The swing from a $100 billion surplus to a deficit somewhere between $38 and $68 billion in just two years illustrates the volatility of California’s tax system. It also has Governor Gavin Newsom eyeing changes to how much money the state saves during years of surplus.
Newsom and state lawmakers from both parties want to be able to save more. But constitutional rules constrain how much they can put into California’s rainy day fund. And they’ll have to convince voters before they can make any meaningful changes to the state’s savings account.
It’s pretty dry stuff to dig into the state’s accounting rules. But it’s important, especially if you’re a voter, since you may have to weigh in on this at some point. So stick with us as we make the trip among the billions of dollars in California budget land.
Why California’s budget pendulums from surplus to shortfall
First, it’s important to understand why California’s budget fluctuates so wildly.
The Golden State has a progressive tax structure, which means higher earners pay a larger share of taxes. When the state’s highest earners do well, the state budget does well.
Newsom has long defended this setup, arguing it creates a lower tax burden on low- and middle-income workers compared to states that have a flat income tax rate or no income tax at all.
But this system also comes with a natural boom-and-bust cycle, which can present a challenge for state lawmakers and the governor from one year to the next. Last week, Newsom repeatedly compared a chart showing decades of income, sales and corporate tax revenue fluctuations to an EKG chart, which measures heart activity.
Governor Gavin Newsom compared this chart, which shows "Big 3 revenues" or the state's combined income, sales and corporate tax revenue, to an EKG chart.California Governor's Office
How Newsom wants to change budgeting law to save more
Voters created the state’s rainy day fund 20 years ago under Proposition 58 to help state lawmakers — who are responsible for passing a balanced budget — navigate the oft-erratic revenue streams.
A decade later, in 2014, voters also approved Proposition 2, which requires an annual deposit equal to 1.5% of the state’s General Fund into the rainy day fund. The General Fund is sometimes called California’s checking account because it holds revenue from income, sales and other taxes.
But once the rainy day fund — formally called the Budget Stabilization Account — equals 10% of the state’s General Fund revenue, those deposits are no longer mandatory.
The account currently has a balance of $23.1 billion, which is more than 10% of the current fiscal year’s General Fund revenue of $196.8 billion. That means the rainy day fund is considered full.
Newsom sees a problem where the rainy day fund meets another pillar of California tax law: the Gann Limit, which requires the state to issue refunds to taxpayers if spending gets high enough.
State leaders are allowed to deposit money into the rainy day fund beyond what is constitutionally required, but any additional installments are considered expenditures. That means adding more to the rainy day fund counts against the state’s Gann limit.
“Saving a dollar is treated the same as spending a dollar” beyond the required 1.5% deposit or once the rainy day fund is considered full, said Anthony York, who until recently Friday was communications director for Newsom. (York is now working on a campaign for Proposition 1, Newsom’s $6.4 billion bond for behavioral health treatment centers.)
“Once you hit that Gann Limit … you also have to return one dollar to taxpayers and then give an additional dollar to the schools. So it costs you three dollars to save one dollar,” York said. “What the governor would like to do is find a way to say, maybe the money that you put into the budget stabilization account is not counted against the Gann Limit.”
Newsom said during his budget presentation last week that the 10% cap on the rainy day fund is “not adequate” and “we’d love to capture more.”
The challenges of budgeting by ballot measure
Chris Hoene, executive director of the nonpartisan California Budget and Policy Center, agreed a change could help state lawmakers and the governor weather budget uncertainty.
He said it’s important for leaders charged with passing a balanced budget to have flexibility when it comes to spending, saving and refunding tax dollars. He pointed to tax rebates in 2022, which Democratic legislative leaders pushed heavily to send to low- and middle-income Californians.
“I think if state leaders had to go back, they’d still make those kinds of decisions to provide that relief” to the Californians more likely to be impacted by inflation, Hoene said.
“But what they don’t want to see is their hands tied completely by constitutional measures,” he said. “There’s no way anything you put in the constitution from years ago could predict a global pandemic” and its massive economic impacts.
Hoene also said this problem illustrates a “challenge” of using ballot measures to govern state budget rules.
“You inevitably end up with unintended consequences because the technical nuances aren't able to be adequately dealt with in the confines of ballot measures,” he said.
The governor said he raised the issue with state lawmakers last year, but many were more focused on the Gann Limit. Newsom said he does not have a specific proposal yet but wants to “re-engage the Legislature” on the topic.
Will lawmakers and voters go for it?
The nonpartisan Legislative Analyst’s Office and some lawmakers have raised this issue in recent years, when California had enormous surpluses and was on-track to hit the Gann Limit.
Senate President pro Tempore Toni Atkins (D–San Diego) signaled she would be on board, saying while the state’s budget reserves have grown over the past decade, “out-of-date constitutional restraints continue to limit our common sense options.”
“I look forward to the Legislature and Governor working together to strengthen our reserves and finding even more ways to budget responsibly,” she said.
Assembly Speaker Robert Rivas’ office (D–Hollister) declined to comment.
Republican lawmakers have long criticized the way Democrats budget, accusing them of excessive spending.
Sen. Roger Niello (R–Fair Oaks), the top Republican on the Senate Budget Committee, said he supports the idea of allowing more flexible deposits into reserve funds.
“It would discourage irresponsible spending by the Legislature and would also better prepare the state for economic uncertainty,” Niello wrote in a statement. “The reality now is that the Governor and the majority party chose to spend the funds in other areas than building the reserves, despite two years of major surpluses.”
Because many of California’s budget rules are outlined in the state constitution, any changes require voter sign-off. State lawmakers can — and often do — add constitutional amendments to the ballot for voter approval.
Newsom said he commissioned surveys on the issue and found “we’ve got tons of work to do” when it comes to educating and convincing voters to make the change.
The governor is focused on supporting Prop 1, which will be on the March primary ballot, and said a proposal to reform the rainy day fund could be months or years away.
Hoene also agreed it could be a tough sell to voters.
“People want to see progress happen,” he said. “They want to see their tax dollars put to work, rather than saved.”
