Rich Pedroncelli/AP Photo
California Governor Gavin Newsom delivers his annual State of the State address on March 8, 2022.
A couple weeks ago, I pointed out that giving people money can act as an effective short-term shock absorber to manage rising prices. But it goes without saying that any cash benefit of this type would work best if directed at those who could really use the relief.
California is revealing the promise and peril of cash benefit policy. With proposals from the Democratic-dominated legislature and the governor released in recent days, there’s likely to be some kind of cash rebate given to residents this year related to the cost of gasoline, which stood at an average of $5.91 per gallon on Monday in the state, compared to $4.24 per gallon nationwide. But how that money is targeted really matters, and California may be headed down a feel-good road traveled by other states, futilely aiming to solve a global oil crisis with a meager set of tools.
Thanks to a surge of revenue, the state has enough money to protect its most vulnerable citizens from broad inflation shocks. But due to a byzantine series of budget obligations placed on the state legislature by voter-enacted initiatives, that fiscal blessing may simultaneously be a curse, with surpluses bizarrely creating more debt.
The experience in California simultaneously speaks to the need to take care in crafting public policy and the need to radically overhaul a failed experiment in direct democracy.
The Four Rebate Plans
California’s leaders have proposed essentially four different rebate plans. The first and least likely comes from legislative Republicans: a gas tax holiday, which several other states have proposed and three have instituted so far. Maryland, Georgia, and most recently Connecticut have suspended gas taxes of anywhere between 25 and 36 cents per gallon for a period between 30 and 90 days.
While logistically it’s easy to suspend state gas taxes, politically it’s hard to restore them. Moreover, they starve state infrastructure budgets of needed funds that may not get backfilled. In addition, they target just one particular good when inflation is rising more broadly, don’t offer much consumer savings, and could eventually go mostly to producers and gas station owners who can raise prices and pocket the difference, since they’re the ones paying the tax. We’ve already seen gas consumption in Georgia and Maryland go up substantially over the national average; gas tax holidays that actually reduce prices encourage more burning of fossil fuels.
Yet there is a need to offer some support amid rising inflation, and the other three Democratic proposals in California envision a cash benefit that families can put toward whatever they want. The main difference is who receives them. Last week, Gov. Gavin Newsom unveiled a plan to give $400 on a debit card to every vehicle owner in the state, capped at two cars, or $800. per household. Newsom’s plan would also give cities money to encourage free public transit and pause a scheduled summer gas tax increase in California.
Newsom’s proposal was met with wide condemnation. “From a logical standpoint, people with higher incomes would have two cars,” said Chris Hoene, executive director of the California Budget & Policy Center, a nonprofit analyst. “They will either save it, or spend it on luxury items. That’s really not the intent here, to get [money] into the hands of people for whom rising prices are destabilizing.”
For a variety of reasons, the governor’s is not likely to be the final program. On March 17, Assembly Democrats proposed a $400 benefit for all taxpayers. Newsom will assuredly come to realize that if you want to deliver a cash benefit to a mass of Californians who are facing inflation right now, moving money through the Franchise Tax Board will be far more efficient than standing up a brand new system through the DMV, which Newsom had proposed would do the job. Last year California used the FTB to send out $600 “Golden State Stimulus” checks in a fast and useful way.
But the method of delivery doesn’t fix the targeting problem: universal checks will still find their way to people who don’t need them. State Senate and Assembly leaders qualified the legislative proposal with a smaller base benefit of $200, the dollar amount rising based on the number of dependents, and limiting eligibility to earners making no more than $250,000. But that would still reach 90 percent of California taxpayers.
The Fifth Option
Analysts like Hoene note that the critical mass of households struggling to meet basic expenses amid the inflation spike ends at around $75,000 in income. He would prefer to use existing programs California has to support working families. And one would be particularly attractive.
Of all the pandemic relief programs that have expired, the loss of the federal Child Tax Credit enhancement, given monthly to parents, stings the most. The expanded CTC benefited poor families the most, came close to cutting child poverty in half and generates long-term social benefits worth ten times its cost. Its expiration likely diminished Biden's approval rating.
It so happens that California has a Young Child Tax Credit for children under the age of 6 that goes to the state’s poorest families. That credit could be built upon and modeled to add back everything that families lost with the expiration of the federal CTC. The annual cost of the expansion in California, approximately $9 billion, would equal what Newsom proposed for the per-vehicle rebate. (Incidentally, a $9 billion program in a $3 trillion state economy is highly unlikely to trigger additional inflation on its own, so don’t be fooled by that line of reasoning.)
“The advantage is it would address more than one challenge the state is facing at same time,” said Hoene. “What’s troubling about the current debate is that it’s solely focused on the gas price issue. That’s certainly important, but low and moderate-income Californians are facing a lot of issues.”
On top of that, it would make California a national leader in supporting anti-poverty programs that value families, using a technique that we already saw work, however briefly, at the federal level.
California is in an unusually good position to decide how to throw money at its citizens, thanks to an enormous budget surplus that is largely the result of the state’s highly progressive income tax. But paradoxically, that gift of surplus money is also raising anxiety in Sacramento.
The Gann Limit, Explained
What hasn’t been said much in the rebate debate is that California, for all intents and purposes, is actually compelled to do some kind of rebate. In 1979, California voters passed Proposition 4, establishing what has come to be known as the Gann Limit, after its sponsor, conservative activist Paul Gann. This was during the height of the state’s infamous tax revolt (Proposition 13 had passed one year earlier), and the Gann initiative capped state spending at 1978-79 levels, adjusting for population and per capita income. The twin ratchets of low property taxes and spending caps have made it difficult to fully fund California’s needs, though the income tax hikes on the wealthiest Californians passed in 2012 made the situation less onerous.
But due partly to those 2012 changes, a bounty of revenues have put California over the Gann Limit. The governor’s January budget measured the overage at $2.6 billion over the two-year average that triggers the limit. Since then, revenues have come in at a rate that’s $18 billion over that January estimate. This is essentially the first time ever that the state has been this significantly over the limit, and it would be so even without federal stimulus dollars from the American Rescue Plan.
There are a lot of options to deal with this, though handing money back to taxpayers always seems to wind up as the most politically attractive fallback. If at the end of the year the budget comes in over the Gann Limit, by law the legislature must use half the surplus to refund taxes by a minimum amount, and the other half for K-12 schools and community colleges. But the other option is to structure the budget to get under the Gann Limit.
That can be done through spending on what the governor has declared as a state emergency, for which the pandemic would qualify. So, stimulus checks for COVID relief, or even for a declared emergency on inflation and gas prices, would exempt that money from the Gann Limit. Tax refunds also are exempt from Gann, and even a rebate for car owners could be sold as a refund of vehicle registration fees or auto sales taxes.
The state could also engage in capital outlays. Amendments in 1990 to Gann allowed for infrastructure investment to escape the limit, as long as it has a useful life of more than ten years. Budget officials told me that they will almost certainly use some of this on school facilities this year, because voters rejected a school bond two years ago. Supplementing any rebate, you could pour billions into upgrading air quality in schools and public buildings, a lasting improvement to guard against future airborne viruses. A promising innovation in ultraviolet light that makes indoor air radically safer could be pumped into every state classroom, for example.
But stimulus payments that go to a broad cross-section of citizens hit every part of the state, whereas infrastructure projects often lack full legislative consensus and could wind up more localized. “If you have a billion dollars, you can buy something significant in one region of the state,” said one Assembly budget staffer. “But to really touch all parts of California, you need tens of billions of dollars.” To use one example, housing investments would be eligible as Gann-exempt spending, but that would largely be directed to the state’s unaffordable coastal areas. It might be difficult to get the large legislative buy-in you’d need to do that.
That leads to the de facto use of rebates as a way to get around the Gann Limit. “There’s kind of a rebate mania that has been totally exacerbated by the fact that state leaders are trying to deal with the spending limit for first time,” Hoene said. So those carping about why California is giving money to people in a broad and untargeted way have a 1979 ballot measure to thank.
The Gann Death Spiral
There’s even a bigger problem with the Gann Limit. The Legislative Analyst’s Office has predicted that the state will find itself more and more over the Gann Limit over time, due to expected income growth from high-income Californians. This creates a scenario that’s almost impossible to wrap your head around: it’s actually worse for the state budget to have a better revenue forecast.
This is because voters have placed other obligations on the state budget in the years since they voted for the Gann Limit in 1979. In 1988, Prop 98 set a minimum funding guarantee for schools and community colleges, and Prop 2 in 2014 requires setting aside excess revenues in a budget reserve. Neither of those guarantees are exempt from the Gann Limit, leading to a perverse scenario.
Voter initiatives have created a scenario that’s almost impossible to wrap your head around: it’s actually worse for the state budget to have a better revenue forecast.
“Every added dollar of revenue, you have to take care of Gann by spending on tax rebates or infrastructure,” said the budget staffer. “At the same time, that dollar is generating 40 cents for Prop 98 and 20 cents under Prop 2. For every dollar that comes in, you’ve got to spend $1.60. And if you spend it on something Gann doesn’t exempt, you have to spend $2.60.”
This isn’t necessarily a problem right now, because the state has built up very large reserves over the years. But the longer the state is over the debt limit, the more it has to allocate to all these cross-cutting obligations that don’t talk to each other very well. That will deplete the reserves and lead at some point to a crisis, where state budgeters will have to claw away basic services to feed these obligations, and nullify types of spending needed in the state, like health care, housing assistance or child care subsidies (more than 30 percent of child care providers closed during the pandemic).
State voters, “through a series of constitutional obligations over a 40-year period, put ourselves in a place where we create debt for ourselves when we raise additional revenue,” said Hoene.
That is an insane way to run the world’s fifth-largest economy, but the straitjacket is hard to loosen. To change it you’d have to go back to voters, and tell them why they have to weaken guarantees for school funding, eliminate rainy day fund payments, or uncap state spending by repealing Gann. These are hard sells with the electorate.
“The [Gann] limit was structured for a California in 1979 that is a very different place than we’re living in today,” said Hoene. “The limit stands in the way of state leaders crafting state budgets that help the most vulnerable people in the state.”
You’d think there would never be a situation where a state would be imperiled by too much money. But that’s what we have in California, and the culture of letting voters micromanage the slightest budgetary situations is a big part of the reason why. Giving people money is a good way to solve problems. But the broken nature of state government must be solved at the same time.
