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Fiscal Health Calls for Painful Remedies

California's governor -- whoever holds the office -- will have to bite the bullet.

September 02, 2003|John W. Ellwood | John W. Ellwood is a professor of public policy at UC Berkeley.

When it comes to California's ballyhooed financial woes, there's more than enough blame being passed around.

One camp will tell you that Proposition 13 is the culprit; another cites tax-and-spend liberals. Some say the fault belongs to Gov. Gray Davis, but others are sure his policies just need a full second term to work. And still others claim that the answer is leadership that's greener, more populist or more Latino.

One thing is certain, they can't all be right. So what's a California voter to do? Start by separating the money myths from the facts. And be prepared: We can't dig out of our budget mess without paying a price.

Myth 1: California's economy is in truly terrible shape.

The truth is California has tracked the national economy over the last several years. People are hurting, and times are not great, especially in Northern California, but the state has not experienced a deep recession. That came in 1991 through 1994, when California's unemployment rate averaged 8.8%. Since 2001 the rate has averaged 6.3%. After inflation is taken into account, California's gross state product declined in 1991, 1992 and 1993. For the last three years, by the same measure, the state's economy has continued to expand, though at a lower rate.

Myth 2: The overall economic decline has caused California's budget shortfall.

Most states have experienced deficits because of the 2001 national recession and the weak recovery. But California's massive shortfall is mostly the result of the collapse of a single state revenue source -- the tax on capital gains and stock options.

During the high-tech boom in the second half of the 1990s, individual income tax revenues from capital gains and stock options surged and provided the state with $10 billion to $15 billion above typical growth patterns.

Then in 2001 the high-tech bubble burst, and the tax revenue gains disappeared, with no chance of returning for the foreseeable future. (That's why they call it a bubble.)

Myth 3: The state has a $38-billion budget gap.

California got rid of its $38-billion problem this year, "balancing" its 2003-04 budget by making some permanent cuts and tax increases, but also by borrowing heavily and using a series of gimmicks and one-time accounting tricks.

The good news is that even using the most pessimistic set of assumptions, the deficit has been cut by half. The bad news is that we've largely run out of budgeting gimmicks. Which means that a $9-billion-to-$15-billion "structural" shortfall -- about the amount of the lost bubble revenue -- will be an annual problem until we permanently make more cuts or raise more taxes.

Myth 4: California is wildly wasteful; if we just make government more efficient we can make up the shortfall, maintain the services we want and not raise taxes.

California already has one of the most efficient state governments in the nation. It has the fewest number of state and local government employees per population of any state, and traditionally it has led the nation in the quality of its efficiency watchdogs. Its legislative analysts' office, which calculates the costs of proposed laws, was the model the U.S. Congress turned to when it created the Congressional Budget Office; the state has an auditor, and it even has a Little Hoover Commission that seeks out duplication of effort in state government.

More to the point, however, long experience with efficiency commissions shows that one voter's streamlined program is another voter's lost service.

Myth 5: Californians are overtaxed and can't be taxed any more.

It depends. The average California state and local tax burden is somewhere between the sixth-highest in the nation (calculating on a per capita basis) and 14th (calculating on a percent-of-income basis).

But an average can be misleading when some are taxed at higher rates than others. Using a model created by the Institute on Taxation and Economic Policy, it turns out that the bottom 80% of Californian households by income (those earning $80,000 or less) have a combined state and local tax burden that is below the national average for their income group. On the other hand, the top 20% of California households by income pay much more than the national average, with those in the top 1% (with household incomes above $567,000) having the second-highest state and local tax burden in the country.

Some would say that even if a household is at the national average it's paying too much in taxes. Others would say there's room and reason to raise at least some of the rates.

Myth 6: Capping state budget expenditures will solve our problems.

Caps do lead to lower spending levels, but only by providing fewer public services. And, because the cost of services varies, capping schemes tend to create distortions.

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