The Bear State

The eight largest economy in the world in 2005 according to the CCSCE(1) , responsible for 13% of the United States GDP, the world’s fifth largest supplier of food and agriculture commodities, home to the aviation and entertainment industry and 21% of the U.S. oil reserves, is the Bear Flag Republic of California. With all these advantages and resources, how is California on the brink of bankruptcy? To understand this you must review California’s state taxes, gargantuan spending habits, and inept politicians.

California’s income and sales tax is the highest in the nation. The income tax is 10.55% while sales tax increased to 9% this past April. Many businesses as well as residents are fleeing the state to California’s tax friendly neighbors, Nevada and Arizona. The graph on the right shows the amount a single individual is taxed at the highest marginal rate. From 2000 to 2007 California lost 1.2 million residents, approximately the size of San Diego, to domestic migration(2). In that same time period California has grown by 7.5%, which equates to 2 million new legal immigrants(3). With California’s high tax rate, the state is taxing the established residents right out of the state.

California’s current budget deficit is $21.3 billion, down from $33.9 billion earlier this year. California has always had budget problems. In 1991, Gov. Pete Wilson faced a $14.4 billion deficit, and in 2003 Gov. Grey Davis received a special election to be kicked out of office because of a $35 billion deficit. Then came Arnold and his $21.3 billion deficit. California deficits seem to come and go with recessions, while the surpluses usually come in good economic times. However, the surpluses always seem minute compared to the deficits. To close the deficit politicians in Sacramento have resorted to budget cuts and accounting gimmicks, and then they asked Californians to vote for a tax hike. It was not well received as you might imagine. The most recent attempt, voted on Tuesday, May 19th, was Propositions 1A, B, C, D, E, and F. All but Prop 1F failed. Prop 1A was for California to set up a rainy day fund, except it allowed state legislature to raid rainy day funds when needed. Prop 1B allowed $9.3 billion from the rainy day fund to be diverted to education. Prop 1C, D, and E allowed the state to raid trust funds and use surpluses to pay current general fund bills. The only proposition to pass was 1F, which blocked pay raises for lawmakers if they failed to balance the budget – finally some accountability. I wonder if Washington is watching? Decidedly not with another $50 billion marked for Grand Misappropriation…whoops, I mean GM. With these measures voted down by California residents, the Govenator is turning to new and creative ways to reduce the budget gap.

The state’s current plan calls for major cuts to education, healthcare and borrowing from municipal governments. This will, however, only get California a third of the way to break-even, maybe halfway if the cuts are large enough. The other half or so will come from bonds, elimination of the Cal grants, and loans from Wall Street, according to Arnold. Arnold was recently in Washington lobbying the Feds to back California’s next $6 billion bond issuance. A Wall Street loan might be too pricey for California which could result in a federal bailout. Can the American people stomach another bailout? Only if Obama wills it. California has also discussed releasing prisoners to save extra money. The last ditch effort calls for selling state infrastructure such as fair grounds and racetracks. My personal favorite is selling the LA Coliseum for $400 million, last appraised in 2001 at $16 million and depreciating. So how does California become Golden once again?

The first step is for California to stop paying for local education. The state currently pays for education from its general budget unlike other states that use local property taxes. Proposition 13 was passed in 1978 placing strict limits on property taxes with those taxes going to local communities. When the proposition passed it reduced property taxes by 57% on average statewide. If Prop 13 gets repealed California could obtain enormous amounts of funding for its school districts and cut primary and secondary education entirely from the budget leaving only higher education. California currently spends about 52-55% of the State General Fund Budget on K-12 and higher education(4). The state can also cut teachers’ salaries and benefits, which currently rank 35% above the national average. But with the Teachers Union running the show in Sacramento it is doubtful that will happen, unless done by federal mandate. Until then Sacramento’s best bet is to break into the U.S. mint in San Francisco and print its own money.

1)Center for Continuing Study of the California Economy, January 2007
2)Demographia State Domestic Migration 2000-2007 December 27, 2007
3)Demographia State Domestic Migration 2000-2007 December 27, 2007
4)http://www.dof.ca.gov/HTML/BUD_DOCS/question.htm#question7