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Senate Budget and Fiscal Review Committee California State Senate
Follow its sittingsSpeaker 2
McNerney? Menjabar? Ochoa Bogue? Here. Perez?
Reyes? Richardson? Here. Cerrado. Here.
Smallwood Cuevas. Weber Pearson.
Speaker 1
Here. Cabaldon here. Cabaldon's here, and Reyes is here. So with that, we will have a quorum. Today is our last full budget hearing before our subcommittees start work on Thursday, February 26.
Today is an informational hearing only, It is going to cover the state's budget stabilization account, also known as the rainy day fund. Let me just say that when the vice chair and I were Vice Chair and Chair in the Assembly almost twenty years ago, there were no reserves. The only reserve we had in the budget was to just cover unanticipated expenses in that budget year. There was no larger reserve that was designed to deal with the volatility that exists in the state budget. Additionally, and this is just speaking for myself, you always have the option to address volatility by amending the tax structure.
And yet to amend the tax structure to do that, it probably means you have to give a tax break to the wealthiest people and increase taxes on people that are lower wage earners and middle income people. That politically is just not viable. And so it leaves us with the option of dealing with volatility through the rainy day fund process. It was established ten years ago by initiative, and we now have ten years of experience, and we now have volatility that seems to be more pronounced. And in today's hearing, we will discuss that and discuss the options we might have in putting all the facts on the table and deciding if we have reforms that we would at some point like to make.
That is are the contours of today's hearing. And we will we have one panel. We will have the panel, then we will go to members' questions and comments, and then public comments. And before we go to the panel, let me ask the Vice Chair if he has any introductory comments he would like.
Speaker 6
Yes. Thank you, mister chair. And I remember that time, twenty or so years ago. And, let me say that, budget reserve policy is one of the truly fascinating, engaging, and interesting topics of the entire budget universe and you can tell that by the throngs of public that are here in this hearing this morning. Everybody is fascinated by this subject.
I jest a bit, I guess, but the fact of the matter is I believe that. It has been an important issue to me in my entire time dealing with public sector budgets. Senator Laird is right. Changing the tax structure is not gonna happen, but we can change the way we use it so that we effectively do the same thing by monitoring its use, and that's always been my preferred approach to it. And we were in dire straits back in 2009.
No reserves and no cash. Even though we passed the budget in February, we ran out of cash that summer, and I remember the controller had to actually withhold payments to some folks, which would have been far worse had we not, passed that that budget. But part of the result of those negotiations was a proposition on the ballot in, 2009, I think, that would have revised the reserve policy substantially and very much, in line with what the LAO has, discussed recently. And, given the way that would have handled the surge that we had in revenues back in 2021, we would be nowhere near in as much trouble today as we are. So the reserve policy can truly, truly assist our budget writing woes in very positive ways.
Proposition two was not enough. What the governor proposed last year was not enough. And I look forward to the information that we get today and the discussion.
Speaker 1
I, for purposes of AI and reuse, love the sentence that Mr. Laird is right. So we will take that out of context and paste that in a number of I places through the appreciate that. So let me invite our panel to the table. We have with us Anne Hollingshead from the Legislative Analyst Office, Carolyn Chew from the Legislative Analyst Office, Lisa Merzinski from the Department of Finance, Irina Asmanson, who's the CEO of Practical Idealism Economics, and Scott Graves, the Budget Director of the California Budget and Policy Center.
We will go in that order, if it's okay. We'll start with the Legislative Analyst's Office. So, welcome to the committee.
Speaker 7
Thank you so much, Mr. Chair and members of the committee. Anne Hollings, head of the Legislative Analyst's Office. I'm going to be speaking to you today from a handout, which hopefully you do have a copy of in front of you. And because this presentation is on the lengthier side, let me give you kind of a high level road map of where we're going today.
So I'm gonna start by talking about revenue volatility and what it means for the budget, where it comes from, why it's important. Then I'll discuss reserves at a high level, an illustrative level, including how reserves can help the state mitigate revenue volatility. Third, I will talk about California's reserve system, including the current paradigm that exists under proposition two, as well as a kind of brief overview of the history of California's reserves. Then I'll speak about our evaluation of reserves, essentially our answer to the question of how do we know if a reserve policy is working or not, and how does the current reserve policy stack up against that evaluation. And then finally, I'll conclude with some recommendations that are based on our analysis.
So with that, I'm gonna turn to the first page. So why are California's revenues volatile? So first of all, what does volatility mean? Volatility means that in any given year, revenues can grow very quickly, in many cases, much faster than the underlying economy or than expenditures in other years, so they're gonna contract really quickly. And the key reason for revenue volatility in our state system is the personal income tax, which makes up most of general fund revenues.
Personal income tax is volatile for essentially two key reasons. One, the incomes of high income earners are more sensitive to changes in the economy and asset prices. And then second, the state's progressive rate structure essentially concentrates the tax on those high income earners. And the graphic at the top of this page is gonna show you essentially why. So on the left hand side, we have components of the personal income tax, that are much more stable, that, you know, you can see are not so volatile.
That includes pension and annuity income, wages income. And on the right hand side of the graphic, we have, types of personal income that are much more volatile, including capital gains, partnership income, dividend, interest, and rents. And high income earners are going to mainly earn income on the right end of the spectrum, whereas low and middle income earners are going to mainly earn income on the left end of the spectrum. And since the state taxes those higher income earners at higher rates, that's essentially doubling down on the already existing underlying volatility. I do want to, though, draw your attention to the fact that capital gains are not the only source of volatility for the state, and that is just a little bit of foreshadowing for a point that I will make later.
Finally, volatility presents two related but nonetheless separate issues. So one is related to forecast error. Forecast error just means that it's very difficult for our office, for the Department of Finance to forecast with a great deal of precision what revenues are gonna be for the upcoming fiscal year. This is true both on the upside and on the downside, excuse me, where when revenues are surging, it's very difficult to predict how much they're surging. And when revenues are dropping, it's very difficult to predict how much they're dropping.
And that, of course, makes the budget more difficult to manage and more difficult to enact a budget that is going to be, accurately reflecting exactly what income what the state's income sources are gonna be for the upcoming year. A separate issue is downside risk, and that is really gonna be the focus of the presentation today. It is the main issue that is dealt with by budget reserves, and it is what, essentially, we are going to, as I already said, as we are going to focus on here. Okay. So turning to the next page.
So I wanna talk at kind of an illustrative level of how reserves work and how they help the state manage its revenue volatility. This graphic is, of course, purely hypothetical. It is not reflective of real data, as you can probably tell. But nonetheless, it's here to illustrate the point. So revenues revenues are shown in that purple line.
They go up and down, as we've already talked about. That's that revenue volatility. And then spending on core services, what we think of the state's ongoing service level, the service commitment that has been made to Californians, is in the green line. And because of revenue volatility, you're going to have some years where revenues are surging and they exceed that spending on core services. And then you're going to have some years where revenues are contracting and they are, of course, below the level of core services.
And revenues, reserves are exactly what helps you smooth the difference. It helps you bridge this gap. So you save them when, revenues are surging, and then they're available for when, revenues have declined. And they are essentially what allows the state not to disrupt the core service level when revenues have declined, right, so that the state can maintain its commitments even when we're in a period of downturn. So turning to the next page.
I just wanted to give a kind of brief high level overview of, the history of California's revenue, reserves because it really is, it is a picture that has certainly changed rather dramatically over time. So this graphic goes all the way back to the early 1950s until today. In the purple line, you can see what was called at the time the year end enacted surplus or deficit, which we would now refer to as a special fund for economic uncertainties. This is essentially the difference between the year end projected revenues and expenditures. It's sort of like the the small buffer that's built in at the end of the year.
In the early nineteen fifties through the early sixties, the state had something called the revenue deficiency fund, and that was the only reserve that the state had to speak of until the budget stabilization account in the early two thousands. So, essentially, as you can see between the fifties, sixties, and seventies, the state had these really significant surpluses and also had built up money in, its reserve. But then starting in the early eighties, the state had almost no reserves to speak of. The only time that changed was with, proposition two, which was passed in 2014. And as you can see at the end of the period, the budget stabilization account has built up balances in those red bars accordingly.
So this really did represent a substantial improvement in the state's reserve policy. Turning to the next page. I want to give a bit of a high level overview of how proposition two works. The formulas that are in the constitution are very complicated, so I will not go into a huge amount of detail unless it's in response to questions. But I do wanna just draw your attention to essentially two different basic components of the formulas, and that is the base amount, which is a steady amount that is deposited each year into the BSA and excess capital gains.
I'll also mention that proposition two has requirements both for depositing money into reserve as well as paying down certain eligible debts. I'm gonna focus on the BSA side, but happy to get into debts in response to questions. So how these two components work? The base amount the state very simply sets aside 1.5% of general fund revenues each year. Half of that goes to reserves, and half of that goes to debt.
And then in excess capital gains, the idea here is that the state wants to leverage some of that volatility in capital gains revenues that we've already talked about and set aside the peaks in capital gains revenues into reserve. So to do that, the state compares total capital gains revenues to a threshold of eight percent of general fund taxes. And then the share that is over that is what's considered, quote, excess capital gains. Importantly, and this is also some foreshadowing for later, not all of the excess capital gains are actually deposited into reserve and go to debt. There is another set of formulas that are also very complicated that determine how much of that share should actually go in.
And I won't get into it unless there are questions about it, but the sort of bottom line point is that it's only a share of it. I also want to just make sure that I mention that in addition to these rules, the BSA has a 10% cap on total constitutional deposits, meaning that constitutional deposits are required under the formulas until the BSA reaches a maximum of 10% of general fund taxes. And after that, anything that would go into the reserve is spent on infrastructure instead. That cap is is also very important. So turning to the next page.
So how do we think about how to evaluate California's reserve policy? How do we think about whether or not it's working? So I think it's important to first set the stage that we consider a reserve policy to be performing well if it meets the central goal of reserves. That is that it allows the state to maintain core spending even when revenues are declining. And the time horizon over which we would want to measure this is not going to be years, but going to be decades because we think it's very important that a reserve withstand the test of time, that it is adequate through multiple economic cycles and not just one or two.
So we do know in the future that there are going to be revenue downturns. We do not know how big they are going to be, how frequent they are going to be. But that said, we can use information about history to project or forecast a range of possible outcomes that we see for the future. And this is very illustratively the point that we're trying to make in the graphic on this page. So you can imagine there being lots of different scenarios for the future of the state.
Right? Some of these scenarios might be more unfavorable where the state has multiple downturns in revenues or those downturns are very large. Some of the scenarios could be much more favorable where the state has very few downturns in revenues or those downturns are very small. We don't know which one of these the state actually, know, sort of the future will hold, but we can make a forecast of what is the total range of the scenarios that we're looking at, and then we can choose a scenario to benchmark against or to say, let's make sure that the state policy performs well in at least this kind of scenario. So how do we choose that benchmark?
Well, you might think, well, we should choose the median scenario. But the problem with the median scenario is that then it's going to be successful half the time, and the policy is going to fail half the time. And if we're in the time that it fails, then it looks like the policy that has been enacted is is not is not at all what what the state intended. So instead, we follow the practice of what is done commonly in actuarial markets, in pensions, in in insurance. And we pick a scenario that is an unfavorable one, but not the worst possible case.
And in this case, we're picking the ninetieth percentile. So if you turn to the next page, essentially, what this means is whenever we talk about how we're evaluating, the state's reserve policy or how we're evaluating alternatives to the state's reserve policy, what we're talking about is what share of funding shortfalls, what share of those red shaded regions is the state able to cover in that ninetieth percentile, in that benchmark scenario, over the course of fifty years? And so our analysis found that for the current policy for essentially what exists under proposition two today, the state would be able to cover about a third or 30% of funding shortfalls over the next fifty years in that benchmark scenario. That is obviously a significant improvement to 0%, which would be what would be the case if the state had no reserve policy. But at the same time, 30%, suggests that some more improvements are warranted.
So turning to the final page, this includes our recommendations for how to improve reserve policy based on this analysis that we've done. And we have essentially two different recommendations with two options in the second one. So for the first recommendation, we suggest that this the legislature raise the cap from the current level of 10% of general fund taxes to 50% by 2055. This is, in fact, the most important of our recommendations. One of the really surprising parts of our analysis that we had was that, in fact, the only way to improve upon the state's current rules is to raise the cap.
That even if you significantly change the deposit rules but kept the cap at 10%, that that wouldn't cause kind of a significant increase in the state's ability to cover more funding shortfalls, and that's because that 10% cap is really limiting. So we consider this the most important part of our recommendations. That said, the 50% need not take effect immediately. It would certainly take time for the state to be able to build up reserves of these magnitude. So we would suggest since this would have to go before voters that the legislature ask voters to to make a 20% cap effective immediately and then increase that cap by 5% every five years until it reaches, 50%.
If the cap is raised, then the state is going to want to deposit more money into reserve in order to dependably reach this higher level sort of consistently over multiple economic cycles. And for that, we have two options for the legislature to consider, either of which would help put aside more in those peak revenues, those really significant surges in revenues that we've seen, especially in recent years. So the first would be to create a new set of more flexible, robust deposit rules that capture volatility not only in capital gains, but volatility across all types of tax revenues. And as I mentioned earlier, capital gains is, of course, the most volatile source of income, but it's not the only source volatility. Moreover, we don't know that it's going to be the exclusive source of volatility going forward.
So we think it's important as kind of a risk management strategy for the state to hedge against various kinds of risks with more robust rules. That said, replacing the rules of her proposition to kind of in whole cloth may not be feasible. And so we've also offered a second option where the legislature would set aside the entire amount of those excess capital gains that I mentioned earlier to essentially get rid of the very complicated formulas that set aside a portion of them, and and instead to set aside the entire amount. This too would allow the state to, put more money into savings when revenues are peaking significantly. So those are our recommendations, and I'm happy to take questions at the end of the panel.
Speaker 1
Thank you very much. And it was our intention that you do what you just did, which is lay it out in wonky detail in way that we can all have a conversation afterwards. Do you have anything you would like to add? Okay. Thank you.
We will move to the Department of Finance. Welcome to the committee.
Speaker 8
Morning. Lisa Marzinski with the Department of Finance. Thank you for having me, and also thank you for having this very important discussion. Anne laid out nicely some of the issues that we're facing. So last year in the Governor's budget, the administration proposed two changes to the BSA, one of which is increasing the cap from 10% or the cap on deposits from 10% to 20%, and the other was to exclude appropriations or deposits into the reserve and out of the reserve from counting against the SAL appropriation limit.
The state appropriation limit and the cap tend to be the two primary reasons that limited our ability to deposit more money back a few years ago when we had large surpluses. So we felt tackling these two issues. We're still maintaining the intent of the BSA as it was presented to voters initially, but also just allowing a little bit more flexibility for the legislature and the administration to put, again, you know, more reserves aside that we could use for future budgets. So with that, I would be welcome any questions or can answer questions later. Thank you.
Speaker 1
Thank you very much. Now we'll move to the CEO of Practical Idealism Economics. Welcome.
Speaker 9
Thank you very much to the committee. My name is Irene Asbenson. I am the founder and CEO of Practical Idealism Economics, formerly of finance. I would like to thank that committee as well for dealing with this very important issue. If the state of California's health in terms of our economy were to be done as a Hollywood movie, this would be at the heart of the drama, I think.
So as the chair and the vice chair laid out, the reserve policy of California was done because of the deep trauma that the legislature had to deal with in the last couple of downturns. Unfortunately, when the reserve policy was set in place, I don't think that some of the structural changes that have happened to the economy were contemplated. So I'm going to be a little bit depressing. I'm very sorry. Things that have happened that are probably going to mean that the reserve policy is inadequate are the increasing inequality of the economy has meant that people are much less likely able to self insure.
So during a downturn, we have an unemployment insurance system, and we want to make sure that people pulling back on their own spending does not further exacerbate a recession, which is a possibility. That is what the unemployment insurance system is set up to do. California's unemployment insurance system has not been updated in decades. And so people are not going to be able to keep up their spending, and structurally, that is going to mean that California's next recession is probably going to be worse. During the pandemic, the federal government spent a lot of money to supplement unemployment insurance, and that greatly helped the economy not go into a downturn.
It is very unlikely that in the next recession, the federal government is going to do a similar thing. That is partially because the current federal administration is running very large deficits at a time when they should be paying down debt. They have exacerbated inequality through tax policy, and they have also shown, at least the current administration, that they are going after their political opponents. In other words, if they wanted to fool around with California, they would be able to do so through a number of administrative mechanisms. So for example, in the last recession, California borrowed tens of billions of dollars, about $20,000,000,000 from the federal government to pay for our unemployment benefits.
That does not cover all of the extra supplemental benefits of $600 a week that we got from the federal government. The federal government paid for that entirely. Right now, the unemployment insurance system of California tops out at four fifty dollars per week in terms of benefits. That's for the very top earners. That is $1,800 for four weeks or just under $2,000 per month.
That is completely inadequate to keep people from becoming homeless. During the pandemic, we also put in place moratorium on evictions, which helped a lot of people stay in their homes. Again, I don't know how likely that's going to be during the next recession. So California has some structural problems that the legislature is going to be called upon to fix in the next recession, and the current reserve system is not going to be large enough to meet those demands. So that's the depressing part.
The encouraging part is that there are things the legislature and the governor can do right now. One is update the unemployment insurance system. The other is to look at structural spending controls and look at the structure of how we are helping the people of California. The other thing the federal government has done has been to completely change how the Affordable Care Act is working and the kinds of money that is available to states there. California has a very large share of people who participate in the ACA, I am among them, also who are covered under Medi Cal.
I think at the last count, it was around onethree of the state is covered by Medi Cal. We do not want people to be losing their health insurance during the next recession. Unfortunately, health costs are still a source of bankruptcies for people. They are still a source of huge financial stress for people, and it is going to be very difficult for you politically to cut off those or reduce those when people are looking for work. The other structural change that has happened is that many more people now rely on gig work.
Gig workers, unfortunately, are not covered by many of the benefit systems. And so they are doing gig work because they can't find other jobs that are adequate. They are not making a living wage, probably, and they are probably finding it completely impossible to build up the kind of emergency safety nets that they would need to self insure. So those people are also going to be in need during the next recession. You, as the legislature, are probably going to be under pressure to do something about that.
So again, you can think about structural issues, such as updating the unemployment insurance system or expanding the safety net or looking at who is covered under what circumstances. So I am very encouraged by the fact that you are thinking about reserves. Please also think about the structural spending side and the other safety net issues at the same time because that is what the reserve system was set up to help you deal with. And I will take questions at the end of the panel. Thank you.
Speaker 1
Thank you very much. And now we'll move to the Budget and Policy Center representative. Welcome.
Speaker 4
Yes. Thank you, Mr. Chair and members. Good morning. My name is Scott Graves.
I'm the Budget Director at the California Budget and Policy Center. We're a research and analysis nonprofit that uses our budget expertise to advance policies to improve the lives of Californians. We appreciate the opportunity to join this conversation today around the state's reserve policy with a special focus on the Budget Stabilization Account or BSA or Rainy Day Fund. So, over the next couple of minutes, I'm gonna focus my remarks on two key concepts, balance and diversification, and I'm briefly going to weigh in on the kind of rainy day fund reforms that we think would make good sense. So let me take these one at a time, starting with balance.
Two things need to be balanced. First, saving for future emergencies, and second, meeting the critical needs of Californians. The Budget Center has long agreed that saving for a rainy day is an important fiscal practice that helps prevent deep cuts to vital public services during budget emergencies. But building reserves must be balanced with generating and committing the resources needed to both build a California for all and protect Californians from the deep cuts made by HR one, the bill signed into president by President Trump into law last year. We know that h r one's cuts are likely to cause millions of Californians to lose health care and access to vital food assistance.
We also know that Californians are looking to state leaders to address the many affordability challenges they face, including lack of adequate access to child care, food assistance, health care, and so much more. Reforming the rainy day fund shouldn't come at the expense of addressing these substantial challenges now and in the future. Let me turn now to my second point, diversification. When it comes to solving a budget problem, the BSA or rainy day fund clearly is important, but it isn't the only game in town. State leaders, you, have multiple options for closing budget shortfalls.
For example, I'm gonna use a word we haven't used yet this morning for the most part. You can raise revenue, a tool that's been used multiple times going back decades, and under current BSA rules, would actually increase state reserves. The state can also borrow from internal funds, a common practice that's been used multiple times and that the LA highlights in their excellent report. And, let's not forget that the legislature recently created a new account to better manage revenue surges and avoid avoid self inflicted budget crises. As a reminder, I always have to look this up.
The name of the new account is the projected surplus temporary holding account. Long name. This account hasn't been used yet. But, the idea is to allow the state to avoid committing revenue that later fails to materialize. So, while the BSA is a critically important tool for helping the state to close budget shortfalls, it is just one of several tools in the toolbox that state leaders can, use to solve or even avoid a budget problem.
So, with these points in mind, we think the reforms that were proposed by governor Newsom last year strike a good balance. They were described earlier on the panel. I'm not going to re describe them. I'll just say that if adopted, the governor's proposal would facilitate greater savings without being overly rigid and hindering spending to meet Californians' essential needs. The governor's approach also would make the BSA significantly more effective.
And here, I'm gonna cite the good work of the LAO. Under the governor's plan, the BSA would cover around half of future funding gaps. That's up from one third under the current rules. This is according to the LAO's analysis. And keep in mind that this major improvement would result simply from doubling the BSA cap from 10 to 20% of general fund tax revenues and would not require the state to shift a larger share of annual state revenue into the reserve.
So, in short, the type of reforms suggested by the governor would allow California to save more for a rainy day without taking more resources off the table to meet Californian's critical needs. So, I'm gonna sum up my three major points here to close out. First, we agree that it is crucial to responsibly manage California's revenue ups and downs and set aside funds for a rainy day. We also strongly believe that any BSA reforms must be balanced with meeting Californians' needs while also recognizing that budget reserves are just one tool in the budget balancing toolbox. And, finally, we think the modest but effective rainy day fund reform proposed by Governor Newsom last year strikes a good balance.
Thank you and happy to take questions.
Speaker 1
Thank you. I'm going to ask a few sort of level setting questions. Senator Nilo's in line. Let me ask There's senator Kabalden, senator Grove, Sarto, Reyes, Dorazo. Oh, okay.
Sorry.
Speaker 1
No. No. No. No. I'm not automatically having all of us do this.
Okay. Okay, we have quite a line. I have Nilo, Cabaldon, Grove, Sarto, Reyes, Dirazzo, Richardson, Weber, Pearson, Smallwood, Cuevas. And I will look forward to saying that Senator D'Arrazzo is on deck at some point because she does a fake swing of the bat whenever it happens. So let me just lead off with a few questions.
And first for Ms. Osmondson. Given the fact that I should make an observation along the lines of what the Vice Chair said. We must have had 70 people at one recent hearing testify about potential expenditures and cuts, and yet this hearing will affect our ability to deal with those more than anything else and nobody is here. It's our job to educate people as to how important this is.
Ms. Osmondson, given the fact that we now have a couple of months revenue forecasts that are above what the Governor's revenues were when he shut down the revenues for his proposed budget, how would you recommend, because you called out services on that side, how would you recommend to the legislature consider balancing these two things between funds for program and services as opposed to setting some of those or a lot of those funds aside in reserves?
Speaker 9
Old habits die hard. It very much depends on what the legislature would like to protect and what they would like to bolster. I come from mostly the revenue side. And so in times like this, when I am extremely worried about the future forecast and uncertainty, my first instinct is almost always to put it in reserves to preserve your ability to deal with unexpected situations in the future. And doing that in conjunction with also opening up discussions about how to do structural reform To do structural reform almost always requires some sort of compromise.
And if you have cash to make those compromises a little bit more palatable, that can use short term revenues to solve longer term problems. And so my personal opinion, which should not be taken as, like, the opinion of anyone who has previously employed me, would be put it in reserves and start those structural discussions because those are going to be very difficult. There's a reason why unemployment insurance has not been reformed in decades. It's because it's difficult to know how to balance taxes on employers and also the level of benefits that would be adequate to help people during recessions.
Speaker 1
Does anybody else wish to comment on that before I go to the next question? Yes. Legislative analyst.
Speaker 7
Think we might have a related but maybe slightly distinct perspective on this issue. If you think in any single year, there is going to be a trade off between putting money into reserve and spending it on programs. But if you're thinking over a longer period of time, those things are one and the same. Putting money into reserve is what allows the state to spend money on programs later. And so when we do our analysis, what we're doing is we're saying we're gonna take the state's revenue structure as it currently exists as given.
The legislature, of course, has the possibility of expanding revenues and expanding the size of government. But under the current revenue structure, what is the level of state service that is affordable? And that is going to then dictate what your reserve policy should be because that reserve policy is going to be what allows you to afford that service level. So I guess I we often hear this presented as a trade off, and it is certainly a trade off in any single year. But we also think it's important to shift the framing to understand that reserves are about being able to afford the state services.
Speaker 4
Yeah. I would just note that affording state services, let's keep in mind, isn't dictated solely by the existing tax system. US policymakers, along with the governor, always have the option to revise that system if you wish to bring in more revenue in order to use that revenue to support a higher level of services, if you wish. So, I want to make sure that as you all are thinking about reserves, it's not just reserves versus spending, it's how do revenues fit into the mix as well. And I know you all have different opinions about this when the term revenues and tax increases comes up, but it's really important to keep that in mind rather than letting the conversation strictly be limited by we have a tax system, it's imposed on us, somehow we don't know where it comes from, this is what we're working with.
In fact, you all created the tax system, and you all can revise that system as needed to provide the level of services that Californians want and need.
Speaker 1
Thank you. And then let me ask a question of the LAO. Do you believe there was a specific rationale for treating a deposit in the budget stabilization account as an appropriation for the purposes of the state appropriations limit, or was this just an unintended consequence of two overlapping processes?
Speaker 7
No, it was not unintended consequence. If you look at the kind of broader media discourse that happened around the time that both Proposition 13 and Proposition four, which was what enacted SAL in the seventies, took place, it it was very directly related to if you turn to page three and you see that kind of massive spike in what we would call the year end surplus, There was absolutely a response from the greater public and from the media about what was called, quote unquote, obscene surpluses at the time. And so the SALS restriction on having deposits count toward appropriations that are subject to the limit was a way of addressing what was seen at the time as a problem. Of course, the state's revenue system, budget picture, tax system are completely different today. And so for those reasons, we think that there and we've mentioned in reports on the sell, we think that there are some inconsistencies that are created by having reserve deposits at this point be appropriations subject to the limit.
But there was certainly a rationale at the time that it
Speaker 1
it I don't want to get in I want to appear, for the moment to be agnostic on Proposition 13. But when Proposition 13 was enacted, it contributed to the volatility that's happened in the decade since by removing one of the more stable sources of or lowering one of the more stable sources of revenue in contravention to the others. No, go ahead. When you're reaching for the microphone, I'll take that as an ask to be recognized.
Speaker 11
Oh, Chu, Legislative Analyst Office. I would offer and apologies, I wasn't sure if that was a question. I would offer that, as the committee knows, in response to Proposition 13, the state and subsequently Proposition four, in which the state appropriations limit was created, the state did become a much more active participant in funding what had prior to Proposition 13 been local responsibilities. And so to your point, the growth in property tax revenues was certainly muted by the passage of Proposition 13. But then the confluence of that with increasing the state's role in the provision of local services has created a dynamic in which sort of the state's revenue picture and local government's fiscal capacity are now intertwined in a way that they had not been prior to that time.
Speaker 1
Thank you. Anybody else wish to comment before I move to my last question? Is this for you, your opinion?
Speaker 9
This is. I am happy that Prop 13 came up because it is the thing that drives all of the revenue volatility. I would like to point out that at the time that Prop 13 I'm so sorry that my phone seems to be going off at the same time that Prop 13 was passed. It was, as the LAO notes, people were very outraged at the amount of surpluses. And that was partially as a result of all of the inflation that was happening at the time of the oil crisis shock.
And also, at the same time, the Serrano decision, which said that, the state was responsible for adequately educating California children, meant that there was going to have to be some local revenues that were redistributed from richer districts to, less wealthy districts. And so there is academic support for the idea that Prop 13 itself was passed for racist impulses. It has completely driven all of the revenue decisions ever since then. And even though Prop 13, I acknowledge, regularly polls at 67% approval, I think that this is an overdue conversation that California should be having. That's my personal opinion.
Thank you.
Speaker 12
Just had a question. You said Prop 13 was passed as a and I didn't get the next words.
Speaker 9
There is some evidence because things like Prop 13 had been proposed as an initiative before it actually passed in the '70s. There are arguments that have been made that the reason it finally passed was, one, the outrage of the surpluses, but also people were unhappy that the idea that their local taxes were going to be redistributed to less wealthy districts. And so there was some racism involved. Thank you.
Speaker 1
And let me move to my final question and address it to the Department of Finance. And that's that the Governor's proposed suspending the true up deposit into the budget stabilization account for the 'twenty five'twenty six fiscal year. Would that be a priority for the administration if there continues to be, like, higher than anticipated revenues?
Speaker 8
I would have to take that back. That's part of our budget proposal as it stands, and I don't really know where the governor and the administration stands with changing it if there is more revenues. But it was it is something that is consistent with what we did last year and is part of the emergency declared with from last year. So but I would have to take
Speaker 1
I that think that we would like to jointly reflect on that with you over time and discover if that's a place that we might be going just given what's happening since the governor locked down the revenues.
Speaker 1
Okay. Thank you. I'm going to go to the list. I'm going to start with Senator Nilo and Senator Kovalta Nisantek.
Speaker 6
A question of Department of Finance. In your comments, you talked about the limitation of reserve deposits, particularly during that high surge of revenues. But there is still the ability to, at discretion, make additional deposits to the reserve as Governor Brown did prior to him departing, which left the budget in much better shape when he left than when he arrived. So, perhaps you could answer that question.
Speaker 8
So, that was true under Governor Brown, but what happened in 2020, '21, '22, 'twenty three, 'twenty three, 'twenty four, is we hit the state appropriation limit. And since all appropriations, any reserve, whether they're discretionary or into the BSA, count against the state appropriations limit, we were unable to do so because we hit the cap on the limit. So, we not only hit the cap, but we also hit the limit for state appropriations limits. So, any dollar that goes over that limit either needs to go back to the taxpayers, which we did quite a bit of that, but also or towards, like, infrastructure spending, etcetera.
Speaker 6
Interestingly, that was a very unique time. The appropriations limit limits the growth in spending to population growth and income growth, which I would submit makes absolutely no sense. It means that the demand for public spending is a direct proportion of increasing revenues, and the reality is the exact opposite of that. So, we'll probably never experience we never experienced that before, and we'll probably never experience it again because it was such a unique time of the pandemic and what I call the, the dollar bills from helicopters coming from Washington DC, which was had a huge impact on where we were. So, another thing about history, by the way, it is fascinating, but many times it is totally unsettled And the fundamental reasons for proposition 13 have been debated ever since proposition 13 passed.
I would suggest that fundamentally, the problem with property tax is it's the only assessment on personal resources that is not cash based. Income tax, sales tax, every other tax is based upon transactions that by definition involve the possession of cash. Property tax doesn't do that. And what was happening in California at the time was increasing property tax rates, particularly for people on fixed incomes that didn't have the cash. They had the property, but they didn't have the cash.
And while there could have been other issues, as you suggested, that might have compounded the desire for the reform of property tax, I would suggest it was fundamentally that people couldn't afford it, they had property, but they didn't have the cash to go along with the increased value of property that local governments were imposing in the property tax rate. So history is a fascinating thing. Sometimes, as I said, it's not totally settled, but I have a little bit different view. So a couple of comments. First of all, the essential role of reserves.
In the LAO's report, it's So the state can pay for spending on its core services when revenues drop. I would suggest another way of stating that is to avoid unsustainable spending commitments. That's the role of reserves. And I think it's important the two latter testimonies were calling us to, I think, emphasizing think of the safety net, consider revenues, and balance whatever you're looking at against the needs of today. Now I think we can all probably agree on the statement that regardless of the level of tax revenues that are available to us, whether it's limited by a reserve policy or not, there is never enough money to meet all of the demands that people have.
There just isn't. So while those are very good points to maintain safety net, to think about the thieves of today, the level of that is in the eye of the beholder. And given that there is no level of revenue that would meet all potential demands, it still remains that particularly given the volatility of our revenue sources that there has to be a way to establish a sustainable level of funding so that we don't spend spikes in funding and then have to pull the rug out of programs that we established at a particular time because we had the money and everybody wanted those programs. That's the purpose of reserves, to put a small g governor on on the spending of very high revenues, speaking in the automotive sense. I used this the other day.
So I think it's important to realize that, And it's good that you raise the issue of revenue because certainly that is part of solving a current budget problem. And there are some proposals. I suspect that there aren't the votes to go in that direction, but I think certainly we have to consider that that could be part of it. So I want to make sure that I get the other points that I had gotten here. The with regard to our existing reserve policy, the LAO talked about proposition two having a complicated sense set of rules.
There's two problems with proposition two. Number one, as we're seeing today, it is inadequate. Number two is exactly that complication. I have always believed that the best way to limit spending is the simple way. You establish a moving average of revenues over a five, six year period, and when revenues exceed that average, those all go into the reserve.
And when revenues drop below that average, you can automatically use the reserves and that maintains steady spending by putting a, as I said, small g governor on the ability to spend revenues. And the challenge with that is when we have really high revenues like '20 21 and that moving average sinks a significant amount of money into the reserves, people who want to either enhance programs or establish new worthy programs are gonna be very frustrated with it. But when we come back to a time like today, they're gonna be happy that we did that. Delayed gratification, whatever. Seems to me that is far more simple and I think would be far more effective in the longer term and that proposition that I referred to in 02/2010 whenever it was was essentially that.
It didn't pass but would have made today's challenge significantly easier.
Speaker 1
Thank you very much. Appreciate your comments and questions. We'll move to Senator Kibaldin. And Senator Grove is on deck. And if she's not back in time, Senator Sciarto is next.
Senator Kibaldin.
Speaker 13
Thank you, Mr. Chair. And want to really applaud the whole panel. I took the chance to read a few other similar reports in other states and the LAO report from last year that is the subject of the slides today is far and away the best in the country at applying this methodology and also making it reasonably understandable, a subject that's fundamentally not comprehensible. You've done a really excellent job and then to test it against the actuarial scenarios I haven't seen before last year.
And it's a really important contribution. And I want to agree almost in all points with my colleague from Fair Oaks in Sacramento County, the vice chair of the committee, on the fundamentals here. I first sat with the Assembly Budget Subcommittee my
Speaker 13
I was 22, which was three recessions ago. So I've seen this movie play out before in how seductive or how intoxicating the upside revenue, being on top of the purple line, how it feels. And how it feels like there's so much more need to be met. And particularly in the last decade where even the civic discourse around the capital and my district has been sort of like the job of the legislature is to do a really great job of figuring out what do people need and what do they deserve and then how do we fund that. Which is a radically different conception of what the job of state government is relative to state government's entire history or every other state government in America.
They don't start with that supposition. They're more of here's our resources, what share of those needs and what we deserve can we meet. Which is essentially what a nonprofit does, a small business or a family sitting around the table. This has uniquely been a place where we felt our role in society was to keep finding more needs and then meeting them. So I think the challenge that the vice chair has raised is a real one for us.
And that political dynamic is so powerful. And also the political resistance to revenue measures, especially during downturns, makes sort of a But you can raise taxes later whenever there's a downturn. That's not a real strategy. Honestly, it's not. I've lived through a bunch of these.
No one is prepared to do that at any sort of scale during the downturns. And even if they did, when you get back on the upside curve of the line, then you have a state appropriations limit problem. So the notion that we can just continue to spend and then we'll just raise revenues when we have a quote unquote emergency isn't a real strategy. We have to face that directly. Also like the Rainy Day Fund name.
It makes sense to me as a person from this part of the state because it rains all the time as everybody knows. But I feel like Rainy Day Fund means something different to people from LA and San Diego where it doesn't rain that much. So they're like, oh my god. Once in a while, it will happen. Rainy Day Fund to me me means like, we have to be ready for next Thursday.
Like it's going to rain all the time. And so conceiving this as an emergency fund is really I mean, I think that's one of the most important contributions of the Aleo report. This is a periodic shift. It's going to keep happening. And we have to budget for that as a normal part of the benefit that we get by having a progressive tax structure that puts most of the burden on the wealthiest as it should.
Maybe it should be doing even more. But that policy means that we have to accept that level of volatility. And I really appreciate also Elias pointing out the obscene surplus that led to that was a significant contributor to Prop 13. Also Serrano, but I guess I would take a slightly different view, is that Serrano essentially meant that the effectiveness of local tax increases to support education went down to zero because the state was, except for the few basic aid districts, the state was going to backfill it. But that said, and also to disagree with the vice chair, I was only a small child when Prop 13 passed, but I don't recall anybody having these kind of tax policy discussions at the time.
So trying to impute a whole bunch of meaning to what the voters were thinking. But it was clear even to a six year old that the state had a lot of resources. And so building those up through just revenue solutions every downturn is going to will lead inevitably at some point to a public backlash of the scale of Prop 13 that we're still having to live with today. And so we cannot simply that's not a long term strategy. I do have a question though, and that is around Elliot, you briefly have touched on the infrastructure piece, and I want to explore that with you.
And then Ms. Adjeransson, who I just want point out is a member of a very important family in my own district and the former mayor of Davis's two mayors of Davis's family, which is on the counter cyclical side. Because what I absolutely loved about your presentation, Ms. Asmussen, is that the state is most needed in the downturns. So it's not just about how do we hold on for dear life when the downturn inevitably comes next Thursday, metaphorically.
But it is that we will be even more needed because our people will be hurting much more. And also the hurting of our people will intensify and have a feedback effect and make the downturn even worse. That means we to be as healthy as possible in those moments. So to those points, so you mentioned infrastructure. And so I'm curious with respect to the reserve and also the GAN limit issue, whether we can be more expansive and are thinking about infrastructure being equally allowed as refunds or reserve deposits and what the implications of that are.
I've been thinking about this a lot because bond financing, and I'm carrying one of the major bonds this year, I'm a big believer in it. But bond financing is more sensible when you have steady revenues and you're going to borrow against it over time. When you have radically volatile incomes, it may make more sense or may make sense also to be doing some pay as you go infrastructure financing when you have $50,000,000,000 more of revenue than you thought you were going to have. Maybe it's better to spend some of that than it is to issue a bond against that longer time, including the downturns. So I'm curious if you can go a little bit more into the infrastructure side of the equation, how we might think about that issue in terms of that's also a part of our reserves in some sense in terms of the state's capital.
And then second, similarly, but we've never dealt with this before, can we imagine making more countercyclical investments within the state appropriations limit, for example, at a downturn or even at the higher level. Say we were bumping up against the state appropriations limit, and right now we can do refunds or make other rebates, essentially. Can make some infrastructure investments. Maybe you'll talk to us a little bit about that. But could we imagine a change to that limit that would also allow us to make investments in countercyclical things, including the kinds of changes to the unemployment, things that cost a lot of money but that will be necessary for the inevitable downturn as well.
Have we thought about that note, that part of the equation, kind of strengthening the resilience of the state and of the people of California when we're at the up and we're hitting that limit so that we're more better prepared when we're at the down?
Speaker 7
Yeah. I might offer a couple of thoughts because this is certainly something that our office has thought about. And it's a complicated point, but nonetheless, you know, certainly agree a very important one. The legislature has a good amount of flexibility to define what infrastructure spending is under both proposition two and SAL. They are very similar definitions in both cases.
I would have to, you kind of think about if whether they're exactly the same. But actually, I guess they are not. But in the case of proposition two, when the state has hit that infrastructure requirement in the past, the money has mainly been used to offset bond debt service. And essentially, what that means is that it has been used as general fund spending. It's essentially supplanting existing general fund spending.
And in the case of the SAL, to some extent infrastructure spending, when we're at that peak and we've spent a lot more on infrastructure, to some extent that's supplanting general fund spending, and in some cases, it is new spending that we would consider kind of supplemental. In both cases, though, to address your point about using the infrastructure requirement to improve resiliency of the budget, we have suggested in the past that the state could put the money in in an infrastructure fund as opposed to for direct expenditures on infrastructure. We think this is almost certainly allowable under proposition two, likely allowable under SAL as well, and that that would allow the state to essentially it's like a reserve, but a reserve that would be pegged only for infrastructure, and it's a way of improving the budget's, resiliency during the upswings that allow for the state to use some of that money in a productive way during the downswings. It is, of course, though, admittedly, like, a workaround to the existing requirements, and a cleaner and better way, that we've also suggested in the past would be to make deposits excludable from SAL themselves.
Speaker 13
Yeah, that makes sense. I mean, the challenge with workarounds is that they tend to be voluntary. Maybe I'm taking up the chair's offer to jointly reflect on the suspension of the true up money. If we need to suspend the BSA payments in a year when we have $43.50 plus billion dollars worth of unanticipated revenue. It's a very clear marker or signal of how our system doesn't really It's incapable of voluntarily doing these things.
So we do need the constitutional mechanisms to accomplish that. Then my last question, Mr. Chair, on think Ms. Antrimati, you were talking about inequality being a major driver of some of this. I'm curious if you can talk to us so the vice chair described how the state appropriations limit works, which is a function of population and economic growth.
But economic growth is measured by per capita personal income oversimplifying. But that personal income figure is not in a small way influenced by the ultra wealthy. And so I'm curious for the state appropriations limit dimension of this, if we didn't have the ultra wealthy, the state appropriations limit would be dramatically lower. As we think about the Because it's their ridiculous wealth that is driving at least the larger amount of the growth and limit. If we only had the rest of us, the limit would be flatter over time.
Have we thought about how we might make the limit itself less dependent on inequality, essentially, to allow us to be able to meet the service needs of the people of California? And that's it, mister chair. Thanks. I didn't have a question. But I was just letting
Speaker 9
Very quickly because I know lots of other people have questions. So, I have not looked into what it would mean to change the definition of per capita income for the SAL. I would like to point out, having lived through the experience of increasing the minimum wage and seeing the legislature take that on as a legislative matter rather than as a state constitutional amendment, I'm very aware that there's unintended consequences all the time. So if the legislature if there was political appetite to do something about the solemn it, I would maybe suggest that it gets repealed entirely with the commitment to take it on as a legislative matter because that gives the state much more flexibility. So that's one.
Two, in terms of setting aside extra money for infrastructure, that has the additional benefit of allowing for the state to take advantage of cheaper prices during downturns. So the state can if they have that money set aside to do infrastructure, they can both help stimulate the economy and add to jobs, but also do it at a cheaper price than if they were doing it when they had to compete with the private sector. There's this whole thing about crowding out, the government doesn't want to be too big because then it crowds out private investment. But during downturns, the state or the government is not crowding anyone out and, in fact, is adding to the benefit for the economy. So, that is a great idea to sort of allow for this extra firepower to have the state spend more during downturns.
Speaker 1
Does that complete your questions? Thank you very much. We're going to move to Senator Grof, and Senator Seyrich is on deck.
Speaker 2
Thank you. Thank you, Mr. Chair. 350 companies left California in the last five years. We have put policies in place that, for instance, we shifted state policies from prison budgets, and I realize that we're talking about reserves, but we shifted state policies or state expenses from policies that passed that shift, like AB two, one zero nine, where we shift state resources, like prisons closing that's estimated to save, what, dollars 166,000,000 a year.
It's a total of $3,400,000,000 so far based on, numbers that are available online for everyone. Three fifty companies have left, including Oracle, Valero just last year. We've created Cap and Invest and Cap and Trade, or both the same a name change. We have a company that just gave a warrant notice. 350 employees are losing their job.
They're shutting down the facility because they got a $48,000,000 bill from, CARB, which is not you guys. And I'm very offended that your solution is to raise taxes on businesses. Every single dollar, every single dollar that is collected by the state of California is from a business. If you go all the way back to the originating piece, a business pays, property taxes on the property they own, employment taxes, fees, different policies that create additional taxes on them. And I have some of my colleagues in an argument last year were like, well, I pay taxes out of my paycheck.
Well, it originates from an employer who pays taxes to the state fund. And they go, oh, well, we get money on the stock market too. But you wouldn't have the money to invest if it wasn't from an employer paying taxes, whether they paid their employees and their employees paid taxes. I have one, individual that I just had a conversation with when I stepped out because I got a call, and he called, like, three times. They're moving.
They're leaving the state of California. So, it was just ironic that it happened right at this time. I said, What do you pay for taxes? And he goes, well, last year I paid $18,000,000. How many of us does it take to make up that one guy?
And he's leaving because of PAGA. He's done. He's written his last check. He's done. He's not going to unionize.
PAGA was a bill that says, and all those PAGA things go away if you join a union. It's just union extortion. That's how the policies are written. But they're done. So he's done.
And that was a conversation I just stepped out and had. So to say that you're just gonna raise taxes on employers, And by the way, the EDD the EDD payments are 100% employer funded. They don't contribute no one contributes to that. And we are I think in 2000 and he blamed it on president Trump. That was interesting too.
But in 2008, president Trump was a talk show host or a talk show, I don't know, television show person and a business mogul. He didn't have anything to do with the 32,000,000,000 that was overdrafted on that particular thing, that it took employers employers ten years, from 2008 to 2018, to pay off. Let's think about that for just a second, when you look at adjusting the EDD piece. Employers had to like, for instance, a small business like I have had to pay $125,000 a year for the previous four years, like four years ago, in the 2008 part. We can't go back and bill our clients.
We can't go back and generate that revenue and put it into our budget to cover those costs, And then that bill increases every year into all the way up until the time that the total bill of the $32,000,000,000 is paid off. And now, we're estimating $55,000,000,000 and they're saying that a huge portion of that was fraud. There was and I had a list of stuff that I looked up on the internet. Somebody got an EDD employee got fined, got put in sixty six months in prison for taking $866,000,000 out of the system under fraud. There was like 20 top cases that was on the site I just looked at.
But yet, the solution is to tax employers more. A reality, the United States government has negative $17,000,000,000,000 in tax deposits. China has a $173,000,000,000,000 in tax assets in the positive. We're in a situation where we have played the shell game way too long. We've moved stuff from the state level to the county's levels, putting counties in jeopardy.
We're taxing employers to the point that they are going out of state. You're talking about Prop 13 that's being elevated when we have property tax issues. We have to have real solutions, and taxing employers and just falling back on that is not going to make this state better. There are huge issues that we have to face. When you look at the benefits and the fraud that took place in these benefits, when you look at housing programs, we spent a ton of money on housing.
It didn't make a dent in the process. Then you have all this exposure going on where the one guy running a housing program bought his girlfriend a Burmese bag. I don't even know what a Burmese bag would. I had to look at it. Google it right there.
It's $174,000 for a Burmese bag. Somebody running a housing program has the ability to do that. We have serious spending issues with no oversight. And to keep letting revenues go out of this building without having some type of oversight on it and to fall back on just taxing employers, these employers and these high wealth individuals that have created wealth, they have the ability to leave this state at a moment's notice. Do they want to?
I don't think so. It's one of the most beautiful states in The United States Of America, one of most beautiful places in the country. But they can't do it anymore with everything going on. I got a war notice for 03/2024 employees that are losing their job. Now, these are high wage jobs.
These are equipment operators. And you know what they're gonna do? They're just gonna we'll get our we'll get our soda ash that produces glass and plastic and borates. In the state of California, we produce that mineral here, but it's gonna go to China. They've already said that.
So, to say that you're going to tax us more as employers, I'm speaking from a small business that I've had for thirty years, sometimes in spite of this state, is absurd. I look at the revenue. I think Valero laid off three twenty eight people. I could be wrong. I think it's three twenty eight people.
They were high wage dollar jobs. Those people paid taxes that went into our income tax to fund the state of California. It was paid for by a business. The sales tax, the things that they would buy that would generate sales tax, it's a ripple effect of lost revenues in all areas. And to think that you can just revamp the unemployment insurance or increase cost for employers is completely absurd.
And I'm actually very offended by it. And we should have someone that's on the opposite side of the way you think that money just grows on trees no offense to counteroffset that because there are people out there way smarter than me that can give you all the data of the money that we have lost because employers have left this state. And it's the state of California policies that continue to increase that exodus. Again, deeply offended, mister chair, today. Thank you.
Speaker 1
For the record, she was deeply offended with a smile. So, we'll go on to the person who turned a new leaf and is thanking people, Senator Ciardo.
Speaker 3
Thank you. I want to start off by thanking everybody for being here and creating a more robust discussion than I was anticipating because we started getting into areas about administration and then prop 13 and some of these other things when I was hoping that we were really going to be focused on this issue of how do we create a more robust way of offsetting. In other words, how do we create a better reserve system for California? Now, one of the issues as I was reading through here is and somebody did bring up the emergency word. My question for anybody who cares to answer it, do we have a difference between an emergency fund an emergency reserve and the reserve that we have now, the stabilization fund, is there a difference or is it all kind of combined into one concept?
Speaker 7
By emergency, do you mean for like natural disasters and those kinds of emergencies?
Speaker 3
I mean when a bridge falls down and they have to rebuild the Bay Bridge for $6,500,000,000
Speaker 7
Yeah. In the past, our office has suggested that the legislature establish a separate reserve account because they are very distinct kinds of risks. The revenue downturn risk that we've been talking about today is a distinct risk from there being an earthquake or there being a flood and that causing infrastructure damage that the state needs to step into to pay for. Of course, the calculation for those kinds of issues is somewhat different. The expenditures associated with emergencies, the pandemic notwithstanding, although maybe somewhat inclusive, the the expenditures associated with the these tend to be much, much lower actually than than revenue losses.
Because in revenue losses terms, we're often talking about tens of billions, dollars 100,000,000,000. Emergencies can, of course, cost the state in the billions of dollars, but it's a different order of magnitude. Nonetheless, our office has recommended in the past having separate reserve accounts for these issues, just to have some peace of mind that the state is prepared for both of these things happening simultaneously.
Speaker 3
And I agree that that's something that we should be looking at, is having an actual emergency fund. Because over the years, we had the Loma Prieta earthquake that happened in 1989. And what resulted from that was a bridge that had to be rebuilt for $6,500,000,000 The I-eighty 880 that had to be unpancaked and rebuilt at a cost of $1,100,000,000 But that was over a span of time. The Bay Bridge took till 2014 to finally get it done. Down in Southern California, had several bridges fall down and we had one bridge that needed to be replaced because a tanker exploded underneath the bridge and they took it down.
Amazingly enough, they were able to replace both the I-ten Bridge and the I-sixty Bridge in less than three months at a cost of about $40,000,000 for one and 30,000,000 for the other. Those are the types of incidents that we should have an emergency fund that sets aside just to be able to absorb those type of things. When we have these massive brush fires in our agency, CAL FIRE goes out and we have to expend a bunch of money on overtime and reserves. Well, what happens now is we absorb that but then we spend the next two years trying to sue whoever we can find that we can try to pin the cause of the disaster on. So, I think it's really important that that fund be established.
Separate from that is what this revenue stabilization fund. My concern with having really high revenue stabilization funds is it discourages the practice of actually being really conservative when you're looking at your revenue streams. And it's kind of like a boat or two sides where you have water sloshing back and forth. Yeah, you want to catch that. But if you build it higher, people are likely to put more water in so you have higher sloshes going back and forth.
I think that's a bad practice because I think we've already landed in this spot where we are today because we like to spend money and we like to spend a lot more money than we actually bring in. And then we talk about what we're actually bringing in and who's actually paying that, that part of it, the income tax earners. Now there was a suggestion that we could just raise taxes on everybody. So when you raise taxes on the people that actually pay the taxes, you're talking about taking them from 50% of what they earn in some kind of tax going to 60 And those 60%, that difference is that many more people moving out. We have made California really unaffordable.
And what we're losing, and I don't know whether people have their eye on the ball, we are losing our future talent because those kids are not setting up shop here. They are raising their families in other states. And some of those kids have higher incomes. They've been educated. Their attorneys, their doctors or whatever they are.
They're making a half $1,000,000 a year and guess where they're paying taxes? Not in California anymore. They're going to Colorado. They're going to Oregon. They're going to anywhere but here because looking forward, they're thinking, you know what?
This state is not going to support us being here. We're just going to become donors for people who need help. We've identified that 38% of our population needs help and that's going up and up and up. If you have 38% of the population needs help and that goes to 50, that means less than 50% and then only the high wage earners from that are able to help with the money which means you're gonna have to get even more money from that. You keep raising taxes, the people that pay the taxes are going to leave.
Where are you going to get the money? Now, my last comment is the prop 13 comment. So my dad was an elementary school teacher in a poor district. He was actually one of the first special ed teachers in the state in the seventies. So I was actually there and I got to watch his anxiety every time the tax bill got there because my mom and dad were teachers.
My mom passed away and he was stuck with three kids, not stuck, but two of them were actually he had to adopt. And he had a new house to pay for. It wasn't new. He bought it in a foreclosure, but they could barely afford that thing. There was no no insurance.
He could care less about what was happening with the school district. His anxiety was every time he got that property tax bill, he didn't know whether we were going to be able to make it and we're going to lose that house. He was going to have three kids and not any other than moving into maybe his parents house to take care of them. That's what the anxiety was back then. That's why he voted for that when according to you, his district and him, he he was susceptible to this this racism.
Absolutely had nothing to do with white people voted for prop 13. It had to do with affordability and the in and the inability and and the penchant for local agencies to just pile all costs of anything they wanted to do into your property taxes and present you with a new bill that you could not predict how high it was going to be. So that, you know, when when you mentioned that, that really brought up some kind of bad memories of the struggles we had to make in the seventies. So, you know, that's not that's, you know, I I really was kind of offended by that. So you know, I appreciate that you think that that's how it happened, but I can tell you from experience that ain't what was going on.
What was going on is nobody could afford stuff because property tax are going out of control. The tax system already taxes us so much that we're losing people. We're losing businesses. And so we have to get a control on the spending part of this. That's the part where we have to focus on.
And what we have to do is stabilize what we our revenue we have to stabilize our our funds so that we can with with with we can absorb the shocks to it. The emergency shocks as well as this stabilization idea. I believe in the stabilization concept. I really do. But I don't believe in making it even wilder than when we have now because all that does is allow us to think that we can spend more, even more than we're doing now with revenues that are pretty suspect going forward.
You can raise taxes all you want, but if there's nobody here to pay them, we're gonna be in trouble. And I think that's where we're headed. And people like me, once the grandchildren move out, my wife gives us the we're moving out to. Yeah, we're gonna we'll be gone to. And so we have to fix this and we have to fix it in a manner that makes California attractive not just to people but the people that employ them because people with no jobs can't pay taxes either.
So those are my comments about today's.
Speaker 1
Thank you very much. We'll move to Senator Gomez Reyes and Senator D'Arrazzo is on deck.
Speaker 12
Thank you, mister chair. Some comments from the vice chair. I really appreciate those. I think getting the the history just as as my my colleague, senator Cabaldon, mentioned it's important to look at that base, to look at how things work. I appreciated the comments from Mr.
Graves that reserves are there to ensure that we can provide the services that Californians want and need. Californians
Speaker 12
ones that are paying taxes and some pay more, some pay less. Some are more blessed than others. They have a higher income and so with a higher income comes more taxes. And that is to provide the services that Californians need. Some cannot get that job.
Some are not getting paid the minimum wage. Some are not barely getting by with minimum wage. Some have two and three jobs to try to take care of their families. Something that my colleague said is not only it's what Californians want and need, it's what they deserve to live in the fourth largest economy. And we are still, even after people have left, businesses have left, we are still the fourth largest economy.
So we still have the number of people that are needed. We hate to see businesses leave. We hate to see the billionaires leave. We want them to stay here, but everybody has a reason for why they're going to make their decisions. I I don't know why, but I just feel like I need to say that we something that we hear is to whom much is given, much is expected.
We're blessed to have the more we're making, the higher our income. Yes, we have to pay more taxes. We have an absolute responsibility. It is still a percentage. If you take a percentage of a low wage earner, I mean, it's a lot to them.
It's a lot to them. And you know, when you take that same percentage of a high wage earner, it's a lot to them also. It means more money for this great state that we live in. What a privilege it is to live in this state. I do want to move and talk about prop 13.
I think prop 13 for people like senator Sarto's father, I mean, it was meant to protect them. It was meant to protect our seniors. That was the purpose of it. For those on fixed incomes, didn't want them to continue to pay more and more and more in taxes when they weren't going to receive more and more and more income. That's not the problem with prop 13.
The problem with prop 13 is all those corporations that found the loopholes in prop 13. When you have a corporation like Disneyland paying no property taxes, there's a problem. There's a problem with our property tax system when somebody, some some corporation like like Disneyland is paying no property taxes. That's a problem. That our seniors that are in fixed income, I am grateful for prop 13.
I am grateful for prop 13 because that was the purpose of it. For those with fixed income. But when those loopholes that allow all those corporations to just sell part of the the property, maintain the rest of it, and then take the property tax discount because they found that loophole. We've got to close the loopholes. We've got to close those loopholes.
We have to revisit prop 13. It cannot remain the way it is because the more we do that, then the less money is going to our counties, the less they're able to to provide for the indigent, the more the state has to pick up. That has to be revisited. Something that my colleague, Senator Gabaldon, my colleague from Yolo? Alright.
See, sometimes I don't remember where y'all are from, so I'm just gonna call you by name. You mentioned that our people will be hurting. The truth is our people are hurting now. This is a time when our people are hurting. I know that there's been lots of talk about HR one, the devastation to our to our state.
And it isn't to us. We're fine. It is to those who most need the help. Those who have the minimum wage jobs. Those who have barely enough money to cover the roof over their head.
Barely enough money from food stamps or from from the various programs from the food banks to provide food, put food on the table for their families, for their children. They're going to feel it. They're they're beginning to feel it. They're already hearing about it. They're beginning to feel it.
By next year, with so many people who will have no health insurance, who will be going to the food bank, expecting the county, the state's not providing the services, the federal government isn't providing the services. Now they're going to the food banks. The food banks barely have enough money because there isn't enough money from the counties to cover that indigent help that the county is required to provide. But again, because the county is not receiving the property taxes, because of all those loopholes, then where are the people going to go? Okay, a question now.
Irina Asmudson. One of the things that you talked about was the need to update the unemployment insurance program. Can you talk a little bit more about that?
Speaker 9
Thank you very much for the question. And I apologize to the senators that I offended. One of the very perverse things for employers in the unemployment insurance system taxes right now is that unemployment insurance taxes are capped at around $7,000 And so for those who employ lower wage workers or part time workers, they pay the full freight into the system. And because of the way California has borrowed all of that money from the federal government and and because of the way the loan repayment terms work, employers are absolutely on the hook to repay all of that money. And the state has chosen not to redo that system, to uncap those amounts so that the burden is more fairly distributed amongst employers and across payrolls.
So that means that to pay this money back, the rates on that very small amount per employee has to go up and up and up. That's what's so perverse about it. So it is making the burdens on employing part time workers, minimum wage workers be much larger than on higher income workers, and it unfairly penalizes those small businesses who are just starting out or who are trying to, like, expand a little bit. And so the system as a whole is not sustainable.
Speaker 2
I just want to correct what Yes. You You said it creates an unfair burden on the employee. It doesn't create an unfair burden on the employee to have a $7,000 cap. The employer pays that percent.
Speaker 9
I misspoke. Thank you. Okay. Yes. Those employers who employ those workers and have to pay escalating rates So if you are employing a minimum wage employee and you face a much higher rate and those rates are escalating automatically under the terms of repaying the loan, then that is effectively increasing the minimum wage that employers in California have to pay over time.
That is, to me, a huge opportunity to redo the system and to make the system more fair and to reduce the burdens on employers by doing this. Does that answer your question, Yes. Senator And I'm sorry, was that clear, Senator Grove? Or did you have further questions? Can I?
Okay.
Speaker 12
Ms. Reyes' Reyes' Reyes, you talked about, first, setting aside for a rainy day, which we are doing. Second, the balance. And I appreciated your comment. It's to find the balance to build a California for all, especially to help as a result of HR1 on health care, food assistance, and child care that you mentioned.
I just wanted to say that I appreciated that you talked about this balance and to make sure that the services that are needed for Californians are provided. And I did have a question on the diversification. Raise revenues. Now, where would how would you recommend that we raise the revenues? What are your thoughts on that?
Speaker 4
First, I wanted to note sort of a historical note here that several governors have signed off in California's recent history on revenue increases as a way of helping to get the state through budget crises. We can go back to Governor Reagan in the 1960s, Governor Wilson in the 1990s, Governor Schwarzenegger in the early 2000s. So, it certainly is not unusual for California's policymakers, your former predecessors in the legislature maybe, who have seen revenue increases as one option for helping to close a budget shortfall. Not the end all, be all. It was always coupled with other solutions, including some pretty deep cuts, especially before the legislature and the governor agreed to put prop two on the ballot in 2014 and help to build a solid reserve.
So, I just wanted to make that context clear. In terms of revenue options at this time, my colleagues who focus on tax policy on our website at calbudgetcenter.org maybe some of you have seen the research, have been focusing a great deal on how very well off corporations doing business in California we're talking about billions in profits every year somehow manage to pay very little in corporation taxes or perhaps nothing. And this is all legal, right? These are all loopholes that are built into the state tax code that previous legislatures and governors decided to drop in there. And so, our perspective is that that means these folks aren't paying their fair share.
They're making money hand over fist, billions of dollars in profit. We're asking all Californians who can to contribute to the personal income tax. On the corporation tax side, we see a lot of loopholes, billions of dollars per year that are not coming to the state treasury to help not just offset budget gaps, but also invest in Californians' health and well-being. There is a bill that was introduced on the other side of the legislature in the assembly. I don't know the bill number off my head.
Off the top of my head, this would close the waters edge election loophole. This is the one where we're losing 3,000,000,000 or $4,000,000,000 per year. This is a way of offshoring corporate profits to evade state taxation. And so, at least some of your colleagues, maybe in this House, as well as in the Assembly, are very concerned about this. There are other opportunities, as well.
I'm not our tax policy expert, so I would encourage I could follow-up with you, if that would be helpful, and put you in touch with those on our team who can give you a lot more information about that.
Speaker 12
The other option that you mentioned was to borrow from state funds. Could you tell us a little bit more about that?
Speaker 4
Yes. So, this is another one that has been used historically as a way to help muddle through prior budget crises. Right? As a way of saying, yes, we could solve this all with revenues or we could solve it all with deep cuts or maybe let's just do cuts in revenues. But actually, there might be another opportunity here, which I think drives some people crazy because they don't necessarily like the idea of doing this, that we have lots of special funds in California, hundreds of them.
And many of them have fairly substantial balances for good reason. And in bad budget years, the legislature and governor will often say, that money is sitting there and could be temporarily used to help get us through this general fund shortfall we are facing now, maybe a few billion dollars borrowed that is always paid back with nominal interest. Right? So, these funds are not being rated and never paid back. Right?
These are loans from special funds. And this allows the legislature to sort of work through a budget crisis without feeling like the only options you have are to deeply cut services or to just do huge tax increases. Right? So, it's sort of another tool in the toolbox that I wanted to highlight. I know there are questions around whether you may or may not have exhausted that strategy at the moment, But, to the extent that special funds are paid back over time, that will always be an option in the future.
So, I guess, what we often counsel is that sometimes people are hoping for the big bang approach to all of this. We can solve it all with this one silver bullet that will get us through. And sometimes, muddling through may be a better way to do things, even if it maybe isn't the most satisfactory method at the moment.
Speaker 12
Thank you. And my colleague reminded me that it was Assembly Member Connolly who's carrying that particular bill. The last option under diversification was you talked about the projected surplus temporary account. Tell us about that account, please.
Speaker 4
Well, I mean, this was a really interesting idea that was put into law just maybe two or three years ago. You, the legislature, created this new account as a way of giving yourselves and the administration an option of saying, wow, revenues are really doing they look like they're doing pretty well. Right? We're we're riding high here. Revenues are coming in way better than we thought.
But how much of it is real? Not quite sure. Maybe we should carve off a piece of those expected revenues and put them into this new account with a very long name. It's like, it's a surplus holding account. And it gives you an option to avoid committing those dollars immediately.
And then you come back and you take a look. A year later, let's say, come back and say, did those dollars actually materialize? And if they didn't, you didn't commit them. No harm, no foul. If they did materialize, then you have the option of saying, ah, we now have those revenues in place and we can invest them appropriately as we see fit, whatever our priorities are at the moment.
It's been a little puzzling, I guess, that this account I know it's pretty new, but it hasn't been tried out yet. It's so it's still untested, and it seems like a good opportunity for the legislature and the governor to give it a try and see if this would help get the state through, you know, some tough situations. Thank you.
Speaker 1
If you can begin I've to wrap been really generous with everyone. We have six people on the list. Okay. And if they each took ten minutes, we wouldn't have time for it. We need to get to the end and to the other people on the list.
Mister Well, no, I think Senator Reyes' husband has been sitting there making notes and he's gonna have extensive public comment when we get there.
Speaker 12
Ms. Hollingshead, first I want to thank you. I'm so glad you began today's discussion giving us this history and providing the charts that you did. It was easier to understand. At page seven of on the recommendations, you talk about raising the cap from the 10% to the 50 and doing this gradually.
Legislatively, how would that done, or is that sent to the to the to the to Californians, to the voters? How is that going to be done?
Speaker 7
Yes. It would have to be sent to the voters because it would be constitutional amendment on the budget stabilization account. And we would suggest that the the legislature's bill that would go before vote that would eventually become the ACA that would go before voters would have a schedule under law where the cap would automatically increase by, you know, by a set number of years.
Speaker 12
Wonderful. Thank you very much. And, Mr. Chair, that was my last question.
Speaker 1
Thank you. And our list is growing. So my previous admonition about ten minutes should actually get smaller. Senator D'Arrazzo is up, and Senator Richardson is on deck.
Speaker 5
So the lesson learned is put your name on the list right away. Don't be the last one.
Speaker 5
I don't know exactly what you meant, miss Irena, but you mentioned something about the structural changes in the economy when changes in the economy were not reflected, have not been reflected in in terms of our policies. And I just I wanna comment that I I I could see that happening right before our our very eyes. Just as one example, again, I don't know what you meant by it, but employers providing health care insurance to their employees, the number and the percentage of that has over the decades has diminished enormously. And I think there's a correlation there with the number of people who are on Medi Cal. The number has grown enormously over the last few decades.
So there's something about we're not we're not taking into account what's going on out there in the real economy for for people. And that's where my concern is, not only for what you you present today, all of you present today, but how do we, you know, how do we determine the success, not measuring just by credit ratings and bond markets, but by whether Californians can consistently access health care, pay for the food, pay for a roof over their heads, and other core needs. They're not asking for, you know, 10 cars in the, you know, in the garage. It's just like these are basic needs, and that's what they need government to help them achieve. They wanna do it on their own.
So if an employer does not provide the health insurance, does not provide the retirement, where do they go? They go to government. So we have to pick up the tab when it's not being provided. So my my, you know, questions are how should these reserve policies or any any other policies be structured to explicitly prevent disruptions to health care access or other basic economic security, especially during downtown downturns. We have got to make sure that our policies our policies here at at the state do not leave people behind and out when it comes to these basics.
And so I'm I'm concerned that we're coming up with reserve policies that are just not connected, directly connected to regular working people and what they need and what they try to reach every single day. The majority of people on Medi Cal work. The majority of people on Medi Cal work. They are not sitting at home. You know?
Major the demand for child care is enormous. Enormous. We're not helping to build a child care system or a part as part or not part of our education system. So we're not addressing these basic needs, it seems to me, in these policies. So I I just how how do we how do we do that?
How do we how do you propose ideas for policies that are gonna be based worker center centered economy or a human being based economy? The people who work every day are not looking
Speaker 5
billionaires. They wouldn't mind it. But that's not where they're all coming from. They're all coming from, I want to have a basically good life for me and my kids. So, what do you suggest based on that?
Not, you know, the bond markets.
Speaker 7
I mean, I do want to recognize that a lot of the language that we're using here is very technical and theoretical. But ultimately, what we're talking about is protecting services for Californians that have been committed to by the legislature in previous years. So when we talk about, you know, this idea of core services or we talk about the state's ongoing service level, what we mean is that the state won't need to look to the programs that it usually needs to cut during downturns in order to balance the budget. So that's often, you know, as you've already mentioned, health and human services programs within limits by the federal government, universities, the judicial branch, you know, right? There's parts of the budget where the state has relatively more flexibility and ability to control spending and isn't so constrained by constitutional requirements or court requirements.
And so those are often the places where the legislature goes to make budget reductions when revenues drop. So I think it's important to emphasize that, you know, that there is a very clear bridge between having the money available and then being able to support the service level for Californians. I did also want to mention, I think this is an issue that's been kind of touched upon in various places, But there is also the issue that when revenues are surging, often, you know, what we would think of as sort of the opportunity cost of that money is going to be lower than when revenues are falling. And by that, I mean that the needs are are broader and bigger when revenues are falling because that tends to happen during a recession, during a downturn when there's higher unemployment, when people have more need for state service. And it's precisely that time that it's important for the state to be able to meet those needs and to be able to, you know, maintain the service level that it has committed, rather than pulling back.
So, recognize that, you know, the way that we talk about this sounds very theoretical, but it is meant to be connected to the state's programs.
Speaker 5
Yeah. I I understood what you were saying. It's not so complicated that I don't understand what you're saying. The question is for you. How do you develop policies that are more explicitly aimed at working people and them not having to be without health care, be without, you know, a roof over their heads.
So I think you all need to be much more directly focused on working people and what their needs are versus, you know, how does this look, you know, you know, on the stock market. I and gentlemen, it's
Speaker 4
I'm just and to put this in the context of reserves, I just wanted to remind us all that the state you all did create a safety net reserves several years ago and had $900,000,000 in it at one point. It was specifically designed to protect CalWorks and Medi Cal during downturns. And that money was used, I don't remember exactly when, within the last couple of years. And so, that I wondered if that was where your question was going. It is true that the budget stabilization account is a general fund reserve.
It can be used anywhere the legislature wants to put those dollars. In theory, it could use be used to prop up the prison budgets, which may or may not be a priority for you or anyone. So, if you have designated discretionary reserves with different labels on them, like SafetyNet, then those dollars could be directed where you want them to go during recessions in order to protect specific programs, as opposed to we're just gonna pull money out of a larger general fund reserve and then figure out where to put it. So I'm not sure if that's where you were going with your
Speaker 5
I mean, that's that's a that's a better idea there. I just I think that, you know, there's other policies that we just have to think out of the box. You know? Other policies about where do we invest our like, our infrastructure. Someone mentioned infrastructure dollars.
That creates jobs. It creates good paying jobs. It it it probably in the downturn, someone said, right, it's probably less, expensive to do it. But policies like that, which are gonna create the jobs that we need, be more explicit about what we're doing with the funding that we do have and how that could benefit working people and not just, well, we're gonna make more money by investing over here, not by creating better jobs.
Speaker 1
I Do you want a response? Direct it to somebody and they will respond. Who would you like to have respond?
Speaker 11
I could offer something. I don't know if you'll find it satisfactory. Think various comments, including yours, Senator, point to kind of three challenges that the state of California is facing simultaneously. One that is highlighted by this hearing is that the reserve policy that the state currently has is not gonna be sufficient to sustain the level of service that we have in recessions. We have a separate issue of what to do with revenue surges to the surplus holding account.
That's an estimation error issue. But fundamentally, the state does not have sufficient money set aside under the rules of Proposition two to sustain the level of service that is currently offered. The second challenge the state is facing is that the federal government has pulled back significantly, particularly in the areas of health care and food assistance, and the state faces very difficult choices about how to respond to that change. And then the third challenge that is intertwined with that second one is that the state faces notable structural deficits. We, the LAO, cannot weigh in on what the right size of government is.
That is a decision for the policymakers. And so when faced with this structural deficit, we can offer you ways to change your levels of revenue, your levels of spending. But ultimately, these two things are not currently in balance. And so the revenue ultimately, kind of turning back to this reserve policy, and I think to the point that you're you're aiming, us to answer, is that what we are trying to offer is a reserve policy that can help the state meet its commitments for services to Californians, regardless of what that level of commitment is, such that when there is a change in the state's revenue structure or potentially in the level of support from the federal government, the state can respond and potentially backfill some of those losses to ensure that the services are sustained. Because, as you know, outside of Proposition 98, the vast majority of general fund spending goes to the state's safety net programs for Californians.
I hope that helps a little bit.
Speaker 1
Okay, thank you very much. We have forty minutes left. And we have six more people. Which actually the list can't get longer because we will now have every single member of the committee make comments or ask questions. I appreciate this level of participation.
We'll go to Senator Richardson, and Senator Weber Pearson is on deck.
Speaker 10
Thank you, Mr. Chair. Let me preface my comments. Call Mr. Laird and I the OGs of the group, but I've been around here long enough to know that please don't take personal when people say they're disappointed and upset.
It's not you. It's you know, sometimes the reality of what we're hearing. Sometimes it's we may agree to disagree, but I have found in my one short ear here, I don't think most people mean it personal, so I don't want you to walk out feeling bad. You did your job, and now it's time for us to do ours. So be encouraged.
That's my first point. My first question is, when we're talking about doubling the reserve from 10% to 20%, are we talking about approximately $3,500,000,000 to $7,000,000,000 or somewhere between 7,000,000,000 and $8,000,000,000 Is that what we're saying? Could we say the numbers associated with this?
Speaker 7
The Department of Finance might have the numbers off the top of their heads better, but I do believe currently 10% is around $20,000,000,000 of reserve, and so 20% would
Speaker 10
be closer to 40,000,000,000 Wow. Okay. Is that your understanding, ma'am?
Speaker 8
Yeah. I would say the estimate of the 10% through the multi year would be between 22,000,000,000 to $25,000,000,000 and then taking it up to $20,000,000,000 would be up to about 50,000,000,000 in multi air, if we could reach those.
Speaker 10
So, in light of that, I won't pontificate on my perspective of that and where that would come from. That's kind of a daunting that's why I wanted to hear the number, and I wanted us to hear the numbers so we would really understand the significance about what we're talking about. From the LAO, could you please provide to the committee I'm sure you've done reports on Prop 13. There's been a lot of discussion on that. Would you kindly share them with the committee at a later date when available?
Also, if you have any reports regarding Prop 98, those funds, what has come in, maybe what is covered, not covered, and so on, to give us a little more knowledge. And then, finally, if the LAO has any reports on initiatives that we have that are not paid for. So, for example, Prop 36, although it was passed, there was no money allocated towards it. So, if you have any information on that, I think that would be helpful for us to better understand as we go forward with dealing with initiatives. My next question has to do with where revenue increases come from.
It's my understanding at the budget retreat, we went over a little bit about a large part of those are coming from health issues. Is it possible for someone to help us delve into better to understand, are those health implications due to are they deal doing, having to do with the baby boomers, and we're at the tail end of the baby boomers? And can we expect that number to begin to go down? Does it have to do with, people who are working for companies that aren't being covered by insurance? Could we get a little more information on where we think those numbers are coming from?
And I don't expect you to have the answer today, but if you do, that would be great. But if not, if you could follow-up with the committee, that'd be helpful. Is that something you might know?
Speaker 11
Yes, just to make sure I understand the question, you're looking for cost drivers in Medi Cal. Is that the underlying question? Like, what are the core cost drivers in the Medi Cal program?
Speaker 10
Yes, the cost drivers. And do we anticipate any changes? Meaning, this is I was reading I'm at the tail end of the baby boomers. So, are we going to see now a decrease? Because now a lot of those initial baby boomers are in their eighties.
Are we going to expect to see a decrease? Or no? Because we have people who are gig workers and aren't having insurance. I don't know if it's possible to and I don't know if this is something I should be requesting officially in legislation and a report, or is it generally, info that you know. But I think it would really help us to to see a little further down the road of, are these numbers looking to be consistent, or do we expect to
Speaker 11
see any changes? We are so we are currently undertaking our analysis of the Medi Cal program for the purposes of understanding the budget, and it will delve into the very questions you are asking. What are the major cost drivers in Medi Cal? What proportion is driven by demographics? What proportion is driven by kind of underlying just growth in health care costs?
Demographics are a piece of it, not a significant piece of it. But that's something that will be in our forthcoming medical analysis, and we'll make sure to get that to your office.
Speaker 10
Okay. And I have three last quick questions. I haven't heard in the senator of, I believe from Los Angeles, Senator Reyes, briefly started talking about cities and counties. I've been around long enough to remember when, for example, San Diego, you know, had bankruptcy. Who would have ever thought San Diego would have had that experience?
So we're talking about balancing our budget, but what happens when the cities and counties, their budgets aren't balanced and they're gonna be coming to us? Have we looked at those types of numbers to anticipate if we're going to ask to be helped to help cities and counties in these projected years? Has anyone looked at that or talked about it or?
Speaker 11
We're certainly familiar with some of the budget constraints and budget challenges that a number of localities are facing. At the moment, the state does not have budget capacity to provide funding to those localities. The state has allowed local jurisdictions to go bankrupt in the past and to undertake kind of fiscal restructuring in that process. But at the moment, the state, too, is faced with notable financial constraints that make such assistance challenging.
Speaker 10
Did you have anything to add? Got a pretty good name here. Asmundunson? I did my best.
Speaker 9
Asmundenson. Asmundenson. Thank you for the question. This is, in fact, the work that I am trying to do right now. I know that the associations of League of Cities, CSAC, they're concerned about these issues, CSBA, both the aging of the population and the structural issues that affect the California economy, those are all hitting cities and counties.
Oftentimes, they don't have capacity. And so, honestly, one of the best things that you could do for your constituents is to talk about these issues and make sure that, at the local level, the elected officials are also talking to people. As a general point, I think we've all realized that social contract issues are at play here. And so we're going to have to figure all of this stuff out together. There aren't any easy issues.
But again, talking to your constituents, making sure that they realize that the state cannot bail them out is a huge service to them.
Speaker 10
And as you complete your work, we would certainly remain open to learning more. Serge, did you want to add?
Speaker 4
I was just going to note, I'm not here representing the counties, but a couple weeks ago, they did put out a report where they estimated the cost of HR1, implementing those provisions, and their estimate is that the annual cost to counties with no state backfill would be $6,500,000,000 to $9,000,000,000 maybe six somewhere between 6,000,000,000 and $10,000,000,000 per year. That's a range, but that is their estimate. And as I understand it, they are talking to the administration right now about the fact that they can't take on 6,000,000,000 to 9,000,000,000 or $10,000,000,000 per year in new costs to implement H. R. I.
Speaker 1
And we commented on that report and discussed those numbers at our hearing on H. R. I. And the top end was 9,500,000,000.0 So
Speaker 10
a copy of that report, that would be great. I'm assuming staff has it. And then my last question is, sir, for you. You mentioned that there were various funds that we could consider potentially borrowing from. You also mentioned potential loopholes.
If you would provide those to the committee so we could look at them further and potentially have a further discussion. But thank you for all of your participation and look forward to working with you all. Thank you.
Speaker 1
Thank you very much, Senator. We're going to move to Senator Weber Pearson. And Senator Smallwood Quavis is on deck.
Speaker 14
Thank you, Chair. I promise this will be quick. I want to thank everyone so much for taking the time. This has been an excellent panel discussion this morning. Wanted to quickly just ask a question within the LAO's presentation.
Around the excess capital gains and I know you had said there was this formula that was created, a very complicated formula. Before we embark on potentially changing that formula, just wanted to understand the historical the history behind why that formula was created in the first place.
Speaker 7
Yeah. So, essentially, there is a I'm going say theoretical, but not actual relationship between Proposition two and Proposition 98. And the way that this formula works that reduces the excess capital gains is it says, what would Proposition 98 spending for schools and community colleges? What would Proposition 98 spending be were it not for excess capital gains? What is it actually?
And then the difference between these two things is what's subtracted from the total excess capital gains requirement. I think we have I want to say, importantly, this has absolutely no effect on school and community college spending. There is no I I people I think that sometimes that can get confused because, of course, if I say, like, well, there's this confluence between Prop two and Prop 98, you would assume that that means that that affects school and community college funding. But it does not. All that happens with that excess portion that is not going to the formulas is that it goes back to
Speaker 7
fund. I think we have tried to understand the rationale behind this, given the complexity and given, given the complexity of how it works, it often results in these incredibly counterintuitive, calculations where, you know, you'll suddenly have a 100% of the excess capital gains are no longer required because you're switching tests between the two calculation. You know, there's there's just, like,
Speaker 7
really odd things that can happen, and it creates almost like we would think of, like, a random number generator in the formula. So we've we have asked ourselves and asked and and talked to the Department of Finance about, like, why does this exist? I mean, I think the the sort of underlying rationale, as best we can understand it, is that the idea is that you wouldn't want to kind of doubly commit money that has been committed under the prop 98 formulas also for prop two. Both prop 98 and prop two are saying that there's a share of general fund revenues that need to go to these commitments. And so you don't want to sort of double commit the same tax dollar.
That's the theoretical idea. In practice, it doesn't work at all that way. Practice, as I said, it's more like a random number generator. And so given that complexity and given the way that it's reducing excess capital gains that go to reserves, we do think that it makes sense to change that.
Speaker 14
Thank you. So if we changed or eliminated that formula, it would not necessarily have an impact on anything else?
Speaker 7
It would essentially mean that there's less money for the general fund in years when revenues are peaking as a result of capital gains. So, like, in year you know, in for example, in recent years, in '22, '23, in '23, '24, if I'm gonna get those right. No. I didn't. '21, '22, and '22, '23, when the state had really, really significant surpluses, it would have meant that those surpluses were a bit smaller, not hugely smaller, but a bit smaller, and that that money would have gone to reserves instead.
Speaker 15
Thank you, Mr. Chair. I really appreciate the conversation and especially, you know, the recognition of the purpose of reserves. And for me, what's clear is that the purpose of reserves is to protect people, to protect the investments that people have asked the government to make, especially during economic downturns when we have before us the need to cut health care, to cut child care, to cut all of the workforce programs and vital programs. I think this is a very helpful conversation.
I was a little surprised by the disappointment and being offended because I am both disappointed and offended at the ways in which the Trump administration has created for California a crisis now that we have to have these kinds of discussions, essentially giving trillions of dollars to the wealthiest 101% individuals and corporations while working people, particularly young mothers, young families, are facing the dim prospects of losing their health care, having their health care get out of reach, and we know just everyone struggling to make ends meet. I want to just double down on comments made by my good colleague from the Empire, who just talked about how it is unacceptable that we have the wealthiest 1% getting a trillion dollars while we're going to cut a trillion dollars out of our Medicaid funding slashing the safety net for so many. And again, we're here having to do this work because of that. We're here because of that. Not that we haven't looked at balancing our budgets.
We created the rainy day funds to do just that. But we have this external pressure now that we have to respond to. And so I am incredibly offended and disappointed by that. I really wanted to ask a follow-up question to Ms. Asmundson, because you talked about the human infrastructure, and you talked about our unemployment system and how, you know, during COVID, the strategy was to invest more into workers, the human infrastructure, so that we could weather the impacts of COVID and avoid recession, which, obviously we have.
And it was a strategy that worked. And certainly, no major undertaking like that happens without some challenges. But for the most part, California was not able we didn't see huge layoffs. We didn't see a total chill in our economy. And so, my question is, as we're talking about reserves and ways to reform those strategies to increase our ability to weather these kinds of downturns.
And we're also talking about the question of how do we raise revenue overall to ensure that there's a balanced and shared responsibility and ensuring that we are able to maintain the programs that the people of California have wanted. I go back to the question about the human infrastructure and workforce. And what are or what do you see as some of the out of the box thinking to address the affordability question and the ability for workers to be able to sustain themselves during these downturns. I I I see we talk about revenue, we talk about cuts, we talk about reserves, but what I don't hear us talking about is sort of workforce development strategies. What I don't hear us being intentional about is saying, Okay, who's in the safety net and how do we move them from being part of an extraction on resources to sort of a revenue contributor through income tax by moving them into quality jobs.
So I'm curious, you know, are there strategies that the legislature should take that can strengthen wage based income while we also are looking at this question of performing our reserve policy and looking at other revenue strategies? And is there a sense that if we did that, we could sort of take some of volatility out of the economic cycles that we seem to go in in terms of boom and bust. Because one thing is true, that the personal income is that stabilizing factor. So I'm just curious, how is there a possibility to do more investment in looking at workforce and those strategies to help to stabilize that personal income? That is
Speaker 9
a great question. That is well beyond the scope of this panel, but I will note a couple of things. First, a lot of the easing of barriers to allow people to get education. Senator Kibaldin, I was very proud of the fact that you made it much easier for people to go to CSUs through an automatics. That was an administrative thing that the state did.
And hopefully, over time, that's going to really increase the employability of people. So one is good wage jobs, which people can get qualifications for. The other part is, again, it comes back to the social contract of what kind of affordability challenges do we face in the state. And a lot of that has to do with housing. A lot of that has to do, unfortunately, with Prop 13.
And so those are much longer conversations that have to be had, both on the wage side and on the affordability of California. And so those intersect with the reserve discussion that we're having right now. But I applaud you for taking that on, and I would be happy to come back and talk more about that issue in future testification. Thank you.
Speaker 15
No, I appreciate that. I mean, because we saw that work in the Great Depression sort of era where we invested in the works program administration. We saw it in the, you know, crisis in the seventies around the gas crisis with the creation of the community employment and training program to really bring those most vulnerable folks in the safety net into a structured process that would track their ability to move into higher paying jobs and out of the safety net, overall reducing the cost that we had to share for safety net and programs and core services. So I appreciate that. My other question that I had is having to do with looking beyond California and what other revenue models may exist, in sort of large other large states, states that have diverse, economies that we should be looking at in terms of this balance of potential revenue strategies and reserves?
Are there any other models that are out there that are showing some promise?
Speaker 9
So I will also say the social contracts in the different states are so widely varied. I used to get questions all the time about, Okay, how does California compare to other states? It really is comparing apples to oranges, but I'm happy to have a conversation about that, if you want.
Speaker 1
Thank you very much. And just before I go to Senator Achalabog, there was a follow-up question from Senator Weber Pierce.
Speaker 14
Yes, thank you. Just one follow-up question. If we were to change the formula or no longer use the formula for the excess capital gains, is that something that we could do from a legislative standpoint, or do we need to take it to the voters?
Speaker 1
Thank you very much. And just before I go to Senator Choi Bogh, we had Senator Choi and Senator Archuleta in line. They had to leave. Senator Archuleta really wanted to put on the record that his concern was how we're funding GO BIS and how GO BIS fits in the budget. So I just want to let everybody know that was his concern, that he would have raised in a comment and a question if he was here.
Then we'll go to Senator Ochoa Boak.
Speaker 16
Thank you, Mr. Chair, so much. This has been incredible. And I just my hat has just been my eyes have just been open quite a bit. And I have appreciated so much the perspective that my colleagues have actually brought up.
And also appreciated some of the comments that have been made here today. So, many, many aspects, but I'm going to try to be as quickly as possible in addressing some of the things that I have learned and some of the comments that I would like to make. I'm not sure if there's going be a question on the end. But first of all, we've talked a lot about the reserves. You know, this is about reserves and what the purpose is behind those reserves.
And as we look at the reserves and the programs that they're supposed to be addressing, which is the basic core safety net, what we should be considering safety net components in government. That's what they're for. One of the things that I've said, and I've said very often in my town halls, is that, you know, government should really be there to provide safety nets for those that are the most vulnerable in our communities. Right? That is what we should be focusing on as far as programs go.
But here's a couple of things that I want to address. According to the Calmatters article that came out just about a week or two weeks ago, said it stated in there that in the seven budgets that Newsom has signed beginning in 2019 and '20, and the eighth one he has proposed, revenues have increased by 60%, mostly from taxes that tapped into a 48% increase in Californian's personal income during the period. Total spending, however, jumped 72% from $2.00 3,000,000,000 to $349,000,000,000 So, when we talk about revenues and talk about new revenue, the need for new revenues, folks, we've had an increase in revenues every single year, 60%. So, as we talk about the need for or the assessment or the reconsideration of taxes, let's think about that. In that same note, I want to point out I also want to point out that when we look at the tax perspective in California, according to the Tax Foundation, California has one of the highest overall tax burdens in The US, ranking forty eighth for competitiveness in 2026.
Let us sit on that for a bit. And it says here that it features the nation's highest top marginal individual income tax rate of 13.3% and up to 14.4 with payroll tax, and a high combined state and local sales tax of 8.98%. So, are just some of the tax rates, how we compare to the rest of the state. So revenues are up, highest one of the highest tax state in our in in our nation. So having said that, I wanna talk a little bit about, you know, we're we're talking about programs that we are addressing here that we're supposed to cover.
And part of our responsibility as far as protecting, you know, those that are the most vulnerable are safety net programs. And we talk about why they're there. You know, how these programs have actually skyrocketed with our programs and our government growing a little long growing quite bigger. So, a couple of things. You know, my colleague from Bakersfield mentioned the cost of doing business in California.
Extremely expensive. And much of the taxes also being paid by, you know, being paid by these businesses. When the cost of doing business in California is so extremely expensive, we're going to see industry moving out. Right? And we're seeing that.
We see articles of these major corporations leaving the state. So we see and, you know, it was mentioned earlier today, if these people by my colleague from Temecula, when these industries or these businesses leave, those are the ones that are creating industry jobs. And when they leave because the cost is not bearable, including minerals in my district that just announced the closing of their plant after over a hundred years being in business in California. They're laying off over 300 people because they can't afford to do business. So let's talk about the cost of doing business and how that impacts everybody else.
As industry leaves, right, we don't have people that are paying into the system. Downward spiral. The cost of doing business also increases the cost of goods and services, which cater to the cost of living increase. So, we have families that are currently working two, three, four jobs to make ends meet. We talk about the importance of education, ensuring that we have a workforce that is prepared to be able to move up economically.
Right? Which is incredibly important. But here's the problem. That regardless of what we pay people, if the cost of living continues to grow up, it's gonna be incredibly difficult for these folks to be able to stay in this in this state. As mentioned by my colleague, our young professionals are leaving.
Why? Because as mentioned earlier by mister mister Graves, right, he was talking about, you know, we not we because I I'm haven't supported many of the things that make it become very costly to do business in California. But this legislature has created a system that has made the cost of living incredibly, incredibly costly in California, brought by legislation that has made the cost of business, of conducting business, incredibly expensive. Also, the cost of actually being able to live here. So let me let me bring this forward and give a different perspective.
The system that currently is in place is not working for the average Californian. And we're trying to create more reserves to pay for those for those programs that are going to kind of subsidize, the need because people can't afford housing. Right? But why can't people afford housing? Well, it's legislatively.
It's policy that has made the building of California housing so expensive that it doesn't work out. It doesn't pencil out. So what do we do? Those regulations that have made building housing so expensive is now being looked at to government, to the legislature to say, How do we subsidize that housing? And then we go into education.
Education. Much of education in California is incredibly expensive. So expensive. This is why my kids are going to school in Utah. Right?
My kids are in school in Utah because it's so much less expensive for them to actually go there. But as we are looking into the cost of of schools, the cost of schooling is so expensive for our universities. Incredibly expensive. So what do we do? We subsidize.
We create programs so that we can subsidize the education of our students to be able to complete their education in California. Right? But why is it costly? Because of everything that we expect them to do and not fully subsidizing the schools. So then we subsidize the students because we're not fully funding our schools, our universities to be able to do that.
And then their costs of running those schools are incredibly expensive. Why? Because when we look at what we have are imposing as far as energy. Let's just talk about energy. Right?
We have so many goals, green goals, that are very costly to producing energy in our state. That means that the cost of, of those services go up, adding to the cost of living in California. So everything that we've done in the state with the cost of living going up has is a direct result of this what this legislature has done for several decades, Increasing. So it won't matter what we pay people if the cost of doing business because of legislation that's imposed on industry continues to go up. And then we tax everyone in order to make that up.
And so I see government going and expanding, whether it's, you know, more bodies to be able to implement those programs, which cost more money. Right? So we have more programs, more folks we have to we have to pay into the system. And so it continues to go up. Everything goes up.
And we wonder why people can't make it. Cannot make it. I bet you that rather than having everything subsidized, whether it's health care, housing, education, if people didn't have to pay so much in taxes all the way around, they would rather be able to keep that that money in their pockets on various levels and not have cost of business doing so being so expensive. They would rather keep that money in their pocket and pay out of their own for everything rather than making everybody so dependent on every single government program that we are compelled to create because we've made it so difficult for people to live. So it's the system itself that is broken.
And regardless of how much more we think we're gonna have to tax people or corporations because they're not paying their fair share, well, if it's a percentage if it's a percentage that people are paying, that percentage is going to the amount that that percentage is producing is going to continuously go up because their revenues or whatever they're producing is going cost more money. So they're going to be charging a little bit more every single time. I think that everybody needs to talk to the people on the ground. But understanding and helping them understand the system that we currently have when it comes to legislation that impacts industry, that impacts the cost of doing business, that impacts the that has an impact on the cost of services and goods. And then, adding to that, the component of the highest taxed state, if not in the top two, in the system.
And yet, yes, we're absolutely
Speaker 16
you. I'm sorry. What I'm trying to say is that the need for our reserves have to be there. But I think the programs need to be reevaluated as to why we need them in the first place. Why do we need those programs in the first place?
It is the system that we have created that makes the people dependent and that we feel compelled to fix it. So we need to have those conversations at a different angle about how do we start addressing them. And as we move forward on that end, I think it's gonna be incredibly important, because what we have right now is just spiraling downward. We're having our talent, once educated, leaving our state. Let's see.
Then one last comment that I wanted to make, my great colleague from the Inland Empire, we were just discussing Disneyland and whether or not they pay their their property taxes. And that she just mentioned that everything that they're doing is legal, is within the scope of what the law is. And we are seeing different numbers, so we don't know. She feels that they don't or she understands that they're not paying property taxes.
Speaker 1
If she wishes to express herself, that would be good. But you shouldn't characterize her comments and that she has a chance to do that herself.
Speaker 12
Well, I will say that I I I I did tell my good senator, my my neighbor, that I'm not saying anything that Disneyland is doing is illegal. Yeah. I'm just saying that when you look at the property taxes, they are not paying their fair share. But that was
Speaker 16
Actually, she asked me to mention that. That's why I was mentioning it. It was going be part of my comments, but she asked me to bring that up.
Speaker 1
We're good. Does that complete your comments? Thank you. We appreciate your comments. Thank you for waiting till the end to do that.
That completes our list. The one person I thought that might give public testimony is walking out of the room. So let me give people an opportunity. Is there anybody that's present here that wishes to offer public comment on the subject of today's hearing?
Speaker 1
I just remembered a dentist appointment. Let me thank everybody because I think I picked up from different members that this was much more of an exhaustive conversation than they thought we were going to have. And that we really got into the depth of this. And I think it gives us a lot to think about in terms of whether we wish to take some action at some point on these various reforms. And I think the discussion today will guide us in sort of having conversations about whether to do that.
I want to thank everybody that participated today. If you were not able to testify because you couldn't wait or you couldn't get here, We would be happy to receive your comments or suggestions and you could do it by writing the budget and fiscal review committee or visiting our website because those comments are important to us. So thank everyone for their patience, their cooperation, the meaningfulness of this hearing. And the Senate Committee on Budget and Fiscal Review stands adjourned.
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