MOORLACH UPDATE — Budget and Tax Reform — June 13, 2016

This week we begin the process of reviewing the proposed state budget that was approved by the Senate and Assembly Budget Conference Committee. The Bond Buyer, a national weekday publication for the municipal bond market, provided a piece recently on the subject of the budget and it is provided in the first piece below. Also see MOORLACH UPDATE — Budget Hearings — May 14, 2016 may 14, 2016 john moorlach. At the time of the Orange County bankruptcy, it seemed that I was in about every other issue of this highly regarded publication. I was also a subscriber for more than ten years as the Orange County Treasurer.

The Bond Buyer also covers the topic of tax reform, which is provided in the second piece below. State Controller Betty Yee released a report on this topic last Thursday (see http://www.sco.ca.gov/eo_cea_contextual_framework.html).

One minor clarification. Earlier this year, the Governor invited me, two other Republican Senators, and several Democratic Senators to the historic Governor’s Mansion for dinner. During the evening, the Governor turned to Senator Bob Hertzberg and said that he should include me in the Senator’s tax reform efforts. Subsequently, I took Sen. Hertzberg to lunch and we have had several engaging discussions on this topic.

When it comes to the topic of tax reform, something should be done. What shape it takes is the big question. So, I would prefer to be at the table than on the menu. And, if the direction is not satisfactory, I’m not afraid to assemble my own panel of economic and business community leaders to review and propose a competing proposal. In the meantime, I prefer having an open dialog with Sen. Hertzberg.

Brown Faces Pushback On California Budget

By Kyle Glazier

PHOENIX- Lawmakers on both sides of the aisle are digging in for a struggle over California Gov. Jerry Brown’s revised budget proposal, as both parties try to adjust priorities with California’s fiscal outlook apparently dimming.

Brown released a revised fiscal 2017 state budget proposal May 13 that adds 5% from last year’s spending, but is nonetheless lean on new initiatives at $169.3 billion.

The Democratic governor painted his approach as prudent in light of a revenue forecast that has been reduced by $1.9 billion due to poor April income tax receipts and more sluggish sales tax receipts than expected. The state had entered April with cash receipts slightly ahead of revenue projections made when the governor made his initial budget proposal in January.

In presenting his revised budget, Brown cited a Moody’s Investors Service report that named California as being among the states least prepared for another recession.

Democrats in the legislature don’t necessarily agree with what they see as Brown’s unnecessary austerity.

Sen. Holly Mitchell, D-Los Angeles, said that Brown’s proposal has its priorities wrong.

"I fully recognize our real-world responsibility is to manage moderate public funds prudently," Mitchell said in a statement. "Since the state’s cash flow has slowed, let’s focus on what the most urgent needs are and how to best spend our money to help those most in need."

She singled out Brown’s January proposal to put what she said would be more than $3 billion into ‘rainy day’ beyond what is required, and another $1.5 billion in infrastructure renovations.

"Infrastructure and savings are meant to meet people’s needs, not the other way around," she said.

Brown’s budget revision, reflecting lower revenue projections, would set aside $1.3 billion less for the state’s rainy day fund than his January proposal.

"As we face the prospect of state revenues that do not match expectations or live up to our hopes, it is important to bear in mind how much better California is doing than five years ago – and yet how many Californians are still waiting to feel the benefits of the improved economy," Mitchell said.

Mitchell applauded Brown’s plan to issue bonds to finance mental health programs that aim to address California’s growing homelessness problem among its mentally ill population. The program would spend about $267 million in bond proceeds in 2016-17.

"I appreciate the governor’s call for fiscal prudence in his May Revision of the 2016-2017 budget," Sen. John Moorlach, R-Costa Mesa, said in a statement. "However, this fiscal restraint does little to address our state’s unaddressed run-up of debt. If managing the budget is ‘like riding a tiger,’ looking out ahead ten years from now is like standing on the deck of the sinking Titanic."

Moorlach says the true state of California’s finances is reflected in the unrestricted net position reported in its certified annual financial report, which went from a $116 billion deficit to $170 billion from the fiscal 2014 CAFR report to the FY 2015 CAFR.

"And that’s before fully adding in the estimated $80.3 billion in retiree medical unfunded liabilities," he said. "When will California acknowledge it needs reform? The time has come for state leaders to establish a 10-year financial workout plan to get our fiscal house in order — one that establishes a common set of goals and a framework by which all legislative and executive actions can be measured. Only then can we truly leverage our state’s resources to solve both our short and long term fiscal problems."

Assembly Democrats struck a more noncommittal tone.

"The governor’s budget revision makes clear that the rainy day fund first proposed by Assembly Democrats is doing its job and absorbing the ups and downs of revenue forecasts," said Assembly Speaker Anthony Rendon, D-Paramount. "That means we are able to make necessary improvements to the budget without impacting existing services or using one-time money for ongoing programs. In the coming weeks, the Assembly will work to craft a responsible budget that protects reserves and reflects the values of the people of California: fighting poverty, improving early education, expanding access to higher education, and making progress to increase affordable housing."

Brown is getting support from a man who wants succeed him as governor: State Treasurer John Chiang, who announced this week he will seek the governor’s office in 2018.

"The governor strikes a prudent balance between investing in California’s future while girding the state for the next recession by calling for spending restraint," Chiang said. "If we want to keep IOUs, slash-and-burn program cuts, and shenanigan-laden budgets in our rear view mirror, California must continue to be disciplined in paying off its debts and living within its means."

Although the budget shows a $2 billion operating deficit in fiscal 2017, that includes the effect of funding the supplemental $2 billion deposit into the state’s budget reserve, which leads S&P Global Ratings to view the plan as balanced, the agency said in a report authored by analysts Gabriel Petek and David Hitchcock .

The state Department of Finance also expects state finances will be liquid enough to cover intra-year cash deficits in the general fund without borrowing externally, S&P noted.

"Perhaps a more cautionary indicator than any modest softening of California’s fiscal position in fiscal 2016 and 2017 is the emergence of a structural deficit in the coming years," S&P said. "According to the DOF’s five-year forecast, baseline general fund revenue will begin falling short of existing spending commitments after fiscal 2018 despite the forecast assuming the economy avoids a recession."

S&P takes note that the state budget’s operating position is projected to deteriorate even without the proposal containing any new material ongoing spending commitments, or doing anything to begin prefunding retiree health care benefits obligations for state employees.

"Future expenditure growth outpaces revenues under baseline projections," the S&P report said.

If voters in November approve an extension of the temporary income tax increase for higher earners they adopted in 2012, the state will face smaller deficits in coming years, and S&P said the budget will likely hinge on policy debates.

"Similar to recent years, we anticipate the final stage of California’s budget negotiations will center on the policy tradeoffs implicit in the governor’s recommended fiscal priorities," the rating agency said.

State lawmakers are supposed to adopt a final spending plan by June 15.

California Leaders Talk Tax Reform

ByKeeley Webster

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California Sen. Robert Hertzberg, D-Van Nuys said he and Controller Betty Yee agree that "it’s time to make the tough decision on tax reform – and stop kicking the can down the road."

LOS ANGELES — California should overhaul its tax system, State Controller Betty Yee says in a new report.

The report, issued Thursday, is the result of several months of meetings by Yee’s Council of Economic Advisors on Tax Reform.

"California needs a tax system that reflects the 21st century economy, is less vulnerable during economic downturns, and is more sustainable, providing greater certainty from year to year," Yee said when she launched the panel in April.

State lawmakers are contemplating tax reform measures that include ideas about changing sales taxes, income taxes and property taxes.

Critics say a state tax system that is heavily weighted toward income taxes on high earners leaves California vulnerable to revenue crashes when the economy or the stock market slows down.

The sales tax on physical goods ignores the rise of the services-based economy, some critics say.

Yee said she asked the committee not to recommend specific tax changes, but to instead identify principles, concepts, and questions to spark broad public discussions to be led by policymakers and constituents.

"If comprehensive tax reform were easy, we would have achieved it long ago," Yee said. The report "pulls together all the pieces of the puzzle to lay a foundation for real change."

"It’s time to make the tough decisions on tax reform – and stop kicking the can down the road," said state Sen. Robert Hertzberg, D-Van Nuys.

"I compliment Yee and her Council of Economic Advisors on Tax Reform for taking a comprehensive, sober look at California’s tax structure, it’s volatility and its inequities," Hertzberg said. "This report leaves no doubt that the present tax system is woefully out of date, inherently unfair and in desperate need of reform."

California Sen. John Moorlach, R-Costa Mesa said he just attended a dinner at the governor’s mansion a few days ago to meet with Hertzberg and other senators about what form tax reform should take.

While Moorlach, a CPA, said the report was good, he hopes senators will read the appendixes. He pointed to a chart on Page 25 of the report that ranks California 44th out 50 states on its tax structure.

"Since I have been elected, we have moved up to 44th place, but I can’t take credit for that, because Hawaii and Kentucky have dropped down as they have had to reveal what their unfunded pension liabilities are," Moorlachsaid.

The states ranked near the bottom tend to be largely Democratic, are union run, provide high wages to state workers and attractive pensions – and they also have the highest tax rates, Moorlach said.

Moorlach said he wants to see more research around the services tax that Hertzberg is floating, which he says would solve some of the volatility problems, but could have unintended consequences. He does not support tax reforms, like a split roll for property taxes between residential and commercial properties, that could shift the tax burden to small business owners.

"We keep yakking about the symptoms, but we haven’t gotten to the core reasons that we are in such poor shape," he said.

There isn’t currently a working group looking at tax reform that includes both Democrats and Republicans, butMoorlach said he might create one.

"I get nervous about Sen. Hertzberg’s bill with his services tax," Moorlach said. "I haven’t seen any hard proposals from Bob, but I am open. I want to work and understand, because I think we do need reform."

Hertzberg introduced Senate Bill 1445 on Feb. 19, which "updates California’s antiquated tax system to reflect modern economic activities, including information and services. The bill helps reduce the volatility of state tax revenues and create a more stable tax base by broadening the sales tax to include non-essential services."

It would impose a tax on retailers measured by the gross receipts from the sale of tangible personal property sold at retail, or on the storage, use, or other consumption in this state of tangible personal property purchased from a retailer for storage, use, or other consumption in this state.

The bill is aimed at "broadening the tax base by imposing a modest sales tax on services."

It would also establish a fund to provide tax relief to middle- and low-income Californians to offset the effect of a sales tax on.

"The present system is not fair to Californians, and to continue with this unstable system that produces wildly fluctuating, zig-zag revenues will hurt Californians and the services they depend on and will undercut the state’s future," Hertzberg said.

California Gov. Jerry Brown said in his May revise budget speech that "reducing revenue volatility would be good."

As for tax reform, Brown said, "I’m willing, and maybe over the next year or two we can get Republicans to join us and we can do something."

Changing the tax structure "is not that simple," Brown said.

"There’s a reason why we tax the one percent. It’s because that’s a tax that people have shown they are willing to vote for. And that’s the way it is," Brown said.

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