Governor Gavin Newsom this week unveiled his budget for the 2023-24 fiscal year, proposing total spending of $297 billion from all funds, down from $307.9 billion in the budget enacted last summer.
The plan would repeal last year’s pledge to pay down debt in the Unemployment Insurance Fund. The governor proposes undoing both of last year’s budget agreements by withdrawing a $750 million general fund debt repayment to the fund in 2023-24 and canceling a $500 million one-time program that was described as a way to help small businesses cover higher employment taxes.
CalTax and others noted last year that the 2022-23 budget language did not actually require the state to allocate the $750 million for 2023-24, so there was no guarantee the payment would ever be made.
The state owes the federal government more than $18 billion to repay loans used to pay benefits after California’s fund went insolvent early in the pandemic.
Newsom said his budget does not propose any general tax increases. However, in addition to allowing the employment tax increase, the budget includes a hidden tax on motorists and a variety of targeted taxes, described below.
Revenue projections are down approximately $29.5 billion from the current year, the governor said, largely because of a roughly 50 percent reduction in personal income tax revenue from capital gains. Total PIT revenue is projected to be roughly $25 billion lower than projected in the current budget, Newsom said.
“What is constant is the inconsistency of our revenue on the basis of a progressive tax structure,” Newsom said during his January 10 press conference to release his spending plan.
State reserves will be $35.6 billion, Newsom said.
“We’re not touching the reserves, because we have a wait-and-see approach to this budget,” Newsom said, adding that the budget was crafted with “a fluid mindset.”
The governor’s position on using reserves could change when the May revision is released and more is known about the state’s financial situation. Democrats in the Legislature recently indicated a desire to tap reserves to avoid reducing the growth of various programs.
The governor’s proposal is in line with a recommendation from the Legislative Analyst’s Office to begin the budget process without using reserves, and reassess the situation after April’s personal income tax collections.
This morning, the LAO released a report stating that Newsom’s “emphasis on spending solutions to address [the] budget problem is prudent,” but the specific provisions in the budget are not necessarily the best for addressing the problem.
“Our estimates suggest that there is a good chance that revenues will be lower than the administration’s projections for the budget window, particularly in 2022-23 and 2023-24,” the analyst wrote. “Given this risk, we recommend the Legislature: (1) plan for a larger budget problem and (2) address that larger problem by reducing more one-time and temporary spending. Taking these steps would allow the state to mitigate the heightened risk of revenue shortfalls. The Legislature need not adopt the Governor’s spending solutions, however. Recent budgets have allocated or planned tens of billions of dollars for one-time or temporary spending purposes in 2021-22, 2022-23, and 2023-24. The Legislature can select an entirely different set of spending solutions to address the budget problem. To develop its budget, we recommend the Legislature evaluate recently approved augmentations and only maintain those augmentations that meet certain criteria.”
Key provisions of the governor’s budget proposal include:
- Tax on Non-Grantor Trusts: Newsom proposed an estimated $30 million tax increase on non-grantor trusts (the budget would require net income derived from incomplete non-grantor trusts to be subject to California income tax where a grantor of the trust is a California resident, an issue presented in a precedential Court of Appeal ruling in The 2009 Metropoulos Family Trust v. Franchise Tax Board, involving a dispute over the taxation of nonresident trust shareholders resulting from a transaction that involved the sale of an S corporation’s wholly owned subsidiary).
- Managed Care Organization Tax: The budget proposes the renewal of the Managed Care Organization (MCO) Tax effective January 1, 2024, through December 31, 2026, to generate revenue to expand the Medi-Cal program. The MCO Tax “is estimated to offset $6.5 billion in General Fund spending over the three years,” and the administration “will explore opportunities over the next few months to increase the MCO Tax to provide support for the Medi-Cal program,” the administration’s budget summary stated.
- Budget “Solutions”: Newsom said his budget “solutions” – actions needed to keep the budget balanced if prediction of lagging revenue turns out to be accurate – are $7.4 billion in funding delays, $5.7 billion in spending reductions, $4.3 billion in fund shifts (cashing out bonds, including urging the California State University to use bonds for current spending, with the state assuming the obligation of repaying the bond debt later), $3.9 billion in “trigger reductions” relating to climate and transportation, $1.2 billion in internal borrowing and potential revenue from the federal government, and an unquantified amount of “good government/efficiencies.”
- Film and Television Tax Credit: The governor proposes to extend the Film and Television Tax Credit Program at $330 million per year for five years beginning in 2025-26 and make it refundable prospectively for the new “Program 4.0.” The budget summary states: “Making the credit refundable will benefit a wider range of productions and ensure the competitive program will maximize economic benefits to the state. Credit recipients with insufficient tax liability will be able to claim a tax refund at a discounted value over multiple years to lessen the revenue loss to the state. Credits applied against tax liability will retain their full value.”
- PIT Exemption for Student Loan Forgiveness: The budget proposes to exempt student loan debt forgiven under the 2022 federal student loan debt relief plan from state income taxation, “assuming litigation around the plan is resolved.”
- Education Spending: The budget includes $109 billion in total education spending, which equates to $23,723 per pupil (a new record, up from $22,893 in the current year).
- Gas Tax: The budget proposes no change to the gasoline excise tax. Under previously approved legislation, the tax rate is scheduled to be increased for inflation by the California Department of Tax and Fee Administration effective July 1. The current tax rate is 53.9 cents per gallon. With this tax included, Californians pay 72.4 cents per gallon to cover state and local taxes and fees – the highest gas tax in the nation. The nonpartisan Legislative Analyst’s Office notes that in addition to the state excise tax, California’s cap-and-trade auction increases the price of gasoline by an additional 23 cents per gallon. The federal excise tax on gasoline adds another 18.4 cents per gallon to the cost at the pump.
- “Penalty” on Oil Company Earnings: Newsom’s budget summary describes a “a price gouging penalty on excess oil refiner profits as well as transparency and oversight measures to help prevent future price gouging in California,” but does not provide details about this hidden tax on California motorists. The proposal “will be developed outside of the budget process,” according to the summary. (An undetailed version of the governor’s proposal has been introduced by Senator Nancy Skinner as SB 2X.)
- Homelessness: Newsom proposes $15.3 billion in homelessness funding. The governor said Californians are “fed up” with the “out-of-control” homelessness situation in the state, and said the budget requires more accountability for results. The population of homeless Californians has increased despite large spending increases in recent years.
Asked about the possibility of addressing revenue volatility by extending the sales tax to services, Newsom indicated he has no plans to pursue such a tax increase, citing the lack of public support. The governor, who has voiced support for taxing services in the past, said California has used a “rainy day” fund and other strategies to mitigate the volatility of the tax structure.
The release of the governor’s proposal – constitutionally required by January 10 – marks the official beginning of the state budget process. In recent years, the Legislature’s Democratic supermajority and Newsom have passed numerous “early action” items even before the May revision, and have continued amending the budget long after passage of the main budget bill. Lawmakers have a June 15 deadline to approve a budget bill or forfeit their pay, giving the governor time to sign the budget – and make any line-item vetoes – before the July 1 start of the new fiscal year.