When Californians elected Jerry Brown, they sent a message to the rest of the country, ' we will not change our habits of tax and spend. We expect the rest of country to help us stay the way we are'. For California's sake, I hope that's wrong.
This article is a little long but a must read to understand where California is now and where they must go to survive.
How to Revive the California Dream
Mr. Atkeson is a professor of economics at UCLA. Mr. Simon was the Republican nominee for governor of California in 2002 and is currently a visiting professor at the UCLA School of Law.
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. WSJ 1-10-11
By ANDREW G. ATKESON AND WILLIAM E. SIMON JR.
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.
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.
First, Gov. Brown should join with other governors across the nation to work with Washington to design a Medicaid program that the states and federal government can afford. Both the Government Accountability Office and the Congressional Budget Office have pointed to Medicaid as the greatest challenge to state budgets over the long term. Right now, roughly 60% of Medicaid spending is on optional populations and benefits that states have added to maximize matching federal dollars. A plan along the lines of the Rivlin-Ryan proposal to convert the federal contribution to Medicaid into block grants would give California the latitude and the incentive to control costs and to match Medicaid spending to overall budget priorities.
Second, education reform that simplifies school finance, fosters innovation and choice, places responsibility with local school districts by reducing categorical spending requirements, and holds districts accountable for performance should be high on the governor's list of priorities. Much of the funding for education, therefore, should be devolved from Sacramento to the local level and, with it, the flexibility needed to better manage our schools.
Third, pensions and retiree health-care benefits must be renegotiated with the state's public-employee unions. Employees and retirees should contribute larger shares toward their benefits. New employees, meanwhile, should be moved into defined-contribution retirement plans, such as 401(k)s, like their counterparts in the private sector.
Fourth, and perhaps most important, Gov. Brown must build a better business climate in California by reducing corporate taxes, regulations and red tape that are now strangling existing business enterprises and keeping new ones from starting up.
Economic growth, opportunity and innovation have always been and must continue to be the foundations for the California dream.
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