PD Editorial: California’s rainy day exposes tax flaws

California, the rainy day has arrived.

We aren't talking about the weekend weather forecast, although any precipitation will be a blessing after an abnormally dry winter pushed much of the state back into drought.

The subject today is public finance.

In California, the state's fiscal health tracks closely with the stock markets. When investors prosper, so does the state treasury. But when Wall Street stumbles, California is prone to collapse. And the coronavirus pandemic has all but paralyzed the world's fifth-largest economy, putting the state's budget on the critical list.

Remember the ambitious $222 billion spending plan unveiled three months ago by Gov. Gavin Newsom, with relief for the homeless, funding increases for public schools and a new consumer protection agency? It's a casualty of the pandemic.

“The January budget is no longer operable,” Newsom said during his coronavirus briefing two days ago. “The world has radically changed since the January budget was proposed, so everything is on the table.”

The fiscal picture is fading for California's cities, counties and school districts, too. Many of them were struggling to make ends meet before the coronavirus struck. Now, they're headed into uncharted financial territory. So are the giant pension funds for teachers and other public employees.

“This is really going to be a recession unlike anything we have ever seen before,” Stanford University economist Mark Duggan told USA Today. “Usually with recessions, it's somewhat gradual. This will be just an instantaneous change in the economy.”

More than 1 million California residents already have filed unemployment claims, and stay-at-home orders have been extended through April.

California has $21 billion in budget reserves to cushion the blow. But no one knows how deep the hole is going to get. It's possible, even likely, that the rainy day fund won't be enough to offset a looming cash crunch that will hit as the same time that unemployed residents will be seeking public assistance.

No one should be surprised. It's a predictable outcome with California's boom-and-bust tax system, echoing the rapid reversal of state finances when the housing bubble burst in 2008.

The state is increasingly dependent on income taxes, with nearly half of its revenue coming from about 1% of taxpayers. A soak-the-rich approach is popular politically, and it delivers big dividends in a growing economy. But much of the revenue comes from capital gains, and they dry up fast when the economy hits the skids.

Between 2007 and 2008, capital gains revenue fell by about 80%, and the state went from a small budget surplus to 11-figure deficits that lasted for several years. In 2019, the state collected $15 billion in capital gains taxes - about 50% more than in 2007.

When the crisis passed, Gov. Jerry Brown insisted that lawmakers set money aside in a rainy day fund, warning regularly that another economic downturn was somewhere beyond the horizon. Unfortunately, neither the governor nor the Legislature was willing to take on the task of overhauling the state's tax system. Making it more resilient to economic cycles almost certainly means more people sharing the burden, and no one wanted to take the political heat.

So, as Brown warned, an economic downturn has arrived. Instead of spending on new and expanded programs, Newsom and state lawmakers must tighten their belts and hope the crisis ends soon. When it does, they will face another test of leadership: Are they willing to fix a flawed tax system before it's exposed again by the next economic calamity?

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