State Leaders Should Use Budget Surplus to Restore Tax Incentives, Repay UI Debt

Only 18 months ago, expecting a massive pandemic-induced collapse of economic activity, California finance officials predicted a staggering $54 billion state budget deficit. The prediction was prudent since nobody in the modern era had ever experienced the economic fallout from a global pandemic.

It was also completely wrong. A combination of creative and agile workplace responses by employers and employees, along with a massive influx of federal income support, business relief, and loose monetary policy limited the worst of the economic impacts. California’s steeply progressive tax system ensured that the state treasury would benefit from any economic upside.

Instead of suffering a $54 billion deficit last year, state coffers brimmed with a $75 billion surplus. Policy makers expanded the social safety net, boosted school spending, and even returned some money to low- and middle-income taxpayers.

2022 Budget Surplus

The prospect for 2022 appears to be more of the same. California will have a “historic budget surplus,” according to Governor Gavin Newsom. The nonpartisan Legislative Analyst recently pegged the surplus at $31 billion, and noted that during the 12-month period ending last September, tax collections grew at an annual rate of 30 percent, the fastest rate in at least four decades.

The debate over how to spend the latest windfall will begin in January with the release of the Governor’s proposed budget. The usual suspects will form a line for one-time or permanent budget boosts. But this time around, tax-paying employers should have a place near the front of that line.

For a relatively small share of the windfall, the Governor and Legislature can relieve California businesses from long-term liabilities that were a direct consequence of pandemic-related public policies.

Restore Tax Incentives

First, the Governor and Legislature should restore tax incentives and net operating loss tools they suspended in 2020. The earlier action may have been prudent, given the then-expected economic outlook. But the subsequent revenue bonanzas obviate this cash-saving tactic, which has hamstrung productive employers from reinvesting in California operations and growing their businesses.

A recently released report by the Milken Institute found that suspending the research and development (R&D) tax credit “increased cost uncertainty for businesses at a time when economic volatility was already high. For three decades, this incentive had helped businesses lower the risks inherent to investing in product and process improvements, but the policy change signaled a diminished commitment to innovation-led growth.”

Restoring the R&D tax credit, along with other business incentives, plus the ability to utilize net operating loss carryforwards, would cost the state budget only a few million dollars and only one time. More important, restoration would signal to businesses the state’s commitment to a stable investment climate for companies that in turn want to make a commitment to California.

Return UI Fund to Solvency

Second, elected leaders should use a portion of the budget windfall to return the Unemployment Insurance (UI) Fund to solvency, thereby minimizing looming tax increases on California employers.

The pandemic recession was unique. Unlike a typical business cycle, entire sectors of the economy, especially the public-facing hospitality and tourism sectors, shut down or operated at severely reduced capacity, often at the direction of public agencies. This compelled many employers to terminate their entire workforce and pay unemployment compensation.

This massive bulge in the unemployment rolls forced California to borrow an eye-popping $20.2 billion from the federal government, which must be repaid by employers from steadily increasing payroll taxes, beginning in 2023 and well into the 2030s. To add insult to injury, at least $1.3 billion in fraudulent claims were paid from the UI fund, which nevertheless must be repaid from employer tax increases.

Many other states, both Democratic- and Republican-controlled, acknowledged their liability in ordering economic shutdowns and higher fraud rates, and have allocated portions of their federal funds to help repay their UI debt. California is not among them.

California’s elected leaders should recognize their shared responsibility for the burden of repaying the UI debt by making a firm funding commitment of $3 billion in the upcoming budget, preferably scheduled over the next couple of years.

Restoring the tax incentives and paying off the UI loan are prudent uses of the surplus. These are one-time expenses that will not add to permanent state fiscal obligations. They will also ensure productive businesses are not paying higher taxes when the need for those taxes has either vanished or was created by global catastrophe or the actions of public officials.

Contact: Loren Kaye

Loren Kaye
Loren Kaye was appointed president of the California Foundation for Commerce and Education in January 2006. He has devoted his career to developing, analyzing and implementing public policy issues in California, with a special emphasis on improving the state's business and economic climate. He also was a gubernatorial appointee to the state's Little Hoover Commission, charged with evaluating the efficiency and effectiveness of state agencies and programs. Kaye served in senior policy positions for Governors Pete Wilson and George Deukmejian, including Cabinet Secretary to the Governor and Undersecretary of the California Trade and Commerce Agency. See full bio.