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Wednesday, Jun 7, 2023

Controller Sends IOU Warning to Sacramento

Each day as I read about California’s continuing budget impasse I wonder why, with the collective brain power and good intentions of most of our legislators, is it so difficult for a workable compromise to be reached? To me, the logical conclusion is that the system is faulty and must be fixed. Our present system is composed of both discretionary and mandatory spending categories and, currently it is estimated that the mandatory categories (primarily K-14 education, prisons and debt service) consume between 75% and 85% of our general fund revenues. Therefore, only approximately 15 – 25% of the general fund monies are available to pay for all of the other general fund expense items (i.e. universities, infrastructure maintenance for business, transportation and housing, health and human services, consumer protection, environmental protection, workforce and labor development etc.). With such a large portion of the general fund being subject to mandates, it’s no wonder that there is such difficulty in arriving at a fair allocation of discretionary funds and a means to pay for all necessary services without significantly raising taxes. With 75 to 85% of every dollar of general fund revenue being already spoken for, to pay for one additional dollar of a discretionary category item, we would need to raise between $4 and $7 of revenue. This would require huge increases in taxes and/or fees. The existing mandates are dangerous to California’s financial condition. An example of this is the current education funding mandate: Under this mandate established by Proposition 98, passed by California voters in 1988, funding for K -14 education will always be at least equal to the amount of the prior year’s funding increased by growth in attendance and per capita General Fund revenues. Thus if revenues decrease from one year to the next, the funding requirement will not decrease. The only exception allows the Legislature, with a two-thirds vote, to suspend the “minimum guarantee” for a fiscal year (which has been done in emergency situations). When a suspension occurs the state has provided less growth in K 14 funding than the growth in the economy. This funding gap is called a “Maintenance Factor,” which must be restored in future years by accelerating Proposition 98 spending, regardless of the financial condition of the State. Perhaps a change to an automatic deficit reduction system of priority spending reductions and temporary tax increases (established in advance), without sacred cows (mandates), would eliminate the need for annual negotiation, reduce the pressures from constituents and special interest groups and create funding fairness. Under my proposed method, the 2007-2008 Budget would be the base for all categories of expenses. All categories would be subject to reductions. Priorities would be determined based on a rating system, with “1” being the highest priority. Reductions would be made to the lowest priority categories first. Ratings could be established by secret ballot (by both houses of the Legislature), thereby lessening the potential impact of outside influences. There would be a maximum percentage of acceptable reductions established for each category. Reductions would be made in rounds (say, 10% of each category’s maximum at each round). If the established maximum reductions have been made to all categories and there is still a deficit, a (temporary) income tax surcharge would be triggered to offset the remaining deficit. Since there would no longer be mandated expenditures, the full amount of the revenues raised from the income tax surcharge would be available to offset the deficit. Here is how the system would work: Let’s assume that K-14 education is determined to be the highest priority category. It would receive a priority number of “1.” This would mean that a reduction in K-14 funding would only be made if all of the categories with lower priority numbers were already reduced (per round). For example, let’s say that a particular expense category (“Category Z”) with a very low priority had an anticipated funding amount based on the actual 2007-08 budget of $500 million and assume that the deficit was $400 million. Let’s further assume that the established maximum decrease established for Category Z was 50% and the first round of reductions was set at 10% (of the maximum decrease). This means the system would automatically decrease Category Z’s budget by $25 million. The same procedure would be applied to the next lowest priority item, and continue up the priority list, until the full $400 million deficit was offset. The system could also provide that if a revenue reduction occurred again in the following year, those categories that were reduced in the prior year would not be further reduced until all other categories were reduced by the same percentage of their maximum as applied to those affected in the prior year. Additionally, the system would provide for spending re-instatements (by category) in the same manner in which the reductions occurred, (after first eliminating any existing income tax surcharge and providing for a reasonable reserve) in the event of a surplus. Maximum established reductions could be reviewed every three years and adjusted, if necessary, due to increases in population or, in the case of education, increases in enrollment. There should also be a provision for earlier reviews in the event of extreme changes or unforeseen emergencies. This proposal is being offered as a new approach to eliminate future impasses. It would take some time to implement since portions of it, if not all, would require voter approval, but I believe it is worth serious consideration. Gregory N. Lippe, CPA, is ManagingPartner of the Woodland Hills-based CPA Firm of Lippe, Hellie, Hoffer & Allison, LLP, Chairman of the Valley Industry and Commerce Association (VICA) and a Director of First Commerce Bank

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