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Getting ready for recession, California’s $215 billion budget fills reserves. But is it enough?

Governor Gavin Newsom talks of funding for education in his 2019-20 budget plan

Governor Gavin Newsom releases his revised 2019-20 state budget proposal in a news conference at the State Capitol.
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Governor Gavin Newsom releases his revised 2019-20 state budget proposal in a news conference at the State Capitol.

Stung by severe cuts to services in the Great Recession, California lawmakers are riding the state’s booming economy to put more money than ever into savings accounts meant to soften the hurt of the next downturn.

They just don’t know if it’s enough.

Altogether, the budget Gov. Gavin Newsom will sign this week aims to build up reserves to more than $19 billion in four separate savings accounts by next year.

One account, the so-called rainy day fund with $16.5 billion, can only be tapped in a recession. Another unlocks funding for social services. One more piles up $400 million for education, and the last one is projected to hold $1.4 billion for emergencies and natural disasters.

It’s an unprecedented sum for a state that’s famous for its boom-and-bust budgets.

“We’ve never taken action to be prepared before,” said Sen. Holly Mitchell, D-Los Angeles, chairwoman of the Senate’s Budget Committee. “We’ve only managed by expanding and cutting, cutting and expanding. This is the first time we’ve had something considered a safety net reserve.”

Mitchell a dozen years ago led one of the largest nonprofit agencies in the state, which delivered assistance to low-income families. She had to take out loans to keep checks moving to families every time the Legislature failed to pass a budget on time.

To her, the reserves represent an effort to end the cycle of welfare cuts and IOUS that characterized the years of chronic deficits and prolonged budget battles. In 2009, the state faced a $42 billion deficit. This year, it’s projecting a surplus greater than $21 billion.

“We have worked for years to get to this,” Senate President Pro Tem Toni Atkins, D-San Diego, said last week.

But others argue the Democratic governor and Legislature could do more to guard against the reductions they may have to make in a recession.

The nonpartisan Public Policy Institute of California last month issued a report suggesting the state had adequate reserves for a mild recession, but could see revenue fall by to $185 billion over five years in a severe downturn. The Legislative Analyst’s Office also has consistently made a case for more savings this year.

“By building even more reserves than it already has, the Legislature could mitigate the need for program cuts, tax increases, or spending deferrals when the next recession strikes,” Legislative Analyst Gabriel Petek wrote in April.

California and the U.S. as a whole now are in one of the longest-ever periods of economic growth. Newsom and lawmakers say they know a recession is on the horizon. Here’s a look at what keeps California budget hawks up at night, and what comforts them.

The glass is half empty

VOLATILE REVENUE

When California’s wealthiest residents catch a cold, the state’s budget gets the flu.

California collects 70 percent of its general fund revenue from personal income tax, and almost half of that money comes from the state’s wealthiest 1 percent of households, according to the Public Policy Institute of California report.

The ratio leads California tax collections to swing dramatically in recessions because wealthy taxpayers are less likely to cash in big bonuses or capital gains in down economies.

California has taken a number of steps to moderate its tax volatility since the Great Recession, but its fundamental reliance on the wealthiest households persists.

LOCAL GOVERNMENT WARNING SIGNS

While state leaders in Sacramento sock away a surplus, school districts and local governments around California are raising taxes and trimming their budgets.

Sacramento County, for instance, approved a budget this month with $43 million in cuts. School districts from Sacramento to Paso Robles are reporting financial trouble, too.

In general, schools and local governments are reporting tight margins because of the rising cost of funding their employees’ pensions and benefits. Newsom’s budget offers schools some help by making supplemental payments toward their pension debts at the California State Teachers’ Retirement System, but Republicans say the financial distress is a sign that more severe cuts will come.

“Here we are in a time of plenty, and I don’t see any money other than the amount flowing to CalSTRS to help out local school districts. I don’t see anything going to help cities or counties. They’re going to be hit really hard,” said Sen. John Moorlach, R-Costa Mesa.

UNKNOWN UNKNOWNS

Despite the surplus, some California state leaders talk about the economy in terms of looming austerity.

Devastating wildfire seasons can wipe out savings in a heartbeat, for instance. Newsom is proposing a $24 billion plan to prepare for the kinds of catastrophe that wiped out Paradise and parts of Santa Rosa over the past two years.

Meanwhile, changes in the way people work can alter how they pay taxes. The gig economy and robotics could lead to fewer Californians paying payroll taxes.

Those changes are hard to predict, and they could lead to serious consequences in a downturn.

In a recession, “it will all converge in terms of challenges we have,” State Controller Betty Yee said. “The best thing we can do now is just keep building up these reserves.”

The glass is half full

BIG SAVINGS

The rainy day fund and other state savings accounts are designed to cushion cuts in a recession, and lawmakers plan to use them when the time comes.

NEW REVENUE

Since the Great Recession, California voters and lawmakers adopted a number of new taxes that will keep money flowing to the state in a downturn. They include:

  • Proposition 55, the voter-approved tax on households with incomes greater than $250,000 that expires in 2030.
  • The gas tax, a 2017 law that aims to raise about $52 billion for transportation projects over a decade.
  • Cannabis taxes are coming in below initial projections, but they’re still on track to raise hundreds of millions of dollars for programs every year.
  • And, California now demands that out-of-state online retailers collect state and local taxes on behalf of their Golden State customers. That wasn’t the case a decade ago.

SUNSETTING PROGRAMS

Some parts of Newsom’s budget avoid ongoing commitments by committing to only temporary funding.

One example is a measure that eliminates sales tax on diapers and tampons for just two years. The short window lets lawmakers decide whether they want to continue the tax breaks and services if the economy changes.

The Legislative Analyst’s Office last month projected that Newsom’s budget included $1.8 billion in spending that would “sunset within a couple of years.”

LESS DEBT

Newsom and the Legislature celebrated paying off the “wall of debt” the state accumulated during the recession. Former Gov. Jerry Brown chipped away at the $33 billion in liabilities during his terms, and the new budget puts away the last of those short-term debts.

To be sure, California still owes tens of billions of dollars that it doesn’t have on hand for pensions and other debts, but clearing Great Recession debts heartened lawmakers who were in the Capitol when they last made serious cuts.

“If you look at the new revenue, 82 percent of this surplus money either goes to a reserve account of which there are a number, pays down (debt) or pre-pays pensions,” Senate Majority Leader Bob Hertzberg, D-Los Angeles, said last week. “It evidences a level of responsibility of where we’re focused.”

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