California Governor Gavin Newsom’s proposed budget for FY 2020-21 projected a $7 billion surplus and record state spending, but his revised budget projects as much as a $54 billion deficit in light of COVID-19’s impact on the state’s economy and deep revenue reductions. Newsom’s May Revision Budget—the last official estimate of revenues and spending before the enactment of the actual budget for 2020–21 in June—includes tax proposals as a critical component of his plan to raise new revenues to help fill California’s budget hole. The Legislature has begun hearings on Newsom’s proposed budget and many legislators are expressing alarm by the deep cuts proposed by the Governor and are responding with alternative proposals of their own.
- Suspension of Net Operating Loss (NOL) Deductions, projected to increase revenues by $1.8 billion. This proposal would prohibit corporations with a net income of over $1 million from using net operating loss to reduce their state tax liability for 2020, 2021, and 2022.
- Limitation on Business Credits, estimated to increase revenue by $2 billion. The proposal would limit businesses to no more than $5 million in tax credits per year for 2020, 2021 and 2022.
- Simultaneous Payment of Sales Tax and Fees Used by Car Dealers, estimated to increase revenues by $12 million General Fund in 2020–21 and $24 million General Fund in 2021–22. The proposal would require used car dealers to pay sales tax and registration fees simultaneously to the Department of Motor Vehicles (DMV) instead of paying the fees separately.
- Modification of Use Tax on Vehicles, estimated to increase revenues by $30 million General Fund in 2020–21 and $61 million General Fund in 2021–22. Under the proposal, a vehicle buyer can pay the use tax (similar to sales tax) on the vehicle purchased based either on the reported sale price or 80% of the estimated market value of the vehicle. To take advantage of the latter, however, a vehicle buyer must provide the DMV a certified appraisal of the vehicle purchased.
It should be noted that the Governor’s post-COVID-19 budget does maintain a handful of tax relief proposals for individuals, small businesses and the film industry originally proposed in January, including:
- Exemption From Minimum Franchise Tax for limited liability companies and certain partnerships, projected to reduce revenues by $50 million in 2020–21 and $100 million in 2021–22
- Extension of Sales Tax Exemption for Diaper and Menstrual Products to July 1, 2023, projected to reduce revenues by $48 million annually
- Extension of Carryforward Period for Film Tax Credits from six to nine years; revenue reduction to be determined
The Legislature will review these tax proposals and is likely to modify them or make alternative proposals as it works to put together and pass a balanced budget by its June 15 constitutional deadline to send a budget to the Governor.
The California Legislative Analyst’s Office (LAO) provided an independent analysis and response to Governor Newsom’s tax proposals and, like some legislators, took issue with some of them. For example, instead of suspending the NOL deduction based on a corporation’s net income, the LAO suggests capping the deduction at a specific amount, perhaps $100,000 per taxpayer. This would allow most corporations to deduct their NOL while targeting the revenue burden of NOL suspension mostly to higher-income corporations. The LAO further rejects the modification of use tax on vehicles given the limited time the Legislature has to develop the proposed tax structure. The LAO also recommends the Legislature consider additional alternative revenue sources, including such politically difficult choices as eliminating state deductibility of local taxes and mortgage interest on first and second homes, as well as increasing inheritance tax liability.
Legislators themselves are also proposing revenue alternatives, with some endorsing a split roll property tax on the November 2020 ballot, which would amend California’s Proposition 13 with big adverse consequences for commercial property owners; others urging enactment of sports wagering with a statewide tax, rent relief for renters and tax credits for landlords, and prepaid future tax vouchers; and others proposing ideas most of which are unlikely to be adopted given the narrow window of opportunity to consider and decide on very complicated solutions to very large, very difficult budget shortfalls.
On Wednesday, the State Senate leaders announced a set of alternative budget proposals that would add legalized sports betting, including wagers made via mobile devices, with a projected $500 million in new state revenues, and “adjustments” in the Managed Care Organization tax that could garner $1 billion in revenue to prevent Medi-Cal rate reductions for doctors, dentists and Planned Parenthood clinics. These are likely not the only tax proposals that will be put forward before the June 15 budget deadline.