The Magazine

Going for Broke

California's budget nightmare.

Jul 22, 2002, Vol. 7, No. 43 • By STEPHEN MOORE
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California, the sixth largest economy in the world, is in economic and fiscal freefall. It has by far the bleakest budget outlook of any of the 50 states. Deficit projections have been revised upwards every six weeks or so. The latest two-year forecast points to $24 billion in red ink, an unprecedented level of debt for the state. California's deficit is larger than the entire budget of 26 states combined.

Under Governor Gray Davis, the state budget has mushroomed by nearly 40 percent in four years. In 1999-2000, at the height of the Silicon Valley frenzy, California increased its expenditures by a staggering $9.7 billion or 13.4 percent. The 2000-01 budget leapt upward by another 14percent. Meanwhile, the state's payroll swelled by 34,000 new employees during Davis's first 3 years in office, a larger increase than that of the next 3 biggest states combined. There were some nickel and dime tax cuts, but 75 to 80 percent of increased revenue went to new budget bloat. During Gray Davis's first four years, the budget has busted out from just under $65 billion to $100 billion.

The governor's bungling of last summer's electricity debacle also added to the state's financial miseries. The brownout crisis left Davis with two choices: Let the market's pricing mechanism ration electricity by forcing users to pay temporarily higher costs, or keep prices artificially low and throw the costs onto the backs of taxpayers. He chose the latter course and now it's time for Californians--many of whom share Davis's faith in the existence of free lunches--to pay up. They will be doing so for a long time. To cover the costs of long-term electricity contracts, the state borrowed $6 billion last year on top of a $4.3 billion bridge loan. As Davis's rotten luck would have it, he bought electric power for what is now nearly twice the market price.

Credit agencies are noticing the ocean of debt Davis has taken on. Moody's has already downgraded California bond ratings twice this year. Economist and southern Californian Arthur Laffer thinks the credit agencies may downgrade again. He points to the California ballot this year, which is already crammed with populist bond initiatives: $13 billion for schools, $3 billion for water, and $2 billion for low income housing. Laffer reminds us: "California's credit rating matters--and in the context of [the state's] total debt issuance [since 1984] of $500 billion, it matters a lot."

But is all this Governor Davis's fault? His predecessor Pete Wilson was no paragon of fiscal virtue. In fact, Wilson's income tax hikes in 1991 threw the state into its last deep recession. But when Wilson left office, the state enjoyed a plump $12 billion, two-year budget surplus. However, California's Democratic party, which controls almost everything that is politically determined in the state, shares much of the blame.

For example, the state legislature, which is almost two-thirds Democratic, has failed to conform to the federal welfare act, which required a five-year limit on welfare benefits. For all intents and purposes, California still offers a lifetime on the dole. Along with New York, it has the most lenient work-for-welfare program in the country. These policies cost at least $1 billion a year. They also explain why California has been one of the least successful states at reducing its welfare caseload.

Another reason California's financial ship is sinking is taxes, which have been raised on so many occasions over the past decade that Californians now pay a larger share of their incomes in taxes today than they did before the passage of the historic tax-slashing Proposition 13 in 1978. "If taxes and outlays had only risen as fast as inflation and population growth since 1990," according to state senator and GOP candidate for state controller Tom McClintock, "the average California family would be paying some $4,000 less per year in state-local taxes today."

Seemingly oblivious to these unpleasant realities, State Senate majority leader John Burton wants to balance the budget by raising the top income tax rate from 9.5 to 11 percent. California already has one of the five highest tax rates in the nation. Under Burton's proposal, it would move to number one. In the early '90s, Pete Wilson, with the help of Democrats, tried this same tax-the-rich scheme. The state actually lost revenue.

Davis is at least savvy enough to realize this proposal is economic and electoral poison. In fact, Davis is campaigning as a taxophobic Reaganite. "Let me just say this," he declared during his State of the State address back in March. "I want to give you every assurance that taxes will not be increased. That is my strong belief. I do not want to. I'll do everything I can to resist the need to raise taxes." Problem is, practically no one believes him.