Spending Plans Will Run Up Against Fiscal Reality

Gavin NewsomGavin Newsom was recently inaugurated as California’s 40th governor, taking over a general-fund budget that is flush with cash and a state government that is in remarkably good shape — at least superficially — from a fiscal perspective. For all his flaws, outgoing Gov. Jerry Brown left Newsom with a $15 billion surplus and a rainy day fund that is nearly full. As an added plus, the economy that is humming along even though an erratic stock market points to storm clouds on the horizon.

The big question is whether Newsom will heed Brown’s advice and govern as if there’s always a recession around the corner — or ignore the former governor’s warnings about Democratic lawmakers who always say “yes” to any “harebrained” spending scheme. Unfortunately, based on Newsom’s inaugural words, initial budget and many of his early high-level administrative appointments, the safe money is on the latter. Newsom wants to spend big.

One need not read between the lines in Newsom’s introductory words. He spelled it out clearly. Newsom pointed to Brown’s inaugural address, which quoted from the Sermon on the Mount. There was the foolish man who built a house on sand and the wise man who built it on rock. “For eight years, California has built a foundation of rock,” Newsom said. “Our job now is not to rest on that foundation. It is to build our house upon it.”

So now that the state is on solid financial footing, the new governor envisions a rapid expansion of government social programs. “We will support parents so they can give their kids the love and care they need, especially in those critical early years when so much development occurs,” Newsom said. That speaks to the $1.8 billion in early childhood programs that the new governor is touting. The term “we,” of course, refers to California’s taxpayers.

“We will launch a Marshall Plan for affordable housing and lift up the fight against homelessness from a local matter to a state-wide mission,” he added. The term “Marshall Plan” is not subtle. That was the American financial assistance program to help Western Europe rebuild after the devastation of World War II, at a cost of $100 billion in current dollars.

Continuing the metaphor of California as a home, Newsom added that “In our home, every person should have access to quality, affordable health care.” He has long advocated for some type of universal healthcare coverage (although not necessarily the single-payer system that failed to make it through the Legislature in 2017), and some of his most noteworthy aides have a background in promoting government healthcare programs.

“Everyone in California should have a good job with fair pay,” he said. “Every child should have a great school and a teacher who is supported and respected. Every young person should be able to go to college without crushing debt or to get the training they need to compete and succeed. And every senior should be able to retire with security and live at home with dignity.” Those are vague, feel-good ideas that would garner few objections. But his ideas for implementing them, such as his bidget plan for free community college, will come with a hefty price tag.

There will be plenty of time to dissect the specific policy proposals that will move forward as the legislative session gets under way. For instance, the community college idea is a particularly bad one. California community colleges already are inexpensive. Making the second year of tuition “free” (the first year already is free for first-time California students) will only clog up the classrooms with free riders, thus making it tougher for those students who are serious about getting an education to get classes and improve their job prospects.

However, the main purpose of this article is to provide a warning amid the exuberance of a new gubernatorial administration. Basically, that financial foundation might be built less on rock and more on sand than many of us would like to believe.

There’s no complaining about the size of the budget surplus and rainy day fund, but there’s more to a budget than those items. As a comprehensive new California Policy Center report from Ed Ring and Marc Joffe points out, “We estimate that California’s total state and local government debt as of 6/30/2017 totaled just over $1.5 trillion. That total includes all outstanding bonds, loans, and other long-term liabilities, along with the officially reported unfunded liability for other post-employment benefits (primarily retiree healthcare), as well as unfunded pension liabilities.” That’s a 15-percent increase from two years ago—and a number that equals 54 percent of the gross state product.

The Brown administration had done little to deal with the unfunded liabilities. Its one major pension reform law, the Public Employees’ Pension Reform Act, was exceedingly modest. In the waning days of his administration, Brown’s attorneys argued before the state Supreme Court for changes in the “California Rule,” which restricts the ability of governments to reduce pension benefits going forward. That’s still unresolved and Newsom already has made clear his opposition to changes in pensions—and one of his top aides comes out of the California Labor Federation.

Bottom line: Just because the general-fund budget is in good shape does not mean that California’s overall fiscal picture is all that bright. A responsible new administration would attempt to fix those problems, which are crowding out public services at the local and state level, before engaging in a spending spree that will add to the state burden. Newsom’s early budget hits $209 billion overall and includes a grabbag of new programs, although he does send money to pay off some pension debt and is bolstering the rainy day fund.

The outgoing governor increased taxes early and often. It’s unwise to add new burdens on taxpayers, especially given that economic boom times always are followed by a bust and many Californians continue to flee the state’s high tax burden. Newsom already is proposing new fees on water and 911 service.

California’s most notorious public-policy disasters have come, counter-intuitively, during the best fiscal times, when revenues were swelling and budgets were flush with cash. The best example came in 1999, when Gov. Gray Davis signed a law that caused a pension-hiking frenzy and led directly to the state’s debt crisis. The stock market was riding high and the California Public Employees’ Retirement System (CalPERS) promised that increasing pensions by 50 percent retroactively wouldn’t cost taxpayers a dime because market returns would cover the costs.

It didn’t cost a dime, but cost billions of dollars annually in general-fund payments and added hundreds of billions of dollars in taxpayer-backed liabilities. The biggest danger to California is now a governor who believes that the state is in such great financial shape that he can start spending with wild abandon. He will not be restrained by the Legislature, which now has strong Democratic super-majorities that are itching to spend money. We don’t want to wish for an economic downturn, a stock-market crash or another busted housing bubble, but that appears to be the only hope right now to derail the coming spending train.

This column was first published by the California Policy Center.

Steven Greenhut is Western region director for the R Street Institute. Write to him at sgreenhut@rstreet.org.

Gavin Newsom’s Budget Calls for More Spending, Higher Taxes

Gavin Newsom budgetTo the surprise of absolutely no one, California’s new governor has proposed a state budget with billions in increased spending and lots of tax hikes. And, as an added bonus, he is proposing new mandates on businesses and local governments as well as depriving Californians of the right to vote on certain kinds of local debt. From the perspective of taxpayers, this is not a propitious start.

Gov. Gavin Newsom’s budget envisions spending $144 billion of general fund dollars, a 4 percent increase over former Gov. Jerry Brown’s last budget, which clocked in at $138 billion. To put this in perspective, general fund spending was less than $100 billion just six years ago. In California, state government is the No. 1 growth industry.

No California spending plan would be complete without new “revenue enhancements.” And the biggest item on this list is the imposition of the “individual mandate” for health insurance. Recall that President Obama’s so-called Affordable Care Act (which was anything but affordable) imposed a burdensome tax on millions of Americans. (Indeed, it was only the fact that the ACA imposed a “tax” that saved it from a constitutional challenge).

The good news is that Congress repealed the tax at the federal level. The bad news is that Gov. Newsom wants to reimpose it at the state level in order to save Covered California from imploding. The cost to Californians for a state-imposed individual mandate with a penalty?: $700 per person, which is projected to raise $500 million in new revenue.

To read the entire column, please click here.

California’s Budget “Surplus” Ignores Crushing Debt Burden

BudgetCalifornia’s new governor, Gavin Newsom, delivered an inaugural address earlier this week that accurately reflected the mentality of his supporters. Triumphalist, defiant, and filled with grand plans. But are these plans grand, or grandiose? Will Governor Newsom try to deliver everything he promised during his campaign, and if so, can California’s state government really deliver to 40 million residents universal preschool, free community college, and single payer health care for everyone? It’s reasonable to assume that to execute all of these projects would cost hundreds – plural – of billions per year. Where will this money come from?

While California’s budget outlook currently offers a surplus in excess of $10 billion, that is an order of magnitude less than what it will cost to do what Newsom is planning. And this surplus, while genuine, is the result of an extraordinary, unsustainable surge in income tax payments by wealthy people. California’s tax revenues are highly dependent on collections from the top one-percent of earners, and over the past few years, the top one-percent has been doing very, very well. Can this go on?

To illustrate just how unusually swollen California’s current state tax revenues have gotten, compare state tax collections in FYE 6/30/2017 (our most recent available data) to seven years earlier, in 2010. Back in 2010, California was in the grip of the great recession. Total state tax revenue was $94 billion, and $44 billion of that was from personal income taxes. Skip to FYE 6/30/2017, and total state tax revenue was $148 billion, and $86 billion was from personal income taxes. This means that 80 percent of the increase in state tax revenue over the seven years through 6/30/2017 was represented by the increase is collections from individual taxpayers, which doubled.

It isn’t hard to figure out why this happened. Between 2010 and 2017 the tech heavy NASDAQ tripled in value, from 2,092 to 6,153. In that same period, Silicon Valley’s big three tech stocks all quadrupled. Adjusting for splits, Apple shares went from $35 to $144, Facebook opened in May 2012 at $38, and went up to $150, Google moved from $216 to $908.

While California’s tech industry was booming over the past decade, California real estate boomed in parallel. In June 2010 the median home price in California was $335,000; by June 2017 it had jumped to $502,000. Along the California coast, median home prices have gone much higher. Santa Clara County now has a median home price of $1.3 million, double what it was less than a decade ago.

As people sell their overpriced homes to move inland or out-of-state, and as tech workers cash out their burgeoning stock options, hundreds of billions of capital gains generate tens of billions in state tax revenue. But can homes continue to double in value every six or seven years? Can tech stocks continue to quadruple in value every six or seven years? Apparently Gavin Newsom thinks they can. Reality may beg to differ.

Just a Slowdown in Capital Gains Will Cause Tax Revenue to Crash

The problem with Gavin Newsom’s grand plans is that it won’t take a downturn in asset values to sink them. All that has to happen to throw California’s state budget into the red is for these asset values to stop going up. Just a plateauing of their value – which, by the way, we’ve been witnessing over the past six months – will wreak havoc on state and local government budgets in California.

The reasons for this are clear enough. Wealthy people, making a lot of money, pay the lion’s share of state income taxes, and state income taxes constitute the lion’s share of state revenues. Returning to the 2017 fiscal year, of the $86 billion collected in state income taxes, $28 billion was from only 70,437 filers, all of them making over $1.0 million in that year. Another $7.3 billion came from 131,120 filers who made between a half-million and one million in that year. And since making over $200,000 in income in one year is still considered doing very, very well, it’s noteworthy that another 807,000 of those filers ponied up another $15.1 billion in FYE 6/30/2017.

There is an obvious conclusion here: if people are no longer making killings in capital gains on their sales of stock and real estate, California’s tax revenues will instantly decline by $20 billion, if not much more. And it won’t even take a slump in asset prices to cause this, just a leveling off.

Debt, Unfunded Pension Liabilities, Neglected Infrastructure

When considering how weakening tax revenues in California will impact the ability of the state and local governments to cope with existing debt, it’s hard to know where to begin. To get an idea of the scope of this problem, the California Policy Center just released an analysis of California’s total state and local government debt. As shown on the table, California’s total state and local government debt as of 6/30/2017 is over $1.5 trillion. More than half of it, $846 billion, is in the form of unfunded pension liabilities.

Calculating pension liabilities is a complex process, with controversy surrounding what assumptions are valid. In basic terms, a pension liability is the amount of money that must be on hand today, in order for withdrawals on that amount – plus investment earnings on that amount as it declines – to eventually pay all future pensions earned to-date for all active and retired participants in the fund. Put another way, a pension liability is the present value of all pension benefits – earned so far – that must be paid out in the future. The amount by which the total pension liability exceeds the actual amount of assets invested in a fund is referred to as the unfunded liability.

The controversy over what is an accurate estimate of a pension liability arises due to the extreme sensitivity that number has to how much the fund managers think they can earn. Using the official projection which is typically around 7.0 percent per year, the official pension liability for all of California’s government pension funds is “only” $316 billion. But Moody’s, the credit rating agency, discounts pension liabilities with the Citigroup Pension Liability Index (CPLI), which is based on high grade corporate bond yields. In June 2017, it was 3.87 percent, and using that rate, CPC analysts estimated the unfunded liability for California’s state and local employee pension systems at $846 billion. Using the methodology offered by the prestigious Stanford Institute for Economic Policy Research, California’s unfunded pension debt is even higher, at $1.26 trillion.

Where pension liabilities move from controversial theories to decidedly non-academic real world consequences, however, is in the budget busting realm of how much California’s government agencies have to pay these funds each year. California’s public sector employers contributed an estimated $31 billion to the pension systems in 2018. Extrapolating from officially announced pension rate hikes from CalPERS, California’s largest pension system, by 2024 those payments are projected to increase to $59 billion. And these aggressive increases the pension systems are requiring are a reflection more of their crackdown on the terms of the “catch up” payments employers must make to reduce the unfunded liability than on a reduction to their expected real rate of return.

Huge unfunded pension liabilities are another reason, equally significant, as to why California’s state budget is extraordinarily vulnerable to economic downturns. If assets stop appreciating, not only will income tax revenue plummet. At the same time, expenses will go up, because pension funds will demand far higher annual contributions to make up the shortfall in investment earnings.

A cautionary overview of the economic challenges facing California’s state government would not be complete without mentioning the neglected infrastructure in the state. For decades, this vast state, with nearly 40 million residents, has been falling behind in infrastructure maintenance. The American Society of Civil Engineers assigns poor grades to California’s infrastructure. They rate over 1,300 bridges in California as “structurally deficient,” and 678 of California’s dams are “high hazard.” They estimate $44 billion needs to be spent to bring drinking water infrastructure up to modern standards, and $26 billion on wastewater infrastructure. They estimate over 50 percent of California’s roads are in “poor condition.” In every category – aviation, bridges, dams, drinking water, wastewater, hazardous waste, the energy grid, inland waterways, levees, ports, public parks, roads, rail, transit, and schools, California is behind. The fix? Literally hundreds of additional billions.

What Governor Newsom might consider is refocusing California’s state budget priorities on areas where the state already faces daunting financial challenges, rather than acquiescing to the utopian fever dreams of his constituency and his colleagues.

California Doesn’t Have a Budget Surplus

BudgetIt’s become common folklore that California is booming and incoming Gov. Gavin Newsom and the Democratic supermajority have more taxpayer money than they will know how to spend, save or invest. Nothing could be further from the truth; and it’s the California voters and taxpayers who will continue to be pay for this mistake. We literally owe trillions that isn’t being discussed. Just the estimated payments on public employee pensions in California will increase from $31 billion in today’s dollars to $59 billion in 2024; and this number is based on non-recessionary conditions or a major correction in the stock market. And California immediately needs $800 billion to over $1 trillion worth of infrastructure repairs, upgrades and new construction.

A conservative estimate of California’s total debt by the California Policy Center in a 2017 study – before new tax and bond obligations recently voted in were factored – puts California’s total local and state debt at $1.3 trillion. The Stanford University Pension Institute (www.pensiontracker.org) in 2017 calculated California’s unfunded liability at $1.4 trillion and CalPERS also with an unfunded liability of $1.4 trillion, with CalSTRS billions underwater as well to give, “real state debt of $2.8 trillion.”

Whichever calculation is used California owes trillions and doesn’t have a plan in place to address this issue. What should be clear is that California does not have a surplus or anything near a surplus factoring in total debt and infrastructure for a basic, functioning society California citizens and non-citizens expect. This figure also doesn’t factor in health care costs rising under Covered California, Medi-Cal or possibly expanding Medicare to include all Californians living in-state.

These financial and societal facts will affect overall fiscal health and the ability to pay back debts accruing interest or fall under the category of a future obligation. Government services at the state, county and local level are at risk if a recent announcement by the CalPERS board is taken into consideration titled, “Risks Report,” highlighted, “The greatest risk to the system continues to be the ability of employers to make their required contributions.”

Taxpayers will have to make up the shortfall through additional taxes – like eliminating Prop. 13, voting in a VAT or services tax or some combination thereof – otherwise first responder response times, social services for the poor and needy, and environmental standard protocols will erode.

There are other factors California will need to overcome to pay back their debt and realize we do not have a budget surplus. California’s unemployment rate rate is 33rd in the nation at 4.1%. The national unemployment rate is 3.7%. We have the highest taxes in the nation when the variables of the gas tax, state income tax, and sales tax are put into the equation. Additionally, California has the highest housing and rents in the nation per amount of residents. The median home price in California is roughly $544,900 whereas the remainder of the United States is estimated at $220,000. We artificially suppress housing supply (particularly, single-family-home) – though demand hasn’t diminished – driving up prices. Our stringent environmental standards evidenced by CEQA, SB 375, AB 32, SB 100 and CARB is hurting job growth and economic sustainability.

High taxes and regulations; and a tough business environment are some of the reasons why Toyota, Occidental Petroleum, and Nestle USA food conglomerate left California. Now the second largest firm in California – McKesson Pharmaceuticals is seriously contemplating leaving for Texas – according to a report by the San Francisco Business Times. The issue isn’t whether or not these companies leave; instead it’s the high paying jobs with benefits across all income spectrums being driven out of California. Moreover, we need successful firms to assist tackling the trillions we owe in pensions, bond obligations and infrastructure requirements.

After this recent election where it has become proper to bash Republicans – especially California Republicans – many will postulate there is no difference between Republicans and Democrats. When there is nothing farther from the truth. I’m not speaking about politics, which is essentially the means for winning elections and building coalitions for governance, I’m speaking about actual policies. How do you allocate taxpayer money? Do you want to tackle California’s debt or speak about a surplus instead? Do you believe in abortion, gay marriage, some form of socialism? Do you build a larger navy to confront global problems? Do you believe in fracking?

Those are policy decisions that have wide ramifications for California policymakers and voters. The California Democratic Party currently believes in spending more than it takes in by amounts it will never be able to recover; though incoming Governor Newsom showed variables of fiscal restraint as mayor of San Francisco. Of course there are establishment cronies and swamp-dwellers in both parties; but if you only take environmental policy using Tom Steyer as an example there has never been a more powerful oligarch in recent memory.

The planet and California isn’t better off for the policies Mr. Steyer advocates for and our poverty and homelessness continues being the worst in the nation. These are examples of policy decisions similar to believing there is a budget surplus that have long-term, negative ramifications.

What the surplus doesn’t take into account is California’s real poverty rate that the Census Bureau standard now has at 19% and 43.9% higher than the remainder of the US. Disenchantment and disillusionment with both parties is en vogue, but there is to much at stake in our financial future to allow the Democratic supermajority be let off the hook by continuing to spout the mantra of budget surplus.

Gov. Jerry Brown signs his final state budget, California’s largest yet

California schools, healthcare and social services programs will see spending increases under the state budget signed Wednesday by Gov. Jerry Brown.

The $201.4-billion plan, which takes effect next week, is the final budget of Brown’s eight-year tenure. It is also the third consecutive blueprint that includes notably higher-than-expected tax revenue, a sizable portion of which lawmakers are diverting into the largest cash reserve in California history.

“This budget is a milestone,” Brown said at an event in Los Angeles. “We’re not trying to tear down, we’re not trying to blame. We’re trying to do something.”

Lawmakers sent Brown the budget last week, and he chose to sign it Wednesday without any line-item vetoes — unusual in comparison to previous governors, but consistent with his recent budget actions. ..

Click here to read the full article from the L.A. Times

California’s Budget Process Should Worry Every Taxpayer

California Gov. Jerry Brown points to a chart showing the growth of the state's Rainy Day fund as as he discusses his proposed 2018-19 state budget at a news conference Wednesday, Jan. 10, 2018, in Sacramento, Calif. Brown proposed a $131.7 billion state spending plan, dedicating $5 billion toward the fund. (AP Photo/Rich Pedroncelli)

Let’s face it, when it comes to the state budget of California, most citizens suffer from MEGO (My Eyes Glaze Over).  Because even public finance experts are confused by the thousands of pages of budget documents, it’s no wonder that citizen taxpayers don’t stand a chance. Besides, normal people are too busy working hard to pay for all the spending increases reflected in the budget.

Nonetheless, passage of the state budget remains one of the most important functions of the Legislature because it reflects the state’s spending priorities for years in the future.  Here are some key takeaways that should concern every California taxpayer.

First, government spending is out of control. While projected revenues are up eight percent – a good thing – from a year ago, expenditures continue to accelerate at a faster clip, up by nearly eleven percent to a record $138 billion budget. When other state funds, including special funds, are added to the total, nearly $200 billion in state funds will be spent in this budget. Legislators will argue that some of these expenditures are going to bolster a rainy day fund to protect against an economic downturn. While this fund is also at a record $14 billion, this will hardly protect state programs even in the event of even a moderate recession.  Second, we doubt that the spending priorities of politicians reflect what taxpayers think are important.  For example, this year’s budget includes a billion-dollar plan to completely remodel the State Capitol, while the state continues to lose ground on nearly a trillion dollars of unfunded pension obligations.

Finally, as in prior years, the 2018-19 budget is a vehicle for numerous abuses. It is now common to enact politically motivated legislation as so-called budget “trailer bills” as a means to avoid any meaningful analysis and public hearings.  This column previously alerted readers to one such sneak attack, a precedent-setting tax on water that thankfully was beaten back – at least for now.  But two other proposed bills represent the worst of Sacramento special-interest politics.

Two years ago, the Howard Jarvis Taxpayers Association sponsored Assembly Bill 195 (Obernolte), a bill that increased transparency for local bonds and special taxes by requiring disclosure of the rate, duration and amount of revenue to be raised. AB 195 mandates that these important facts be included in the actual ballot label, typically the last thing voters read before deciding.

Now, education lobbyists and building trades groups are attempting to delay the implementation of AB 195 for local bonds by two years, to keep this important information from being presented to voters. In other words, our legislators are using a corrupt, non-transparent process to deprive local voters of transparency regarding the cost of bonds at the local level.  This is a double insult to taxpayers. …

Click here to read the full article from the San Bernardino Sun

Brown’s final budget plan proposes $132 billion in spending

Democratic Gov. Jerry Brown proposed a $131.7 billion state spending plan Wednesday, launching his final year of budget negotiations as he prepares to leave office.

Brown’s proposal is up 5 percent from last year but includes little new spending on new programs. Once again warning that he believes a recession looms, Brown dedicated $5 billion toward the state’s Rainy Day fund, more than is constitutionally required. He also proposed a new online community college program.

“It’s not exciting, it’s not funding good and nice things, but it’s getting ready and that is the work of a budget,” Brown said.

Notably, Brown’s plan makes no changes related to federal tax changes out of Washington, which are expected to hit taxpayers in high-tax states like California the hardest. That’s because Brown had to finalize his plan in December, before the federal changes were finalized. He said he expects to make revisions to his plan during ongoing negotiations with the Legislature. A final plan must be passed by lawmakers in June.

The spending plan also includes nearly $59 million in special funds and bonds, which are dedicated for specific purposes. …

Click here to read the full article from  KPPC

Gov. Jerry Brown’s LAST budget

Jerry Brown Budget 2017Governor Jerry Brown and his Finance Department are putting finishing touches on his final budget to be presented soon. This is a second time that Brown has wrapped up two terms as Governor of California offering a final budget. While much has changed in California government, politics and demography since that “first” last budget in 1982 was completed, a look back may offer some hints on where Brown will go with his second final budget.

Brown’s budget will reflect California’s current circumstances of a big economy with surpluses into the near future. The Legislative Analyst’s Office projected in November $19.3 billion in reserves for the 2018-19 budget if the legislature doesn’t create new budget commitments. Brown will do his best to keep those commitments in check.

But much can happen in the next few months to affect the budget Brown plans to present. Decisions out of Washington, D.C. on health care and the federal tax law changes, and also a possible repeal of California’s gas tax may upset any near-term picture on the budget.

One key difference from 36 years ago was that California was still living in the shadow of the tax revolt of 1978. Another key difference, while no longer running for governor, Brown would be on the 1982 ballot as a candidate for United States Senator. Recently, California legislators and voters have loosened their grip on the purse strings in recent legislative terms and elections. This time around Brown is not seeking another office and political considerations will not cloud budget decisions.

Ironically, just like the end of Brown’s current term, the year prior to his final budget the gas tax was increased in California. In 1981, the gas tax was raised two cents from 7-cents to 9-cents, a 28% increase. In 2017, the gas tax rose 12-cents from 29.7-cents to 41.7-cents, a 40% increase.

Brown was still famously speaking about the “era of limits” when he signed the $25.3 billion 1982 budget on June 30. The budget he offered in 1982 came at a time a recession hit. Brown’s 1982 budget was barely 1-percent larger than the previous budget.

Brown had an eye on his senate race and didn’t want to offer ammunition to political opponents. Reserves in certain accounts were tapped and gimmicks employed to make the budget appear balanced. It wasn’t. By the close of 1982 the budget was nearly $1 billion out of balance and the Senate Finance Committee held several hearings to come up with a fix.

The budget solution would not come under the Brown Administration. As tax historian David Doerr stated in his book, The California Tax Machine, “For the third time in four administrations, an outgoing governor used one-time revenues to balance the budget, leaving a dismal mess for the incoming governor (the exception was Ronald Reagan, who left Jerry Brown with a surplus.)”

The trend of inheriting a deficit was certainly felt by Brown when he took office for his third term in 2011. He does not want to leave a deficit again. His personal history from his first tour in the governor’s office and the experience of his recent gubernatorial journey will have him focused on the budget bottom line to maintain the surplus that the LAO projects.

Legislators should put their spending plans back in their pockets.

This article was originally published by Fox and Hounds Daily

How to Reduce the California State Budget by $40 Billion

BudgetAs of a few days ago, high-wage earners have a new reason to leave California: their state income taxes are no longer deductible on their federal income tax returns.

Can California’s union-controlled state legislature adapt? Can they lower the top marginal tax rates to keep wealthy people from leaving California?

The short answer is, no, they cannot. They cannot conceive of the possibility that California’s current economic success is not because of their confiscatory policies, but in spite of them.

Earlier this year California’s union controlled legislature approved a gas tax increase that will increase state tax revenue by about $5.0 billion per year. Next in their sights is changing property taxes to a “split roll” system, whereby all commercial properties will no longer be protected from steep tax rate increases. Also under consideration is extending sales taxes to services, along with taxes on watermarijuana, and, who knows, maybe even robots.

These new taxes have attracted a lot of attention, but in reality California’s state government derives most of its tax revenue, 58%, from personal income tax. In recent years personal income taxes have contributed as much as 65% of the California state government’s total tax revenue. California’s top marginal income tax rate of 13.3% is by far the highest in the U.S. Oregon has the 2nd highest rate, at a much lower 9.9%. The impact of this can be seen on the chart depicted below, which is taken from the State Controller’s most recent annual financial report for the fiscal year ended June 30, 2016. As can be seen, state income taxes accounted for 58% of all tax revenue in the most recent fiscal year for which we have data. Nothing else even came close.

California Tax Revenue By Source – 2015 and 2016

Taxes graphic

When around 60% (or more) of all state tax collections depend on how much money individual residents make each year, revenue can be volatile. A recent analysis by the Franchise Tax Board, as reported in the Sacramento Bee, showed that the top 1% of California taxpayers by income paid 45% of the total income taxes collected. This means that in the last fiscal year, the top 1% paid 26% of ALL taxes collected in the State of California. If you extend that comparison to the top fifth – those Californians who earned on average over $237K in 2013, it can be seen they paid nearly 90% of the total income taxes collected, or 51% of ALL taxes from all sources.

California Income Tax Burden by Income Group – 2013 vs 1994

Income tax burden

When you have the top fifth of your wage earners paying more than half of ALL taxes collected in your state, you definitely don’t want those folks moving to other states. California has really great weather, but there are a lot of reasons to leave: An inhospitable business climate, a global economy with burgeoning new opportunities in many low tax regions, and an increasingly virtual work environment which means you don’t have to live within 50 miles of the California coast in order to attract venture capital or find business partners.

Just for the sake of argument, here are ways to cut expenses in the state budget, in order to keep California’s state government solvent without punishing the wealthy, or, worse, losing them to other states and nations.

HOW TO REDUCE THE CALIFORNIA STATE BUDGET BY $40+ BILLION

(1) Reduce Costs for Prisons – $2.0 billion or more:  California now spends over $75,000 per year per prisoner, a cost that has doubled since 2005. In Alabama, it costs less than $15,000 per year per prisoner. If California contracted with the State of Alabama to have them house its 130,000 prisoners, that would save California taxpayers $7.8 billion per year. If doing business with Alabama is unpalatable, how about right across the border in Nevada? The State of Nevada spends under $18,000 per year to house their prisoners – sending California’s prisoners across the Sierras to Nevada could save taxpayers $7.4 billion. Obviously relocating California’s prisoners to other states is an extreme solution. But there are many other less extreme, bipartisan solutions to lower prison costs, including alternatives to incarceration.

(2) Cut Ratio of Administrators to Faculty in Public Universities – $2.0 billion or more: In 2000 California’s UC System employed around 4,000 administrators and 7,000 faculty. Only 15 years later, in 2015, the UC System employed 10,500 administrators and 9,000 faculty. Just assuming for a moment that the administrative overhead in the UC System wasn’t already bloated in 2000, the UC System could reduce their administrative headcount by over 5,000 administrators, and save at least $500 million per year. Do the same thing in California’s much larger Cal State and Community College systems, and you can probably achieve total savings of around $2.0 billion per year

(3) Outsource CalTrans Work and Eliminate Redundant Positions – $2.5 billion or more: CalTrans is set to consume $12.8 billion of the State 2017-18 budget. As recommended by State Senator John Moorlach after an audit of the agency, just eliminating 3,500 redundant positions would save $500 million. But competitive outsourcing of roadwork contracts could save much more. CalTrans only outsources 10% of its roadwork, whereas, for example, Arizona outsources 80% of their roadwork. It is common to take competitive bids from private contractors to do public road maintenance and upgrades – CalTrans is the exception. A very expensive exception.

(4) Fund all CalTrans Work With Proceeds from Bullet Train Financing – another $10 billion per year for ten years: Ok, this isn’t entirely fair. Bonds are deferred taxes. But just imagine if instead of paying for a train that will never make any meaningful contribution whatsoever to relieving the congestion on California’s roads and freeways, all that money was used to improve the roads? Redirecting Bullet Train funds – which are destined to total well in excess of $100 billion – into CalTrans projects would save taxpayers nearly 100% of CalTrans budget for a decade or more.

(5) Slash State Agency Headcount and Pay/Benefits by 20% – $6.5 billion: In 2015 the average pay and benefits for the 154,000 full time employees of state agencies was $116,887. Eliminating 20% of these jobs would save taxpayers $3.6 billion per year. Reducing pay and benefits for the 123,000 remaining state employees by 20% would save another $2.9 billion – their average pay package would “only” be $93,500 per year after this reduction. Is this feasible? Recent history proves that it is. In 2009, cash-strapped California state agencies implemented “Furlough Fridays,” which functionally achieved both objectives described here – there was a 20% reduction in work being performed, and state workers collected 20% less in pay. And guess what? The state government continued to function.

(6) Reform Pensions – $2.1 billion: When you talk about pensions, it is understating the problem to restrict the discussion to state agencies. Local cities, counties and school district pensions combine with state agencies to produce an unfunded liability that – depending on who you ask – ranges between $200 and $700 billion. Moreover, pension reform might be subsumed under the preceding Option #5. Nonetheless, here are the numbers for state agencies: Taxpayers contribute, on average, $21,900 towards each state workers pension, representing 26% of their pay. Just lowering that to a contributory 401K equivalent to 10% of pay would save at least $2.1 billion per year. In reality, because these pensions are so underfunded, getting control of pension benefits would actually save much more than this estimate.

(7) Face Reality and End the “Sanctuary State” – around $20 billion: According to the United Nations, there are now over 250 million displaced refugees in the world. Right behind them are another 1.2 billion individuals living in extreme poverty. America, with only $330 million residents, is not nearly capable of absorbing even a fraction of these multitudes, much less California with not quite 40 million residents. Yet California has thrown open the doors and foots the bill, betting that the tech boom and asset bubble will last forever. A study by the Federation for American Immigration Reform estimated the cost of undocumented immigrants to California taxpayers at over $25 billion per year – $14.4 billion for education, $4.0 billion for health care, $4.4 billion for justice and law enforcement, $0.8 billion for public assistance, and $1.6 billion for general government services. This scrupulously footnoted study, published in Sept. 2017, got virtually no coverage in the media. What did receive extensive media coverage was a study promoted by the Institute on Taxation and Economic Policy that estimated the total state and local taxes paid by California’s illegal immigrants to equal nearly $3.0 billion per year. Net cost and potential savings: $22 billion. At the least, California should stop being a magnet state for undocumented immigrants, and instead should help craft then adhere to a realistic national policy.

The most powerful special interest in California, government unions, wants nothing to change. They are hostile towards corporations and individual wealth. They have strong incentives to want inefficient, expensive prisons, universities, and infrastructure projects. They have strong incentives to expand all government services to accommodate destitute immigrants. Why? Because the more government workers are hired and the more taxpayers’ money is wasted, the more dues paying government union members they acquire.

Joining these government unions are California’s powerful Latino Legislative Caucus and their allies in the identity politics industry, who recognize a huge political opportunity by spewing separatist demagoguery, nurturing a bleak, tribal paranoia in the collective minds of recently arrived immigrants. Also joining these government unions are left-wing oligarchs and the monopolistic businesses they control, who see in an expanded government and a hostile business climate a chance to prosper through legislated scarcity and mandated product choices. And, of course, the asset bubbles produced by contrived shortages add precarious value to the pension funds and increase property taxes.

So these solutions, while eminently practical, may never see the light of day. But California’s voters should understand that around $40 billion could be cut from the state budget if California’s government was ran in the interests of the people, instead of in the interests of government unions and their elitist allies. If $40 billion were cut from California’s state budget, not only could the new gas tax be repealed, but the top marginal tax rate could be dropped to under 10%. And as any student of the Laffer Curve knows, that might actually keep California’s wealthy from leaving; it might even cause income tax revenue to go UP, as fewer high income individuals feel the need to shelter or defer their taxable earnings.

The Laffer Curve
Depending on where you are on the curve, lowering taxes can raise tax revenue.

Laffer curve

*   *   *

Edward Ring is a contributing editor for the California Policy Center.

 

Beware of Props. 51, 55, and 56 Wreaking Havoc on CA Budget

budget-constantin-cagle-Nov.-26-2013-300x203As a professor of public budgeting and someone who has worked their entire career analyzing public budgets, I can say that ballot box budgeting wreaks havoc on the California budget process and taxpayer interests.

Yet it is something that voters are so accustomed to doing that most average voters don’t even know what “ballot box budgeting” is.

In short, ballot box budgeting is the practice of making major budget decisions at the ballot box. And unlike the normal budget process, these decisions are commonly written into the California Constitution, and not subject to change in any way short of another ballot measure.  

The result is that funds are locked in to being spent for a particular purpose regardless of other budget needs and priorities, and commonly lack the same accountability and oversight that the rest of the California budget is subject to through the legislative process.

There are three measures on the November 2016 ballot that represent ballot box budgeting at its worst, and should be rejected — Proposition 51 School Bonds, Proposition 55 School Funding and Proposition 56 Tobacco Tax Increase. There is one other measure, Proposition 64 Marijuana Legalization and Tax, which represents ballot box budgeting, but is less egregious and is worthy of consideration on its policy merits given that marijuana is not currently legal and therefore not taxed at all but should be considered on policy grounds.

The reality is that nearly all initiatives have some type of budget impact, but initiatives that allocate a significant dollar amount of public funds should generally be looked at with great skepticism, particularly those that raise taxes or reallocate existing public funds in some way.

Another common element in ballot box budgeting is a “pay to play” element, characterized by a situation where special interests sponsor a ballot measure that allocates public funds that benefit their private financial interest.   All four initiatives mentioned above have a significant “pay to play” element, that should be considered as well, and viewed with great skepticism.

In generally all such cases, initiatives are sold as being crafted in the “common good” or for the “public interest” but the real motivation is to benefit the private interests that raised the money to quality the measure and run a support campaign.

For example, Prop. 51 authorizes $9 billion in general obligation bonds for construction of K-12 public schools.  The construction of school facilities is done through a process at the local level, with state bond funds providing a state match, but this local process has come under great fire in the media recently, largely due to California Treasurer John Chiang’s efforts.

Treasurer Chiang has stopped short of criticizing Prop. 51 specifically but he has came down hard on the local municipal bond process as being a “pay to play” process that “rips-off taxpayers,” according to Treasurer Chiang’s press release.

Chiang says this “pay to play” process rewards special interests including developers, bondholders, and construction companies who offer to fund local bond campaigns in exchange for lucrative contracts, which are “no bid” contracts in many cases.

“Not only are these “pay-to-play” arrangements unlawful, they rip off taxpayers and endanger the integrity of school bonds,” Treasurer John Chiang declared, noting that between 2012-15 K-12 school districts issued $43.8 billion in long-term debt.

Without cleaning up this “corrupt” process, Prop. 51 essentially puts $9 billion in public funds at risk for misallocation by school districts and public agencies.  And will subject taxpayers to huge future costs, for spending with questionable public benefits given the process through which these bonds are issued under the current system.

Of course, the same special interests who benefit from this “pay to play” process are the primary proponents of Prop. 51, and are putting up millions of dollars to lock in these lucrative contracts for public bond spending.  A number of local districts are also proposing local bonds on the November 2016 ballot to provide a local match for these highly questionable public projects.

Prop. 55 is the example of another measure which might appear legitimate on its face because it raises money for “schools” and “health programs.”   But should also be rejected on ground of being a terrible case of “ballot box budgeting” and “pay to play” corruption of the state’s initiative process.

Prop. 55 extends the Prop. 30 (2012) income tax increases taxes on individuals and small businesses, which expire at the end of 2017, for another 12 years until 2030.  The effort is being sold as being a legitimate effort to fund schools and health care because Prop. 30 is something that the Governor, Legislature and business community agreed on back in 2012.

But Prop. 55 is not the same as the deal cut back in 2012, and should be rejected.  First, Prop. 55 is much more expensive, nearly twice as expensive as Prop. 30—and represents an $8-11 billion tax increase, as opposed to a $6.5 billion annual hit from Prop. 30.  Secondly, the measure is not “temporary,” and results in a broken promise Governor and Legislature made to voters in 2012—that’s why Governor Brown says he will not endorse Prop. 55.

Lastly, Prop. 55 adds a significant “pay to play” element as well by giving private hospital interests a piece of the action.  Specifically, Prop. 55 locks in another $2 billion in funding for “health programs,” which did not even exist in Prop. 30, and is a pure handout to the hospital interests which have already contributed more than $21 million to the Yes on Prop. 55 Campaign.

Public employee union interests get the bulk of the funds, estimated at $75 billion over 12 years, in salary and benefit spending primarily but the public generally does not view them as being the same type of “special interest” as purely private interests.  Yet, these public employee union interests have put up another $18 million thus far to support Prop. 55, and stand to reap huge rewards for their members and dues increases if Prop. 55 passes.

From a ballot box budgeting perspective, both Prop. 55 and the Prop. 56 $2 per pack tobacco tax increase are terrible budget policy because they lock in significant expenditure of public funds that will be allocated outside of the state’s annual budget process without regard to actual need or other pressing spending priorities.

Prop. 55 locks in $8-11 billion in spending with the bulk going for education, but another $2 billion going to “health care” programs—again not allocated according to need or the accountability standards under the state’s annual budget process which subjects all public spending to annual review.  Prop. 56 locks in another $1-1.4 billion in health care spending that will be allocated outside the state’s budget process.

Voters are encouraged to reject Propositions 51, 55, and 56 on grounds that they are terrible examples of “ballot box budgeting,” in which special interests put up millions of dollars, even tens of millions of dollars, to try to pass “public interest” measures with the expectation of a big payday at taxpayer expense for the years to come.

David Kersten is executive director of the Kersten Institute for Governance and Public Policy (www.kersteninsitute.org). He is an expert on fiscal issues and teaches a masters’ course on public budgeting for the University of San Francisco.

This piece was originally published by Fox and Hounds Daily