Governor Arnold Schwarzenegger today signed the 2008-09 state budget, concluding a very difficult budget year and delivering a real win for Californians with a proposal to achieve meaningful budget reform. It addresses California’s $15.2 billion budget shortfall with a combination of cuts and increased revenues. It fully funds education’s Proposition 98 guarantee and does not borrow funding from voter-approved local government or transportation funds. The historic budget reform package includes a strong rainy-day fund aimed at helping smooth out the unpredictable highs and lows in revenues that plague our state and create massive deficits.

“While California is certain to face a difficult budget situation again next year, this budget does not take money out of people’s paychecks or borrow from voter-approved local government or transportation funds, and it includes real budget reform with teeth,” Governor Schwarzenegger said. “These budget reforms, when approved by voters, will finally put California’s budget on a path toward long-term fiscal stability.”

Throughout California’s history, numerous attempts have been made to reform our state’s broken budget system. When the Governor was elected, he committed to finally end California’s feast and famine budget cycle. In 2004, the Governor worked with the legislature to pass Proposition 58, which took the first step toward budget reform. In 2005, the Governor attempted the next step in budget reform with Proposition 76, and while it was defeated, the Governor remained committed to reform.

Today, the Governor delivered on his commitment with reforms to address two major flaws in the state budget system—wildly volatile revenues and over spending. In fact, had these reforms been in place over the past decade, this year’s budget problem would have been approximately $10 billion smaller and California would have benefited from $8 billion in additional funding available for infrastructure and other one-time purposes. The proposal will now go before voters on the next statewide election ballot.

Over the weekend, the Governor used his veto pen to make an additional $510 million in General Fund reductions, reflecting the Governor’s determination to reduce spending to the maximum extent possible. The state also captured $340 million in savings due to the delay in enacting the budget and the effect of the Governor’s executive order.

BUDGET REFORM

A Rainy-Day Fund With Teeth

Ø Increases the size of California’s Budget Stabilization Account (BSA) from 5 percent of General Fund expenditures to 12.5 percent—or approximately $13 billion dollars today.

Ø Requires annual transfers to the BSA of 3 percent of General Fund and eliminates the ability to suspend those annual transfers. During economic downturns, when funds can be drawn out of the BSA, the transfer would not occur.

Ø In addition to the annual transfer of 3 percent of General Fund to the BSA, requires that all current-year revenue that is above 5 percent of the amounts included in the Budget Act be transferred to the BSA, after first providing funding to education as required under Proposition 98. This means that unexpected spikes in revenues that occur during the fiscal year – normally recognized in the Governor’s May Revision – will be transferred to the BSA or used exclusively for one time spending.

Ø Funds can only be transferred out from the BSA under the following conditions: 1) actual revenues during the Fiscal Year must be below a specified level: prior year spending adjusted by population growth and per capita personal income growth; 2) funds transferred from the BSA back into the General Fund must be appropriated in a stand-alone bill. The amount transferred out of the BSA during a fiscal year will be limited to the amount which would bring revenues up to prior year spending adjusted by population and per capita personal income growth.

Ø When the balance in the BSA reaches 12.5 percent, any excess revenues acquired mid-year will be available for one-time expenditures only. One-time purposes will include: paying down debt, paying off outstanding General Obligation bonds, investing in infrastructure and capital outlay projects, paying for “settle-up” dollars owed to education, pre-paying health care liability for retired employees (OPEB) and tax relief.

Mid-Year Reduction Authority

Ø Authorizes the Director of Finance to do the following when s/he determines, mid-year, that revenues have fallen below specified levels:

Reduce state operations budgets by up to 7 percent without modifying or suspending the law.
Freeze Cost of Living Adjustments (COLAs), rate increases or increases in state participation in local costs, as designated in the Budget Act, for up to 120 days.
The governor can submit urgency legislation to permanently suspend COLAs and other rate increases. If the governor fails to act within the 120 days, or the Legislature fails to adopt the suspension, the COLAs and other rate increases are reinstated.

ADDITIONAL BUDGET CUTS

Ø This budget holds General Fund spending to virtually no growth this year—$103.4 billion 2008-09 compared to $103.3 billion in 2007-08.

Ø The Budget includes a reduction of $850 million General Fund spending or one percent below the amounts proposed in the budget bill adopted by the Legislature. This reduction represents $9.7 billion in spending reductions and is due to:

o $510 million—General Fund vetoes. These vetoes reflect the Governor’s determination to reduce spending to the maximum extent possible given constitutional, statutory and court-ordered spending requirements.

o $340 million-General Fund savings due to the delay in enacting this Budget and the effect of the Governor Executive Order S-09-08. Given the state’s fiscal condition, the order will remain in effect for the remainder of the year.

LOTTERY MODERNIZATION AND SECURITIZATION

Ø Proposes a ballot measure to modernize the state Lottery and improve the performance of this underperforming state-owned asset.

Ø If passed by voters, future proceeds of an improved state Lottery would be securitized (estimated to be approximately $5 billion in 2009-10) with the additional revenues used to pay down debt and fill the rainy-day fund in the out-years.

EDUCATION FUNDING

Funds the Proposition 98 guarantee at $58.1 billion – $1.5 billion higher than the current-year funding. This level of funding eliminates the proposed reductions in the Governor’s May Revision and maintains funding to base categorical programs such as class size reduction, special education, child nutrition programs and child care.

BRINGING IN REVENUE

The budget passed by the Legislature originally included a measure that would have taken more money out of hardworking Californians’ paychecks by requiring that they pay 10 percent more state taxes from Californians to balance the state’s books in 2009 – for a total of $1.6 billion. The Governor rejected it, and it was replaced instead with a plan to bring in outstanding tax revenue owed to the state by increasing penalties on corporations that under-report by more than $1 million what they owe the state.

Ø Imposes a 20 percent penalty on the under-reporting of tax owed to the state and applies to any corporation that under-reports by more than $1 million. (Applies to taxable years beginning in 2003 in which the statute of limitations is open and allows taxpayers an opportunity to file an amended return by May 31, 2009, to avoid the penalty.)

Ø The Franchise Tax Board estimates that the state will bring in $1.51 billion over the 2007-08 and 2008-09 budget years. California has had success will this kind of tax collection program before. The similar tax amnesty program the state conducted in 2005 brought in an additional $3.6 billion, according to the Department of Finance.

A two-year suspension of the Net Operating Loss (NOL) tax deduction: Suspends for two years the ability of corporations to reduce their tax liability based on prior losses and phases in conformity to federal law over three years starting in 2010 by allowing losses to offset profits in two prior years; also extends the period for carrying forward losses from 10 to 20 years.

ECONOMIC STIMULUS

Includes an economic stimulus package that:

Ø Expedites the allocation and disbursement of existing transportation and housing bond funds to stimulate economic growth and job creation immediately.

Ø Authorizes new lease revenue bonds to accelerate capital outlay projects for higher education.

Ø Provides flexibility in overtime laws to exempt high-paid software engineers in the competitive technology industry from overtime rules.