Democrats in the state Senate released a budget proposal this week that agrees with Governor Gavin Newsom’s proposed limit on tax credit utilization and suspension of net operating loss deductions, but rejects some of the governor’s proposed spending reductions and focuses on using reserves and deferrals to balance the 2020-21 budget.

A significant tax change previously suggested by Senate leaders – discounted income taxes for those who prepay a year or more in advance – is not part of the current proposal.

Senator Holly Mitchell, who chairs the Senate Budget and Fiscal Review Committee, said that after a budget is approved, she expects the Legislature to continue working on “new and creative ways to increase revenue to support our state’s recovery.”

Newsom’s Tax Proposals

Newsom released details during the Memorial Day holiday weekend outlining his proposal to raise $9.2 billion in taxes on corporate taxpayers by suspending the net operating loss deduction for three years and limiting utilization of business tax credits and incentives from offsetting more than $5 million of tax liability for tax years 2020, 2021, and 2022.

Budget trailer bill language released May 24 details how the Department of Finance proposes to limit the utilization of business tax credits and incentives. The proposal would put the $5 million-per-taxpayer annual limit on these tax credits:

  • Research and development tax credit (RTC section 23609);
  • Jobs tax credit (RTC section 23621);
  • California competes credit (RTC section 23689);
  • Motion picture production credit (RTC section 23685);
  • New motion picture production credit (RTC section 23695)
  • Expenditures for the production of a qualified motion picture (RTC section 23698).
  • Qualified enhanced oil recovery project credit (RTC section 23604);
  • Credit for costs of transporting donated agricultural products (RTC section 23608);
  • State low-income housing tax credit (RTC section 23610.5);
  • Prison inmate labor credit (RTC section 23624);
  • New employment credit (RTC section 23626);
  • Natural heritage preservation credit (RTC section 23630);
  • Joint strike fighter wage credit (RTC section 23636);
  • Credit for disabled access expenditures (RTC section 23642);
  • College access tax credit (RTC section 23687);
  • Donated fresh fruits and vegetables credit (RTC section 23688.5);
  • Qualified rehabilitation expenditures with respect to a certified historic structure (RTC section 23691);

The Department of Finance previously released draft language for suspending the net operating loss deduction. The proposal states that a net operating loss shall not be allowed for the tax years 2020, 2021 or 2022 for a taxpayer with net business income of less than $1 million for the taxable year.

CalTax leads a large coalition in opposition to the governor’s proposals. The tax increases would hinder economic recovery, thus delaying the state’s rebound and a return to the activities that provided the state with a record surplus and record reserves that are cushioning the pandemic’s impact on state government.

Department of Finance Director Keely Bosler testified this week during legislative hearings that the tax changes “can also be seen by some as borrowing” because companies could keep tax incentives on the books and use them later. Opponents noted that this would not help businesses that go bankrupt in the meantime.

Bipartisan Concerns With Governor’s Plan

The Assembly, meanwhile, met for more than five hours May 26 as a “committee of the whole” to hear testimony from the Newsom administration’s finance director and the nonpartisan legislative analyst, and to air concerns about Newsom’s proposal.

Legislative Analyst Gabe Petek and Bosler presented Assembly members with contrasting estimates of the state deficit – the difference between projected spending and projected revenue if no changes are made to the current budget. Petek said the deficit will be $18 billion or $31 billion, depending on how fast the economy recovers from the COVID-19 recession. Bosler said the deficit will be $54.3 billion.

Democratic Assembly Member Autumn Burke, who chairs the Assembly Revenue and Taxation Committee, questioned the governor’s proposals to suspend the NOL deduction and limit tax credit utilization.

“While I’m thankful the administration has not called for an increase in tax rate, we are still being asked to limit the degree companies can use previously earned tax credits,” Burke said. “These are companies engaging in socially useful behaviors like union work on environmental projects, building homes for the poor and researching new technologies. If we are not in a position to honor those investments in the short term, we should at the very least be thinking about how we can lift other burdens on the very businesses we will need to carry us into a more hopeful future.”

Republican Assembly Member Jay Obernolte also criticized the governor’s tax proposals. He said that under the NOL proposal, “We’re going to penalize the companies that are already doing poorly.” The limitation on tax credit utilization would be “reneging on promises we made when we passed those tax credits …  promises the businesses have been relying on when they put together their business plan for the last couple of years,” Obernolte added.

June 15 Budget Deadline

The Legislature has a constitutional deadline of June 15 to send a budget bill to the governor. The budget must be balanced on paper, based on projections of revenue and spending. If lawmakers miss the deadline, they permanently forfeit their pay from June 15 until they approve a budget.

Senate Committee Votes on Placeholder Bills

The Senate plan was aired May 28 during a Senate Budget and Fiscal Review Committee hearing. Senator Mitchell said the plan uses the governor’s framework, but makes some significant changes.

The Senate plan also proposes moving state employees’ final payday and a state pension payment by one day, shifting more than $1 billion in spending from the 2020-21 fiscal year to 2021-22.

The Senate also rejects Newsom’s proposed reductions to education and health care programs, and instead uses more money from state reserves and defers payments into the next fiscal year. The plan calls for approximately $8 billion more education spending than Newsom’s budget, mostly in deferred payments to school districts.

Senator Jim Nielsen, cochair of the Senate committee, said this year’s condensed budget process has reduced legislative scrutiny of the budget. Nielsen urged his colleagues to pay attention to how this year’s actions will impact future Californians. He said the Senate Democrats’ plan would “roll back decades of change and reform that have been very successful” at reducing the state’s structural deficit and building reserves.

The Senate committee voted to send skeletal budget language to the Senate floor, with the intent of having the full Senate send the budget to a conference committee for joint negotiations with the Assembly. The NOL and tax credit provisions were approved by the committee on a party-line vote, with Democrats in support and Republicans opposed. The final budget bill must be made available to all lawmakers and the public at least 72 hours prior to floor votes.

Assembly Members Discuss Budget Priorities

The Assembly did not take any votes during its committee of the whole meeting, which was led by Assembly Budget Committee Chair Phil Ting. Each member of the house was given a maximum of four minutes to speak about the budget and/or ask questions of Petek and Bosler.

Most Assembly members used their four minutes to urge more spending on issues they have championed in the past, or to oppose spending on programs they have long opposed

After the hearing, Assemly Members Kevin Kiley and Vince Fong announced legislation (AB 3199) to suspend funding for the High-Speed Rail Project for two years, saying this would free up more than $3 billion to stave off cuts to education while also giving the public time to decide whether the project should continue.