Episode 12: Go-go Economy Fuels Record Budget Surplus

Welcome to the Workplace, a podcast by KAL Chamber. I'm Alan Zarenberg, president of the California Chamber of Commerce, and with me today is Lauren Kay, president of the California foundation for Commerce and Education. So today we're going to talk about the governor's recently released May budget revision and the state's budget surplus that was highlighted in that. And you know, I think what we want to discuss most importantly is the state seems to be pretty flush with revenues. Loren, how did we get there? How did this happen and who's responsible for that?

Well, there's a couple of reasons for that, Alan. First of all, the economy just doesn't know when to quit. It is going gangbusters. As you know, unemployment's low. In fact, businesses are finding a hard time finding workers. But the economy is great in California. Growth is good, especially along the coast. And so receipts from taxes by these companies have been fantastic. And so a huge amount of credit for the state budget surplus goes to employers and businesses that are working hard and making money. The other reason, though, that revenues are so good is because of a tax increase that was passed originally back in 2012 and it was re upped a few years later. It's a tax increase on the wealthiest Californians. And this year it's estimated to bring in almost $9 billion. So that makes a big difference.

So let's step back. In 2012, Jerry Brown had just been elected governor and had inherited what, a $26 billion deficit? Is that about right?

Yeah, that's about right.

So today where are we in terms of a surplus?

Well, we have a $21 billion budget surplus this year. It's, you know, almost mirrors the budget deficit that we had back in the early part of the decade. About 15 billion of that, or I should say about a third of that surplus is being used to reduce debt. About a third of it is going into our rainy day reserve, and about a third of it is being used to pay down long term unfunded liabilities. We can talk about that a little bit later. But that's how most of the money is being saved or is being used to pay down debt. A little bit of it is going into new spending.

Well, we'll talk about the rainy day fund in a minute, but let's just focus a bit on how good the economy, how much our business community is generating for the state of California. So let's start with we were less than 10 years ago. We had a $26 billion deficit. Now we're at a $21 billion surplus. So we've erased the $26 billion deficit and we've added an extra $21 billion. And is this growing?

Yes. Our budget this year, Alan, is more than $200 billion. Our state total budget, more than $100 billion is going into education. It is a very, very flush budget with a lot of spending.

So let's just put it in perspective here. So less than 10 years ago, we had this $26 billion deficit, and now we've reverse that, but we've increased spending in addition to that.

Oh, yes, spending's gone up quite a bit, especially for schools.

Okay. So we're able to do this. And this is all generated out of our strong economy and for people that are doing well with the high wealth individuals who are contributing an extra, not just, but an extra 10 billion a year when the rates went from 10% to 13%, is that correct?

That's right. But you know, Alan, I'd like to put a little bit of a cloud on the silver lining that we're talking about.

Okay, good.

And that is that what goes up in California often comes down with a big crash and the fact that we've raised taxes on the wealthiest Californians, and in fact, a huge part of that tax revenue from the wealthy comes from capital gains, comes from profits from the stock exchange, sales of assets like the expense of real estate. But should the economy slow down, should we go into a recession kaput, that stuff just disappears. And that's when we run into budget deficits. So the reason that you want to have a rainy day fund and the reason that we can't be so profligate in our spending is because we have a very volatile and even unpredictable revenue system.

So we've done well. I mean, we've made this reversal in state revenues and deficits to surpluses. We funded education, dramatically increased it, but at the same time, we're at risk for having dramatic downturns because this is dependent on people doing well in their capital gains, the high wealth individuals, which could make a difference easily in what, $10 billion a year, if not more. Because corporate taxes could reduce too.

Oh, easily. The governor has said that even with a mild recession, the revenues could go down over, say, three years by $70 billion. So it's a very touchy revenue system. As you pointed out, corporate taxes were very, very strong this year, or I should say the revenues from corporate taxes were very strong this year of the federal tax reform. Very strong corporate taxes. But with a recession, as we know, corporate tax receipts go down. And in the case of the high wealth individuals, A recession where you have a stock market that goes down, where real estate prices start to level off, where the value of other assets doesn't appreciate, then you'll see real, real damage to the state budget.

So let's go back a second to where did this rainy day fund come from? So I think Governor Jerry Brown recognized that we had volatile revenues and the state was at risk for during a recession. So when the rest of the US economy or the world economy catches a cold, California gets pneumonia, possibly because we're so dependent on high wealth individuals and corporate taxes. So the Governor Brown recognized this and he went to the ballot with a rainy day fund. Is that correct? And how does that work?

That's right. And you'll recall that Cal Chamber was an original supporter of, of that and we helped Governor Brown pass that at the ballot in 2014. Since then, again with a strong economy, we've been able to fill up that rainy day fund where it's going to be topped up in the next year or two. Right now there's $16 billion in the rainy day reserve. Plus there are other buckets of reserves elsewhere in the state budget which provides something of a hedge against a recession.

So the business community and people who are engaged in business in California have turned the deficit around into a surplus. But you also mentioned they've increased spending for education. Is this K12 higher education? How does this work out?

Pretty much across the board. As I mentioned earlier, K12 education for the first time is receiving more than $100 billion in revenues. That'll be for next year. And so there's quite a bit of money going into K12 education. The governor made a deal with the 24 year public hire institution branches. He said, I will propose a couple hundred million dollar increase for each of your budgets if you promise not to raise tuition on resident students. They agreed to that. And so they'll be getting budget increases from the state budget for the community colleges. Governor Newsom has proposed that the first two years of community college be tuition free.

So I think from a. If you're in the business world, you know your job as most people are employees or independent contractors or in business for yourself here in California, you should be okay with how this extra revenue is being spent if it prepares our workforce for these jobs of the future.

Generally speaking, that's absolutely true. And one of our strongest competitive advantages in California is our skilled workforce. But that requires the school systems to continue to produce well qualified students. And you know, frankly, that's been kind of a challenge lately, which is why, along with all of this new money that's going to both K12 education and higher education, it's up to us, and it's up to the legislature and the governor to insist on good quality performance from those institutions.

So we need to really expand upon that because, I mean, this is good use of the revenues. It comes back to benefit the business community because as you mentioned, that we're almost at full employment. Does that limit our ability to grow and grow the state's revenues?

I think that the shortage of a skilled workforce in California is probably the biggest threat that we have to continued growth apart from what happens in the national economy. There are more job openings in California than there are unemployed people. And so we have a real, real need to both produce more skilled workers and frankly to import them from elsewhere.

So this notion about artificial intelligence or robotics really is not about we're going to displace workers. We don't have enough workers. Does that create more efficiencies? And we still have job openings that we need workers for. Is that a limitation on our economic growth?

The threat to the worker and the threat to the business and the threat to the economy right now is not artificial intelligence. It's not machine learning. It's getting enough people who know how to do the job into the workplace and doing the job. We're a long way from the threats of not having enough work. We don't have enough employees to do the job.

So we should be, I think, supportive of if we're going to have additional revenues and we can't give the taxes back because it's in the Constitution. So the only way to avoid the volatility would be to broaden the tax. And I'm not sure, you know, many people would be supportive if it's in the Constitution. You have to go back to the people with a vote to reduce taxes on high wealth individuals and raise them on themselves. Middle class, probably unlikely to happen. So if that's not going to happen, I think what we're talking about here is that we get the money spent that invests in California's future. Is infrastructure also part of that?

That's a very important part of it. We have some real strong infrastructure needs. Fortunately, there's some new money going into highway and road construction. But that's not the only infrastructure we need to work on. Our water system, our sewage and waste system, certainly our communications, Internet and electricity and utility system, those are all very important infrastructure needs that we have.

So they're all essential also to growing the economy, which also, as we see here, that growth in the economy leads to growth in revenues and gets back invested in things that are necessary to keep the business community viable.

That's right. And also when you make these good investments in skilled workforce and infrastructure that keeps businesses here economically productive, profitable, and tax paying, that'll reduce the need for higher taxes in the future as well.

Well, we have a couple things that go back to producing jobs and education. You know, we see our research universities are really where they're really vibrant. We have probably the strongest economies in America around Berkeley and Stanford and UCLA and Caltech and UC San Diego. Is that a stimulator and do we need to duplicate that in the rest of the state? Maybe I should preface that. Are we leaving part of the state behind with this economic growth?

Certainly inland California is not seeing the go go benefits that the metropolitan and coastal California have been seeing. And so we definitely need to put more investment of resources, especially education resources in inland California. Now, happily, inland California doesn't have some of the severe drawbacks that are happening along the coast, especially these high housing prices, but it's still expensive to do business in inland California. The cost of energy and the cost of transportation when you have to go long distances to get to work. But we could certainly, and the legislature and the governor absolutely should focus on lifting inland California to the extent that coastal and metro California have been lifted.

And that's partially due to their magnets for high wealth research jobs. And that helps produce a better economy in those areas. And can we duplicate that elsewhere in the state?

Well, California's great advantage has been its culture of innovation. And that starts with universities and with the businesses that universities spin off and with the employees who go among those businesses to create new products and services and ways of improving the society. You can spread that to other parts of California, but by spreading more knowledge, more universities and more innovation.

So when you talk about innovation, so we're going to wrap it up here, but let's talk about how these revenues get spent and how we should encourage them to be spent, because I think that's what it's about here. If business is going to help deliver these revenues, we should have a say in how they're being spent. And I think this discussion centers around education has a role to play in the growth of the economy in the future, whether it be preparing people for the university level or the university level. And we still have lots of openings, so we need to make sure we prepare those people. You also have an involvement in what's called workforce development linked learning with people that may not be going to graduate school or four year institutions because they're still needed too, right?

Yeah. Don't get me wrong, we don't just need college graduates for our skilled workforce. We need high school graduates who have some college, community college certificates, credentials who can get in and get to work on skilled positions that don't need a four year degree. There are plenty of jobs out there that don't need a four year degree but are vital to moving California and improving our economy.

So let's just wrap it up a little bit here in terms of where is the best place for the business community to get their investment back? Education is one. Infrastructure, transportation, movement of goods is another. Do we see other places the state spending money on health care, Is that helpful to businesses too?

Well, certainly if the state spends money to take care of people who cannot afford their own health care, that's important for businesses directly. It's important because if the state doesn't spend that money, then the business's insurance premiums go up to cover the people who aren't paying for insurance. And so it's important in that degree. Yes.

And so the rainy day fund also, I think finally where we look at where government can help people is natural disasters. And so make sure we're prepared for that. And these revenue surpluses that the business community helps deliver to the state of California are very helpful in making sure that we can overcome natural disasters in California, whether it be potential earthquakes or wildfire.

That's correct. And the governor has set aside money specifically for that purpose. It wouldn't be there if we didn't have a healthy economy fueled by a successful business sector.

Okay, well, let's just make sure we all understand what we're talking about here is that the government's turned around a deficit, but it's been due to the growth in our economy, due to the growth in the revenues that high wealth, individuals and their taxes. But most importantly, if we can ensure that those revenues get reinvested back into our workforce and into our infrastructure, we can certainly keep this economic growth moving forward.

That's right.

Thanks for joining us on the workplace. Please comment, subscribe and share. Kyle chambers podcast@calchamber.com.

Sam.