How to Revive the California Dream

The decline in tax receipts from Golden State households earning more than $200,000 accounts for fully 93% of the decline in total tax revenues from 2007-08.

This article is worth your time. Whether or not you agree with Atkeson and Simon's four recommendations for fiscal reform, these guys give a great overview of the current California budget issue and have an interesting perspective on how to deal with our state's current debt.

-Jim

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By Andrew G. Atkeson & William E. Simon JR.
Los Angeles Times

California faces its most serious budget crisis since the Great Depression. Newly inaugurated Gov. Jerry Brown is inheriting a deficit that is expected to be at least $28 billion over the next 18 months. Nonpartisan legislative analysts project a long-term structural gap of some $20 billion per year between revenues and expenditures in the state's general fund, on an annual budget that is now $93 billion.

Mr. Brown has a brief window of opportunity to take bold steps to put the state government back on a sustainable path. His first budget proposal, which will be submitted this week, should contain aggressive reforms to contain year-by-year increases in state spending.

Our greatest concern is that California is no longer the attractive place to live, work and start a business that it was when Mr. Brown was last governor. California's share of the nation's population steadily grew from 2.5% in 1910 to more than 12% in 1990. But the most recent data from the 2010 Census tells us that California's rapid growth came to an end 20 years ago. California lost more than one million residents to other states in each of the past two decades.

The state legislature has not come to terms with this new reality of slowing long-term growth compounded since 2007 by a severe recession whose effects could linger for years. Over the past decade, the state relied on revenue windfalls from the dot-com and housing bubbles to build a permanent baseline of expenditures that is no longer affordable.

As the nearby chart clearly shows, the state's expenditures from the general fund have grown relentlessly since fiscal year 1999-2000 and, according to California's nonpartisan Legislative Analyst's Office, are projected to continue on that path through 2015-16. (That trend was interrupted briefly between 2008 and 2010 when the state was able to reduce spending from the general fund by drawing on federal stimulus funds, short-term borrowing and budgetary gimmicks to maintain state-sponsored programs.)

In recent years, revenues have collapsed because of the recession and California's high unemployment rate. But there is also a more fundamental cause. California is now paying the price for its dangerous reliance on high income tax rates on the state's top earners.

In 2007, the last of the "boom" years, a mere 7,000 households with adjusted gross income of more than $5 million paid nearly $11 billion in personal income taxes to the state, or one-fifth of all income tax collections. Two-thirds of all income tax revenue was collected from households with incomes over $200,000.

In 2008, after the recession began, there were only 4,700 households in the state with adjusted gross income over $5 million, and revenue from these households fell to less than $7 billion. This $4 billion drop in tax revenue from top earners accounts for fully half of the $8 billion drop in total personal income tax revenue from 2007 to 2008. The decline in tax receipts from those households earning more than $200,000 accounts for fully 93% of the decline in total tax revenues from 2007-08.

Worse, the estimate for state expenditures does not take into account the looming threats to the budget from the deficit in the state's unemployment-insurance fund and outstanding borrowing from local governments and special funds, which together amount to more than $25 billion. More ominously, Stanford University's Center for Economic Policy Research has estimated that the shortfall in the state's pension fund may be as much as $500 billion.

Borrowing at this time would be counterproductive. California has the lowest credit rating of any state in the union. It is already carrying an accumulated debt of $91 billion, a figure that's grown by nearly 50% since the recession began three years ago. Even with today's low interest rates, debt service amounts to nearly 7% of the general fund per year.

Another option, of course, would be to raise taxes. We would urge extreme caution here. California is already a high-tax jurisdiction. In 2007-08, California's state and local tax burden was above the average for the U.S. as a whole, and higher than that of all neighboring states. The state's top marginal personal income tax rate is one of the highest in the country, and its corporate tax rate is among the highest.

The third and final option is to take a close look at projected spending growth. Here several harsh realities present themselves.

California has locked up more than two-thirds of the general fund in mandated spending over which the state now has little or no control. For fiscal year 2011-12, the Legislative Analyst's Office forecasts that debt service, funding for pensions and retiree health-care costs, K-14 education constitutionally mandated by Prop 98, and the state's share of Medicaid spending together lock up $65 billion out of a total projected budget of $103 billion. On top of this, federal court orders limit the state's control over prison spending as well as many health and social-service programs.

In light of these facts, some argue that it is impossible to balance California's budget. We disagree. Here are four ideas for fundamental fiscal reform that would bring about long-term reduction in the budget deficit and make room for the investments California needs to restore its former growth.

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