Passage of Proposition 30 by California's voters finalizes the state's fiscal year 2012-2013 budget.
According to California Department of Finance (DOF) estimates, the measure raises the state's revenue base by more than $6 billion annually through fiscal year 2016-2017 and by smaller amounts for the two subsequent fiscal years.
The additional revenue materially benefits the state's projected fiscal position and is consistent with Standard & Poor's Ratings Services' positive outlook on California's general obligation debt ratings (A-minus).
Passage of the measure avoids triggering about $6 billion in midyear cuts that otherwise would have fallen heavily on the state's public schools beginning in January. Also, passage of the measure averts incorporating the trigger cuts into future years' budgetary baseline.
Although its tax provisions are not permanent, the rating agency views Proposition 30 as part of the state's more structural approach to budgeting that began in 2011. The measure does more than temporarily increase operating revenues and is the linchpin to the governor's broader, multiyear strategy for reversing the state's negative budget position.
Weighed down by around $34 billion in budgetary liabilities and payment deferrals, California's credit rating reflects approximately 10 years' worth of heavy reliance on one-time measures in response to a recurring structural budget deficit.
Proposition 30 allows the state to forecast paying down 74% of these liabilities by the end of fiscal year 2015-2016.
The beneficial effects from correcting its budget position to this extent could endure well beyond the time frame of the temporary taxes. However, the state's degree of success in retiring the budget liabilities according to its schedule will be an important factor in evaluating whether or how much its credit quality improves as a result of Proposition 30's passage.
In either case, the agency is aware of no alternative approach to reduce anywhere near the amount of off-balance-sheet obligations than that projected under Proposition 30.
Proposition 30 also contains an important spending-side provision by constitutionally protecting the redirection of revenue to local governments for the state's realignment initiative. The $5.9 billion revenue shift for realignment generates $2.3 billion in general fund savings during the current fiscal year by removing it from the formula that determines the Proposition 98 funding guarantee for education. These savings permanently reduce the state's budgetary spending base and will increase in value as the realignment revenues grow in future years.
On the other hand, Proposition 30 could exaggerate the state's tendency for revenue volatility. This is primarily because most of the new revenue (about 80%, according to DOF projections) will come from higher taxes on the state's high income tax filers.
Revenue volatility is a weakness in California's fiscal structure. But because the tax increases are temporary, Proposition 30 does not permanently alter the state's revenue composition -- or its propensity for volatility. The only permanent provisions of Proposition 30 relate to the realignment funding mechanism, which generates a relatively stable source of general fund savings.
Furthermore, given that the state faces a predictable budget gap when the temporary taxes expire, lawmakers will necessarily revisit the state's fiscal structure as it transitions to a lower post-Proposition 30 revenue environment. The interim situation, therefore, presents an opportunity for policymakers to pursue fundamental reforms to the state's fiscal problems -- including revenue volatility -- but in a less crisis-like budgetary environment.
There is potential for material improvement of the state's credit quality if lawmakers reach agreement on reforms that help stabilize the state's fiscal performance while the temporary taxes are in effect. Conversely, assuming no fiscal reforms, the state could simply face a new structural budget gap when the temporary taxes expire. Under the latter scenario, the agency said it would be unlikely to view the state's credit quality as significantly improved.
Even without additional fiscal reforms, however, Proposition 30 is still beneficial to the state's credit quality, if to a lesser degree. By providing a temporary but significant boost in tax revenues and permanently lowering its general fund spending baseline, Proposition 30 helps alleviate the state's chronic fiscal strain. Projected revenue from the measure also allows the state to credibly plan for reversing the majority of its payment deferrals and budget liabilities. Potential for additional credit strengthening beyond this depends on whether lawmakers can enact substantive fiscal reforms during this window of opportunity.