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In My Opinion

The Gann Limit is Back in the News

By Jon Coupal

On the first day of the new legislative session, Assemblymember Avelino Valencia, D-Anaheim, introduced Assembly Constitutional Amendment 1 (ACA 1). The proposal would double the amount of state funds that could be placed in the Budget Stabilization Account (BSA) from 10% to 20% of the annual budget. The ostensible reason for the increase is to address the very real problem of revenue volatility. Because California is overly reliant on high income earners who generate massive amounts of capital gains and stock option funds in boom years, it is vulnerable to big drop-offs in revenue during the bust years.

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Indeed, revenue volatility has been such a large problem that Gov. Arnold Schwarzenegger created the California Commission for the 21st Century Economy to come up with solutions. Regrettably, while there was a broad consensus that something should be done about the boom and bust cycle, the commissioners could not agree on what to do about it.

The goal of placing more funds in reserve because of volatility makes sense, if it can be accomplished without violating the letter and the spirit of Gann spending limit. Unfortunately, ACA 1, in its current form does just that. Here’s how.

Just a year after Proposition 13’s passage in 1978, California voters approved the Gann spending limit which, like Prop. 13, sought to restrain the size and growth of government. But unlike Proposition 13, which was a direct limit on taxation, Gann attempted to limit government spending. It limited the growth of state and local government expenditures to a base-year level adjusted annually to reflect increases in population and inflation.

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Initially, the Gann limit performed as designed and resulted in a modest rebate to taxpayers in 1987. But subsequent measures backed by special interests weakened the Gann limit by creating exceptions for education and transportation spending as well as substituting a far more generous inflation factor.

Ironically, after these changes, most public finance observers – including yours truly – wrongfully assumed that California would never again bump up against the limit. But a big surplus in fiscal year 2022-23 put the state on the brink of reaching that limit. While that collision was briefly avoided due to COVID-19, California once again is confronted with a Gann issue that can no longer be ignored.

For taxpayers, the best outcome would be to let the Gann limit run its course and return money to taxpayers “by a revision of tax rates or fee schedules within the next two subsequent fiscal years.” Cal.Const., Art. XIIIB, Section 2(a)(2). This is consistent with the plain language of Gann and is more than warranted given California’s heavy tax burden.

But ACA 1 might prevent taxpayer refunds due to the change in treatment of transfers into the budget stabilization account. Under Gann, the state and local governments may create reserve accounts, like the BSA, but those transfers are subject to Gann’s spending limits. On the other hand, spending out of a reserve account is not so limited.

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As currently drafted, it appears that ACA 1 would exempt transfers out of the reserve account – currently permissible under Gann – but would also exempt appropriations into the BSA: Section (i) provides, “Transfers to the Budget Stabilization Account pursuant to this section do not constitute appropriations subject to limitation as defined in Article XIII B.” This appears to create a fund into which unlimited funds can be appropriated, guaranteeing that taxpayers will never get a refund of their tax dollars.

There are better ways to address revenue volatility without injury to the goal of the Gann Spending Limit, which was enacted to provide a modicum of spending restraint in a state that doesn’t have any.

California taxpayers need something more than a rainy-day fund that’s all slush.