How We Got to Where We Are
In my last newsletter, we discussed the resolution to the $42 billion budget shortfall reached between the Governor and the Legislature in February. Now I would like to discuss briefly why we got to that position.
As we saw during the debate on the budget crisis, drastic measures had to be implemented in order to avert fiscal insolvency. How did we get into this situation and what must the state do to prevent a reoccurrence of this magnitude?
Some believe that we got into this fiscal crisis because of a spending problem. Others say it’s a revenue problem. The reality is that California’s budget woes are due to overspending of volatile one-time revenues. It is a spending problem and a problem with our tax system.
First, California’s overly progressive tax structure subjects the state’s primary source of funding to massive volatility. Under the current tax system, the top one percent of California taxpayers pay about half of all state personal income taxes. Since revenues from the personal income tax make up more than 50 percent of all General Fund resources, this means that a large portion of all funds the state has available for spending is dependent on the fortunes of just one percent of the taxpayers. And, because they’re tied to capital gains in the stock market and other investments, these taxpayers’ incomes are highly volatile.
As a result, when the economy is robust, these taxpayers have more taxable income and the state General Fund is more flush with cash. However, when the economy takes a downturn and these taxpayers take losses, the state’s primary source of funding nosedives.
Second, the Legislature has chosen to use one-time revenues gathered during good times to fund ongoing spending. During boom years the state goes on a spending spree, expanding entitlement programs. When the economy goes down, the state is left with a pile of bills and less money to pay them.
According to the state Department of Finance, a structural deficit was created between 1998 and 2000 when the state, under the Davis administration, used a one-time 23 percent revenue increase from stock market earnings and the dot-com bubble to add new permanent spending increases. When revenues declined the following year, the state had no money to fund these costs. Rather than taking the fiscally responsible approach to reduce overspending on ongoing programs, the state made minor one-time reductions and borrowed money. This exacerbated the structural problem and left the state with a $14 billion deficit the subsequent year.
Third, California does little to set aside funds for a rainy day. The state tends to spend every nickel it gets. In 2004, the state attempted to institute a constitutional requirement for funds to be set aside in a rainy day fund through Proposition 57. However, the parameters were too loose and weak to be effective. Essentially, the Governor was able to withdraw money shortly after a couple of deposits. Moreover the set-asides have been, on average, no more than one-and-one-half percent. To put this in perspective, financial experts advise households to maintain a cash reserve to get them through at least three months. The state’s reserve is the equivalent of five days of state spending.
Opinions vary on how the state got itself into this mess, but economists and fiscal experts generally agree that an approach that includes an effective reserve requirement; a spending cap on state expenditures; and stable revenue sources would go a long way towards mitigating budget deficits in the future.
According to the non-partisan Legislative Analyst’s Office (LAO), the most effective tool for mitigating deficits is to implement a reserve requirement. Then, when the state receives revenue growth that is determined to be above average the state is required to set aside these funds for a rainy day. The state would only be allowed to withdraw these funds in years when revenues were determined to be below average and under very stringent conditions.
In tandem with a reserve requirement, we need to have a spending cap. Specifically, the amount that the state General Fund is authorized to spend in a given year would be limited to an amount determined by the average level of revenues over the last ten years. Together these two proposals would, in effect, hold the state General Fund to a specified spending level even in years when the state is flush with cash, and force excess funds into a reserve account as a fallback in lean years. This reserve/spending cap idea is contained in Proposition 1A, which will appear on a statewide ballot on May 19, 2009.
Besides fixing the spending problem, economists believe that stabilizing revenues would help guard against future deficits. Some proposals include flattening the income tax, or rebalancing the mix of tax revenues.
The Tax Foundation reports that California has one of the most progressive tax structures in the country. This progressive nature makes California’s revenues highly volatile because they are dependent on the incomes of the very few. Flattening the income tax structure by changing the rates so that the burden is more evenly distributed among a broader base of taxpayers would make General Fund revenues more stable. This approach could also be characterized as “fair to all”, since all taxpayers will pay the same tax rate and will know exactly what taxes they are paying.
Other economists suggest rebalancing the mix of revenues among the three major taxes (income, sales, and corporation tax) so that the General Fund draws more evenly among them as opposed to the current 50 percent draw from personal income tax. Specifically, this proposal would entail increasing or expanding the sales and corporation tax, which tend to be more stable because they are less progressive. However, this approach does not fix the inequities in income tax rates.
Governor Schwarzenegger and legislative leaders have appointed a commission to examine the tax structure in California. Called the Commission on the 21st Century Economy, its report is due on April 15, 2009.
California has gotten itself into a deficit crisis of unprecedented proportions because it relied on an overly progressive income tax system that produced volatile one-time revenues, and overspent those funds on ongoing programs. Last month the state took drastic action to prevent insolvency. For many years, I have recommended a rainy day reserve coupled with a spending cap to solve the overspending problem. The Commission on the 21st Century Economy will make recommendations on a more modern tax system. I look forward to their recommendation.
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More Bad News
The budget we approved in February projected a $5.6 billion operating surplus and a $2 billion reserve for the General Fund at the end of 2009-10. Last week, the Legislative Analyst’s Office (LAO) updated its revenue forecasts, identifying a new $8 billion shortfall of estimated revenues for 2009-10. Absent any corrective actions, the LAO now projects that the state will face a $2.3 billion operating deficit and the General Fund will end the 2009-10 fiscal year $6 billion in the hole (with no reserve). And, the LAO estimates that the state will face huge operating deficits that will grow to $26.4 billion in 2013-14. The following table reflects the LAO’s projections for operating deficits over the next five years.
These projections assume that California voters will approve all of the ballot measures on the May 19, 2009 Special Election ballot. As such, there are very major risks associated with the existing budget plan. If the measures related to the lottery ($5 billion), Proposition 10 ($600 million), and Proposition 63 ($230 million) are defeated, the state will need to solve for an additional $5.8 billion hole in 2009-10.
Even though the LAO’s expenditure estimates for 2008-09 and 2009-10 are similar to those of the enacted budget, revenue projections continue to decline rapidly. In February alone, receipts for the state’s big three taxes (Personal Income, Sales and Use, and Corporate Income Taxes) were collectively $815 million below the February forecast. Given that February has historically been a low-collections month; the LAO has translated this shortfall and other key economic indicators into an $8 billion deficit for 2009-10.
State finances continue to struggle. Absent any corrective action this $8 billion revenue drop will consume the budget’s $2 billion reserve and generate a new $6 billion shortfall for 2009-10. Even if all assumptions included in the budget package go as planned, the state’s operating shortfalls are projected to grow to $12.6 billion in 2010-11 and to $26.4 billion by 2013-14.
To look at the Legislative Analyst’s report go to:
http://www.lao.ca.gov/2009/bud/feb_overview/feb_overview_031309.aspx
This is a very comprehensive report, and may take some time to download. The revenue projections for future years are found at the end of the report.
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California's Colleges and Universities are a Bargain
The California Postsecondary Education Commission has just issued a draft report that compares our state university system, state colleges, and community colleges to those of other states. The conclusion: Even with recent fee increases, California’s colleges and university fees are much lower than those in other states.
The average fee for full-time students at our fine California State Universities is $3,849. The average for other state colleges is $7,516. The average fee at the highly regarded University of California is $8,027. The average for comparable state universities is $9,905.
California’s community college fees are the lowest in the nation. A full time student in California would pay $600. The next lowest state is New Mexico with fees of $913. Nationally, community college fees average $2,700.
The Commission has not posted its draft report online yet, but you can view their historical review of student fees on their website at:
http://www.cpec.ca.gov/StudentData/50StateOptions.asp?Type=StudentCosts.
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How Safe is Your Child Care Worker?
The California Child Care Resources Referral Network wants to remind Californians of the availability of the Trust Line Registry, a free tool that parents can use to verify that a child-care provider does not have a criminal background.
Started in 1987, Trust Line allows parents to make sure that participating child care workers have a background clear of criminal convictions. Caregivers submit their name and fingerprints to the California Department of Justice, who look for criminal convictions and substantiated child abuse reports in California. Most people on the registry also had their fingerprints processed by the FBI.
Individuals with criminal histories are denied a listing on the registry. Trust Line reports that individuals with convictions for murder, child cruelty and child molestation have been successfully screened out through the background check procedure.
All caregivers who work in state-licensed child care centers are required to go through the Trust Line verification process. However, any caregiver, regardless of affiliation, can request to be listed on the registry.
You may call Trust Line at 1-800-822-8490 to find out if a caregiver is registered on Trust Line, and to verify their status. More information is available on their website: www.trustline.org.
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Donner Travelers Look Forward to I-80 Improvemements
Many a traveler on Interstate 80 passing through the foothills to Nevada has commented on the poor condition of the roadway. Nearly 50 years old in some places, the concrete roadbed is damaged from years of heavy traffic, snow removal equipment and lack of maintenance.
Nearly $1 billion in repairs will be made, with construction starting March 31, and expected to continue into the fall of 2010. Projects will start just East of Colfax, continuing all the way up Highway 80 through Donner Pass and the Nevada state line. Improvements include upgraded pavement, new guard rails and median barriers, and widened shoulders.
Evening hour detours can be expected during various phases of the construction, which, according to the California Highway Patrol, will have a significant impact on traffic while in effect.
Travelers can get information on the current status of the I-80 repairs by calling 1-877-362-8080 or via the internet at www.getacross80.com.
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Quote of the Month
“Our leaders must remember that education doesn’t begin with some isolated bureaucrat in Washington. It doesn’t even begin with state or local officials. Education begins in the home, where it is a parental right and responsibility.”
- Ronald Reagan
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