In depth analysis of Prop 1A from Bill Leonard, Member, State Board of Equalization

The following is an in depth analysis of Prop 1A from  State Board of Equalization Dist. 2 Member Bill Leonard. Smart voters should kick the tires before simply accepting opinions from people we might not know. Although I have met Bill at several events it is important to share his credentials with each of you as you decide how to vote on May 19th.
 “Bill Leonard served in the State Legislature for 24 years. He was first elected to the State Assembly in 1978 running as a Prop. 13 tax cut advocate. In 1988 he was elected to the Senate where he served in leadership and authored a tough anti-drunk driving bill. He returned to the State Assembly in 1996 and served as Republican Leader. During all that time, he became well known as a fighter for low taxes, quality schools and a better business climate..”

He “was elected to serve on the Board of Equalization in 2002 and was re-elected in 2006 with more than one million votes. He has fought for justice for taxpayers, and has advocated for taxpayer rights and public accountability. In addition, Bill has spearheaded a pro bono assistance program to provide advice to individual taxpayers appearing before the Board. ” 

Inside the Leonard Letter
By: Bill Leonard
*** Looking for Prop. 1A’s Loopholes: Part 1***

“While the linkage of Proposition 1A to extended tax increases is the killer for me, there are still many interesting policy questions about Prop. 1A itself. The answers to these questions, and my confidence about the loophole-finding aptitude of legislators and governors, give me even greater doubts about the efficacy of 1A.

The biggest issue is the integrity of the Budget Stabilization Fund, or “rainy day fund.” The good news is that the measure creates such a constitutionally mandated reserve fund. The bad news is that any of the decision points about the implementation of the fund constitute a loophole that would open the reserve. Also, remember that the reserve percentages sound modest at 3% per year until the cap of 12.5% is reached, but each 1% is roughly equal to $1 billion of taxpayer dollars that might or might not be taken off the table for spending. So we are talking about large dollar amounts worth fighting for.

The first point of possible contention is that the Controller (not the Governor) will transfer a percentage of the state’s revenues into the reserve. The Controller must do this by September 30th of the current year, which means that the amount transferred will be based on an estimate of total revenues with only one quarter of the year completed. That estimate is likely to be wrong, but close enough for government work. It does not appear that there is any provision for true-up at the end of the year to correct the estimation.

So, the revenues transferred could be higher or lower than required depending upon the errors in estimating. The legislature and governor could choose to transfer more, but they are not required to do so. Transfers to the reserve are first used to pay off the Deficit Recovery Bonds. Transfers to the reserve are re-transferred to the Prop. 98 (K-14 education funding guarantee) account if Prop. 1B passes, otherwise the same amount is re-transferred to the Supplemental Budget Stabilization Account (see below). Even if the reserve is at its maximum of 12.5%, which will a really long time coming, there will still be annual transfers through the reserve from the General Fund to the Supplemental Account of 1.5% of the annual revenues forever.

The next point of contention will come when someone considers tapping the reserve. There are two ways to do that. First, when the total state revenues are less in the current year than compared to the prior year the governor can transfer whatever it takes to make up the difference. There is a fudge factor here because the comparison is not between equal years since the current year number is an estimate (made by Department of Finance presumably) of the upcoming revenues augmented by the percent increase in population and the percent increase in inflation. That means that even in two years where the revenues were the same, the government would still be able to tap the reserve and grow by the amount of these indices of population and inflation. The inflation index is particularly troublesome because it was designed to measure cost of living (groceries, rent, etc.) of a poor family in California, not the cost of government of the biggest state in the union.

The practical effect of tapping into the reserve is that state spending will not be reduced in first year of a flat revenue situation. In fact, if the reserve is big enough to cover the shortfall, then there is almost no incentive to reduce any state spending. The risk, of course, is that once the reserve is exhausted in Year One then it is not available for problems in following years, nor is it available for real emergencies.

The other way to tap the reserve is in a real emergency when the governor can transfer the money into the General Fund. The language is vague so there will be a fight over whether it can be interpreted as limited (to pay emergency response crews) or as broad (to repair and replace all of the public property destroyed in the emergency). “Emergency” is defined as it was in the Gann Limit as “such conditions as attack or probable or imminent attack by an enemy of the United States, fire, flood, drought, storm, civil disorder, earthquake, or volcanic eruption.” 

Looking for Prop 1A loopholes Part 2 
Prop. 1A also creates a second pot of money known as the Supplemental Budget Stabilization Account. (The first pot is called the Budget Stabilization Fund. If their goal was to confuse me, they succeeded.) If the estimators calculate that revenues have jumped above the expected trend line of taxes over the last decade, that excess amount of revenue cannot be spent in the General Fund but will be deposited into this account. That money can then be spent on any of eight approved uses, or transferred to the main reserve, or given back to taxpayers in some kind of rebate. So the General Fund spending limit is a calculation of what revenues the state took in for the last decade projected forward to the current year. This calculation is to be done by May 29th of each year with the idea being that at the end of the fiscal year the state would have a good idea of the actual revenues received that year. The concept is that one-time splurges in revenues should not be spent or built into the base of the budget. The flaw in the concept is that all seven of these approved uses are expenditures that are regularly done with General Fund appropriations. So if the one-time revenues were used to pay off bonds, then the amount of General Fund money that had been budgeted for the debt service on those bonds could then be spent on anything.

The eight ways to increase state spending using one-time money are not all that complex. Prop.1A has language validating the payment of maintenance factor funds to schools under Prop. 98. Then the first use of one-time money required under Prop. 1A is to pay the schools the current maintenance factor obligations. It is not clear to me that if this factor is an obligation why it is not being paid out of the General Fund, but it is number one priority for this money. The second required use of the money is to restore the main reserve to 12.5% of revenues. This is not spending, so it should not be counted as one of the eight uses. This transfer back to the reserve could be as low as zero and as high as billions of dollars. If Prop. 1A were ever in effect long enough it would probably be both.

After these two huge requirements are met, any revenue left in the Supplemental Account must be used on “budgetary obligations.” You guessed it: that means this money can be spent on things the budget was supposed to pay for, thus freeing up money in the General Fund to be spent elsewhere. There are four items in this section of priorities: paying for prior Prop. 98 school obligations that should have been paid but have not; paying for any past suspension of property tax payments to local governments; paying for any past suspension of the transfer of the sales tax revenue on fuel sales to the Transportation funds; and paying all of the outstanding Economic Recovery Bonds of 2004. If the General Fund is making any payments on these items, then having them paid off will free up space in the budget for new spending.

This list is so huge that it effectively ties the hands of all future legislatures and governors on how one-time revenues can be spent, but then, pretty much as a joke, the permissible spending list for the Supplemental Account continues. Those who have access to the historic data have been reluctant to conjecture on how often, if ever, the state would have one-time excess revenues enough to fund the first choices let alone the last. It would be helpful to proponents, opponents, and undecideds on Prop. 1A to see some charts on what future budgets would look like. On the slim chance that there may be extra money after the entire state budget is funded and all obligations been paid, then the list continues with the last five. This list is not in priority order so the legislature and governor could mix and match any way they chose. They could add money to the reserve; they could build things also known as one-time capital outlays; they could pay off any state bonds; they could give the taxpayers a rebate; or they could pay pension liabilities for state employees. Again, most of these choices are really expenditures due from the General Fund so by paying them with reserve money, General Fund obligations are freed up to be spent elsewhere.

My conclusion? All in all, the reserve requirements of Prop. 1A are better than those of the Gann Limit (mostly because Gann did not even have a reserve requirement), and they are better than Prop. 58 because its reserve rules never worked. However, will the 1A requirements constrain state spending or end volatile budget chaos? No. It may help, but it is not as good as advertised. And I have great expectations that future legislators and governors will think of even more loopholes I did not see.”

About Larry Gilbert