Whats Up With the Economy and the California Budget

1
Whats Up With the Economy and the California
Budget?
2
Agenda

• Whats up with the economy?
• How did we get here?
• Whats the relevance to Californias Budget?
• What are the relevant policy issues?

3
Whats Up With the Economy?

• We are entering a recession
• Unemployment may reach 10
• Downturn could last 2-4 years or more
• Stock market in free fall
• Massive selloffs in September and October
• Two days of trillion dollar losses
• Loss of 40 value since October 2007

4
Whats Up With the Economy?
Closing
Dot.Com Recession Official Start Mar 2001
5
Whats Up With the Economy?
6.1 Sept 2008
6
Whats Up With the Economy?
49.1
7.24
7
Whats Up With the Economy?

• Its really bad
• Stocks are falling
• Unemployment is rising
• Increasing foreclosures

8
How did we get here?

• Two spurts of economic activity

Housing Bubble
Dot-Com Bubble
9
How Did We Get Here?

• Speculation and Asset bubbles
• Price Speculation vs. Real Investment
• Betting on Short Term Prices vs. Long Term Yield
• Three Examples
• Cows vs. Milk
• Land vs. Crops
• Machines vs. Widget Production

10
How Did We Get Here?

• The Real Value of a Cow
• Price of the cow or the milk it produces?
• 500 dollar cow
• 300 worth of milk per year for 5 years
• Based on yield you double your money in 5 years
• Would you pay 3000 for the cow?

11
How Did We Get Here?

• The Value of Land
• 1000 piece of land
• 300 worth of crops per year for 10 years
• You can double your money in 10 years
• Would you pay 5000 for piece of land?

12
How Did We Get Here?

• The Value of a Machine
• 10,000 Machine
• Produces 2000 worth of widgets per year
• Would you pay 50,000 for the machine if you
  could sell it for 60,000 tomorrow?

13
How Did We Get Here?

• Asset Bubbles
• Happen as a result of speculation
• economic activity is focused on short term prices
  
• not long term yield

14
How Did We Get Here? Dot-Com Bubble
Dot-Com Boom NASDAQ closing values from 1994 to
2008
15
How Did We Get Here?Housing Bubble
16
How Did We Get Here?

• Aggravating Factors
• Cheap Credit
• Financial Deregulation
• Expanding money supply
• Household debt
• Government debt
• Growing paper economy
• Less dynamic real economy
• Growing Bubbles

17
How Did We Get Here?

• The Outcome
• Bubbles always break
• Why?
• Because speculation drives prices up faster than
  the real economy grows
• Short term prices do not reflect real value
• Market Correction

18
How Is This Relevant to Budget?

• Exacerbates Structural Deficit
• Big expansions of revenue during bubbles
• 5.9 annual growth rate since FY 95-96
• From FY 98-99 to FY 99-00, grew 22
• From FY 04-05 to FY 05-06, grew 13.6
• Massive spending Increases
• 6.1 annual growth rate since FY 95-96
• 31 increase in spending from 1999-2001
• 23 increase in spending from 2005-2007

19
How Is This Relevant to Budget?

• Tax cuts during bubbles
• VLF, Sales, and Income Tax cutsCost 5 billion
  during the tech stock boom
• VLF cut under Schwarzenegger6 billion a year
  during the housing boom
• Mismatch between taxes and spending
• Made worse by tax cuts
• Made worse by recession

20
Whats the Current Budget Situation?

• Shrinking revenues
• Septembers revenues were 8.7 below what was
  projected in the budget signed just last month
• Lower-than-anticipated Personal Income Tax, Sales
  Use Tax, and Corporation Tax receipts
• Year-to-date, we are 1 B below projected
  revenues
• It is currently projected that we will have a 3
  B shortfall this fiscal year (i.e., through June)

21
What Has Been Done So Far?

• Massive Cuts
• 10.9 B in cuts alongside 510 M in vetoes,
  08-09
• Education and HHS services took biggest hits
• 3.3 B to K-14 spending
• Deep cuts to CalWORKS and other services
• Medi-Cal 10 provider reimbursement rate cuts
  extended through Feb. 2009

22
What Has Been Done So Far?

• Revenue Changes
• Loans and transfers 855 million
• Borrows 6 B from future revenues
• Yacht tax loophole closed
• Shift of 350 M in property tax revenues
• Tax Credit loophole changed
• Net Operating Loss rules changed
• Tax Amnesty fee increase

23
Whats Coming?

• Lottery and Rainy Day Fund Initiatives
• Mid-Year Cut Authority for Governor
• Special Session
• More cuts
• Another debate on taxes
• Projected deficits in 2009/2010 in the billions

24
Summary

• Precursors Booms, cheap credit, deregulation,
  increased spending, decreased taxes
• Resulting national context Recession,
  unemployment, consumer debt, foreclosures
• Strained California state budget Ongoing
  structural deficit made worse by falling revenues