Brown Tax Boost Gains Urgency as Gap Rises to $16 Billion

California Governor Jerry Brown
California Governor Jerry Brown set out a budget in January with $92.6 billion in spending for the year starting July 1. Photographer: Ken James/Bloomberg

California Governor Jerry Brown bet that a nascent financial recovery would lift the world’s ninth-largest economy enough to whittle down a $9.2 billion deficit. Instead, the gap has widened to $16 billion.

Today the 74-year-old Democrat will unveil his revised budget and explain what additional spending must be cut. Tax collections have run $3.5 billion below what he calculated four months ago. Spending has grown $2 billion above projections. The federal government and court ruling blocked some savings he expected, while his fellow Democrats in the Legislature balked at others.

California, with an economy bigger than Russia’s, lost more than a million jobs in the recession that struck in 2007, costing the most populous U.S. state 24 percent of its revenue. The new deficit estimate increases the urgency of the governor’s plans to increase income taxes on some earners to the highest in the nation, and boost sales levies that are now more than any other state.

“We are still recovering from the worst recession since the 1930s,” Brown said May 12 in a YouTube video. “Tax receipts are coming in lower than expected and the federal government and the courts have blocked us from making billions of necessary budget reductions.”

Four Years

For the last four years, California lawmakers have cut spending and temporarily raised taxes to combat deficits that exceeded $100 billion combined. Deeper cuts now threaten to shred safety nets for the poor, elderly and disabled, reduce subsidies to the state’s renowned public universities and strain funding for public safety and schools.

Brown set out a budget in January with $92.6 billion in spending for the year starting July 1. To get to that figure, he proposed taking more than $4 billion from health and welfare programs, while raising sales and income taxes. The tax increase will be put to a vote in November; if rejected, schools will lose $4.8 billion midway through the year, the equivalent of three academic weeks.

The nonpartisan Legislative Analysts Office said Feb. 27 that Brown’s budget overestimated tax revenue by about $6.5 billion because it relied too heavily on capital gains and other types of income taxes.

Savings Denied

To make matters worse, the Obama administration in February said California couldn’t count on $575 million in savings Brown factored into the current year’s budget by making some poor patients pay medical co-payments.

A federal court has blocked California’s attempt to shave $500 million in spending by lowering reimbursement payments to doctors and pharmacists caring for low-income residents. Another federal judge in January said the state couldn’t cut $100 million from subsidies to low-income elderly and disabled residents, after advocates sued to block the reductions.

It could be worse. Brown’s new budget will count on $1.5 billion of taxes California expects to collect from Facebook Inc.’s initial public offering as the company’s Chief Executive Officer Mark Zuckerberg and other insiders exercise options, according to Brown’s finance spokesman, H.D. Palmer.

The state’s sinking finances may threaten its chances for a higher credit grade. California is Standard & Poor’s lowest-rated state, at A-, six levels below AAA. While the company raised its outlook to positive in February, a larger deficit will “test the Legislature’s commitment to a stronger fiscal position as a public policy priority,” Gabriel Petek, an S&P analyst in San Francisco, said May 1 in a report.

Bond Trades

A California bond due in 10 years traded today at an average yield of 2.45 percent, or about 0.68 percentage point above an index of similar-maturity muni debt with a top rating, according to data compiled by Bloomberg. It was issued in March at a yield of 2.78 percent, or 0.87 point above the benchmark.

It costs the annual equivalent of about $232,000 to protect $10 million of California debt against default for 10 years, compared with about $496,000 for Spain, data compiled by CMA show.

Leaders of the public employee unions have been told to expect an 8 percent to 10 percent cut in worker costs. State workers have already agreed to concessions, including higher contributions toward pension and health-care benefits, according to David Miller, president of the California Association of Professional Scientists.

‘Unreasonable’ Cuts

“We have an agreement with Governor Brown and we expect him to uphold his end,” Miller said in a statement. “Further cuts after years of unpaid furloughs and benefit concessions seem unreasonable and must be subject to the collective bargaining process.”

This isn’t the first time Brown and legislative Democrats have counted on optimistic forecasts. The current year’s budget was passed with the assumption that the economy would push an extra $4 billion into state coffers.

When the revenue failed to materialize as planned, lawmakers had to cut $1 billion for school busing subsidies, public universities, programs for the elderly and disabled, child care, libraries and prisons.

“The imaginary money the majority party counted on in last year’s sham of a budget never materialized, and they have refused to cut big government,” the Assembly Republican minority leader, Connie Conway, said in a statement.

Tax Vote

The initiative for higher taxes is the linchpin of Brown’s balancing plan. His campaign has begun handing in more than 1.3 million signatures to county election offices to qualify the measure.

“We can’t fill a hole of this magnitude with cuts alone without doing severe damage to our schools,” Brown said in the YouTube statement. “That’s why I have bypassed the gridlock and am asking you, the people of California to approve a plan to avoid further cuts to schools and public safety.”

The plan would temporarily raise the statewide sales tax, already the highest in the U.S., to 7.5 percent from 7.25 percent. It would also boost rates on income starting at $250,000. Those making $1 million or more, now taxed at 10.3 percent, would pay 13.3 percent, the most of any state.

The Golden State’s constitution requires legislators to pass a budget by June 15 with a simple majority vote. Tax increases require two-thirds approval. Democrats control the Senate and the Assembly. A voter initiative passed in 2010 strips lawmakers of their pay for every day they’re late. Brown has until July 1 to enact the plan.

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