Davis Says Tax Hikes Likely as Shortfall Soars

The governor raises the budget gap estimate to $34.8 billion. He names former legislator Steve Peace to serve as his new finance director. 

December 19 2002

SACRAMENTO -- Gov. Gray Davis strongly suggested Wednesday that he will propose tax increases to address the state's budget shortfall, which he said has soared to $34.8 billion — nearly $14 billion more than was estimated four weeks ago.

Davis also announced that he is replacing his finance director with Steve Peace, a former legislator who has strong support in the state Senate and Assembly.

The shakeup comes in the face of growing resistance by Democratic legislators and interest groups to $10.2 billion in spending cuts and other savings that the governor proposed earlier this month.

"I'm going to propose a balanced approach," said Davis, who must submit his 2003-04 budget to the Legislature by Jan. 10. "It will have further reductions and in all likelihood it will have some revenue increases."

The latest budget shortfall figure is sharply higher than the $21-billion deficit projected in mid-November by nonpartisan Legislative Analyst Elizabeth Hill. The analyst and many other experts said that even a $21-billion hole would require a mix of spending cuts and tax increases to repair.

The sharp increase in the shortfall projections over the last month led Republican leaders in Sacramento to accuse the governor of having hidden the extent of the state's budget problems last year, as he was seeking reelection. Some of those same adversaries now accuse Davis of raising the deficit predictions in order to build his case for tax hikes next year.

"These numbers go beyond the most dire predictions and projections we were looking at," said Assembly Republican Leader Dave Cox of Fair Oaks.

"It appears to me that the books were cooked last year [to downplay the budget problem] and the books are cooked this year [to exaggerate the problem]," he said.

Davis suggested otherwise, saying Hill's $21-billion projection was based on incomplete information on state tax receipts.

Davis said he released the latest shortfall figure Wednesday — more than three weeks earlier than usual — "to let people know the context in which those $10.2-billion worth of reductions should be viewed."

Addressing the rapidly changing estimates being offered by various players in the budget debate, Davis said state leaders need to agree on the extent of the fiscal problem confronting California.

"I think it does the Legislature a disservice if some people feel Finance's assessment is accurate but others think the legislative analyst is the more accurate one," Davis said. "We need to get them on the same page, or at a minimum, all of the [legislative leaders and the governor] need to agree what set of numbers we're going to work with."

The gap between state spending and tax collections has already unleashed a fierce debate over possible solutions.

Democratic lawmakers are opposed to deep cuts in programs for needy Californians and support tax increases as a partial solution. Republicans say spending cuts alone should solve the problem — a notion that Senate Leader John Burton (D-San Francisco) rejected yet again on Wednesday.

Some experts say the problem is so large that it can be solved only with a two-year budget that would involve rolling over debt. But Davis said his aim was to find a single-year solution.

"As governor of this state, I want to err on the side of being conservative, getting the problem solved," he said. "If in fact the economy recovers sooner than we think, it's always easier to go back and restore things we had to cut."

Davis went to great lengths Wednesday to make the case that the projected $34.8-billion deficit results from the national economic downturn and the corresponding decline in state tax collections. Of the shortfall projected over the next 18 months, half, or $17.7 billion, is the result of declining state tax revenues.

Of the other half, $4.5 billion is the result of increased state spending, and $12.6 billion comes from a combination of reasons, including decisions to borrow against the future. For example, the decision to cash out California's share of the national tobacco tax settlement and use that money to help balance last year's budget will deprive the state of $4.5 billion.

Those decisions added to a deficit caused in part by what Davis called "structural" problems with the state's spending. The governor said Wednesday that even if spending remained static next year and tax revenue flowed as expected, the budget would be more than $12 billion in the red.

The projected increase in state spending, meanwhile, is the result of budget assumptions earlier this year that proved to be incorrect. In particular, Davis, in the 2002-03 budget that the Legislature approved last summer, anticipated receiving money from the federal government that has not materialized, as some had warned. One result is that the state is being forced to spend an additional $1.2 billion on programs it had hoped Washington would pay for.

The spiraling budget crisis requires "quick, urgent action," Davis said, noting the steps he has taken since winning reelection Nov. 5. His recommendations have included $10.2 billion in cuts and other savings from the current budget and the 2003-04 budget.

Republicans applauded the cuts and say they would like to see even more. But Democratic legislators and interest groups have criticized the Davis proposals at a series of public hearings around the state this week.

The state Legislature convened in a special session Dec. 9 to discuss the governor's proposals and other possible solutions to the budget crisis. But Democrats — led by Burton — are reluctant to discuss budget cuts without seeing Davis' full 2003-04 spending plan, including proposed tax increases.

Davis made several tax proposals earlier this year as part of his 2002-03 budget. The Legislature "by and large didn't accept" those tax increases, and Davis said Wednesday that any new revenue recommendations would not necessarily include the same proposals.

Groups facing deep budget cuts applauded Davis for signaling his support for tax increases.

The soaring shortfall "magnifies the desperate need for a balanced approach to addressing the shortfall — both revenue and reductions," said Kevin Gordon, executive director of the California Assn. of School Business Officials, which represents California school districts on budget and finance matters. "There's absolutely no way you can grapple with a deficit of this magnitude without talking about some pretty serious tax hikes. Every tax idea has to be on the table."

Gordon criticized Republican lawmakers for refusing to consider tax increases as part of the budget solution.

"The Republicans point to the governor and Democrats and say they contributed to the problem by increasing spending when times were good," he said. "Republicans, too, contributed to the problem by reducing revenue into the state when times were good."

Republicans, however, countered that, with the state facing difficult economic times, a tax increase now will only delay California's recovery and prolong the budget crisis.

In his package of cuts and savings earlier this month, Davis proposed cutting spending for public schools by $3.1 billion this year and in the 2003-04 budget year that begins July 1. He also recommended reductions of $2 billion in health and social services, $1.9 billion in government operations and $1.7 billion in transportation.

Most of the $17.7-billion revenue shortfall Davis announced Wednesday is accounted for by a significant drop in projected collections of personal income taxes. Income tax collections for the current fiscal year will be $4.7 billion below the previous estimate, Davis said, and will fall $6.8 billion short of earlier estimates in the fiscal year that begins July 1.

In addition, sales tax collections over the next 18 months will be off by $2 billion, and corporate income taxes by $2.2 billion, the governor said. Most of the rest of the revenue loss is from declines in other taxes and fees.

Facing a long and bitter legislative battle over the budget, Davis could be aided in his efforts to mend strained relations with the Legislature by the appointment of Peace, a former state senator, as his new finance director.

Peace will replace Timothy Gage, a Capitol veteran with a background in finance but lacking in political stature.

Burton was joined by several Republicans in praising Peace.

"Everybody knows him. They know he knows his stuff. He's imaginative. I think it's a great thing for the state," Burton said. If you want other stories on this topic, search the Archives at latimes.com/archives . For information about reprinting this article, go to www.lats.com/rights .