Bloomberg News

Brown Closes $16 Billion Budget Gap With Tax Increase

June 28, 2012

California Governor Jerry Brown signed a $91.3 billion budget for the most indebted U.S. state, putting his signature to a second consecutive on-time spending plan after decades of delays amid partisan battles.

The budget passed by the Democrat-dominated Legislature relies on voters approving higher taxes in November. It uses funds intended for mortgage relief and counts on the sale of greenhouse-gas credits to polluting industries. State workers will take a temporary pay cut, and the poor will find it harder to collect welfare if they don’t try to get work.

Brown’s spending plan erases a $15.7 billion deficit, combined with the tax increase, and is aimed at ending years of persistent deficits. In February, Standard & Poor’s, which rates California’s credit the lowest among U.S. states, boosted its outlook to positive, saying the state was poised for an upgrade depending on financial improvement.

“My revenue proposal is fair and temporary,” Brown, referring to the tax increases, said in a statement. “Our state budget problem was built up over a decade, and it won’t be fixed overnight. These temporary increases will ensure funding for our schools until the economy improves.”

The 74-year-old governor crafted the spending plan with fellow Democrats after the deficit ballooned to almost twice the amount projected in January as revenue missed targets. Brown vetoed $129 million of spending from the budget Democrats sent him before signing it late yesterday.

Tax Vote

The budget’s centerpiece is an initiative on the November ballot asking voters to temporarily raise the state sales tax, already the highest in the U.S., to 7.5 percent from 7.25 percent. It would boost taxes on income starting at $250,000. The rate for those making $1 million or more a year, now 10.3 percent, would rise to 13.3 percent, the most of any state.

Brown’s measure will have a more prominent position on the November ballot because Democrats moved up the placement of bond measures and constitutional amendments. Voters will face at least 10 other issues in presidential election year.

Republican View

“Democrats ignore the simple truth that voters have rejected the past eight tax-increase proposals placed before them,” said Senator Bob Huff of Diamond Bar, who joined all fellow Republican lawmakers in voting against the spending plan. “While this budget should be a reflection of the state’s priorities, it threatens $6 billion of education cuts and lacks any of the meaningful reforms the people of California rightfully want.”

If the tax increase fails, it will trigger $6.1 billion of cuts -- $5.5 billion coming from schools, enough to pay for three weeks of classes.

Such mid-year spending reductions, known as trigger cuts, are intended to make sure the state has enough money to repay a $10 billion cash-flow loan that Treasurer Bill Lockyer plans to seek in August.

State and local governments typically sell short-term notes to bolster cash flow until tax receipts increase later in the fiscal year. California would be unable to borrow at reasonable rates without assuring investors of repayment by next June.

Debt Rating

S&P rates California A-, the fourth-lowest investment-grade level. While the New York-based company raised its outlook, analyst Gabriel Petek in San Francisco has said the state needs to better align its continuing revenue with programmed spending.

A California bond maturing in February 2022 was sold today at a yield of 2.45 percent, or about 0.53 percentage point more than an index of top-rated muni debt with a similar maturity, according to data compiled by Bloomberg. The securities were issued in March at a yield of 2.78 percent, or 0.88 percentage point above the benchmark.

It cost the equivalent of almost $237,500 annually to protect $10 million of California debt against default for 10 years today, down from about $260,100 on June 7. That compares with about $550,400 for Spain, up from almost $527,400 three weeks earlier, according to prices compiled by Bloomberg.

To attract support for the tax increase, Brown’s budget freezes in-state tuition in the University of California and the California State University systems next year.

Payroll Cuts

The spending plan counts on a 5 percent cut in payroll costs. Brown proposed achieving that by having employees work 9.5 hours on four days instead of 8 hours in five each week. The largest state workers’ bargaining unit, the Service Employees International Union Local 1000, rejected the plan and instead agreed to 12 days of unpaid leave in the year.

Democrats had stripped language from the budget that would have authorized Brown to order unpaid days off, known as furloughs. Lawmakers subsequently restored the power, giving the governor more leverage with other unions that haven’t agreed to the cuts.

The spending plan makes use of $410.6 million from California’s share of a $25 billion national mortgage-relief legal settlement. The agreement with five lenders, including Bank of America Corp. (BAC:US) and JPMorgan Chase & Co., ended a probe of abusive foreclosure practices stemming from the housing market collapse.

Cap, Trade

The spending plan counts on $500 million in revenue from the nation’s first state-run cap-and-trade program to mitigate air pollution. The budget estimates about $1 billion will be received in fiscal 2013 under the landmark legislation, which lets companies buy and sell carbon credits to reduce greenhouse gas emissions.

About $880 million was cut from welfare spending for the year, which begins July 1. Recipients will be limited to two years of assistance unless they can demonstrate they are in job training. Those with small children would be eligible for exemptions.

The plan eliminates California’s health-insurance system for poor children, who would instead receive care under Medi- Cal, a state-run program for low-income residents. Subsidies for child care will be reduced by 11 percent.

The new budget leaves California with a $948 million reserve, down from the $1.1 billion sought by Brown. Democrats in the Legislature lowered the so-called rainy-day fund to pay for some welfare cuts Brown had sought.

California’s constitution requires lawmakers to pass an annual budget by June 15 with a simple majority vote. Democrats control the Senate and the Assembly, though they don’t hold enough seats to pass a tax increase, which requires two-thirds approval.

A voter initiative passed in 2010 strips lawmakers of their pay for every day they’re late with the budget. This year they passed the main spending bill by the deadline, though not all the supporting legislation to implement it. Democrats insisted that they met the requirements to keep their pay, since they sent the governor the main bill on time.

To contact the reporter on this story: Michael B. Marois in Sacramento at mmarois@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net


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