The governor and legislative leaders are tackling a $44 billion budget. Typically, revenue estimates and spending plans are updated in May, using final income tax payments and new economic data. This “May Revise” builds on budget proposals introduced in January and is a key toward building a final budget that will be approved by the Legislature by June 15.

Last year, these updates were delayed because tax deadlines were postponed by winter storms, which in turn complicated budget projections. And coupled with economic stagnation, the state was suddenly faced with a long-term structural budget deficit.

The governor’s revised strategy aims to address the budget shortfalls for the next few years, not just the immediate deficit. Solutions include a mix of spending cuts, delays, shifting funds and using rainy day reserves.

The proposal does not include any new taxes or increases in tax rates. Public comments by the governor and legislators back this up by consistently voicing a reluctance to entertain new taxes or other rate increases. This is good news as we and other business groups continue to push back on untenable tax proposals, like a tax on professional services or a wealth tax. 

Unfortunately, the budget brings back suspensions of key tax credits frequently used by businesses to spur innovation and growth—particularly in riskier industries like tech, biosciences and other entrepreneurial endeavors. The budget proposes the suspension of the net operation losses (NOL) deduction and limits the use of the tax credits going forward. Specifically, the budget proposes to prevent businesses with annual revenue over $1 million from deducting their net operating losses and cap their use of business tax credits at $5 million for the 2025, 2026 and 2027 tax years.

However, if the state’s “big three” taxes—personal income tax, corporate income tax and sales tax—bring in 3 percent more than the 2024-25 budget forecast from May 2024–April 2025, the current NOL and tax credit laws would be reinstated. The state estimates that these changes will increase taxes by $900 million in 2024-25 and dramatically rise to $5.5 billion in 2025-26.

The state implemented a similar suspension in 2020, which caused significant disruption for many businesses that resulted in higher tax liabilities and disrupted years of careful planning and growth strategies. The state’s non-partisan legislative analyst warns about the use of NOL suspension and credit limits in its analysis of the budget proposal.

“Typically, when a business experiences a NOL, it is allowed to carry forward these NOLs and deduct them from their income in future years,” the analyst wrote. “This allows businesses to smooth profits and losses such that businesses with similar profits over time pay similar taxes. Without this smoothing, businesses in riskier or more innovative industries—such as the technology, motion picture and transportation sectors—could end up paying more taxes than businesses with similar but more stable profits. As such, suspending NOL deductions would lead to a less equitable tax system. While the suspension of NOL deductions has been a go-to budget solution for decades, the frequency at which this approach has been used is now starting to raise questions. Should the governor’s proposal take effect, the state will have disallowed NOL deductions in nearly half of [the] years between 2008 and 2027. At this rate, it seems reasonable to ask whether suspensions have begun to meaningfully undermine the purpose of allowing NOL deductions in the first place.”

Also tucked into the budget is a provision that would adjust corporate taxes on foreign earnings. A recent decision by the Office of Tax Appeals in the Appeal of Microsoft settled a long-running dispute regarding the treatment of foreign earnings. In effect, the appeals panel ruled that the FTB misapplied state law on taxing multinational corporation earnings. The FTB estimates that the ruling could cost the state $1.3 billion in refunds immediately and hundreds of millions more in future years.

In response, the budget proposes a retroactive “clarification of existing law that when a corporation receives income that is excluded from taxable business income, it must exclude this income from its apportionment factor.” This would effectively invalidate the recent ruling, increase tax liability for affected businesses and set a troubling precedent by retroactively changing tax laws after taxpayers have won appeals.

The budget does attempt to make structural changes to address revenue volatility. It proposes to amend rainy day reserve rules to allow more excess revenues to be added to the reserve during windfall capital gains years to help cushion state spending when revenues drop and prevent the Legislature from spending excess revenues immediately.

The Legislature and governor will be working through the proposals before adopting a budget by June 15.