Sal, at the restaurant in the picture, regularly divides the pie. In 1979, voters adopted the "Gann Limit," a constraint on the state revenue pie also known as the State Appropriations Limit (SAL). It set a cap on how much revenue the state could collect based on a formula. If revenue exceeded the formula, rebates of the overage to taxpayers were required. In effect, under Gann, there is a limit on how big the pie can be.
Voters had earlier rejected an alternative limit proposed by Ronald Reagan in 1973 when he was governor. But in 1978, the political mood shifted with the passage of Prop 13, the property tax limitation, proposed by Howard Jarvis and Paul Gann. Gann was eclipsed in 1978 by the more colorful Jarvis and so he came back the following year with his separate proposition. The Gann Limit applies both to the state and to local governments separately.
Because of two back-to-back recessions that came along after the Gann Limit was enacted, revenue fell well under the Gann Limit until the late 1980s when rebates were issued due to revenue exceeding the limit. At that point, the K-14 educational establishment - school boards and teacher unions - which had become more dependent on the state thanks to Prop 13 put Prop 98 on the ballot earmarking revenue for the schools and community colleges by formula. Prop 98 was subsequently modified by Prop 111. The result was a softening of the Gann Limit. At the peak of the dot-com boom and the resultant revenue surge, the state came close to triggering the modified Gann Limit. But the dot-com bust and later the Great Recession again reduced Gann to a non-issue.
However, despite initial predictions that the pandemic-related recession of 2020 would drastically cut revenue, the projected cut didn't happen. Revenue has been surging reviving talk of exceeding the Gann Limit. That's why the governor regularly has been announcing new programs for this and that. Some of these programs - the latest being an idea of rebates tangentially linked to the rise in gasoline prices. Giving revenue back is a way of avoiding Gann.
The Legislative Analyst's Office (LAO) has been raising concerns about the Gann Limit, particularly as it interacts with constitutionally-mandated spending, i.e., the formulas that control spending on K-14. Essentially, the K-14 spending formulas are geared to actual revenue. But the Gann Limit means that some of that revenue is not available and must be rebated to taxpayers and/or used in other prescribed ways. In fact, LAO's projections indicate that every dollar over the Gann Limit diverts $1.60 from discretionary spending. In short, if there is no recession, we are likely to hit the Gann Limit, triggering a budget crisis. If there is a recession, it would be of the conventional revenue-cutting type (not the pandemic type), triggering a budget crisis.
From the UC perspective, Gann (or recession) can become a major problem - although not this year, but in the future. UC is one of the most discretionary areas of the budget and no compact with the governor or legislature can change that fact. Unlike, say, the state prisons, UC has an alternative source of revenue: tuition. The legislature knows that at the end of the day, it can cut the UC budget, decry the resulting tuition increases, and let the Regents get the blame for them. That was the scenario during the Great Recession.
The LAO is now warning about the Gann Limit and predicting that whether we have a recession or not, the current course of state spending and the governor's various program proposals are "unsustainable." That state's heavy dependence on the highly progressive state income tax is the key to why state revenue is growing rapidly. There are various gimmicks which the LAO points to by which the state can put off the inevitable for a year or so. But, it says, the inevitable is, well, inevitable.
Below is a summary from a recent LAO publication on the Gann Limit. As blog readers will know, the LAO uses the word "surplus" very loosely and really means the various state reserves that have piled up in recent years. Of course, 2022 is a gubernatorial election year and even though the governor has a lock on another term, neither he nor the Democrats in the legislature are anxious to take drastic budgetary actions. Note that while the Democrats also have a lock on the legislature, individual legislative members could face reelection primary challenges.
From the LAO:
SAL Will Constrain the Legislature’s Choices This Year; State Likely to Face Challenges Balancing the Budget in the Next Couple Years. Based on recent tax revenue collection data, the state will face a significant state appropriations limit (SAL) requirement—possibly in the tens of billions of dollars—at the time of the May Revision. The Legislature and Governor can address that requirement with tax reductions and/or with more spending on specific purposes, such as capital outlay. This year, the surplus likely will be large enough to cover those requirements. In future years, however, it is very unlikely this would be the case, requiring the Legislature to make reductions to existing spending. Under our estimates, this could happen as soon as next year.
Under the Governor’s Budget, the State Is Very Likely to Face Future, Serious Budget Challenges. If the Legislature adopts the Governor’s budget proposals and the economy continues to grow, the state would not have surpluses large enough to pay for large and growing SAL requirements in future years. If the economy does not continue to grow, the state would face budget problems due to revenue shortfalls. For this analysis we examined 10,000 possible revenue and economic scenarios. In over 95 percent of scenarios, the state faces a budget problem by 2025‑26 either due to constitutional spending requirements or a recession. In these scenarios, the state would need to make cuts to existing services to bring the budget back into balance.
Options for Avoiding Budget Problems in Future Years. The Legislature has options to avoid budget problems from arising over the next few years. For example, the Legislature can delay paying SAL requirements (for up to two years), change the definition of subventions, and/or reject nearly $10 billion in Governor’s budget proposals and save those funds to meet future SAL requirements. In fact, we recommend all, or nearly all, of the Governor’s budget proposals that do not help the state meet SAL requirements be rejected. However, all of these options are short‑term remedies, not long‑term solutions. Over the long term, as long as the economy continues to grow, the Legislature has two choices: (1) reduce taxes in order to slow revenue growth or (2) request the voters change the SAL... [page 1]
The State Cannot “Grow Its Way Out” of Budget Problems. Higher revenues do not increase the state’s ability to meet SAL requirements. In fact, the opposite is true. ...Because of the state’s constitutional spending requirements—including that the SAL requires the state to dedicate all revenues above a certain threshold for SAL requirements, no matter how much revenues grow—higher revenue growth means each $1 collected results in $1.60 of spending requirements. This dynamic puts the state in an untenable fiscal situation. [page 5]
Full publication at https://lao.ca.gov/reports/2022/4583/SAL-Implications-033022.pdf.