Home Venture Capital A recession is coming. California needs to use its budget surplus wisely

A recession is coming. California needs to use its budget surplus wisely

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After weeks of negotiations, Gov. Gavin Newsom signed the largest budget in California history. Whoever thought that spending $97 billion could be so difficult?

When former California state treasurer Jesse Unruh referred to the “obscene surplus” that led to the Proposition 13 taxpayer revolt in 1978, he was talking about an excess of funds that equaled roughly $3 billion — barely a rounding error compared to this year’s imbalance between revenues and expenditures. Today, the combination of a booming stock market, a highly progressive tax system and a sizable influx of federal pandemic relief dollars has created an embarrassment of riches for our Golden State’s gold-laden coffers.

But storm clouds are gathering and the budget provides a small umbrella at best.

The combination of declining home sales, tight labor markets, plummeting consumer confidence and the highest inflation rates in decades recently led the state’s Legislative Analyst Office to conclude that there is “a heightened risk of a recession within the next two years.” Most ominously, the recent drop in the stock market will cause a disproportionate impact on a state budget that is over-reliant on the capital gains taxes paid by a small number of wealthy investors. That means the state will likely confront budget shortfalls in the near future that will be especially steep, perhaps as much as $40 billion to $80 billion.

In an election year, there are very few bumper stickers or tweets that celebrate fiscal responsibility. Progressive Democrats pushed to expand social programs while Centrist Democrats and the remaining Republicans fought for tax rebates. Their task was complicated even further by the looming requirements of the Gann Limit, a 1979 ballot initiative that caps state and local spending to 1978-1979 levels, adjusted for changes in population and inflation.

But while Gann undoubtedly complicated budget negotiations, the ballot initiative was originally passed as a guard against indiscriminate state spending to protect against future downturns, which is just as necessary now as it was then.

So how should California have used its massive surplus?

First, by sufficiently preparing for the likely recession. Yes, the budget does set aside $23.3 billion into the state’s rainy day fund, but it’s not nearly enough. Given the damage that the stock market drop will cause to California’s budget, the state would have been wiser to put closer to $50 billion into the rainy-day fund and to make additional payments to reduce the deficits in our pension funds that the state is on the hook for, whether or not it has the money to pay for it. A 2019 report from the Public Polling Institute found that a moderate recession could cause revenue declines of $69 billion to $100 billion. In the future, money currently allocated for schools, firefighters and police might need to be redirected to meet pension obligations in a downturn. We need to be prepared for that scenario.

In the brick-and-mortar era of the 1970s when the Gann Limit was passed, “public works” meant traditional infrastructure—roads, bridges and other construction projects. And the budget does include a $14.8 billion transportation infrastructure investment. But in a digital era, the need to overhaul the state’s wheezing technology capabilities is urgent. The pandemic-driven crisis mercilessly exposed the state’s woeful shortcomings: the California Employment Development Department estimated it paid out over $20 billion to fraudsters while legitimate businesses and residents were left waiting for their claims. With Californian lives at risk, we were reminded at the worst possible time that our state’s badly outdated technology was simply not able to meet this challenge.

State government lost immense public confidence because of this debacle. Going forward, it will be critical to invest a piece of the current surplus into bringing California’s technology infrastructure into the 21st century.

To be sure, the governor and the Legislature made some smart policy decisions in the budget — most notably, by allocating more than $128 billion for K-12 schools. After five straight years of improvement, standardized test scores in California dropped last year, widening an achievement gap that already existed and that disproportionately hurts Black and Latino students. This year’s funding allocation will help close that gap.

That our economy has grown quickly enough to generate a stunning $100 billion surplus is encouraging. Californians should also feel good that the state is investing in education and providing residents with some relief from rising gas prices. But, if a recession comes, and the stock market retrenches, we could be looking at major budget cuts that could swamp our $23.3 billion rainy day fund next year. The governor and Legislature should be vigilant about keeping our rainy-day fund intact while continuing to invest in the future.

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