A DAUNTING TASK: CALIFORNIAS PROBLEMS IN DEALING WITH ITS BUDGET DEFICIT

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A DAUNTING TASK CALIFORNIAS PROBLEMS IN
DEALING WITH ITS BUDGET DEFICIT

• John W. Ellwood
• Goldman School of Public Policy
• UC Berkeley

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The California Budget Problem in Perspective

• Over the past four years California has had a
  series of state budget shortfalls.
  
• In this California was not unique -- but as in
  many things its deficits were bigger and it has
  had more trouble dealing with its budget problems
  than other states.

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The National Picture of State DeficitsCurrent
Surplus or Deficit of All US States as a
Percentage of GDP
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The Rise of the California General Fund Shortfall
Deficits After 2000
LAO November 2003 Projection of Revenues and
Expenditures
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Reasons for Growth of State Deficits/Shortfalls
From 1998 to 2002

• Most State Deficits Were Structural Rather Than
  Cyclical
  
• That is they were caused by the policy changes
  (75 of variance).
  
• Tax cuts and Spending Increases (especially for
  Medicaid)
  
• Steven M. Sheffrin, State Budget Deficit
  Dynamics and the California Debacle, Journal of
  Economic Perspectives (Spring 2004), pp.
  205-226.
• Brian Knight et. al., Problems and Prospects for
  State and Local Governments, State Tax Notes
  (August 11, 2003, pp. 427-439.
  

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States Slower to Deal With Problem Comparing Tax
Increases of the Early 1990s to the Early 2000s

• 1990-1991 Recession
• 1991 - Tax Increases Raise Revenues by 3.43
  Percent
  
• 1992 - Tax Increases Raise Revenues by 4.62
  Percent
  
• 2000-2001 Recession
• 2001 - Tax Increases Raise Revenues by 0.20
  Percent
  
• 2001 - Tax Increases Raise Revenues by 1.64
  Percent
  
• Steven M. Sheffrin, State Budget Deficit
  Dynamics and the California Debacle, Journal of
  Economic Perspectives (Spring 2004), pp.
  205-226.
• Brian Knight et. al., Problems and Prospects for
  State and Local Governments, State Tax Notes
  (August 11, 2003, pp. 427-439.
  

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States Slower to Deal With Problem Comparing
Budget Cuts of the Early 1990s to the Early 2000s

• 1990-1991 Recession
• 1991 - Budget Cuts of 2.68 Percent of
  Expenditures
  
• 1992 - Budget Cuts of 1.51 Percent of
  Expenditures
  
• 2000-2001 Recession
• 2001 - Budget Cuts of 0.40 Percent of
  Expenditures
  
• 2001 - Budget Cuts of 2.68 Percent of
  Expenditures
  
• Steven M. Sheffrin, State Budget Deficit
  Dynamics and the California Debacle, Journal of
  Economic Perspectives (Spring 2004), pp.
  205-226.
• Brian Knight et. al., Problems and Prospects for
  State and Local Governments, State Tax Notes
  (August 11, 2003, pp. 427-439.
  

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CALIFORNIA LIKE OTHER STATES BUT MORE SO

• Rapid Growth of Revenues in Late 1990s
• Due to High Tech Bubble (Capital Gains and Stock
  Options)
  
• Allows Democratic Governor and Democratic
  Legislature to Increase Spending and Provide Tax
  Cuts

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The Joy of the High Tech Bubble Revenues

• Because of the high-tech bubble the State
  suddenly gets an extra 8 to 12 billion per year
  from a few very rich folks without raising taxes
  on the median voter.
• This fulfills Senator Russell Longs dictum,
  Dont tax him, dont tax me, tax the man behind
  the tree.

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State Uses These Revenues To

• Raise Californias K-12 per pupil spending from
  47th in the nation to 27th in the nation.
  
• Provide health insurance to upward of 1 million
  working poor and their children
  
• Roll back the tax increases enacted to deal with
  the recession of the early 1990s.
  

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• In 2001 the High Tech Bubble Bursts and the State
  Finds Itself With a 10 to 15 Billion Structural
  Deficit/Shortfall

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CALIFORNIA HAS BEEN VERY VERY SLOW IN DEALING
WITH ITS PROBLEMS

• Refuses to Raise Taxes
• Makes Very Few Permanent Spending Reductions
• Instead Relies on Borrowing and One-time Cuts and
  Fund Shifts

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Borrowing Used Extensively to Help Balance Recent
Budgets
LAO Data
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Californias Structural Deficit Slowly Shrinks
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Institutional and Procedural Causes of
Californias Budget Problems However Defined

• Super majority voting requirements
• The direct initiative
• Term limits
• Reapportionment to benefit incumbents

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The Effects of Super Majority Voting Requirements

• Without the 2/3rd requirement to raise taxes
  there would have been no deficit/shortfall last
  year and the budget would have been enacted on or
  near time. Can lead to blackmail by minority.
• In the 18 states with super majority voting
  requirements to raise taxes, revenues are 8
  percent lower than non-super majority states.
  
• (Besley and Case, 2003)

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How the Direct Initiative Makes Compromise More
Difficult I

• The initiative process has been used to grant
  special status for some types of activities.
  
• Since 1978 16 initiatives have constrained the
  States fiscal activities.
  
• The initiative creates an incentive for the
  Legislature to duck tough issues knowing that
  they will likely be on ballot anyway.
  
• But Californians love the initiative and think it
  gives them power over the special interests and
  other centers of power.

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How the Direct Initiative Makes Compromise More
Difficult II

• Taxes can be raised by a simple majority through
  the initiative but require a super majority
  through the legislative process.
  
• Unless allowed by the language of an initiative,
  the substance of an initiative can only be
  changed by another initiative.
  
• The initiative electorate is more Anglo-white
  than the electorate represented by legislators.
  

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How Legislative Term Limits Make Compromise More
Difficult I

• Theory predicts that term limits weaken a
  Legislature.
  
• Theory predicts that under term limits power
  shifts from the Legislature to the Executive
  Branch and to interest groups.
  

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How Legislative Term Limits Make Compromise More
Difficult II

• If this is correct, the California legislature,
  once the most professional of state legislatures,
  is on the way to becoming a weak legislature.
  
• Members increasingly lack knowledge on budgetary
  matters.

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How Legislative Term Limits Make Compromise More
Difficult III

• Members increasingly lack personal ties to each
  other and to their constituents.
  
• Members increasingly focus on their next office
  or position.
  
• This makes compromise more difficult since they
  feel they cannot vote against the interest of
  their constituents .
  

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How Reapportionment to Benefit Incumbents Makes
Compromise More Difficult

• As reapportionment has become a bipartisan effort
  to benefit incumbents fewer and fewer districts
  are competitive.
  
• In such non-competitive districts incumbents have
  more to fear from primary opponents than from
  general election opponents.
  
• The result is an unwillingness to move to the
  center.
  

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The On-Going Effects of Direct Democracy

• Through a Recall a new Governor Schwarzenegger is
  elected who promises to solve the deficit problem
  without any new taxes and without significant
  spending cuts.
• This does not work so Governor again turns to a
  tool of direct democracy -- the initiative -- to
  increase the power of those who want to reduce
  spending.

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Prop 76 New Spending Limit

• Establishes a new limit on state spending
  that would be in addition to, not a substitute
  for, the existing State Appropriations Limit
  (SAL).
• New limit based on average revenue growth rate
  of prior three years.
  
• The new limit would apply to expenditures
  supported by fees, as well as taxes, and to
  spending from special funds, as well as the
  states General Fund. The measure would also
  limit expenditures from voter-approved taxes,

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Prop 76 Shift Power to Governor to Make Spending
Cuts

• Allows the governor to declare a fiscal emergency
  and cut General Fund spending if revenues fall
  1.5 percent or more below forecast levels or if
  the governor determines that the state will spend
  more than half of the funds in the Budget
  Stabilization Account unless legislation is
  enacted to address the emergency within a
  specified period.

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Prop 76 If No Budget Passed By Beginning of the
Fiscal Year

• Continues spending at the prior years level if a
  budget is not enacted on a timely basis. In years
  when there is a shortfall at the beginning of the
  fiscal year, the governor would have the
  authority to reduce spending after a specified
  period.

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Prop 76 Greater Flexibility to Set K-14 School
Funding

• Eliminates test 3 and the maintenance factor
  provisions of the Proposition 98 school spending
  guarantee, as well as the states obligation to
  restore the guaranteed funding level to reflect
  repayment of outstanding maintenance factor
  obligations. Instead, the measure requires the
  state to make one-time payments totaling
  outstanding maintenance factor obligations over
  15 years. The measure would also exclude any
  over appropriations from the base used to
  calculate future years? funding guarantees.

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2005-2006 Spending Compared to Hypothetical
Spending Cap

• Base Year Percentage Reductions Needed To
  Meet Cap
  
• 1987 11.1 percent
• 1990 11.1 percent
• 1995 5.2 percent
• Source California Budget Project, Proposition
  76s New Spending Cap Could Require Substantial
  Spending Cuts, CBP Budget Brief (September 2005).

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An Alternative Approach Political Leadership
Matters

• Compare how Governor Pete Wilson dealt with the
  1992-93 shortfall to how Governor Schwarzenegger
  has dealt with the 2003-06 shortfalls
  

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THE REAL PROBLEM THE POGO PRINCIPLE

• We have Met The Enemy and They Are Us.
• Pogo