translate to strong revenue growth for the state budget. Figure 1 compares California's employment growth and general fund revenue growth in recent years. The two trends follow each other consistently, except for 1991, when large tax increases were enacted, providing temporary revenue growth in a year of falling employment.

    Employment and Revenue Growth
    Yearly Percent Change
    Figure 1

    Governor Wilson highlighted California's recent job growth, crediting important reforms for spurring this expansion. Among those reforms are:

    • Workers' compensation system reforms beginning in 1993, which significantly reduced fraud and abuse and lowered the cost of expanding employment in California.
    • Establishment of a manufacturers' investment tax credit in 1993, allowing companies to purchase and install new manufacturing equipment without paying the state sales tax on that equipment. Many other states already had this type of credit or an exemption. Manufacturing employment is now growing in California, even as national totals are declining.
    • Reduction of the corporate income tax rate by five percent, effective January 1, 1997.
    For the past two years, California's economy has grown faster than the national economy. This is expected to continue for the next several years, although the budget forecast assumes slightly slower growth than in 1996.

    "California's economic recovery is in full swing, translating to strong revenue growth for the state budget."

    Tax Reduction

    To further stimulate economic growth, the governor proposes a 10 percent reduction in bank and corporation income tax rates over the next two years. The corporate rate would be reduced from its current 8.84 percent to 8.4 percent in 1998 and 7.96 percent in 1999 and beyond.

    According to the Federation of Tax Administrators, California's current corporate tax rate is 14th highest among the states, as shown in Table 1. If this proposal were enacted, California's rate would be 20th highest, assuming other states did not change their rates.

    Corporate Income Tax Rates
    As of January 1, 1997
    Table 1
    Rank State Top Corporate Rate
    1 Iowa 12.00%
    2 Connecticut 10.50%
    3 North Dakota 10.50%
    4 Pennsylvania 9.99%
    5 Minnesota 9.80%
    6 Massachusetts 9.50%
    7 Alaska 9.40%
    8 Arizona 9.00%
    9 New York 9.00%
    10 West Virginia 9.00%
    11 Rhode Island 9.00%
    12 Maine 8.93%
    13 Ohio 8.90%
    14 California 8.84%
    15 Delaware 8.70%
    16 Kentucky 8.25%
    17 Vermont 8.25%
    18 Idaho 8.00%
    19 Louisiana 8.00%
    California (with 10% Cut) 7.96%
    20 Wisconsin 7.90%
    21 Indiana 7.90%
    22 Nebraska 7.81%
    23 New Mexico 7.60%
    24 New Jersey 7.50%
    25 North Carolina 7.50%
    26 Illinois 7.30%
    27 Maryland 7.00%
    28 New Hampshire 7.00%
    29 Montana 6.75%
    30 Oregon 6.60%
    31 Arkansas 6.50%
    32 Hawaii 6.40%
    33 Missouri 6.25%
    34 Tennessee 6.00%
    35 Georgia 6.00%
    36 Virginia 6.00%
    37 Oklahoma 6.00%
    38 Florida 5.50%
    39 Utah 5.00%
    40 Colorado 5.00%
    41 Alabama 5.00%
    42 Mississippi 5.00%
    43 South Carolina 5.00%
    44 Kansas 4.00%
    South Dakota *
    Michigan **
    Texas ***
    Nevada 0.00%
    Washington 0.00%
    Wyoming 0.00%
    * South Dakota imposes a tax of up to 6% on financial institutions.

    ** Michigan imposes a "single business tax" of 2.3% of federal taxable income of the business, compensation paid to employees, dividends, interest, royalties paid and other items.

    *** Texas imposes a franchise tax of 4.5% of earned surplus."
    Source: Federation of Tax Administrators



    "To further stimulate economic growth, the governor proposes a 10 percent reduction in bank and corporation income tax rates over the next two years."

    Revenue Estimates

    Table 2 shows the budget's estimates of major revenues for the prior, current, and coming fiscal years. Personal income tax is projected to be the fastest-growing revenue, followed by insurance taxes and sales taxes. Bank and corporation taxes are not projected to grow as quickly because of enacted and proposed rate reductions.

    Not shown in Table 2 is the property tax. Property taxes are local taxes, but the portion of property tax that is used locally for schools has a direct impact on the state budget because it offsets the amount of state funding needed for schools. Property tax revenues are expected to grow 1.5 percent in the current fiscal year and 3.5 percent in 1997-98. Property taxes provide 51 percent of total school funding.

    Beginning in 1992-93, the governor and Legislature shifted over $3 billion of ongoing property tax revenue from cities, counties and special districts to school districts. This helped relieve some of the state's budget difficulties but caused some hardships for local governments. This budget does not include any proposal to reallocate property tax back to cities and counties.



    Proposed Spending

    Table 3 shows the governor's proposed spending levels for 1997-98. Most of the spending growth is concentrated in education (both K-12 and higher education) and corrections. Health and welfare categories would mostly decrease from current levels, largely due to implementation of welfare reforms to conform with new federal laws.

    Education

    Of the total increase in general fund spending, 79 percent is budgeted for K-12 schools, which would increase spending by $1.5 billion. This increase is mandated by Proposition 98, the 1988 ballot initiative that dictates schools' share of state spending.

    The governor and Legislature can determine how the increased funds are to be spent, and this budget is very specific, leaving none of the increase to the discretion of local school boards unless they use funding for enrollment and cost-of-living increases to change local programs.

    A significant portion of the increase (27 percent) is slated for class-size reduction in kindergarten through third grades. Last summer's budget provided funding for class-size reduction at most schools in three grade levels chosen from kindergarten through third grade (K-3). This proposal would extend the funding to all K-3 classes.

    One reason the Proposition 98 guarantee demands so much of the budget's new revenue is that during the early 1990s, the guarantee switched to a different formula (known formally as "Test Three"), which allows temporary budget relief during slow revenue-growth years. According to the formulas, the amounts saved during slow years, called a "maintenance factor," must be repaid to schools when revenues grow more quickly. Since the state is now in the repayment period, the Proposition 98 guarantee takes the lion's share of new revenues. After the maintenance factor is satisfied, the school funding guarantee will not grow so dramatically.

    Other proposed school initiatives would:

    • Provide $151 million to fully fund current-year requests for facilities needed for class-size reduction.
    • Place a $2 billion K-12 school bond on the June 1998 ballot, with emphasis on funding space for class-size reduction.
    • Support a constitutional amendment to reduce the two-thirds voter approval requirement for local school bonds.
    • Expand technology in high schools by competitively awarding grants to about 100 districts for comprehensive educational technology projects. Future funding would be provided to all high schools.
    • Expand the donated computer program operated by the Detwiler Foundation, providing $10 million for computer parts and instruction at community colleges and prisons where the computers are repaired and upgraded.

    "The Proposition 98 guarantee takes the lion's share of new revenues. After the maintenance factor is satisfied, the school funding guarantee will not grow so dramatically."
    California State Revenues and Spending
    Adjusted for Population and Inflation
    (Real Per Capita, 1997 Dollars)
    Figure 2

    Welfare Reform

    Last summer, Congress and President Clinton approved sweeping welfare reforms that states are implementing this year. The most significant aspect of these reforms is the end to a decades-old system of entitlements. No longer will federal and state spending automatically increase to cover added case-loads. Block grants will be provided to states, allowing the federal government to budget for these programs with more certainty. The major consequence of that change is that states must find ways to pay for caseloads within their block grants and state funds.

    Block grants are based on caseloads in 1995, which was a high caseload year for California because of the lingering effects of the early 1990s recession. With lower caseloads in the current year, the block grant provides greater funding than needed for welfare programs in California. The surplus funding is $334 million in the current year and $486 million in 1997-98.

    The budget allocates much of this surplus funding to welfare programs, such as providing assistance and training to recipients who must find work, and assistance to counties for welfare and health needs. Some of the surplus also goes into the state general fund reserve.

    The primary welfare grant program, Aid to Families with Dependent Children (AFDC) has been renamed Temporary Assistance to Needy Families (TANF) to emphasize Congress's intent that the program be transitional, not a permanent means of support.

    Other major features of federal welfare reform include time limits on individuals' receipt of assistance and requirements that recipients work to continue receiving aid.

    Governor Wilson's proposed implementation of welfare reform includes proposals to:

    • Reduce welfare grants 15 percent after six months on aid (for able-bodied adults).
    • Require recipients to work or take job training.
    • Expand child care benefits to accommodate work requirements.
    • Place a lifetime limit of five cumulative years on the time individuals can receive aid.
    • Limit current recipients to two years of aid per three-year period. New recipients would be allowed one year per three-year period.
    • Require mothers to declare the paternity of their child or the mother would be ineligible for aid (she could still receive an amount for the child only).
    • Impose permanent ineligibility for fraud perpetrators.
    • Make legal immigrants who arrived after August 22, 1996 (when federal reforms were enacted) ineligible for five years.
    • Repeal the statutory mandate for county general assistance (cash payments to childless, able-bodied adults).
    • Provide help in finding employment, including job training and other services to be provided by the state, counties, and community colleges.

    Local Government

    The budget includes a proposal to realign funding for trial courts, which are currently funded jointly by counties and the state. Last year's budget also included a trial court funding proposal, but disagreement over collective bargaining for court employees caused a stalemate between Governor Wilson and the Legislature.

    The budget proposes the following outline for trial court funding:

    • Consolidate funding at the state level, except for facilities, local judicial benefits, and revenue collection costs.
    • Maintain the county contribution at 1994-95 levels.
    • Give the state responsibility for all future cost increases.
    • Buyout county general fund contributions for the smallest counties.
    • Increase various civil fees.
    Dueling implementation proposals have been introduced in the Legislature, with the differences centering on the collective bargaining issue.

    "No longer will federal and state spending automatically increase to cover added caseloads."
    General Fund Operating Balances
    (Dollars in Billions)
    Figure 3

    Overall Budget Funding

    Figure 3 shows that the deficits of the early 1990s are history. The past three years have ended in operating surpluses, which have largely been used to pay off the carryover deficit that accumulated in the earlier part of the decade.

    The current year is projected to end with a very small operating deficit of about $40 million. However, since the year began with a positive fund balance of about $200 million carried over from 1995-96, an operating deficit of this size does not harm the state's financial position. Operating balances (deficits or surpluses) are simply the difference between current-year revenues and spending. In a year when some of the reserve is spent, an operating deficit results. As long as the operating deficit does not exceed the reserve, no carryover deficit is created.

    The budget proposal estimates an operating surplus for 1997-98 of about $360 million, which, when added to the current-year reserve balance, would create a reserve of about $550 million by the end of 1997-98.



    "The deficits of the early 1990s are history."
    Research Page | Home