State Tax Shortfall May Hit $2 Billion : Finance Director’s 2-Year Estimate Puts Blame on Conformity Legislation

SACRAMENTO —  California could be facing a state tax shortfall of $2 billion and last year’s tax conformity legislation is most likely the culprit, state Finance Director Jesse R. Huff said Tuesday, setting the stage for a possible statewide tax increase.

“A billion dollars in the current year . . . is what we are down. The expectation is that it would be prudent to consider it ongoing,” Huff said. “At least in my estimation, if we are talking about $1 billion in the current year, prudence would demand that we talk about $1 billion in the budget year.”

What that adds up to is anticipation of a potential $2-billion revenue shortfall at a time when Gov. George Deukmejian is in the process of putting out the Administration’s final estimate of revenues and expenditures for the new fiscal year that will begin July 1.

Huff said Deukmejian is still reviewing his options. He could present the Legislature with a list of budget cuts, propose tax increase legislation that would bring in the lost revenues next year, or opt for a combination of the cuts and tax hikes.

Called ‘a Correction’

Huff, Deukmejian’s chief budget adviser, argued strenuously that if Deukmejian chooses to propose changes in the tax law, it will not amount to a tax increase. He chose to call it “a correction” to legislation last year that conformed state income tax codes to changes in federal tax codes that went into effect in 1986.

“There will be no tax increase,” Huff insisted.

If Deukmejian does propose a tax overhaul to raise revenues, it would come less than a year after he signed legislation authorizing last winter’s $1.1-billion income tax rebate. The rebate stemmed from Huff’s surprise discovery at this time last year that the state had an unanticipated $1.1-billion budget surplus. The governor said he was required to rebate the money by a constitutional amendment approved by voters in 1979.

Even before Huff’s announcement, Assembly Speaker Willie Brown (D-San Francisco) was telling reporters there is not enough time left in the current budget year to make up for the shortfall by cutting programs.

“We certainly could not in 60 days stop programs sufficiently to absorb that kind of a hit,” Brown said. But in the fiscal year that begins July 1, Brown said “there is no mystery” that the governor will have to cut programs or raise taxes. “How he is going to do that I don’t know. Either way, 1988 elections will be affected.”

Huff said last year’s tax conformity legislation was the leading culprit for the loss in income tax revenues because it was the most significant change in the tax environment. He discounted the effects of the huge losses suffered by Californians in last October’s stock market crash and the possibility that the losses may have contributed to a drop in taxable income.

“Our revenues from the income tax this year are going to be less than they were last year by maybe $900 million. Now that is just incredible in the face of an expanding economy,” Huff said. “There is a fundamental problem we need to take a look at.”

Huff made the announcement after the last of four meetings held by a group of state tax experts called together by Deukmejian at the end of last month to look into the tax revenue problem.

He said his belief that the tax conformity legislation was the culprit went beyond the consensus view of the group of tax experts. In fact, he said, the group could not pinpoint a specific problem.

‘No Clear Evidence’

“There is no clear evidence at this time as to the specific reason for the revenue shortfall,” Huff said, even though he asserted several times that he believes the problem most likely stems from the tax conformity legislation approved last year.

“We considered information from a variety of sources. The Franchise Tax Board did a number of partial surveys of returns. We looked at historical cash flows. We checked other states. There was not enough data available, and in fact there may never be enough data available to provide the sort of certainty that we would have liked to have had,” Huff said.

The announcement took two Democratic legislative leaders by surprise, and they suggested that Huff’s estimates were wrong and that the problem may not be of the magnitude that the finance director was predicting.

Revenue Needed

Senate President Pro Tem David A. Roberti (D-Los Angeles) said: “We’ve got to raise more revenue. We’ll have to cut (the budget), too.”

Sen. John Garamendi (D-Walnut Grove), chairman of the Senate Revenue and Taxation Committee, said his own staff indicated that Huff might be exaggerating the shortfall.

Garamendi, who helped put together the tax conformity bill, said he believes that the shortfall was possibly a one-year phenomenon tied to taxpayer adjustments to the 1986 federal tax changes and last year’s stock market crash. That would mean the problem is more one of Huff’s revenue projections than a fundamental problem with tax codes.

Only a ‘Calculator’

“The conformity bill was a calculator. It simply added and subtracted the numbers that were given to us by the Administration. The conformity bill is not the problem. The problem is the estimates that were given to us when we put the conformity bill together,” Garamendi said.

Until Tuesday, Huff had been limiting his predictions of the estimated tax loss to $800 million, although other sources, like Legislative Analyst Elizabeth G. Hill, said the shortfall was closer to $1.1 billion.

Those estimates of the loss were limited to the current fiscal year, the 12-month state budget year due to end June 30.

The Legislature currently is awaiting Deukmejian’s final report of revenues and expenditures before taking final actions on the governor’s proposed 1988-89 budget of $44.3 billion.

Delayed Indefinitely

The report was due Monday, but Huff delayed it indefinitely because of the revenue loss.

As a practical matter, the $1-billion loss means that the current year’s budget will end the year with a zero balance, or close to it, because Deukmejian built a $935-million reserve into the spending plan for the current budget year.

But the shortfall will wipe out that reserve and in fact probably will require some emergency budget cuts in the current budget. The revenue loss then would become a major problem in next year’s budget, for Deukmejian would not have as much as the $2 billion that he is counting on--the $1-billion reserve that he had hoped to carry forward into the new budget year and the $1-billion loss that Huff now says must be assumed to exist.