Bloomberg News

California Lawmakers Send Brown $85.9 Billion Spending Plan

June 29, 2011

(Updates bond price in second-to-last paragraph.)

June 29 (Bloomberg) -- California lawmakers passed a budget brokered with Governor Jerry Brown that wagers the state’s recovering economy will bring in an extra $4 billion, after he ceded his plan for higher taxes that was blocked by Republicans.

The $85.9 billion spending package, approved by the Democratic majority late yesterday, erases a $10 billion deficit with higher revenue projections, reduced spending and deferred payments. It triggers $2.5 billion of additional cuts if the better-than-expected revenue doesn’t materialize, to assure Wall Street that the state can repay cash-flow loans by June 2012.

“It’s what we’ve been waiting for,” said Kelly Wine, executive vice president of Encino, California-based RH Investment Corp., as lawmakers were summoned to vote yesterday. “I wasn’t expecting this to be done this soon and I think this is very positive.”

California, which accounts for 13 percent of the U.S. gross domestic product, requires a budget in place before it can sell a projected $5 billion in revenue-anticipation notes, or RANS. The short-term municipal bonds, offered when cash is low, are repaid when the bulk of taxes are collected later in the year. Without the notes, the state could run out of money, as it did in 2009 when the controller issued $2.6 billion of IOUs.

California, which has the lowest credit rating of any state from Standard & Poor’s, can borrow money against the spending plan, which Treasurer Bill Lockyer yesterday called “financeable.”

Credit Rating

“The budget makes substantial progress towards eliminating California’s large and chronic structural deficit,” Lockyer said. “Rating agencies repeatedly have citied the lack of such progress in prior budgets as one of the major reasons for previous rating downgrades. These downgrades have increased taxpayers’ borrowing costs and diminished California’s reputation.”

Brown took office in January facing a $26 billion deficit through June 2012. That gap will have been filled with almost $12 billion of better-than-expected revenue, about the same amount in spending cuts and $3.5 billion of payment deferrals and accounting shifts.

The 73-year-old Democrat had wanted to cover part of the shortfall with $11 billion in expiring taxes and fees. Brown had tried since January to win enough Republican votes to put the issue to a statewide vote, without success. He said he may try to put some sort of tax increase on the ballot in November 2012 through a signature-gathering campaign.

Rising Revenue

California’s rising revenue -- $1.2 billion above projections in May and June -- has been driven primarily by upper-income taxes and capital gains, according to the state budget director, Ana Matosantos. Budget officials project $4 billion more in the fiscal year beginning July 1 than they had estimated in May.

If that money doesn’t materialize, the new budget sets tiered spending cuts. For example, if revenue falls $2 billion or more below the new projections, schools would lose $1.5 billion, the equivalent of about a week of the academic year.

“Going forward, we do expect more revenues in the budget year coming up, but in case that’s overly optimistic, we do have severe trigger cuts that will be triggered and go into effect, and those are real,” Brown told reporters June 27.

“This plan relies primarily on cuts, brutal cuts, which place me and many other members well outside of our comfort zone,” Assemblyman Robert Blumenfield, a Van Nuys Democrat who chairs the budget committee, said before the vote. “These cuts will forever haunt our consciences.”

Budget ‘Nonsense’

The notion of $4 billion in additional revenue is “nonsense,” said Christopher Thornberg, principal at Beacon Economics LLC in Los Angeles. Even a best-case scenario for the state economy wouldn’t yield that much, he said.

“They don’t want to make the cuts that the Republicans are basically forcing them into,” Thornberg said of legislative Democrats. “They’re basically doing a dodge.”

Assemblyman Jim Nielsen, the top Republican on the Budget Committee, said the spending plan neglects changes to pensions and to environmental regulations that would boost California’s economic recovery.

“It does not solve our problems in the long term,” the Gerber Republican said. “There are no sustaining measures.”

The state’s 120 lawmakers have been working without pay since a June 15 constitutional deadline for them to send a budget to Brown. The penalty was prescribed by voters in a ballot initiative in November.

Brown vetoed a spending plan crafted by Democrats that he said was filled with gimmicks. So far, rank-and-file lawmakers have lost at least $3,416 plus $142 for each day they were in session since June 15.

Republican Power

Republicans had been using their power to block his tax plan to jockey for cuts to public pensions and to environmental and business regulations, as well as a push for a permanent limit on how much the state can spend each year. Those talks are now dead.

Republicans argued that Democrats refused to concede on pension reforms and the spending cap because they are beholden to public employee unions.

Some of the money from the tax increase extensions would have paid for a shift of more than $5 billion of government services such as public safety to the city and county level. The new spending plan still finances that shift, but out of existing tax revenue instead.

Sales Tax Drop

With the taxes and fees expiring, California’s retail sales-tax rate will drop 1 percentage point to 7.25 percent, still the highest statewide levy in the country. Vehicle registrations will decline 0.5 percentage point to 0.65 percent of value. Income taxes shrank by 0.25 percentage points in January, and the state’s annual child-tax credit increased to $309 from $99.

The new budget also counts on $200 million under legislation requiring sales-tax collections by online retailers including Amazon.com Inc. for purchases by state residents. Amazon, the world’s largest online retailer, has threatened to sever ties with more than 10,000 affiliates in California over the proposal.

The budget keeps alive more than 400 redevelopment agencies that Brown sought to close, though it requires them to turn over about $1.7 billion next year. Courts have ruled against the state for previous attempts to raid their revenue.

A California general obligation maturing in August 2022 was unchanged at 105.66 cents on the dollar yesterday, according to Bloomberg Valuation pricing. That compares with a value of 101.21 cents on Jan. 3.

“I just don’t think that the Street has digested it,” Wine said. “Cal GOs have traded pretty strongly up until now. I think the consensus was that the state was going to get the budget passed.”

--Editors: Pete Young, John Brinsley

To contact the reporters on this story: Michael B. Marois in Sacramento at mmarois@bloomberg.net; James Nash in Sacramento at jnash24@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net


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