Assembly Standing Committee on Budget

Good afternoon, everybody. Let's call this hearing to order. Welcome to the Assembly Budget Committee. We are going to get started here as today is an informational hearing only, but we are going to discuss a very important and timely topic, which is our budget reserves.

And I would argue that this is perhaps the most important conversation that we are going to have this year and in the coming years, which is foundational to our ability to serve the people of the State of California, to deliver for the people of the State of California, to very prudently and in a wise way manage our resources so that we can do all of the good things in the budget that we need to do for the people that we serve.

And obviously, reserves have been an important tool to allow us to weather storms and hopefully will be a tool that will allow us to weather future storms. And I also hope that today's conversation is one that is going to transcend political ideology. This is about responsible government.

This is about making sure that we are situated for challenges that may come up in the future.

And as I have said to many of our colleagues, as we have discussed this topic, that I that being able to successfully and prudently and thoughtfully manage the volatility that we face here in the State of California, being able to plan for that is a gift that we could leave to our kids, a gift that we could leave to the next generation.

So today will be the beginning of what I expect to be several conversations about how we can best do that. I think it's important that we take the time to really understand these issues and get it right, and then potentially considered policy proposals around this issue in coming years.

So with us today are some experts who are going to help us dive deep on this issue and think about it. We're going to do two panels. The first from the Lao, who's going to help us to give us an overview of state reserves, just to understand mechanically and technically what we're talking about.

And then we have some thought leaders here with us who are going to help us think about a couple of different ideas for how we might be able to improve our use of reserves or maybe make modifications. And so I expect this to be hopefully an important and informative and thought provoking conversation.

So with that, let me thank all of the Members who are here, and let me turn it over to Vice Chair Flora for any opening comments. We're good. Okay.

Well, with that, then we will dive right in and allow me to invite Anne Hollingshead from the Legislative Analyst Office, who's going to provide a brief overview of our current reserves and how they work. Thank you for joining us.

Thank you, Mister chair. And Members Anne Hollingshead with the Legislative Analyst Office. Yes, as the chair already mentioned, I'm going to start with an overview of the state's Reserve system with a particular focus on the budget stabilization account, which is the state's constitutional rainy day Fund.

You should also already have a handout in front of you, and I'll be speaking from that. Okay, so turning to the first page, this provides an overview of the reserves that the state has and how they work.

So, starting with the Special Fund for economic uncertainties, this is the state's main discretionary Reserve, and it also is functionally the state's ending Fund balance. So this means that unanticipated revenues can benefit this Fund, and unanticipated expenditures are going to cause the Fund to go negative.

So this means that the actual balance in the Fund can vary fairly significantly from year to year. But on an enacted basis, the constitution requires the SFU to be set at a balance that is above $0, essentially.

Next is the budget stabilization account, which is the state's constitutional General Purpose Reserve account, also known as the rainy day Fund. Constitutional deposits into and withdrawals from the BSA are governed by the rules of Proposition two, which was passed by voters in 2014.

There is also, you can think of kind of a discretionary portion of the BSA in addition to the constitutional portion, and that's because the Legislature has elected to put additional money into the BSA twice before, and this money is not governed by the rules of the constitution.

I'm going to get into constitutional deposits in greater detail in a moment, but just starting with withdrawals, just very briefly, because some of these rules are a little bit technical. Happy to get into more of a minutiae if it's helpful. So the withdrawal rules are governed by budget emergency rules.

This means that a budget emergency must be first declared by the Governor in order for the Legislature to use funds in the BSA. And the Governor can declare a budget emergency in one of two cases, either in response to a natural disaster or because of a fiscal emergency. There's also a maximum level for the BSA.

It's set at 10% of General Fund taxes. So the balance in the BSA has increased over time relative to 2014, when Proposition two was passed and the constitutional portion reached 10% of General Fund taxes, a total balance of about 12% on two different occasions, once in 2020 and once in 2023.

Part of that balance was used to cover this year's budget problem, and the balance now stands at about 18 billion. Touching just very briefly on some other reserves that the state has, there is the public school system stabilization account, also known as the Prop 98 Reserve.

This is a reserve that is dedicated specifically to schools and community colleges and can only be used for that purpose. Constitutional deposits and withdrawals from this Fund are also governed by the rules of Proposition two, and most of the $8 billion balance in that Fund was used in this year's budget.

There's a safety net reserve, which is a statutory reserve that was established for MediCal and CalWORKS. This Reserve is available to Fund those programs during a downturn or a revenue downturn. The entire $900 million balance was used in this year's budget.

And then finally the budget deficit stabilization account, which is a statutory Reserve that was established in 2018 and it was only briefly funded. Turning to the next page, I'm going to talk in some detail about how Proposition two works. One thing to note, and Proposition two is what governs the deposits into the BSA.

One thing to note that is that Proposition 2 covers both Reserve deposits and debt payments. So talking about the formulas inevitably means that I have to talk about both. Um, but I'll obviously focus on the BSA in particular. These, these formulas can be somewhat complicated, honestly, from year to year basis.

But if you really just think about them from a high level, they make a lot of intuitive sense. So essentially what we're doing is we're taking two amounts that are deposited each year into the Reserve. One is a base amount. This is a steady percentage of General Fund taxes or revenues that is deposited each year.

And then one is excess capital gains. So capital gains revenues are revenues that are levied on the sale of assets like stocks and real estate sales, and they can be extremely volatile.

So the idea is that we're going to set aside peaks or surges in those revenues when they occur, and then those are going to be available to spend during a downturn. So just walking through the figure kind of briefly, the base amount is shown at the top of the figure.

It's 1.5% of General Fund revenues, and that's a split 5050 between debt and reserves. Pretty simple, excess capital gains. So for this one, we take 8% of overall General Fund taxes. That's sort of a threshold amount.

That threshold amount is compared at the budget act to the total amount of capital gains revenues that the state is anticipating to collect over the next year. That is split 5050 between debt and reserves.

But the challenge here is that, of course, anticipating capital gains revenues means saying something about what's going to happen in the stock market over the next 12 months, and that's very difficult to do. So the state revisits this deposit twice, once in each subsequent budget act, and these are called true ups.

And essentially the state relooks at, okay, how much capital gains revenues are we actually collecting? And then if there's more than anticipated, 100% of that goes to reserves. If there's less than anticipated, then all of that money would come out of reserves up to the amount of the initial deposit.

There is one technical adjustment here for the Proposition 98 increment that I'm happy to get into, but it really does get into the weeds. So, in conclusion, as you can see also from an agenda figure that was passed around, the state really has been able to successfully build reserves since 2014, when Proposition two was passed.

And this is the result, really of both the base amount and excess capital gains working in tandem. So the state has been near or at the maximum twice in previous years and has a pretty healthy Reserve available for budget problems this year. With that, happy to take questions.

Thank you very much. Do we have. We're going to get, as I mentioned before, for those of us, for those who are here, we're going to get into more conversations about thinking about how we might make adjustments. But just from a technical perspective, do we have any questions for the Legislative Analyst Office? Let's go.

Assemblymember Quirk-Silva and then Assemblymember Muratsuchi.

Just really quickly, sorry, just really quickly. On your BSA, you say that there is 17.6 billion in the Rainy Day Fund. Is that current as of now, or is that subtracting what we already took out from this last budget, that does.

Subtract what we already took out from the last budget. The one like little technical asterisk I'll put on that is, it's technically what we anticipate will be at the Fund at the end of the 2425 fiscal year. But you can think of it as like the live amount that's available for next year's budget. Thank you.

I was just curious, under Proposition two, why there was, in addition to the BSA, there was specifically a sub Reserve Fund created for the public school stabilization account.

Yeah, I mean, I think so. When you think about the state budget sort of infrastructurally, that's not a word. But the state budget infrastructure, you can think of it as two separate budgets, right?

There's 40%, essentially, that's governed by the rules of Proposition 98 dedicated to schools and community colleges and then 60% of the rest of the budget. That's for everything else.

So when you think about it that way, the BSA and other reserves really are dedicated specifically to the other side of the budget, the 60%, they can be used for schools, but generally what, we would keep those things separately. So then the Proposition 98 Reserve is sort of for specifically the 40% of the budget.

Thank you. Thank you. So many Member Lackey.

Yeah, thank you, chair. According to Ledge Council, the 10% in Prop 2 is not just a cap. It's not really a cap, but a trigger by which mandatory Reserve deposits are no longer required. Voluntary deposits are still authorized and would have actually limited strings attached for use. So why didn't we prioritize deposits when we had surpluses?

Yes, so that's right. The maximum level really does only apply to the constitutional share of the BSA. And it is a threshold after which infrastructure spending is required. So sometimes we refer to it as a maximum, sometimes we refer to it as, as a threshold.

But yes, you're right, there is no cap on the discretionary share of the BSA.

All right, well, thank you for that. My final question is, how would you propose strengthening reserves while ensuring that we return surplus revenues to our taxpayers?

I'm just going to jump in here. We're going to do all of those questions, if you don't mind assemblymember afterwards. But this is just if people want to ask technical questions about how the Reserve system operates. But it's an excellent question. So let's get to it, I think. Mister Alvarez, you have a question?

Yeah, just quick question. On the budget deficit stabilization account, does that still exist?

Yes, it does still exist in the state treasury.

Okay.

And so if the Legislature wanted to deposit additional reserves, that would be one option, because you could, as you just discussed, you could do it in the BSA as well.

Absolutely. Both of those are options.

Okay. And I had seen, and now I don't know where there was a graph that the Reserve levels, in terms of percentage wise, to the question again earlier of there were a couple of years when it was above 10% in reserves in the BSA, right?

Yeah. So it is a little bit complicated, but it speaks to having both the constitutional share and the discretionary share in the BSA. So the constitutional amount is capped at 10%, but the discretionary amount, the amount that the Legislature has elected to put into the BSA separately, has no limit.

And so the Legislature and the state have put more than 10% into the Reserve in the past because of that.

But prior to me being here, there were a couple of years of large surpluses and there was some conversation and I'd like to get some clarity that we actually couldn't put more into Reserve, and that was more having to do with, I think, GAN limit, not Prop 2.

Can you maybe briefly explain there isn't a cap, but there sort of is a cap?

Yeah. So it's a little bit complicated, but the state appropriations limit is a limit that was set by voters in 1979 and essentially limits how much state government can grow over time. Reserve deposits under the constitution. Under the state appropriations limit, Proposition four do count toward appropriations in the year that the deposit is made.

So because the state faced pretty significant SAL constraints, state appropriations limit constraints in those years that we had very significant surpluses, it made it more difficult, arguably, for the state to be able to put money into reserves.

Cause it would have had to count toward the state appropriations limit and it wouldn't have been one of the allowable uses of the excess funds, essentially undersell. So while to change that is to.

Go back and get a constitutional amendment.

That's correct.

Thank you.

We have any additional questions from Members?

Yes, please, Mister, I can just clarify your earlier comment. So you said that the Prop 98 Reserve has been functionally the Reserve for the Prop 98, the 40% port. So. But what if we depleted the Prop 98 Reserve this year, correct?

Well, the constitutional share of the Prop 98 Reserve was used entirely to support spending this year. However, the Legislature also elected to put an additional discretionary amount in the Proposition 98 Reserve. So that amount remains, I think it's about $2 billion, a little bit less.

Okay. But if our budget challenges continue, and in order to avoid cuts to our schools moving forward, that exceed that 2 billion in the discretionary Reserve, are there any restrictions within the provisions of Proposition two to take money from the BSA to cover any Prop 98 shortfalls?

Yeah. No, that would be allowable under the constitution.

Excellent. Thank you very much. Thank you very much to our very capable witness from the Legislative Analyst Office.

We're now going to move to our second panel where we're going to invite a number of additional folks to join her, including Jason Sisney, our budget Director for Speaker Rivas, Brian Brennan from the 21st Century Alliance, Scott Graves from the California Budget and Policy Center, and Lisa Misakinski from the Department of Finance.

And I'm sure that I got that last name wrong, so my apologies. And why don't we kick it off just in the order that we have it here on the paper with Mister Sisney.

Hello. Jason Sisney, Speaker Rivas, Budget Director. The reason I'm here is a lot. For historical perspective, Proposition 2 was originated here in the Assembly. It was authored by Speaker Perez. It was heard in this Committee in April 2014, with Speaker Perez and Governor Brown presenting the Bill.

So we don't often have governors up here before this Committee, but it did then, and it passed with zero no votes in both houses and went to the voters and was approved. That measure was in development essentially for about five years. There were several, several versions of it that went into print.

There was actually an earlier version of a constitutional amendment that was passed and then pulled back and modified as a part of the Prop 2 process. And it was definitely a work that originated from the budget crisis of the Great Recession. Reserves have historically been unpopular and that shaped the debate on Prop two.

Progressives were very concerned that putting more money in reserves would halt the restoration of programs after the Great Recession would take money off the table for expanding programs. And historically, reserves have also been unpopular among many conservatives.

The GAN limit specifically sought to limit state and local governments accumulating reserves, and that originated from the 1970s, where the state had what the former treasurer, Jess Unruh, called an obscene surplus under Governor Brown. And it's one of the factors that went into the passage of Prop 13 and the gain limits.

The reserves have historically been unpopular, but coming out of the great recession, there was recognition that given the budget challenges the state faced, there was a need to do that.

And also between the time Prop 13 passed and the Great Recession, the state's revenue system became much more volatile, much more dependent on income taxes and on income taxes paid by high income individuals.

Over the last decade, Prop two has been successful at building reserves, though that has been in an environment where the economy's been steadily growing, the stock market's been growing, our tech industry has been growing, and high income individuals have been doing disproportionately well.

And so one of the things to consider, as you think over the coming months about reforming our reserves is that the next decade might not be like the last decade. We might not have as much tax revenue coming from those high income individuals as we have. And that is something to keep in mind.

One of the key questions is, should the maximum size of the rainy day Fund be increased? It's absolutely right that more can be put into discretionary deposits, though when Prop two was written, there wasn't a lot of thought given to discretionary deposits because we didn't really have any money at that time to set aside in reserves.

So that was a problem that wasn't really anticipated.

So making it clear how discretionary deposits work as a part of the system is one thing to consider if you go back to the voters to reform reserves, and you'll also want to consider whether the annual deposits to the rainy day Fund, which are said, as Ann was talking about, whether those should be increased.

Another issue is whether it should be harder or easier to declare a budget emergency and withdraw funds from the BSA. There are rules that are there this year that are there now. They allowed the state to withdraw funds from the rainy day Fund this year and are expected to allow the withdrawal from funds next year.

We are not currently in a recession, and some people feel that the rules were too easy this year, and that's something to consider as well. We talked about the GAN limit, and the GAN limit is really one of the key reasons that there's been discussion in the last three years of going back to voters.

In 2022, when the state was up against the state appropriations limit, it basically pushed the Legislature at that time to provide tax rebates and to put funds into infrastructure. Both of those are things that the gain limit allows, but the GAN limit does limit discretionary deposits to reserves.

And so that was something that was very hard for lawmakers and the Governor to do in those surpluses, simply because those constitutional formulas didn't allow it. And so that's a key reason to think about going back to the voters.

And I think that the other thing is that talked about the mechanism, the revenue, the percentage of revenues, the excess capital gains. We've had a lot of those capital gains in the last decade, but we might not in the future.

And in light of that, one thing to think if the Legislature goes back to voters is whether or not the formulas for determining how much goes into the rainy day Fund every year should be changed into something different. The Governor, alongside all of this has been, has proposed a statutory measure for a temporary surplus holding account.

It's technically a Reserve, but really it's functionally a way to delay spending surpluses in the future if, to try to make sure that those surpluses are really there, to try to deal with the problems we had with 2022 where the surpluses were overestimated. So that's a statutory issue.

And in effect, the Legislature would be expressing the intent in the future to not commit all of those surplus funds at once, but rather wait a year or more to make sure that they're there in closing in my comments, I do just want to point out that not only does the state have significant reserves now in our General Fund, the rainy day Fund, but in the last decade, California has really had a new ethic of budgeting, such that as of last month, there is well over $100 billion of available funds in the state treasury, mostly special Fund balances, but also the rainy day and the other Reserve balances that we have in the days of the great Recession, we had to borrow money just to keep that at a minimal two or $3 billion.

We are now well over $100 billion of available funds in the state treasury. That doesn't count the funds that are committed, which are even more committed and obligated. These are funds that in some cases have been budgeted, but they haven't been spent yet.

And I do think that thinking about how to manage that money over the long term is a very important part of the discussion. It's something that the Budget Committee will want to think about in future years. And a lot of that has to do with making sure that departments spend appropriated money promptly and effectively.

But there's a lot of money there, and as the state thinks about growing its General Fund reserves, it also needs to think about that big picture of all of the other cash that is available. So thank you.

Thank you very much, Mister Sisney. Thought provoking as always. We will go back to the Legislative Analyst Office. We appreciate your overview.

I think now is the opportunity as we have a discussion about how might we improve our reserves, how might we tweak them, what proposals might we consider to strengthen and improve them, and would now appreciate your perspective on that as well.

Yes, thank you, Mister chair. So on the third page of the handout that I already spoke from, we have three questions for consideration for the Legislature as you're considering evaluating the state's overall Reserve situation and possibly considering making changes to it. So the first one is why does the state have reserves to begin with?

And we offer this question mainly for context. The reason is that a lot of decisions about reserves, how big they should be, when reserves should be set aside, how they should be used, ultimately involve a lot of subjective decisions, a lot of judgment calls.

And so starting with the specific goal here can really help clarify and frame those choices. So, for example, something that might sound good on its face is for the Reserve to be big enough to avoid budget cuts entirely in any size of recession.

But this would involve a Reserve that is absolutely massive, tens of billions of dollars, if not over 100 billion. And so that's not only sort of prohibitive from a policy perspective, but would also involve pretty serious downfalls.

So the goal may be something more modest, like to avoid certain kinds of budget cuts, ongoing cuts to programs, for example, cuts to the state's core service level. But if that's the case, reserves might not need to be as large, still possibly larger, than they are today.

But it would also mean that the state would still need to make some difficult decisions in a recession, for example, raising revenues or reducing spending. So this is basically, this sort of basic dynamic is how we would encourage the Legislature to think about reserves. This leads to the second two questions.

Should the Legislature raise the maximum level of the BSA, and then should other changes to reserves be made? So, starting with the BSA maximum, as I already noted, the constitutional maximum is 10% only on the constitutional portion of the BSA.

And when we go back and look at previous recessions, the ones, for example, before the pandemic, early 1990s, dot com bust, great recession, and you add up the total revenue losses across those, there's different ways to do it.

It's a little bit complicated, but on average, what you see is those total General Fund revenue losses are closer to 50% than 10%.

Now, this is, of course, a much larger number, but as we noted, you might not want to save fully that amount because the goal may not be to only use reserves to get through the budget problem.

Still, that's, of course, stands in stark contrast to the 10%, and may suggest that the Legislature has reason to want to raise the captain if the cap were raised. This leads to the third question about other potential changes that could be made.

It would almost certainly necessitate changes to the rules because you simply wouldn't be able to save a significantly higher amount with the existing rules. If you raised to, say, 20% or 25%, you'd still probably only reach just above 10%.

That could suggest that the Legislature could make simple changes to the Reserve rules in order to reach that higher threshold, raising the base amount, lowering the capital's gains threshold. And of course, those are doable. But we would suggest that there may be also reasons to revisit the rules more fundamentally than those simple changes.

And we say this for two reasons. So the first one is that over the last decade, the state has really seen almost like a perfect storm of conditions to have the rules be successful. And as successful as they've been. We saw a very long economic expansion between 2014 and 2020.

We saw a Low interest rate environment that resulted in significant growth in asset markets and capital gains revenues and together, those two factors are essentially what allowed the state to hit or nearly hit the limit, I'm sorry, the maximum in 2020 and then 202223. But those conditions may not continue to exist forever.

The next decade might not look like the last decade. And so that may speak to the state's need to revisit the rules in order to ensure that the Reserve can continue to be successful.

The other issue, the second issue is that capital gains, as Mister Sisney already noted, are not the only source of volatility for the state's revenue system. And this has been increasingly true over the last decade. We've seen, particularly in recent years, above average volatility in the corporation tax, in business income to individuals, as well as even withholding.

So this suggests that maybe a broader look at the types of volatility that the state is trying to capture could be warranted. Of course, all of these things involve trade offs and they require some decision making.

But we do think that there are some reasons to think to rebuild or to change the system in order to help the state continue to build reserves as successfully as it has been doing. Thank you.

Thank you very much. And I think one thing that sticks out to me about Mister Sisney's historical perspective here on the fact that it took five years to develop Proposition two.

And what you've said about the trade offs to think about here is it is important to me that we take the time to ask these questions and do the balancing and get it right.

That particularly if we're going to do an amendment to our state constitution or go back to the voters, to do this in the right way, in a thoughtful way, is an important thing. And so to help us think about that more fully, we have, we're very delighted to have Brian Brennan from the 21st Century Alliance.

Thank you, chair Gabriel. Brian Brennan, 21st Century Alliance. I wanted to provide a little bit of context for this discussion and this question of why we need a budget reserve. And as we think about how big that it needs to be, I provided these slides that you should have in front of you.

So I'm just going to walk, I'm going to walk through these very quickly. The context for our discussion, many to a large extent, is around the us business cycle and what that looks like. Slide one captures that. Do you have a copy of this? There we go. Slide one captures that business cycle.

And essentially the story here is recessions happen and they're a part of the world that we live in and the part of the world that you live in and that they are something that we need to plan for over time. You can see that the average duration in between recessions is about seven or eight years.

If you go back to 1945, that gap has been longer in the last 20 years or so. But if you move to slide two, you can see that in recent decades, the impacts have been significant. The Great Recession obviously was an outlier, had enormous impact on our fiscal wellbeing.

But even going back to the early nineties and early eighties, those recessions had a significant impact on the state's fiscal wellbeing and critically, over multiple years. These are not single year activities. You all are at the business end of this, but it's worth keeping in mind that these are multi year problems.

If we move to the next slide, this is the story again that you all are living right now. California has a very volatile tax structure. It's actually the fourth most volatile in the nation. The three states that are ahead of it get a huge amount of their revenue from fossil fuels. Alaska, North Dakota, Wyoming.

California is different, as you know, and the next slide shows one component of that, capital gains. We've done very well over the last decade or so in terms of capital gains. We're essentially as a state playing the market and we're doing really well at it. The other piece of this on the next slide is around IPOs.

The impact of IPOs is very difficult to pin down. These data are actually at the Us national level, but the dynamics are largely the same. In California, we had a big spike in 21. Those were largely driven by the SPAC phenomenon. These are numbers of IPOs too, so you don't capture the size of them.

And that's a huge issue as well. In 2012, for instance, Facebook IPO'd. And even after the fact, it was very hard to identify the impact on the state budget.

Lao ballparked a little over $2 billion, but it was estimated that approximately one fifth of the increase in personal income taxes that year 2012 were due to just that single ipo. So these are the types of factors that will influence how the budget is doing.

If we go to the next slide, we can also see that there's a regional component to this. Disproportionately, our personal income tax come from two regions of the state, the Bay Area and the South Coast, so LA and parts of Orange County.

So we know that and that's a function of our economy and the way that it's distributed, but that can interact with other factors as well. On the next slide, we have a graphic that I've always found super interesting.

And it juxtaposes the unhealthy air quality days in cities across the nation between 2016 and 2020 versus 2009 and 2013. Essentially, this is a story we all lived through because we all had to breathe that smoke. But it really underscores how externalities, exogenous, pardon me, shocks, can have an impact beyond our state's fiscal structure.

And this obviously can include pandemics. It includes changes in technology that allow people to work in different places. And this dynamic, where we had unhealthy air quality between 2016 and 2020 probably played a role in the next graphic, which shows migration from California. That's been ongoing.

And we know about that, certainly at the low income, moderate income levels for many reasons that you all know very well, that shifted in about 20172018 to also include high income individuals, and that's folks making over $200,000 a year function of many different things, for sure.

But it's, again, one of those factors that we have to consider given our tax structure. The last two slides, I just wanted to put our current General Fund in comparative perspective. So this graphic shows the number of General Fund spending days in the current Reserve that we have in California.

As you can see, California actually has a pretty strong policy on this. The Pew Research center looks at this state, across states at many different levels and has really good things to say about California's current structure.

That said, if we go to the next slide and consider days of General Fund spending conditioned by state volatility, California shifts from just on the cusp of the top quartile to just on the cusp of the bottom quartile.

And that really is the issue, I think that we need to consider here is, as we talk about the size of the General Fund, we have to do it conditioned by the state's volatility. And with that, I will close. Thank you.

Thank you very much. We will now turn to Scott Graves from the California Budget and Policy Center.

Mister Chair and Members, good afternoon. My name is Scott Graves. I'm the budget Director at the California Budget and Policy Center. We're a nonprofit research and analysis organization that works to improve public policies for families with Low incomes and communities of color in California.

We appreciate this opportunity to share our thoughts on the state's Reserve policies and perhaps add a couple of new perspectives to the mix as part of these very brief, prepared remarks heading into the conversation I know you'd all like to have.

So let me start by grounding my remarks in a core value the budget center believes that all Californians deserve the dignity and support to lead thriving lives. And clearly, state budget choices are crucial to making that vision a reality.

So while we agree that it's critical to prepare for a rainy day, we also strongly believe that building reserves must be balanced with making ongoing progress toward a California for all Californians are looking to state leaders to address skyrocketing housing costs, the need for affordable child care, and many other challenges that we face.

Strengthening the state's reserves should not come at the expense of addressing these challenges and helping Californians. Now there's some good news. The good news is that bolstering reserves and building an equitable state do not have to be at odds.

In fact, California's current Reserve strategy, in our estimation, is a huge success, thanks largely to Prop two, which, as you know and just heard, originated in Assembly a decade ago.

The billions of dollars set aside over the last decade helped California to address a large budget shortfall this year while sustaining investments in critical services and still leaving a lot of funds in Reserve for the near future. Prop two also has helped California to manage revenue volatility.

Ups and downs are a normal part of a progressive tax system. California was well prepared to manage the revenue swings coming out of the pandemic because so much funding had been set aside to smooth over the highs and lows of our state's tax system.

So with that background, how can state leaders adjust Reserve policies while also ensuring that sufficient resources are available to make progress toward a California for all? Here, I want to make five points before concluding.

The first is an overarching consideration to keep in mind that the kinds of events that cause extremely large revenue swings like we saw coming out of the pandemic are relatively rare.

So it's critical to avoid over correcting by creating excessively rigid savings requirements requirements in response to extraordinary circumstances, for example, significantly raising the cap for the rainy day Fund could tip the balance too far in the direction of saving, leaving less revenue to meet the immediate needs of Californians.

This would make it harder to address poverty and inequality and to create an equitable California where everyone can share in the state's prosperity. My second point we do think it makes sense for leaders to be cautious when a very large budget surplus is projected.

It's reasonable to delay allocating some projected revenue, especially when there's a high risk that a surplus might not fully materialize. But any change in this direction should avoid creating. Here's this word again, rigid requirements that prevent policymakers, you all, from making progress on meeting the pressing needs of Californians.

Third point, Reserve deposits should be excluded from the state appropriations limit, also known as the Gan limit. The Gan limit nonsensically counts Reserve deposits as spending toward the spending cap. This makes it harder to set aside more revenue in years when the Gan limit is a factor in state budgeting.

Voters should be asked to fix this glitch as part of any effort to revise the state's Reserve policies. Fourth point if we're going to amend the state constitution to change Reserve policies, and here's a new one for you, we think it's also important to revisit the debt paydown rules put in place by Proposition two.

Currently, half of each year's required General Fund transfer goes toward paying down certain state debts. That's a requirement that remains in place until 2030. Incredibly, these debt payments can't be suspended or reduced for any reason.

Even if the state faces a severe budget shortfall, like we did this year, voters could be asked to amend the Constitution so that these debt payments could be paused or reduced during tough budget years. This would strengthen budget resiliency and complement the rainy day Fund by freeing up resources to close budget shortfalls and protect vital services.

Last point we think that a portion of the excess capital gains revenues that Prop. Two requires to be set aside should be used to reduce California's extreme inequality.

The gap between rich and poor in California is wider than in most other states, and a majority of Californians, according to a recent PPIC poll, think more should be done to address this gap.

State leaders can start by requiring some of these so called excess capital gains revenues to be directed toward one time investments that would allow more Californians to share in our state's wealth. Now let's keep in mind that capital gains are among the most unequally distributed sources of personal income.

They accrue disproportionately to high income households and more generally to white households, a reflection of structural barriers that privilege white families and block families of color from wealth building opportunities. Meanwhile, disproportionate shares of black and Latinx Californians live in poverty due to these same factors.

So explicitly using a portion of excess capital gains revenue to reduce racialized poverty and inequality would bolster existing efforts to create a California where everyone can be healthy and thrive. Let me sum up. We agree that it's crucial to responsibly manage California's revenue ups and downs and set aside substantial funds for a rainy day.

But we also strongly believe that any effort to revise the state's Reserve policies must be balanced with meeting Californians needs and making progress toward a California that is truly for all. Thank you, and I look forward to the conversation.

Thank you very much for that thought provoking testimony. We will now turn to our final witness and I will again apologize in advance. This is Lisa Mierczynski from the Department of Finance.

Very good. Good afternoon. Lisa Mierczynski from the Department of Finance. I do not have a formal presentation for you today, but I'm here to answer any questions you might have for the Administration.

Thank you.

Excellent. With that, we will bring it back to Members of the Committee for questions, comments, and I will defer first to Mister Lackey, if you'd like to go, since I cut you off before. If you want to kick us off, sir.

Yeah, it's just back to my original question here. I've got too much documentation here. Nonetheless, I mean, we were talking about. I'm sorry, if you can hear me now, how did you propose, and this is for you again, how do you propose strengthening reserves while ensuring that we return surplus revenue to our taxpayers?

Yeah, I'll be honest, that it's an issue that we're working on at the moment as an office and happy to follow up in the coming months with more.

You know, I think clearly we think that there is certainly merit to the idea to raising the BSA threshold above 10% given, you know, kind of the reasons that I outlined earlier. And if that were the case, then we think, you know, sort of corresponding changes would possibly be necessary.

Either, you know, simple changes to change the existing rules to essentially allow the state to save more over time, or more fundamental changes could be considered.

That's good enough. Thank you.

Let's go. Assembly Member Alvarez and then Assembly Member Ward.

Thank you. Thank you all for your. For your presentation. I think I'd start off by making a comment, just General comment that I think, and I made similar statements when we voted on the budget this year, which is, it was a difficult task at hand, given where we were. Certainly having the reserves was helpful.

But ultimately, in a couple of you, I'm really pleased, actually covered this in your presentation, the LAO and the 21st Century Alliance.

This is an issue about volatility, and we can talk about reserves all day long and create Reserve policies, but if the volatility continues to exist in California, where we have this, one year is very, very good with surpluses, and another year we go into a deficit that doesn't allow us to invest in the ways that I think we all want to invest in our communities, which is more consistent.

And I think that's really the most important critical issue we should probably address as we go forward. Certainly we should talk about reserves and we should have a rainy day Fund.

Those are all good things to do than we should do, but we should talk about as part of that and whatever decision we ultimately make, we should be talking about the spikes in revenue and the decline in revenue that happened with the cycles that occur in our economy.

And so I was pleased to hear about that and I'll ask a few questions about that in a second. But I have one question to the LAO on the issue of the. You want us to, you asked the question and are asking us to think about what do we consider essentially reserves?

And you didn't say, say this, I don't think, but from year to year, as we sometimes utilize reserves for spending, you did talk about core services. You mentioned that. And I guess in my mind, and please help me understand and help us. Are you referring to.

We should focus on sort of what I would call baseline spending as opposed to new spending. We saw that a lot, certainly in my Subcommitee, with some new proposals to spend new money utilizing Reserve funding. Some of those did not happen, and I think that was a good thing.

I think some maybe did overall, in the course of a negotiation did happen. But do you want to talk at all about that practice and how maybe we should be thinking about that as we go forward?

Yes, sure. Thank you for the question. So we do. I would note that we have this concept of the state sort of core service level. Right. And ultimately, this is a pretty hypothetical context. It's not necessarily one that we can empirically say this is exactly what the state's core service level is.

But the way that we generally think about it is the amount of ongoing spending that the state has already committed to. And, of course, that ongoing spending level changes over time as the Legislature adds new commitments to it. But we do think that that's a helpful kind of reference case.

And it was one of the reasons that this year we sort of consistently or encouraged the Legislature to pull back on one time spending before using reserves so that reserves were available to cover essentially that ongoing commitment to Californians.

Yeah. And I encourage you to continue to do that next, you know, in the future to remind us when we are in a position of spending one time versus utilization of reserves to spend for ongoing purposes. I think that's important for us to always be aware of.

To the Mister Brennan from the 21st Century Alliance, you focused, and again, I appreciate that a lot of your comments on the volatility of revenue for the state, primarily around capital gains, which is a driving factor.

But I think even Mister Sisney, I believe, mentioned it's not just that it's now corporate tax, it's a number of different revenue sources that are now volatile. Do you want to share more about that and your assessment of that?

Thank you for the question. We highlighted capital gains because that's been sort of where the action is, so to speak, over the last decade or so. We tend to agree actually, though, with the idea that we need to look, if we're going to make this change, we need to look at volatility more broadly.

I mean, if we were to do the quick and easy way on this, it would be to keep the structure largely the same and kind of with the parameters. But a number of other states look at volatility in a more fulsome way.

And I think given that we want to make reform that is resilient through a variety of different economic contexts, I think it probably would behoove us as a state to develop a measure of volatility, a trigger of volatility that is broader than capital gains and includes some of the other factors that. Miss Hollingsworth,

Tell me more about what. The others, because you mentioned the other states, I believe it was in your presentation, and the volatility rankings, if you will, just briefly, what are some of the main differences in those volatility assessment that we have versus other states that just to help us think about things we should be maybe considering as we go forward?

So just off the top of my head, there are a few other models that I've been taking a liking to. I guess so. North Carolina, for instance, the increase in revenues year over year, every increase, 15% of that automatically is deposited into their Reserve Fund. So that's just 15%, everything in excess of the year before.

A couple of other states use sort of when the growth in revenues exceeds some threshold overall. So Nebraska, when the compound annual growth rate, when budget revenues exceed I think the average of the last 12 years compound annual growth rate, then that excess, some percentage of it is then put away.

So this is a broader measure of volatility that doesn't focus on the source of the volatility but simply what's coming into the treasury.

That's interesting. I think that makes a lot of sense for all of us in our household budgets. When you have excess funds, you save some of it and you can spend some of it. I'm definitely interested in more of the findings from other states and how they approach that.

I assume though you also not just in your assessment of volatility, it also has to do with the source of the volatility. Are there assessments of that or it.

Could, I mean, I think, I don't know all the context for the focus on capital gains other than to say that we're particularly subject to capital gains. But I, but as Mister Sisney said, past is not necessarily prologue. And as we think about going forward, there could be shifts that we can't foresee.

So I'm not sure that the source of the volatility is as important as the fact of the volatility. Again, capital gains is probably going to continue to be the largest single source of volatility in California, but it needn't necessarily always be thus.

And if we're going to make a change at the ballot box, you know, we want to make it count. That would be my view.

Okay. Appreciate that. Thank you. I'll leave it at that. I'm sure colleagues will have questions for the other panelists. I would just end again with a comment where I started.

I think as we look at this, I'm all for and have been, in fact, I was sharing with my colleague here from San Diego the first question that I asked about whether that budget deficit stabilization account still exists, and it does certainly in our Subcommitee we talked about how do we create stabilization for higher education, which our University or public University system has to deal with this back and forth.

And so we should think about maybe, although statutory, focusing on the core services, to the LAO's point, we have a safety net Reserve. Perhaps we should consider higher education one of the core services and statutorily at least through that account, maybe further defined.

And so I'm all for reserves and talking about more reserves, but I think we need to get to the core issue, which is the volatility, certainly based on growth, but also on what I believe really hinders our ability to long term plan, which is the revenue for our state. So thank you Mister Chair.

Thank you very much Assembly Member. Excellent questions. And we will now go slightly north in San Diego to your colleague Mister Ward.

Just slightly next door. Thank you everybody for the presentation as well and particularly for some of the very specific recommendations that you're offering here today. Probably just the beginning of hopefully future discussions as well that we can act upon for anything that we can do in our purview and of course engagement with the voters.

And my line of questions actually just really relate to what my colleague from San Diego was talking about as well. And I was curious about actually almost 90% of it was really answered through this. So thank you for that.

But digging a little bit more, knowing California's sort of core structure, our big three on personal income, on sales, and on the corporate tax rates and the volatility within those, are there other, with other states?

Do they have a different sort of mix of their major sources of revenues that are lending them to more natural protections against volatility? Or are you seeing other models where other states are looking at other sources of revenue in a way that just naturally provides for smoother variation over year, over year?

I will say that states that are based, that have their structures based more on sales taxes, sales taxes are, in economic literature, a regressive revenue source. They impact lower income families more. They also tend to be more stable revenues for states and local governments.

And so governments that are based more on the sales tax, they do have challenges with fiscal management, but not as great as states with progressive income tax structures that have capital gains is a big element. California, Illinois, New Jersey, Massachusetts, these are among the states that have the more volatile revenue structures.

And then there are the states, as was mentioned, that are resource dependent revenue states like Alaska and Wyoming. They are the most volatile of all, in some cases much more volatile than California.

So among the states that have a big capital gains personal income tax component, I think it's fair to say California now leads the way among those states in having Prop two. And then other states that don't have as volatile structures also have the types of rainy day structures that were mentioned.

Great. Well, thank you all.

All right, we're going to do Ventura, and then I see Orange County wants to get into the mix and we'll work our way north up here to Torrance. But somebody, Member Bennett, thank you very much.

Very helpful information here. A couple of quick questions just to our Committee staff. The investment of the $100 billion, that's all done and coordinated. And I assume we're trying to maximize revenue at the same time that we're maximizing security of those funds. See any options there? That.

So the funds of the state Treasury are managed by out of the treasurer's office through the pooled money investment board. That consists of three Executive branch officials. And the total in that Treasury is more than $200 billion.

The amount that is called a borrowable, that is fairly liquid on a day to day basis is more than 100 billion. And those are generally invested in us treasuries and securities and equivalents, cash equivalents. So for most of the last decade, they have earned almost no return.

Because interest rates have been Low, they now are earning, effectively a treasury yield of around 4%. So they're managed for safety, they're managed for liquidity, and there are very good reasons for that. Thank you. But the state has never had as much as they do today.

All right, thank you very much. And if I could go to the Laos office, just like a little more explanation of your sentence that says, we advise assessing changes that could allow the state to build reserves in disparate types and lengths of economic expansions. Could you clarify that a little bit more?

Yeah, of course. So the idea here is that it took about eight years or so, right, from 2014 to 2020, for the state to build to the quote, unquote, maximum level of the BSA to 10% of General Fund taxes in that time. But that was also the longest economic expansion in recorded history. Right.

So if the goal of the state is to get to 10% in perhaps a Shorter amount of time, then different rules would be needed.

Thank you. And this is just an overall comment, but hopefully a suggestion. And I'd love to have any feedback after this hearing, not necessarily right now, but, you know, moving averages.

You see, the moving averages issue in a number of the other states, and the data that you've presented to us makes some sense from my perspective, looking at the five year moving averages, etcetera. But the idea of trying to stabilize our revenue sources always runs into the problem of regressive tax questions.

But it seems to me that the benefits of stabilizing our revenue sources are significant.

And we could, in California, adopt a policy that takes the stability that comes from, for example, a change in state sales tax and use some of that stability in revenue to make sure that we offset the economic impact to low income people, because that's who we're really concerned with.

On the regressive side, give a funding source to those low income people. But then be able to maximize the benefits of the stability and the revenue we get from high income people buying cars and other things.

Because value added taxes in Europe, which is not in General European countries, are not considered countries that are regressive in terms of what they're doing.

Value added taxes have tremendous benefits in terms of having people pay the proper cost of providing or disincentivizing consumption that that is higher than the cost of providing the service and revenue as we go forward. So I'd like to throw that out there.

It seems like there are many people in the Legislature that would like to try to find a way to get out of this volatility of revenue, but we won't do it unless we're creative about dealing with regressive taxes and some kind of subsidy. Thank you.

Mister Graves. Did you want to comment on that or Mister Brennan? No? Okay. All right. Then we will move over here to Assembly Member Valencia.

Wonderful.

Thank you Mister Chair. And Mister Brennan, just want to start off by thanking you for the shout out to Orange County. We do provide a substantial amount of revenue to the state alongside LA and of course San Francisco and the rest of our counties across the State of California. So thank you for that.

And I also want to highlight what our Chair mentioned about this having to be a methodical and strategic process and taking the time necessary to ensure that whatever we instill constitutionally and statutorily, is what's best for California.

And so, and as Chair's budget Subcommitee seven on accountability and oversight, I feel a deep responsibility to make strides in safeguarding California's fiscal stability.

I am grateful for the leadership from our Governor, Speaker Rebus Pro Tem Mcguire, and of course our Chair, Mister Gabriel, and the entire budget staff for working to ensure our state has a balanced budget. This year, our state faced a grim reality.

We were tasked with closing a deficit of almost $50 billion and to see the fifth largest economy in the world come to a nearly $50 billion shortfall in spending cuts and resort to tax increases on our businesses should push us to rethink our approach to these issues.

Currently, our state relies significantly on our progressive tax system and rainy day Fund to navigate our unpredictable revenue streams and spending habits. Having these systems is critical, but they are outdated and must be improved to better account for today's financial realities.

And recently I announced that I would be introducing an Assembly constitutional amendment to address California's fiscal stability by revising the rainy day Fund and the GAN limit.

And I intend on introducing that piece of legislation following the end of this session and starting at the next session so that we could have a two year window to hopefully get something that's concrete and strategic.

I believe that with prudent budget management and the modifications of the ganlim and rainy day Fund, we can better prepare the state and our great people for future economic challenges and a more prosperous California.

Thank you.

Thank you very much, Assembly Member. Assembly Member Quirk-Silva.

Thank you for the presentation by everybody. I'm looking at the slide from Brian Brennan's slides, number nine, talking about volatility, but now focusing on migration. And as we can see with your slide, of course, we see that on migration has become an issue. That's a serious issue.

But when we look at that and add that to the age of Californians, I just read an article recently that says we are, of course, growing our senior base.

And because Low birth rates and other factors, affordability in California, that we, a decade out from now, may not have the younger generation here ready to work and do the types of things that we're looking at.

And if you combine that with the corporations that we continue to see, sadly, almost weekly, leaving California and our high wage earners a decade out from now, whether it's through any of the presenters here, are we starting to plan for this in a serious way, focusing on this migration issue?

But I'll let you start off, but anybody else who wants to chime in after.

I mean, I hope. I think that's what we're doing here. As a matter of fact, I applaud you all for asking this question, because I think the demographics of the state, among these vulnerabilities that we're facing, that have to be factored in. So I think the budget Reserve is a great place to start on this.

I think I would. Oh, sorry. Okay. I was just going to add that we did see an increase on net in higher income Californians leaving the state during the pandemic. But some recent research from the Public Policy Institute of California, looking at 2022 census data, gives some inkling of hope that that trend is beginning to reverse, perhaps.

I mean, a trend is never made by one data point or two data points. But I think it's important to keep in mind the bigger picture here, that more recent data showing on that, that higher income Californians, you know, are more likely to remain in the state relative to other Californians who may be leaving.

And there are a lot of different reasons for that. And we also think it's important to keep in mind that academic research shows that there is very little tie to California's tax policy in terms of being a reason why high income Californians would choose to leave the state. So there's no academic evidence really supporting that overall.

One thing I wanted to mention is that the Proposition 30 tax increases on the highest income individuals in California, they expire in 2030.

So the Legislature and the Governor are likely to face a choice in the 2026 or 2028 election cycle whether to put a constitutional amendment or a measure on the ballot to extend those taxes or to change those taxes.

And that's something that the Legislature could do in coordination with a Reserve measure as well in thinking about all these issues.

Sorry, just one more addition on this point. From a revenue perspective, our office does regularly or somewhat regularly look at the effects of migration on revenue found in the last couple years that the effect was about 1% of revenue reduction. And then I think that ticked up a little bit in our most recent estimate.

So a question is, you know, is that trend going to continue or is that basically a stable number?

Thank you very much, Assemblymember. I will now go to Assemblymember Muratsuchi.

Thank you. All of this talk about volatility always reminds me of when I was on the torrent school board during the great Recession and we were on the front lines of having to deal with all the state budget cuts.

We were the ones that had to vote on laying off teachers and increasing class sizes, having teachers complaining to school board Members. I always thought that the Legislature was always benefited from having almost like a buffer between the angry parents and the budget cuts that the state was making, that the school boards had to implement.

But that's a whole other conversation. But talking about the volatility, I remember back then thinking that I wanted to come up here to try to address the volatility. And I remember back then going to the conversation about what other states are doing and what alternatives might be doing.

It was my understanding that other states had a higher percentage of the revenues coming from property taxes, which is a more stable source of revenues. But of course, that raises some of our colleagues favorite topic of Proposition 13, you know, trying to address that.

And then, so then I remember Senator Hertzberger a couple years ago, he tried to introduce the tax reform in terms of, you know, extending taxes to professional services.

And, you know, I think similarly we realized that that was going to be very politically challenging, you know, to start talking about taxing, you know, accountants or lawyers who may pass on the cost to consumers.

And so it seems like we're left with this most politically palatable way of trying to stabilize our revenues, which is to focus on the reserves.

I wanted to, next time I see Speaker Perez, I want to thank him that the best thing he probably ever did was to get Proposition two enacted in terms of his and ongoing legacy for the State of California.

But, you know, the conversation about the gan limit, and I don't know if Mister Valencia is thinking about this in his plans for introducing a Bill, but I'm just reading the staff analysis that the Gan limit was intended to cap state expenditures, but it treats reserves as expenditures.

And so I would think that there would be bipartisan agreement that we want to incentivize reserves. We don't want to disincentivize reserves. And so is there any good argument why we should not propose changing that provision to treat all reserves as expenditures?

Well, I think that one of the challenge that goes to some assemblymember lackeys earlier questions is that what the Gan limit does is set an appropriation limit for state and local governments. And if the state goes over that. There are a few options for the state, infrastructure spending, but also tax rebates, returning tax monies to the people.

And so in a sense, this issue of amending the gain limit comes down to some discussion of how much you want to build reserves versus how much you want to have this mechanism that, among other things, sends tax rebates back to the people. And that is one of the trade offs in this discussion, I think.

Okay, yeah, no, I can appreciate that. As Mister Lackey is looking at me. I know we all talked about the middle class tax refund when we were going back to talk to our constituents.

At the same time, I would think there would be bipartisan agreement that we would want to have stability for school funding, that we don't want to be in these boom and bust cycles where we're giving pink slip layoffs of notice for our teachers.

And so I would hope that there would be progress made in terms of addressing this gan limit, because I think, absolutely, I believe that the best way to, to try to address the volatility issue, politically speaking, is to focus on strengthening or incentivizing reserves, and that we should not be disincentivizing by treating reserves as expenditures.

I also noticed, along with Miss Quirk Silva, the chart about the migration. And it would seem to me that as our economy, as more and more people work virtually, that this is a concern that we always need to keep in mind.

While I appreciate the budget and policy centers focus on making sure that we're providing for the most vulnerable Californians. And we often entertain ideas about like a wealth tax, you know, but we always have to keep this chart in mind in terms of when we're talking about the wealth tax.

I don't know if, is there any, there seems, is there any data that can be cited here in terms of whether a wealth tax would be more or less likely to contribute to this trend of the out migration of wealthy Californians.

I mean, we don't know. What we can say is in Europe in the nineties, there were 12 countries that had wealth taxes of some sort. Today there are five. And they've proven difficult for a couple of reasons. One is they're just really hard to implement.

It's really hard to identify sort of what wealth are we taxing, how much is there? And then the other problem, particularly in European context, but we see the dynamic play out here is folks were leaving, folks were leaving these countries and going to other places. And that's a dynamic we have to look at.

And although sort of pinning down causation is squirrely. There is actually a bit of. There is one paper out of Stanford that looked at the 2012 tax increase, the salt changes in 2017 at the federal level, and there were actually unanticipated increases in the number of high income folks who left just following those points.

Obviously, 2012, that was state level. 2017 wasn't a policy change in California, but it did have these tax impacts. Very rarely, my sense, very rarely do people make decisions about leaving based on taxation.

But when you layer that on with technology changes, with changes in the economy, obviously with environmental issues as well, it's sort of, each has a separate impact.

If I may add. Census data show that most of these interstate moves are driven by family considerations, by job considerations, and also by housing. And obviously, housing is a big motivator for people with middle and low incomes in our state.

And this Legislature obviously knows this and has been working on this for years now, trying to figure out how to get more affordable housing. Because if you can't afford to live in California, of course you're going to look for a more affordable place to live.

So that is one of the biggest drivers, and it's not driving high income folks out of California. Right. Of course, there's a pinch for anyone in terms of housing costs, but what's where. The driving out factor here is really affecting families with low and moderate incomes. So that's an important point we think should be kept in mind.

Academic research does not bear out. And as Brian sort of just reiterated, that folks, higher income folks are leaving because of taxes. Right. There's a lot of research that shows folks with higher incomes have job and family reasons.

As much as they may be able to work remotely from wherever they want, there may be good reasons for staying in California, given the types of jobs they have and the types of networks they're involved in. These factors are most affecting families with low and middle incomes.

I mean, I'm familiar with the data that I've seen that indicates that the number one reason why California are leaving the state is because of the cost of housing. But in terms of talking about budgets and revenues, what is the current figure that the top 1% of California income earners contribute? What, over 50% of our revenues?

It's around that. It varies from year to year, but. That's a good, that's a good ballpark. Okay.

Yeah. So that's, that's my concern that, you know, while we certainly do want to continue to work on making housing more affordable, that, you know, are we, what are we doing to keep that 1% that we're relying for 50% of our state revenue zone.

If I could just add on, I didn't make a point earlier. There's a lot of. It's interesting, all the conversation on the Committee about revenue volatility, considering, you know, we're having a.

You're having a conversation about reserves, and one of the main purposes of reserves is to help smooth out the ups and downs of our state's progressive tax system. It is an alternative to the mythical stable revenue stream that will never cause policymakers any problem from here to eternity. Right.

Any revenue stream will result in some level of volatility down the road and problems will have to be solved. Where I'm not hearing enough congratulations on.

Look at what we did as a state, starting in this chamber and the voters approving a decade ago, a very solid policy proposal to actually sock away more money coming from the highest income earners, largely from capital gains, and set it aside for those times when we know revenues will decline.

We know they will because we've seen it happen, and it'll happen again in the future. So the reserves and the agenda asked a very good question. What is the problem we are trying to solve here? What is the problem you are trying to solve? That's the very first question toward the end of your agenda.

And so I think the conversation, if it can be focused on that question, I think it would be very helpful, because then you don't end up going down all these dead end roads where it's like, if only we had the perfect tax system in California, then all of our problems will be solved.

We have the tax system that we have. It bears a lot of benefits. It brings a lot of benefits to Californians. It allows us to have very robust public services. They could be more robust than they are now.

But I would like us all to at least acknowledge that policymakers did something very prudent here by putting in place requirements to save for a rainy day. And we have seen the benefits of that over the last few years, and we can continue that without changing anything in the future. Maybe some nips and tucks and tweaks.

And of course, you've heard me say we think that there is a reason for even more investments in California's communities. We've got a lot of work to do in this state, and it's gotta be about more than just sustaining and maintaining.

It's gotta be about growing and furthering policies that can really help Californians to not just make ends meet, but to thrive. So that's the conversation that my organization is really excited about having. And personally, I think talking about revenue volatility and how to stop it is kind of a dead end, because we've had this conversation.

I've been at this for almost 25 years, right? We've seen this conversation come and go over time, and it's not going to go anywhere. The question is, how do you most effectively address revenue volatility, right. So that we can have the kind of state we want and solve the revenue shortfalls when they inevitably occur?

Which is why I start off by talking about how that was one of the greatest legacies that Speaker Perez and I think I'm looking around the dice. I think I'm the only one that was around 10 years ago to vote on ACA one.

So I would totally agree with you that establishing the rainy day Fund was one of the. The best things that we've done.

Yeah. Thank you. Congratulations.

Thank you. All right, I think we're gonna. Thank you very much, Assembly Member. I think we're gonna go. Assembly Member Jackson and then our Vice Chair, and then if no one else wants to go, I will jump in, and then we're gonna open it up to public comment.

Mister Graves, I think you're asking us to do too much. We don't focus on good stuff here. We only talk about the. The cataclysmic things.

I think from what I'm gathering here, it doesn't seem as though we need to make some major revision of what we need to do, but make some minor tweaks in order to ensure that we have greater stability into the future?

It seems to me that a 10% Reserve was a good start, but we might need to expand that.

I think the question for all of you is, what do you believe is the appropriate percentage of a Reserve that will continue to help us to get through some of the volatility that we know might end up being more volatile into the future. Right.

Given national, international conflicts and trends, our economy is realigning in terms of our major companies. Right. What would be the appropriate percentage or a reasonable percentage so that we are not doing so much that we are not investing into the people who need additional support? Any thoughts?

I can start. You know, I will say something slightly unsatisfying, which is that our office doesn't have a specific recommendation for, you know, how big it should be. Because ultimately there are, as I mentioned earlier, a lot of subjective decisions. Right. How big of a shortfall do you want to prepare for?

What kinds of budget cuts do you want to be able to avoid. Is it the Legislature's desire to avoid revenue increases at any point in the future, or revenue increases acceptable? So these kinds of questions, of course, drive how big or how small the Reserve should ultimately be.

But for context, as I mentioned earlier, 50% is the amount of General Fund revenue losses that we've seen over the last few decades. So if the state were going to save, say, about half of that, then that would be something closer to 25%.

But again, if the Legislature did significantly increase that maximum level, the rules probably would also need to be changed in order for the state to be able to actually achieve something that big.

So the first step is what percentage do we want to save, and then what rules do we need to change in order to make sure that we can do that? Yes. Right. Okay. And if that 25% was already the law of the land, how would that, what would our budget situation look like right now?

It would look almost exactly the same. We've reached nearly. We reached the 10% threshold nearly in 2020, and we reached it actually in 22-23.

Since 2223 I think it's maybe been, after you account for kind of true ups and some of the adjustments, I think it's maybe been a few $1.0 billion, two to $3 billion that ultimately went to infrastructure instead of the rainy day Fund.

But that would have only put the state at, say, 11%, 12%, not anywhere near 25%.

And I'll add on in part because I came from the LAO, I think, the same way.

I'm not sure there is a single right percentage, but if the goal is to grow it bigger in the next economic cycle than 10%, it's going to have to involve a combination of either setting aside more every year than we do now or doing much more on the discretionary side.

So, in other words, not something that's a rule, but just something that in surplus years, the Legislature voluntarily sets aside a greater amount of money alongside the mandatory deposits. So if the goal is to grow bigger, I think it's probably going to have to involve both of those things.

So it's just basically the length of time the cycle was between the great Recession and now. It's not about the percentage that we would have put aside, but it was the amount every year we were putting in, so we wouldn't have even been able to hit that anyway, is that what you're saying? Right.

If, say, you had a cap of 20 or 25% under the rules that we had in Prop two, we would not be there today. We wouldn't have hit it in the last economic cycle? I don't think so. So I think that if the goal is get it bigger, you have to think.

We have to think about that, looking forward, how to change it.

Anyone else? Go ahead, Brian.

The only thing I would mention, there are a few states that actually stress test. So they evaluate their income, they evaluate their expenditures on an annual basis to determine what the Rainy Day Fund level is. That's pretty complicated. I mean, we're already stressed, so that's true. We know that it's there already. Right.

Our sense is that something on the 20% to 25% level is right. And it doesn't get you a whole lot more sort of precision in terms of a right answer, because there is no right answer.

Basically how much risk we're willing to take ourselves. That's essentially it.

That's essentially it. In the Minnesota context, their goal is to be able to cover. That's the term that they use, and it's not well defined, but cover nine out of 10 recessions, in other words, other than the Great Depression level, that's what their goal is.

So when they're out talking to their colleagues and to voters, that's the way that they articulate what their goal is. But again, I think that may be suggesting that we can be more precise than we can actually. We can actually be.

Got it. I was just going to add a reminder again, yes, any number is going to be arbitrary, but also, as you know, there are so many tools in the budget balancing toolbox, and reserves are one. Right.

So there are a lot of other ways in which this year and in prior years, the Legislature and governors have managed to balance budgets without having a gigantic Reserve. So I guess one question would be, do you actually want to build a gigantic Reserve?

Mister Sisney pointed out how in the 1970s that was a liability leading up to the passage of Prop 13 in 1978. That was not seen as a good thing by Californians to be paying taxes and having a large proportion of that sitting in a Fund and wondering who's going to use it and when.

So there may be political considerations there, but also just a reminder that you have so many ways to balance your budget, and that showed up this way in your June budget package. Right? Borrowing from special funds, a lot of other things that were done.

Sisney mentioning the $100 billion in borrowable resources because of the prudent budgeting we've engaged in over the last decade. So maybe coming at this not from the perspective of we need a Reserve that solves all of our problems in the very worst-case scenario.

But we need a Reserve that acts as a tool that we can use in concert with other tools to help us manage the ups and downs of our progressive tax system.

Right. What comes to mind for me is the idea that for me, I'm not really a fan of just one time funding. Particularly for those who are programs that are geared towards our lower income, those who are in survival mode, because one time funding is not enough.

You need consistency and predictability for people to be on a path to thrive. Right. And so I'm leery about the idea that, you know, on good times, let's just do it one time funding and they have their thing, but then when that's gone, they're back to where they started from.

And so I think the idea is, how do you find that balance? And I guess that's what we're all talking about here, is what is the appropriate balance to the best of our ability. But how can we give the vast majority of our folks the consistent and predictability they need to make California work for them? Right. Yes.

Thank you.

Thank you very much, Doctor Jackson. I will now turn to the Vice Chair.

Thank you, Mister chair. Having this conversation about gan limits. It's very timely. The first call I took this morning was from the Superintendent of Calaveras County Unified School District, which is up in the foothills. And they're in a very tough situation right now.

They have a budget of $41 million, 11 million of that goes through special ed funding. So if you do the math, that's a huge number and they are in big trouble. I mean, to the point of just trying to figure out a way to stay solvent.

And it's something that we're gonna have some conversations with moving forward, because there is a lot of strings attached to funding as it relates to education. I do, it's a different conversation. But as it relates to Gan, if we were. Well, because of Gan, like nine and a half $1.0 billion has been spent to school funding.

And if we were to exclude the Reserve deposits from that, what effect would that have on that school funding?

Lisa Mierczynski, again, I can't pronounce my own last name now, the Reserve deposits would not impact school funding. Their funding is strictly calculated by Proposition 98 guarantee. The reserves are put aside outside of the Prop 98 General Fund. So, you've got non 98 General Fund in your General Fund.

So putting more aside in reserves would not impact that. Even if we were to go towards a surplus allocation account that would not impact schools because that surplus is determined after all the constitutional requirements are met. So that would not now the local limits. Is it concerned with their local limits?

Yes, because at the local limits, anytime they exceed or get to the end of their local limits, those limits fall back to the state. So a local educational agency or district should never really have a problem with their limits because they just, it's a process.

Every year they then notify the state and the state then absorbs that on our limit. So the total limit for the state isn't exceeded, but the local it becomes. And that is another kind of problem that we have with the state is the amount that we're absorbing from those local limits at the state level.

Okay. So that, I mean, that's, and that's kind of good news in some ways because I think one of the things we really do struggle with and, you know, Jackson's brought up as well, like there's a lot of our underserved communities that are really, really struggling.

And I think as we have these discussions on how this affects things, like we really need to make sure that, you know, rising tides rise all ships and we cannot forget about, you know, it's just, I mean, CalVERS unified is in big trouble.

And I think it's just interesting and I want to make sure that as we have these conversations that we're not doing anything that could potentially cut funding from the schools in some of our significantly underserved areas.

And then just on a broader scale, you know, recently we went out of the country on a bit of a trip and their education system in General was very responsive to a modern day workforce.

And I think one of the things that as we think about how we spend state dollars, are we getting the most bang for our buck?

And when it comes to prison programs, I think there is a lot of things within the prison system that we spend a lot of money on programs trying to, you know, for recidivism reasons. But we're not really not getting that return on investment because those jobs may not be available anymore.

The economy, the workforce has moved away from then. So I would love for us to continue to have a conversation as we go through these budget crisis that the dollars that we do spend, we're getting a return on investment. And if there are programs within this particular, the prison programs, I am very passionate about that.

If there's things in there that are not working, let's have that conversation and let's look at that. Because if we're going to just be throwing money down a drain, I think there's better ways to do that.

So I just would love to continue these conversations and make sure that as we fight a budget crisis and there's a lot of great dialogue that's happened today and there's a lot of things that we can look into. But let's have those conversations.

Let's make sure that we are using the dollars that we do have in the most responsible and effective way possible.

Excellent. Thank you very much, Mister Flora. I'm going to jump in with a few comments and we will then open it up to public comment, if there is any. But first, let me thank all of our panelists for sharing your insights, your thoughts, the historical perspective here, the technical expertise. We appreciate it very much.

We expect this to be an ongoing conversation. I think you've given us a lot to chew on, a lot to think about. There are several different dimensions to this challenge, to this, to all of the issues here for us to consider, and certainly trade offs, as all of you have noted.

And those are ones that I think we want to think through carefully. Just a couple of observations from my perspective. One, I want to pick up on what some of Assemblymember Marisucci talked about with the Gan limit. I will confess I was not familiar with it when I was elected, as I think probably many Californians are not.

I know it's older than I am, so I was not here for its inception.

And it was really just mind boggling to me as we were contemplating this historic budget surplus that we had, that doing the prudent, thoughtful, responsible thing of putting money away for a potential future rainy day, that we would be constrained in that I think there is a lot of opportunity there for thoughtful conversations.

Obviously something we'll need to go back to the voters to do. But I do think that that's a conversation that we ought to have to me actually fits within the framework of infrastructure investments. This is something about doing something big and important and meaningful for the state that will serve potentially many generations of Californians.

And I would certainly put building up our reserves if we do find ourselves in a historic, you know, that type of historic situation again. You know, I think it is important for us, as several of the witnesses noticed, to think about that.

What the last decade had looked like is no guarantee of what the future decades may bring. And so as we are trying to build a system to maybe innovate and improve this system, some of the historic economic expansion that we have seen in prior decades, none of that is guaranteed in the future.

And we need to be mindful of that and thoughtful about that.

And certainly also, just to also understand that because of this incredibly innovative economy we have here in the State of California, we may have a lot of volatility just on the natural as people create new companies, as they harness new ideas, as who knows what the boom in AI will bring for California, what that will mean for our budget.

None of us can predict that, but we could. I could imagine a number of different scenarios and how that might work itself out. So I think it's important for us to think through all of these things with a lot of specificity and be really careful and thoughtful in how we approach this.

I do also want to pick up on what Doctor Jackson articulated, because I thought he articulated it very well. To me, it's not that there is a tension between responsible and progressive government. I actually think that they go hand in hand and that it is foundational and certainly that we are exceptionally mindful up here.

And I want to compliment Doctor Jackson and many of our other sub chairs who did the exercise this year. They are incredibly mindful of our most vulnerable communities.

And we understand that there is extraordinary need out there right now and that people really need help and that there are families in crisis and we need to make those investments. But what we don't want is to find ourselves in a situation where, God forbid, we're having to slash those social programs that are protecting our most vulnerable.

And so that requires prudence, that requires being fiscally responsible and planning for what might happen in the future. And certainly it is a good point that we have a lot of tools out there, but we want to be mindful about how we use all of them in concert to put ourselves in the best position.

What I would like to avoid, and I think it's actually a very inefficient way to do government, is you have a good year, you create a bunch of programs, you have a bad year, and you take a bunch of those programs down.

And this, you know, it's not an efficient way, it's not good, it's not an efficient way to do pog policy, it's not good for the people that we serve. And again, I don't think there's actually a tension here between those two things.

I think being smart and thoughtful about our reserves and fiscally responsible is foundational to the kind of government that we want to have that is empathetic and compassionate and serves our most vulnerable communities.

And then the final thing I would offer here is I've always believed that one of the ways in which you can be a true public servant and be responsible is to plant seeds in a garden that you may never live to see or that you might not serve in a Legislature to see.

And so I just want to take us back to the fact we are talking about here with some of this, deferring our own ability to make choices about how we spend money to give a future Legislature the opportunity to protect the people of California in a downturn.

And that to me is an important thing and in some ways runs contrary to political impulses that a lot of other people might have.

And I just want to compliment the Members of this Committee who are willing to exercise that self discipline because they understand that it is ultimately in the public interest to do so and ultimately in the best interests of the communities we serve. So I think there's a lot of opportunity for alignment here.

As I said in my opening statement, I see this as a conversation that should transcend political ideology. Sisney outlined for us some of the concerns in prior generations that progressives and conservatives had about this.

But I think there's a way where those streams can merge together, where people across the ideological spectrum would say this is not about an ideology. This is about being responsible, thoughtful, prudent stewards of managing the budget.

The volatility that we have here in the State of California and finding that balance, I think that was the word that Doctor Jackson used, and I think it's exactly the right word between protecting folks now, making the investments we need to make now, but also being prepared for whatever future storms we might have in the future.

So a lot to discuss, a lot to dig into. Very, very grateful for what we heard here today. I think you gave us a lot to think about, a lot to chew on. Grateful as always for the exceptional hard work of our staff on both sides to tee up some of the questions we need to answer.

Looking forward to continuing this conversation, and with that we will open it up to public comment.

Good afternoon. Linda Wei with Western Center on Law and Poverty. We appreciate that the final budget did protect the safety net program, including CalWORKS nutrition programs, foster youth, as well as health services programs. However, the budget did empty the safety net Reserve, the only Reserve that's dedicated to Cal Works and Medi Cal.

And so we would urge the Legislature to replenish the Reserve. In addition, we align our comments with Mister Graves in the need to mitigate the volatility impacts by advancing equitable policies, as well as ensuring that budget deficits are not balanced on the backs of Low income Californians. Thank you.

Thank you so much for that.

Vice Chair Flora Members Alex Torres here with Brownstein today. On behalf of the new California coalition and the over 800 local and regional chambers of commerce, ethnic chambers and economic development groups in our statewide coalition, we're here to voice strong support of the budgeting reforms outlined and discussed today.

Thank you Mister chair, Mister Vice Chair and staff for outlining this important discussion here today. I'll restate it, but it's been mentioned several times today. It's encouraging on the movement here if we are to avoid the chronic boom and bust cycles that have plagued California and the pain experienced by Californians during the down cycles.

We just had a very difficult budget conversation, Mister Doctor Jackson, you had a particularly difficult conversation and I think to avoid that, it is really critical that we move with expediency, with haste to figure out what we do on this effort.

So Assembly Member Valencia, thank you so much for your notes on the effort you plan to lead. Look forward to working with you on that.

Specifically, we want to express our support for the proposed raising of the cap on the Rainy Day Fund from 10% to 20% of the state budget, the exclusion of deposits into the Rainy Day Fund from the state appropriations limit so that we are not constitutionally disincentivized from increasing the reserves.

We also want to encourage you to consider increasing the constitutionally required contributions to the budget stabilization account from 1.5% to 2.5% to accelerate the rate at which the BSA can accumulate reserves for these and other provisions.

Also want to express support on behalf of the Bay Area Council representing 320 large employers in the nine county Bay Area, and CEO Jim Wonderman. Again, a very important hearing. First of many conversations. Come look forward to having. Thank you.

Brandon Epp here with Brownstein here on behalf of the New California Coalition, voicing support on behalf of partner orgs who can't be here today in support of proposed language around special reserves and grant Gan limit changes. Specifically here to voice support from Mike Roos, Southern California Leadership Coalition, or council and Silicon Valley Leadership Group. Thank you.

Thank you for that.

Hi everyone. Yesenia Jimenez with Grace and Child poverty in California. Just wanted to give a thank you to everyone who centered a discussion on low-income Californians and how they are impacted by our budgetary decisions.

We hold gratitude for the Legislature and Governor for the groundbreaking budget agreement, which for the first time preserves anti poverty safety net during a deficit and rejects austerity measures that harm the most vulnerable Californians.

With that in mind, we are extremely concerned about the budget agreement's complete withdrawal of the $900 million safety Net Reserve, the only state Reserve dedicated to protecting cowworks and medi Cal during an economic downturn. This move leaves the critical programs exposed to future challenges, which means we leave our families on hold during economic downturn.

There is no easy way to say it. Leaving the lives of families on hold who can least afford it will not set us up for a pathway towards prosperity and equity for all. We strongly urge the Legislature to replenish the safety net Reserve and strengthen safety net programs to support families in times of great need. Thank you.

Thank you so much. Would anybody else like to come in front of Mister Brennan? Anybody? Other committees?

Anybody? Can you hear me, sir? Go ahead, please. I want to thank all the panelists, the Members. I've been doing this a long time and it's easy to get jaded. This was actually one of the more intelligent, thoughtful, insightful conversations we had in this building in a while.

We've got a lot of work to do in this area. I look forward to working with all of you on it. It's clear to me that everybody wants more. A valuable tool here, more flexible tool. I'm not sure raising the cap does that, but allowing you to make voluntary contributions with fewer restrictions.

So dealing with the interplay with the gan limit seems to be imperative. And there were thoughtful ideas in all parts. So I look forward to working with you on this. Thanks to.

Thank you so much for that. Any other witnesses?

Nobody else? I have time.

Appreciate it. Any other witnesses? Any other public comment? Seeing? None. Any other questions from this Committee staff? Thank you, everybody. Like we're adjourned.