August 28, 2011
Pursuant to Elections Code Section 9005, we have reviewed the
proposed constitutional amendment related to the funding of local
governments and schools and temporary taxes
(A.G. File No. 12‑0001).
State’s Fiscal Situation
California’s Recent Budget Problems. The
General Fund is the state’s core account that supports a variety of
programs, including public schools, higher education, health, social
services, and prisons. The General Fund has experienced chronic
shortfalls in recent years due to trends in state spending and revenues.
State budgetary problems since 2008‑09 have been caused by a number of
factors, including a severe economic recession that caused state
revenues to decline sharply. To deal with the state’s budgetary
shortfalls, policymakers have reduced program expenditures, temporarily
raised taxes, and taken a variety of other measures including various
forms of borrowing from special funds and local governments.
Ongoing Budget Deficits Projected. The
state’s budget shortfalls are expected to continue over the next five
years under current tax and expenditure policies. In November 2011, the
Legislative Analyst’s Office (LAO) estimated annual budget deficits of
greater than $5 billion through 2016‑17, including a budget shortfall of
roughly $13 billion in 2012‑13. In January 2012, the Department of
Finance (DOF) estimated a budget shortfall of $9.2 billion in 2012‑13
and annual budget deficits of less than $5 billion thereafter.
Taxes and Revenues
The General Fund is supported primarily from income and sales taxes
paid by individuals and businesses.
Income Tax. The personal income tax (PIT)
is a tax on income earned in the state and is the state’s largest
revenue source. Tax rates range from 1 percent to 9.3 percent depending
on a taxpayer’s income. Higher tax rates are charged as income
increases, such that the 1 percent of tax filers with the most income
now pay around 40 percent of state income taxes. An additional 1 percent
rate is levied on taxable incomes in excess of $1 million with the
proceeds dedicated to mental health services rather than the General
Sales Tax. California’s sales and use tax
(SUT) is levied on the final purchase price of tangible consumer goods,
except for food and certain other items. The SUT rate consists of both a
statewide rate and a local rate. The current statewide rate is
7.25 percent. Approximately half of the revenue derived from the
statewide rate is deposited into the General Fund, while the remainder
is allocated to local governments. Localities also have the option of
imposing, with voter approval, add-on rates to raise revenues for
cities, counties, or special districts. As a result, SUT rates in
California differ by county and locality, with an average rate of about
State School Funding
In 1988, voters approved Proposition 98. Including later amendments,
Proposition 98 establishes a guaranteed minimum annual funding
level—commonly called the minimum guarantee—for K-14 education
(consisting of K-12 schools and community colleges). The minimum
guarantee is funded through a combination of state General Fund
appropriations and local property tax revenues. With a two-thirds vote
in any given year, the Legislature can suspend the Proposition 98
guarantee for one year and provide any level of K-14 funding it chooses.
Minimum Guarantee Often Affected by Changes in State
Revenues. In many years, the calculation of the minimum
guarantee is highly sensitive to changes in state General Fund revenues.
In years when General Fund revenues grow by a large amount, the
guarantee is likely to increase by a large amount. Conversely, in years
when General Fund revenues decline by a large amount, the guarantee is
likely to drop by a large amount. In these years, however, the state
typically generates an associated “maintenance factor” obligation that
requires the state to accelerate future growth in Proposition 98 funding
when General Fund revenues revive. Another type of Proposition 98
obligation is known as “settle-up.” A settle-up obligation is created
when the state ends a fiscal year having appropriated less than the
finalized calculation of the minimum guarantee. Typically, the state
pays off settle-up obligations in installments over several years.
2011 Realignment Legislation
Shift of State Program Responsibilities.
The state and local governments in California operate and fund various
programs. These programs are funded through a combination of state,
federal, and local funds. The specific responsibilities and costs
assigned to state and local governments vary by program. As part of the
2011‑12 state budget plan, the Legislature enacted a major shift—or
“realignment”—of state program responsibilities and revenues to local
governments. The realignment legislation shifts responsibility from the
state to local governments (primarily counties) for several programs
including court security, adult offenders and parolees, public safety
grants, mental health services, substance abuse treatment, child welfare
programs, and adult protective services. Implementation of this transfer
began in 2011.
Dedication of Revenues to Cover Program Costs.
To fund the realignment of these programs, the budget dedicates a total
of $6.3 billion in revenues from three sources into a special fund for
local governments. Specifically, the realignment plan directs 1.0625
cents of the statewide SUT rate to counties. Under prior law, equivalent
revenues were deposited in the General Fund. In addition, the
realignment plan redirects an estimated $462 million from the
0.65 percent vehicle license fee (VLF) rate for local law enforcement
programs. Under prior law, these VLF revenues were allocated to the
Department of Motor Vehicles for administrative purposes and to cities
and Orange County for general purposes. The budget also shifts
$763 million on a one-time basis in 2011‑12 from the Mental Health
Services Fund (established by Proposition 63 in November 2004) for
support of the Early and Periodic Screening, Diagnosis, and Treatment
Program and Mental Health Managed Care program.
Exclusion of Revenues From Proposition 98 Calculation.
A budget-related law, Chapter 43, Statutes of 2011 (AB
114, Committee on Budget), stated that the 1.0625 cent SUT realignment
revenues were to be excluded from the Proposition 98 calculation. This
provision of Chapter 43, however, was made operative for 2011‑12 and
subsequent fiscal years contingent on the approval of a ballot measure
by November 2012 that both (1) authorizes the exclusion of the 1.0625
cent sales tax revenues from the Proposition 98 calculation and (2)
provides funding for school districts and community colleges in an
amount equal to the reduction in the minimum guarantee due to the
exclusion. If these conditions are not met, Chapter 43 creates a
settle-up obligation for the lower Proposition 98 spending in 2011‑12 to
be paid over the next five fiscal years.
State Required to Reimburse Local Governments for Certain
Costs. The California Constitution generally requires the
state to reimburse local governments when it “mandates” a new local
program or higher level of service. In some cases, however, the state
may impose requirements on local governments that increase local costs
without being required to provide state reimbursements.
Open Meeting Act Mandate. The Ralph M.
Brown Act (known as the Brown Act) requires all meetings of the
legislative body of a local agency to be open and public. Certain
provisions of the Brown Act—such as the requirement to prepare and post
agendas for public meetings—are state-reimbursable mandates.
The measure amends the Constitution to permanently dedicate revenues
to local governments to pay for the programs realigned in 2011 and
temporarily increases state taxes.
2011 Realignment Legislation
Guarantees Ongoing Revenues to Local Governments for
Realigned Programs. The measure requires the state to
continue allocating SUT and VLF revenues to local governments to pay for
the programs realigned in 2011. If portions of the SUT or VLF dedicated
to realignment are reduced or eliminated, the state is required to
provide alternative funding that is at least equal to the amount that
would have been generated by the SUT and VLF for so long as the local
governments are required to operate the realigned programs.
Constrains State’s Ability to Impose Additional
Requirements After 2012. Through September 2012, the
measure allows the state to change the statutory or regulatory
requirements related to the realigned programs. A local government would
not be required to fulfill a statutory or regulatory requirement
approved after September 2012 related to the realigned programs,
however, unless the requirement (1) imposed no net additional costs to
the local government or (2) the state provided additional funding
sufficient to cover its costs.
Limits Local Governments From Seeking Additional
Reimbursements. This measure specifies that the
legislation creating 2011 realignment (as adopted through September
2012) would not be considered a state-reimbursable mandate. Therefore,
local governments would not be eligible to seek reimbursement from the
state for any costs related to implementing the legislation. Similarly,
the measure specifies that any state regulation, executive order, or
administrative directive necessary to implement realignment would not be
a state-reimbursable mandate.
State and Local Governments Could Share Some
Unanticipated Costs. The measure specifies that certain
unanticipated costs related to realignment would be shared between the
state and local governments. Specifically, the state would be required
to fund at least half of any new local costs resulting from certain
changes in federal statutes or regulations. The state also would be
required to pay at least half of any new local costs resulting from
federal court decisions or settlements related to realigned programs if
(1) the state is a party in the proceeding, and (2) the state determines
that the decision or settlement is not related to the failure of local
agencies to perform their duties or obligations.
Open Meeting Act Mandate
The measure specifies that the Brown Act would no longer be
considered a state-reimbursable mandate. Localities would still be
required to follow the open meeting rules in the Brown Act but would not
be eligible to seek reimbursement from the state for any associated
Increases Income Tax Rates on Higher Incomes for Five
Years. Under current law, the maximum marginal PIT rate is
9.3 percent, and it applies to taxable income in excess of $48,209 for
individuals; $65,376 for heads of household; and $96,058 for joint
filers. This measure temporarily increases PIT rates for higher incomes
by creating three additional tax brackets with rates above 9.3 percent.
Specifically, this measure imposes:
- A 10.3 percent tax rate on income between $250,000 and $300,000
for individuals; $340,000 and $408,000 for heads of household; and
$500,000 and $600,000 for joint filers.
- A 10.8 percent tax rate on income between $300,000 and $500,000
for individuals; $408,000 and $680,000 for heads of household; and
$600,000 and $1 million for joint filers.
- An 11.3 percent tax rate on income in excess of $500,000 for
individuals; $680,000 for heads of household; and $1 million for
These tax rates would affect roughly 1 percent of California PIT
filers due to the high income threshold. The tax rates would be in
effect for five years starting in the 2012 tax year. (The additional
1 percent rate for mental health services would still apply to income in
excess of $1 million.)
Increases SUT Rate for Four Years. This
measure temporarily increases the state SUT rate by 0.5 percent. The
higher tax rate would be in effect for four years—from January 1, 2013
through the end of 2016. Under the measure, the statewide average SUT
rate would increase to 8.6 percent.
State School Funding
Permanently Removes Realigned Sales Tax Revenues From
Proposition 98 Calculation. The measure amends the
Constitution to explicitly exclude the 1.0625 cent sales tax revenues
directed to realignment programs from the Proposition 98 calculation.
New Tax Revenues Deposited Into New Account for Schools
and Community Colleges. The measure requires that the
additional tax revenues generated by the temporary increases in PIT and
SUT rates be deposited into a newly created Education Protection Account
(EPA). Appropriations from the account could be used for any educational
purpose and would count towards meeting the Proposition 98 minimum
guarantee. Of the monies deposited into the account, 89 percent would be
provided to schools and 11 percent would be provided to community
colleges. The EPA funds for schools would be distributed the same way as
existing general purpose per-pupil funding, except that no school
district is to receive less than $200 in EPA funds per pupil. Similarly,
EPA funds for community colleges would be distributed the same way as
existing general purpose per-student funding, except that no community
college district is to receive less than $100 in EPA funds per full-time
Provides More Certainty to Local Governments.
This measure would change the state’s authority over the 2011
realignment. After September 2012, the state could not impose new
requirements to 2011 realignment resulting in increased costs without
providing sufficient funding. Also, the state would share certain new
costs related to federal law or court cases. Consequently, the measure
reduces the financial uncertainty and risk for local governments under
realignment. Any impact would depend on how the state would have acted
in the future absent the measure, as well as what, if any, actions are
taken by the federal government or courts.
Limits State’s Ability to Change 2011 Realignment.
With regard to the state, the measure would have the related impact of
restricting the state’s ability to make changes resulting in new costs
to local governments in the 2011 realignment without providing
additional funding to local governments. The state could also bear
additional costs associated with new federal laws or court cases beyond
the funds provided by 2011 realignment.
Significant Volatility of PIT Revenues Possible.
Most of the income reported by California’s upper-income filers
is related in some way to their capital investments, rather than wages
and salary-type income. In 2008, for example, only about 37 percent of
the income reported by PIT filers reporting over $500,000 of income
consisted of wages and salaries. The rest consisted of capital gains
(generated from sales of assets, such as stocks and homes), income from
these filers’ interests in partnerships and “S” corporations, dividends,
interest, rent, and other capital income. While upper-income filers’
wage and salary income is volatile to some extent (due to the cyclical
nature of bonuses, among other things), their capital income is
highly volatile from one year to the next. For example, the current
mental health tax on income over $1 million generated about $734 million
in 2009‑10 but has raised as much as $1.6 billion in previous years.
Given this volatility, estimates of the revenues to be raised by this
initiative will change between now and the November 2012 election.
Revenue Estimates. The volatility described
above makes it difficult to forecast this measure’s state revenue gains
from high-income taxpayers. As a result, the estimates from our two
offices of this measure’s annual revenue increases vary. Between 2013‑14
and 2015‑16 (the three years in which both the PIT and SUT increases
would be in effect for the entire fiscal year), the LAO currently
forecasts an average annual increase in state revenues of $5.5 billion,
and DOF currently forecasts an average annual increase in state revenues
of $6.9 billion. For the 2012‑13 budget, the LAO forecasts this measure
would generate $4.8 billion of additional revenues, and DOF forecasts
$6.9 billion of additional revenues. (This essentially reflects six
months of SUT receipts in 2013 and 18 months of PIT receipts from all of
tax year 2012 and half of tax year 2013.) In 2016‑17, the measure’s PIT
and SUT increases would be in effect for only six months of the fiscal
year before expiring. In that fiscal year, the LAO forecasts this
measure would generate $3.1 billion of revenues, and DOF forecasts
$3.4 billion of revenues.
Net Increases in Proposition 98 Minimum Guarantee Over
Period. The measure affects the Proposition 98
calculations. The effect of the temporary tax increases would more than
offset the state savings generated by the exclusion of the realignment
SUT revenues. The exact increase in the minimum guarantee, however,
would depend on a number of factors, including the amount of revenue
raised by the measure, year-to-year growth in General Fund revenues, and
the way in which Proposition 98 maintenance factor obligations are paid.
The increase could be in the billions of dollars annually. By excluding
the realignment SUT revenues from the Proposition 98 calculations
beginning in 2011‑12, the state would no longer have a 2011‑12 settle-up
obligation. As a result, the state would not need to pay hundreds of
millions of dollars annually from 2012‑13 through 2016‑17.
Deposits New Revenues in EPA. The new PIT
and SUT revenues would be deposited in EPA. The measure dedicates EPA
funds for spending on schools and community colleges and counts them
towards the Proposition 98 minimum guarantee.
New Revenues Available to Balance State Budget.
As described above, the measure would increase the
Proposition 98 minimum guarantee. At the same time, the measure would
put new tax revenue into EPA, which would be available for meeting the
state’s Proposition 98 obligation. The EPA funds would be sufficient to
fund the increase in the minimum guarantee as well as pay part of the
minimum guarantee currently funded with the General Fund, annually
freeing up General Fund monies to help balance the state budget.
Long-Term Budget Effect Uncertain. The
measure’s tax increases are temporary, expiring at the end of 2016.
Depending on future budget decisions and the state of the economy, the
loss of the additional tax revenues could create additional budget
pressure starting in 2016‑17. The effect would be gradual, however, as
the tax increase will remain in effect for half of 2016‑17, preventing
revenues from dropping considerably in one fiscal year.
Summary of Fiscal Effect
This measure would have the following major fiscal effects:
- Increased state revenues over the next five fiscal years.
Estimates of the revenue increases vary—for 2012‑13, from
$4.8 billion to $6.9 billion; for 2013‑14 through 2015‑16, from
$5.5 billion to $6.9 billion on average each year; and for 2016‑17,
from $3.1 billion to $3.4 billion.
- These revenues would be available to (1) pay for the state’s
school and community college funding requirements, as increased by
this measure, and (2) address the state’s budgetary problem by
paying for other spending commitments.
- Limitation on the state’s ability to make changes to the
programs and revenues shifted to local governments in 2011,
resulting in a more stable fiscal situation for local governments.
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