Governor Gavin Newsom’s Revised Budget Proposal

Rex Halverson

On May 14, 2020, Governor Newsom proposed his May Revised Budget to the California Legislature. The proposal aims to raise $9.2 billion in taxes by suspending net operating loss deductions for 3 years and limiting utilization of business tax credits and incentives. This action could hinder companies from offsetting more than $5 million in tax liability for tax years 2020-2022.

Major Reductions in the Governor’s Revised Budget Proposal

  • Limit utilization of tax credits to $5 million annually per taxpayer for tax years 2020-2022
  • Eliminate net operating loss deductions in 2020-2022 for taxpayers with a net income of less than $1 million
  • Reduce the state budget by $18.87 billion or 8.49%
  • Reduction of education budget by $12.25 billion or 19.9%
  • Reduction of general government fund by $3.2 billion or 28.75%
  • Reduction of higher education budget by $1.8 billion or 10%

The California Senate’s Proposal

The California State Senate has proposed their own revised budget proposal. Although the Senate agrees with the Governor on tax credit limits and suspension of net operating loss deductions, they have rejected proposed spending reductions in lieu of using reserves and deferrals to balance next year’s budget.

California Republicans have argued that this approach would ruin years of progress in decreasing the state’s deficit and building reserves. With that being said, the Senate plan proposes to move $1 billion in spending to fiscal year 2021-22. In addition, the Senate plan calls for $8 billion more spending on education programs through deferred payments to school districts. Additionally, the Senate calls for the inclusion of government-funded health insurance for non-U.S. residents who are sixty-five or older and considered low-income. Governor Newsom originally proposed this spending in January but removed it in his revised budget. The Senate has also cut the $119 million plan to keep seniors out of nursing homes and instead proposes a $1 billion tax increase on managed care organizations.

Both the California Senate’s and Governor Newsom’s plans will shelve $15 billion in budget cuts if the Federal Government approves pandemic relief funds by the start of the new fiscal year.

Tax Credits to be capped at $5 million per taxpayer

  • Research and development tax credit (RTC §23609);
  • Jobs tax credit (RTC §23621);
  • California competes credit (RTC §23689);
  • Motion picture production credit (RTC §23685);
  • New motion picture production credit (RTC §23695);
  • Expenditures for the production of a qualified motion picture (RTC §23698);
  • Qualified enhanced oil recovery project credit (RTC §23604);
  • Credit for costs of transporting donated agricultural products (RTC §23608);
  • State low-income housing tax credit (RTC §23610.5);
  • Prison inmate labor credit (RTC §23624);
  • New employment credit (RTC §23626);
  • Natural heritage preservation credit (RTC §23630);
  • Joint strike fighter wage credit (RTC §23636);
  • Credit for disabled access expenditures (RTC §23642);
  • College access tax credit (RTC §23687);
  • Donated fresh fruits and vegetables credit (RTC §23688.5); and,
  • Qualified rehabilitation expenditures with respect to a certified historic structure (RTC §23691).

Many tax professionals have vehemently opposed a $5 million cap on tax credits per taxpayer, claiming that this act will only hinder the economic recovery of companies that are already struggling during the Covid-19 pandemic. Democratic Assembly Member Autumn Burke, who chairs the Assembly Revenue and Taxation Committee, stated, “These are companies engaging in socially useful behaviors like union work on environmental projects, building homes for the poor and researching new technologies. If we are not in a position to honor those investments in the short term, we should at the very least be thinking about how we can lift other burdens on the very businesses we will need to carry us into a more hopeful future.” This outlook draws into question companies’ future interest in performing these socially useful behaviors if there is no incentive on their part. Rather, their tax credits that were earned in the past are being stripped from their business plan, which will likely result in layoffs and even bankruptcy filings. In defense of the proposal, Department of Finance Director Keely Bosler stated that tax credits could be saved for use following 2022. Sadly, companies will not be able to access these credits if they file bankruptcy, due to the Governor’s cuts. Additionally, there is no guarantee that Governor Newsom will not seek legislation in the future to extend the limitation on tax credits to 2023 and even later.

What Does This Mean?

These changes are seen as a slap in the face by tax professionals in the state, who argue that rather than remedy the economic strife imposed by Covid-19, the Governor’s Revised Budget would prolong the economic turmoil. Instead, efforts should be focused on continuing the economic activities that have provided the state with budget surpluses and record reserves prior to the Covid-19 pandemic.

By limiting tax credits to $5 million dollars per taxpayer, the Governor’s proposal will just lead to more layoffs and a higher unemployment rate. Businesses throughout the state will no doubt once again consider moving out-of-state to the more tax-friendly states like Nevada, Florida, Texas, Washington, Oregon and Arizona.

Simply put, at a time where Governor Newsom claims that California is “facing massive job losses and shortfalls in record time,” it is irresponsible to further tax businesses that would help in righting the ship.

What Can You Do?

If you own your own business in California that will be impacted by the Governor’s May Revised Budget, write your Assembly and Senate representatives today, along with the Governor, and tell each of them what you think of the May Revised Budget. If you do not, the tax burden will fall on you and you will have only yourself to blame later.

Call Rex Halverson & Associates, a tax advocacy and consulting firm, at 916-444-0015 if we can be of any assistance.