Commentary

The Gann Limit Turns 25

This article appeared in Investor’s Business Daily, October 28, 2004.

Today marks the 25th anniversary of the adoption of California’s constitutional spending restriction known as the Gann Limit. The anniversary likely won’t be surrounded with parades, public celebrations or fundraising dinners. Indeed, its very existence has receded from the memory of most Californians. Ballot initiatives in 1988 and 1990 severely weakened the Gann Limit, rendering it virtually powerless. Still, this is an anniversary worth remembering. And the last 25 years of California’s fiscal history — both the good and the bad — teaches some important lessons about fiscal limits and fiscal health.

The Gann Limit was approved on November 6, 1979 by a whopping 74 percent of California voters. That was during the height of the tax revolt, as just 18 months beforehand Golden State residents enacted Proposition 13, granting themselves some much-needed property tax relief. However, after the passage of Proposition 13, fiscal conservatives were concerned that state spending increases would prompt California lawmakers to increase other taxes to compensate for the reduction in property tax revenues. As such, the Gann Limit was proposed as a mechanism to limit state spending.

Under the Gann Limit, a maximum bound was established for tax-funded government services. That bound was to be adjusted each year depending on changes in state population, inflation and the transfer of financial responsibility for various government activities from one level of government to another. Any significant amount of state tax revenue received above that Gann Limit was to lead to future tax rebates or tax cuts.

Admittedly, the Gann Limit had some flaws. It only limited appropriations of tax revenue and, as a result, the legislature reacted by raising more revenue from non-tax sources. Still, the Gann Amendment proved to be relatively effective at keeping spending in check. Between 1980 and 1991, California’s rank in state per-capita expenditures fell from 7th to 16th. Its rank in per-capita revenues showed a similar decline during the same time period. Furthermore, when tax receipts exceeded the Gann Limit in 1987, the state refunded $1.1 billion in surplus revenues to the taxpayers.

However, the 1987 rebate may have led to the downfall of the Gann Limit. The rebate angered education interests who wanted a portion of the money to be used to increase school spending. California’s education lobby responded by working for the 1988 passage of Proposition 98, which required that public schools receive a share of any revenues that exceeded the Gann Limit. Perhaps more importantly, Proposition 98 required the state to compensate for any decreases in education spending that occurred when revenues declined.

The increases in education spending came at the expense of other state programs and generated more hostility toward the limit. As a result, the transportation lobby was able to enact Proposition 111 in 1990, which exempted gasoline taxes from the Gann limit. More importantly, Proposition 111 raised the spending limit by tying it to per-capita personal income growth instead of inflation. That set a considerably higher limit. Ever since, the Gann Limit has ceased to be a meaningful constraint on the size of state government in California.

The weakening of the Gann Limit has had negative consequences for California’s fiscal health. Since the state obtains much of its tax revenue through a progressive income tax, receipts tend to increase sharply during times of prosperity, then crash during recessions. That happened during the tech boom of the late 1990s as the Gann Limit was powerless to prevent the 48 percent increase in spending that occurred during Gray Davis’ first three years in office. When the tech bubble burst in 2000 and 2001, the end result was a $38 billion shortfall and budget deficits that persist to this day. Indeed, California taxpayers are still paying the price for weakening the Gann Limit.

The Gann Limit will never receive the fame of Proposition 13. However, its lessons may be even more important. The limit’s downfall provides insights into strategies that opponents use to undermine fiscal limits. Furthermore, the sharp spending increases during the late 1990s and the large deficits that followed demonstrate the importance of effective fiscal limitations.

Perhaps, as Gov. Schwarzenegger works to restore California’s fiscal health, he should give some thought to reinvigorating the Gann Limit.

Michael J. New is an adjunct scholar at the Cato Institute and an assistant professor at the University of Alabama.