California has more revenue than expected thanks to AI. Should the state save it?

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The question Proposition 2 poses to California voters is simple: Should the state be able to save more money when its economy is booming?

The ballot measure, dubbed the Save for California’s Future Act, seeks to shore up California’s rainy day fund by allowing state lawmakers to sock away up to 20% of the state’s general fund tax revenue — double the current ceiling of 10%. 

It would also require the state to save a bigger share of the gains when revenue is growing faster. 

Proponents, including Gov. Gavin Newsom and Democratic lawmakers, say the state needs a bigger savings account to weather its volatile economy. 

Because California’s tax revenue depends so much on wealthy residents’ stock earnings, the state budget is often caught in a boom-or-bust cycle at the mercy of the market. In recent years, the state has seen robust tax revenue from an AI-fueled economy, which has helped state leaders avoid or delay painful cuts to social services even when they projected significant deficits. But economists have consistently warned the boom may not last, and the federal budget cuts to healthcare and welfare programs this year deepened that uncertainty. 

Supporters pitched Prop. 2 as a common sense solution, noting the nonpartisan Legislative Analyst’s Office, which advises state lawmakers, has long recommended the state set aside funding for downturns. The measure is endorsed by a bipartisan coalition of groups, including labor unions, hospital associations and chambers of commerce.

“It doubles the size of the state’s rainy day fund and requires California to save more during strong budget years, so we’re not caught flat-footed when the next downturn hits,” wrote Assembly Budget Chair Jesse Gabriel, an Encino Democrat, and Assembly Appropriations Vice Chair Josh Hoover, a Folsom Republican and the only GOP lawmaker to vote for the measure.

Most Republican lawmakers opposed Prop. 2, stating that the state should use its excess revenue to give taxpayers refunds instead of saving it. They argue that state government already spends too much and that a bigger reserve would merely give state leaders more to spend.

“When they say we’re here for fiscal responsibility, it’s like the devil offering a Bible study. Don’t buy it,” said Assemblymember Carl DeMaio, a San Diego Republican.

How long have we had a rainy day fund?

Before 2014, California leaders and voters established reserve funds several times to weather financial storms, but ended up quickly withdrawing most of those funds, leaving the state with very little savings on hand, according to the legislative analyst.

In 2004, following the dot-com bust, voters overwhelmingly supported Prop. 58, a bipartisan ballot measure that required the state to establish a budget stabilization account and make annual deposits into the fund. 

But lawmakers swiftly depleted the fund during the early months of the Great Recession and were forced to make steep spending cuts, borrow money at expensive rates and use accounting gimmicks to weather the rest of the crisis. Under then-Gov. Arnold Schwarzenegger, a Republican, the state Legislature slashed health and welfare funding, scrapped tax credits, furloughed state employees and delayed payments to schools and local governments. 

In 2014, as the state’s economy rebounded, then-Gov. Jerry Brown, a Democrat, urged that the state save more. He and the Legislature championed Prop. 2, a bipartisan ballot measure that required the state to save more aggressively and limited when lawmakers could withdraw from the reserves. Nearly 70% of voters approved it.

“When the pendulum swings again, we won’t be forced to raise taxes or make the kinds of harsh cuts that were all too common in recent years,” Brown said in a 2014 op-ed stumping for the reform.

The law requires the state to set aside 1.5% of its general fund revenue and any spikes in capital gains tax revenue each year, with half deposited into the reserves and the other half to pay down state debts. It also made it harder for the state to spend the reserves and carved out portions of the savings for schools. 

Under the law, state lawmakers can withdraw from the reserves only when the governor declares a budget emergency and decides that the state is not expected to collect enough revenue in the upcoming fiscal year to match the spending in the three previous budget years. 

A majority of state lawmakers must vote to ratify the budget emergency. If approved, they are allowed to withdraw up to half of the rainy day fund balance at once, unless they already withdrew half the balance in the previous budget year and still need to take out more. There are no limits on what lawmakers can use the funds for.

Bigger reserve = more to spend?

Prop. 2 would maintain those withdrawal rules, which critics say would give future governors broad authority to spend down the reserves instead of reining in spending.

“The rainy day fund can be invaded even when it’s not raining, simply because spending isn’t as high as it was within the prior three years,” wrote David Crane, a former economic adviser to Schwarzenegger and founder of Govern for California, a nonprofit fundraising powerhouse that aims to “counter special interest influence.” 

“Unless the withdrawal rules change, a larger reserve just lets governors bake in spending based on optimistic forecasts, knowing they can always dip into reserves if revenue falls short.”

In an interview with CalMatters, Gabriel stressed that voters approved those rules in 2014 and emphasized that the measure has bipartisan support. He also dismissed the criticism that the state should just spend less during downturns, likening it to telling families to eat less or downsize instead of dipping into their savings when they fall on hard times.

“I think (the concern) is very misplaced,” he said. “(Prop. 2) is recommended by the experts, because it matches the common-sense wisdom of California families.”