Yet Another Greek Warning for California

While Europe is sinking under the pressure of an unsustainable welfare state, unforgiving austerity and social unrest, America is fumbling its way back to economic sanity. Last night’s presidential candidate debate was a refreshing reminder that we have a bright future ahead of us if Mitt Romney wins. But we should also not forget that our own fiscal problems are enormous, and that refers not just to the federally funded part of our welfare state .  As this blog has chronicled, many states are in such bad shape that they are actually comparable to the worst-performing European welfare states.

Cali-Greece-ia is a good example. Despite decades of reckless over-spending, and random efforts by some adults in Sacramento to rein in the madly bloated budget, the Golden State is still spending taxpayers’ money like there was no tomorrow. (Maybe the state legislators out there actually believe some of the disaster movies where California is obliterated?) This is putting California on a track straight into Greek-style austerity, something that is entirely unnecessary and avoidable.

Unfortunately, there is very little going on in Sacramento that gives us hope that the Golden State will change course. On the contrary, the budget for fiscal year 2012-13 is an excellent example of how the state lawmakers, and the governor, are sticking their heads in the sand. General fund spending is up seven percent, or $6 billion.

Not only is this spending binge entirely reckless from a budgetary viewpoint, but it is also based on some outright ludicrous expectations of where the California economy is heading. For one, it is a rather trivial observation that every dollar the government spends must come from somewhere. In California, as in almost every other state, there is even a law in place that forces the state government to make appropriations based on this trivial fact. So when the lawmakers in Sacramento, and Governor Brown, decide that the state should spend seven percent more in this fiscal year than it did in the last one, you have to assume that they have good reasons to expect a seven percent increase in tax revenues.

Well, that is probably not going to happen. In a recent report on California state tax revenues the Census Bureau explained that the revenue outlook for California is rather pessimistic. That is noteworthy in and of itself, but the most remarkable part of the report is that it really is not relieving anything we did not already know. In May this year I explained that California indeed has a long tradition of overspending:

Total state spending grew at 4.4 percent per year from 2000 to 2010, while state GDP in current prices – the broadest possible tax base – grew at only 3.8 percent per year; in other words, for every dollar the state was increasing spending, 14 cents exceeded what the tax base was able to keep up with;

Even when they have cut spending, it has only been temporary reductions in in-state funded outlays. While we still don’t have final numbers on 2012 spending, the following figures are illustrative of how California lawmakers approach state spending:

  • Between 2008 and 2011 the General Fund was reduced by 11.2 percent;
  • During the same period, California increased its federal funds by 62.7 percent;
  • Other (Special) funds increased by 17 percent;
  • Total in-state sourced spending contracted by 5.4 percent; but
  • Grand total state spending grew by 17 percent.

In other words, the state compensated for cuts in in-state funded spending by taking more federal funds. Some would say that these extra federal funds were stimulus money and therefore do not represent a permanent change in the way states pay for their outlays. However, the stimulus money was not at all meant to “stimulate” economic activity – it was a bailout bill for the states. As such it allowed states to bridge over a supposedly temporary decline in in-state revenues and the following mandatory cuts in in-state funded spending.

Therefore, what the stimulus bill really did was to put out an expectation for the future of rising in-state funded spending. That is what is happening now in California:  after two years of cuts in General Fund spending, Golden State lawmakers are now replacing “stimulus bill” funds with in-state funds.

In order to do so they have to assume that revenues will grow enough to replace the stimulus funds. Otherwise they would not be able to do the spending replacement. To pull that off they expect a $6.7 billion rise in state tax revenues over the next year, an expectation that all sound economic analysis will shoot down as the pie in the sky it is.

For one, who is going to pay those taxes? Only private-sector jobs genuinely create tax revenues (government employees who pay taxes do so with someone else’s tax dollars) so in order to safely predict a rise in state revenues, the forecasters at the state legislature in Sacramento must assume that the state’s economic performance will now be back to where it was before the deep recession began.

There are no economic indicators that make this an even remotely reasonable expectation. In order to have the same income tax base as before the recession, California would have to return to the heydays of 2008. That would require at least five percent inflation-adjusted growth in the state’s GDP for 2012, and a 4.6 percent increase in total compensation of private employees.

Neither number is likely to materialize, partly because of the way the national economy is going, and partly because government is still getting in the way of the private sector in California. In fact, the odds of such strong growth are increasingly unfavorable after the increase in the top state income-tax bracket to 12.3 percent. More and more high-earning entrepreneurs and professionals will go to neighboring states, all of which have lower taxes.

The lawmakers in Sacramento just can’t get their act together. If they really wanted to they could easily start doing away with the welfare state, but they don’t want to. They want to preserve their big government as far as they possibly can. That is why they continue to spend without any concern for the health of the state’s economy; that is also why they are pushing taxes up every chance they get; and that is why the future looks Greek for California.

Once they run out of options to raise taxes, it will only be a matter of time before they turn to European-style austerity instead. And that won’t be pretty.