Tax Analysts Blog

The Joys (and Burdens) of Too Much Revenue

Posted on Jun 26, 2013

The forecast for most state budgets has been steadily improving for the past several years. In fact, the Nelson A. Rockefeller Institute of Government reported that state tax receipts for the fourth quarter of 2012 were up 5.7 percent from the fourth quarter of 2011. It is welcome news.

The news has been surprisingly good for some states, including California. Just three short years ago, California was facing a nearly $60 billion deficit. But now, California is facing an unexpected dilemma: it has more money than it expected. According to the most recent report by the California Legislative Analyst’s Office (LAO), the state’s tax revenue in May was nearly $1 billion above projections. So how did this happen? How did California collect so much more than predicted? Where did it come from, and perhaps more importantly, are California’s budget woes a thing of the past?

While it would be nice to think the increase in revenue is coming from economic growth, that, in and of itself, is probably not the reason. According to Elizabeth McNichol of the Center on Budget and Policy Priorities (CBPP), most of budget surpluses being seen by states are the result of taxes. In a recent study on state revenue increases, McNichol noted that the increased revenue in many states is the result of taxpayers front-loading income in 2012 rather than realizing it in 2013 in an effort to avoid federal tax consequences.

That is likely true, but in California, while federal tax policy may have driven taxpayer behavior, the individual income tax increase approved by voters in November 2012 certainly didn’t hurt state coffers. Last year, California voters approved an individual income tax increase from 9.3 percent to 10.3 percent for individuals making $250,000 and an increase from 10.3 percent to 13.3 percent for those making at least $1 million each year. According to the LAO, California’s May numbers were bolstered by a nearly $550 million jump in personal income taxes.

The LAO seems to concur, at least partially, with the CBPP study. The LAO has suggested a few possible reasons for the increased revenue. First, it may be the result of fiscal cliff deals. That is, as McNichol suggests, the state will see more tax dollars now and less tax dollars in future years. This seems the most likely scenario. Still, the LAO suggested it is possible the state is simply seeing more revenue and the trend will continue in future years.

Regardless of the reason for the additional revenue, the fact is that California actually has a surplus and must determine what to do with the money. If, as it is likely, the increase in revenue is a one-time event, the state should use it for one time goals, such as paying off debts or making repayments into state funds. California should be careful not to depend on the increase in revenue. Although it is possible that the increase will continue in future years, it is highly unlikely.

In addition, approximately 40 percent of the new revenue will be used to satisfy the requirements of Proposition 98, a school funding measure that was approved by voters in 1988. But as if one complicated budget measure isn’t enough, the state has two more to deal with. Proposition 111, passed in 1990, could require even more of the additional revenue to go toward public education.

Proposition 111 was enacted as a safety net during economically lean times. The proposition allows the state to temporarily reduce the amount it is required to pay to schools under Proposition 98. But, and this is a big but, the state isn’t relieved of the responsibility make the full payments as required by Proposition 98. So, under Proposition 111, the state has to play catch up when the economy improves.

Currently, the state owes schools roughly $8 billion and the economy has improved to a point where revenues are growing faster than personal income. That means schools are owed $1.8 billion under Proposition 98 and $2.3 billion under Proposition 111, for a total of $4.5 billion.

This is not to say that California public schools don’t need (or deserve) the money. They do. This is merely to point out that the budget picture in California is still far from fixed.

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