LAO Issues Report on State Appropriations Limit

This week, the California Legislative Analyst’s Office (LAO) published a report detailing the state’s constitutional spending limit, also known as the Gann Limit, and its implications for the state’s budget for the upcoming and future fiscal years.

By way of background, voters in 1979 passed Proposition 4, establishing a constitutional appropriations limit on the state and most types of local governments. The appropriations limits, which were amended by Proposition 111 in 1990, are intended to keep real, inflation adjusted per-person government spending under 1978-79 levels. If the state realizes revenue collections above the Gann Limit over two consecutive years, the state constitution requires the state to split the excess revenues between taxpayer rebates and additional spending on schools.

At the time of the Governor’s January Budget proposal, the Department of Finance (DOF) expects the state to collect revenues in excess of the limit in some years between 2018-19 and 2021-22. Specifically, initial estimates indicate the state has excess revenues of approximately $100 million between 2018-19 and 2019-20 and approximately $500 million between 2019-20- and 2020-21. DOF is anticipated to update its revenue collection estimates at the time of the May Revision, at which point the state’s appropriations limits is anticipated to come into play.

In light of higher than anticipated revenue collections since January, the LAO anticipates the state appropriations limits will become an even more significant issue in the state budget over the coming years. Based on projections conducted by the LAO, the state is anticipated under the vast majority of likely outcomes to have to reduce taxes or issue refunds to taxpayers and make additional payments to schools to satisfy Gann Limit requirements. Further, without significant budget changes, the state likely does not have the capacity for new services or program expansions.

According to the LAO, the Gann Limit has emerged as a significant budgetary issue due to growth in personal income tax revenues which have exceeded the state’s appropriations limits growth rate. The state’s tax rate structure combined with faster income growth among high-income earners are the primary reasons why income tax revenues have exceeded the limits’ growth rate. Secondly, constitutionally required school spending has increased faster than school limits, requiring the state to absorb appropriations above school limits and leaving less room for the state to carry out investments without running into the Gann Limit.

The LAO sets forth a series of policy options available to the Legislature in addressing the Gann Limit. These alternatives include:

• Issuing Tax Refunds and Allocating Excess Revenues to Schools
• Increasing Spending on Excluded Purposes (e.g., subventions to local governments, debt service, federal and court mandates, capital outlay projects, emergency spending)
• Reduce Proceeds of Taxes and Spending
• Make Statutory Changes to the Gann Limit (e.g., shifting room under school district limits to the state, redefining local government subventions)
• Go to the Voters (e.g., request temporary increase in Gann Limit, request change to school and community college limits, request change in when reserves are counted toward the limit, request more fundamental changes)

The LAO notes that few of the above options, in isolation, are likely to be sufficient to keep the state from exceeding the Gann Limit over the coming years. The LAO recommends the Legislature form a strategy for short- and long-term options in responding to the Gann Limit and its potential sweeping implications for the state budget.

Additional information is anticipated with the release of the Governor’s May Revise budget by mid-May. The full LAO report is available here.