$2.5-Billion State Surplus Disclosed : Deukmejian Says Tax Receipts for 2 Years Will Far Exceed Estimates

SACRAMENTO â€”  In a startling announcement, Gov. George Deukmejian disclosed Wednesday that state tax receipts this year and next will be $2.5 billion higher than previous estimates, a windfall that could settle the Los Angeles schools strike and also pump new money into a host of beleaguered government programs.

For weeks, the state Capitol has virtually been under siege from interest groups stirred into a frenzy by expectations that lagging state revenues would require deep cuts in a variety of areas. Competing interests include mental-heath clinics, hospitals, county and city governments, welfare recipients, and those seeking more funds to teach English to immigrants.

State officials said that the biggest beneficiaries of the windfall will be the schools and that the promise of new money could encourage an end to the Los Angeles teachers’ strike.

‘Blown Away’

Even though there have been reports that the state was taking in more money than expected, no one anticipated the figure would be as high as it is. It was the third year in a row that Deukmejian’s budget forecasts have been far off target.

“I’m blown away by it,� Assembly Speaker Willie Brown (D-San Francisco) said.

Deukmejian said that unless he can work out an agreement with legislative leaders, he “would be required to allocate virtually all these new revenues� to public schools and community colleges under the terms of Proposition 98, the school-funding measure approved by voters last year. A small share of the money would be rebated to taxpayers.

The Los Angeles Unified School District could get anywhere from $120 million to $228 million in extra state funding over two years, although there are numerous political hurdles that must be cleared before any checks are put in the mail.

Despite the hurdles, state Supt. of Public Instruction Bill Honig said Los Angeles is sure to get at least some of the windfall and, in the meantime, he urged teachers to go back to the classroom.

“There is no reason to be out on the street when the only issue is when you will get (money from Sacramento). Given the fact that there is so much more money, there is no risk to either side that they will be left short. I think the teachers should go back to work immediately,� Honig said.

Assemblyman Richard Katz (D-Sylmar), chairman of the Assembly Transportation Committee, said after he heard the governor’s announcement, “This ought to settle the Los Angeles school strike.�

Deukmejian, who just months ago proposed a budget for the new fiscal year calling for hundreds of millions in cuts in health and welfare programs, said Proposition 98 and the decade-old, voter-approved Gann limit on state expenditures may require him to go ahead with the cuts despite the new revenue.

He immediately invited the Legislature to help him come up with a plan to spend the extra money, saying that without “significant budget reform� almost all of the windfall will have to be given to public schools and community colleges.

After a meeting Wednesday afternoon with representatives of the governor, lawmakers said no decisions had been reached but that they were encouraged by the general tone of the discussion.

Bipartisan View

Both Republican and Democratic legislators appear in agreement with Deukmejian’s opposition to giving the bulk of the money to schools, although there was wide agreement that schools should receive a fair share of the windfall.

But first, the Legislature would have to suspend voter-approved formulas under which the lion’s share of any surplus state funds goes to the schools. That would require two-thirds majorities in both houses.

Sen. William Campbell (R-Hacienda Heights) said the governor and Legislature now have “a golden opportunity� to enact meaningful reforms in the budget process. Campbell said support is strong to put a ballot measure before voters in a November special election that would permanently change the state spending limit and modify the formulas that control distribution of any surplus money. To put such a measure on the ballot would require approval by a two-thirds majority in each house.

“Republicans are ready to negotiate and move forward,� Campbell said.

Assemblyman John Vasconcellos (D-San Jose), chairman of the Assembly Ways and Means Committee, said, “We have to figure out how we can appropriately and legally spend the new money. Hopefully, we can all cooperate and make smart decisions, not dumb ones.�

Even if Deukmejian gets the reforms he wants, which he refused to spell out in detail in his statement, public schools still should be the biggest beneficiaries of the extra tax revenues. If schools get just their normal share of state budget dollars, they are in line for 40% of the $2.5 billion.

The governor’s statement Wednesday dealt almost exclusively with his desire to reform the budget process and undo some of the legal strings that have tied up the state’s fiscal decision-making process.

Schools’ Share

Under Proposition 98, schools are promised 40% of general state revenues up to the voter-approved spending limit and then get the first $600 million or so of any surplus over and above that.

Before passage of Proposition 98, surpluses were required to be distributed to taxpayers under terms of the constitutional amendment limiting government spending that was approved by voters in 1979. Two years ago, when a surplus of $1.1 billion developed unexpectedly, that money was rebated to taxpayers.

Speaking of the new revenues, Deukmejian said simply, “The Department of Finance has reported to me the state will receive approximately $2.5 billion in greater-than-projected revenues in both the present and upcoming fiscal years.�

Deukmejian, in his announcement, made no effort to explain why his revenue forecasters had missed the mark so widely. The proposed state budget is $47.8 billion and the estimate was off by about 3%.

State Finance Director Jesse R. Huff, Deukmejian’s chief budget adviser, acknowledged that he made a mistake. Huff said he had failed to foresee the strength of the state’s economy and had deliberately been cautious because he had overestimated by $2 billion last year.

“The most significant cause of it is the improved economy. The third and fourth quarters of 1988 and the first quarter of this year showed exceptional strength,� Huff said.

Last year, when Huff overestimated tax receipts by about $2 billion over two years, deep budget cuts were required to balance state spending. On the basis of last year’s experience, Huff told The Times, “We were being cautious.�

Huff said he felt that underestimating revenues when he prepared the proposed budget for the 1989-90 fiscal year last winter “was the right thing to do.� He added, “I still feel that way.�

The year before, in the spring of 1987, a $1.1-billion surplus materialized, which led to that year’s windfall and tax rebate.

Huff said the key contributing factor to the missed revenue estimates in each of the last three years were tax-law changes enacted since 1986, when Congress approved sweeping changes in federal income tax law. One of the major changes was doing away with the relatively low capital gains tax and taxing profits and investment income at the much higher personal income tax rates.

Experts say that many taxpayers cashed in profits in December, 1986, to take advantage of the more liberal elements of the old law. That led to the big windfall in 1987. Then, because so many profits were realized in 1986, receipts during the 1987 tax year were way off, leading to last year’s budget problem. This year, things were more normal, Huff said.

Taxpayer Complaints

Huff also noted there may have been a problem in the withholding schedules released by the Franchise Tax Board. Many taxpayers this year complained that they had to pay extra state income tax because withholding tables did not encourage them to deduct enough money from their paychecks.

The revenue gain is over two years, with $1.1 billion in additional revenues expected during the current 1988-89 fiscal year and $1.4 billion during the new 1989-90 fiscal year that will begin July 1.

Unless the law is changed, schools would automatically receive about $1.9 billion of the $2.5 billion over the two years, with about $350 million left over for a taxpayer rebate and only $250 million available to finance all other government programs.

Given the seriousness of other state budget problems, schools chief Honig, who led the campaign to pass Proposition 98, said he would be willing to accept less than the initiative provides as long as schools get at least 40% of the new revenue.

“We’re trying to be reasonable both because we think about the broader state issues and also we don’t want to be so arbitrary about it that you force people to extreme action,� Honig told reporters after a meeting in the governor’s office Wednesday.

Budget Shortfall

Legislative budget writers said the $47.8-billion budget introduced by Deukmejian in January was about $1.6 billion short of what would be needed to provide just the current level of services, provide state agencies with 4%-5% inflation increases and set aside $1 billion in a reserve fund.

Ways and Means Chairman Vasconcellos said that if schools receive $1 billion of the windfall, or roughly 40%, it would leave about $1.5 billion for other state programs. He noted that $1.5 billion is almost exactly what is needed to write a break-even budget.

But Katz and other lawmakers said they did not think the windfall would ease the funding crisis in transportation that has left highway programs short of revenue needed for new construction and eventually even basic maintenance. Katz pointed out that transportation programs are funded through the gasoline tax, while income tax revenues are earmarked for general government programs.