We'll Be Back...

August 4th, 2009 by 

California recently closed a $26.3 billion budget gap after resorting to issuing IOUs in lieu of checks on state contracts.  The budget worked out to $15.5 billion in cuts and a transfer payment where California will take money from local treasuries to close some of the gap.  The rest is covered through various accounting gimmicks that would make Enron blush.  California's budget compromises lead to many questions including the most important, "Does this fix anything?"

Wishful Thinking

In my mind, California is just kicking the can down the road and hoping for a recovery to take shape on its own.  The problem is that California isn't the jobs creation leader it once was, and hasn't been since the technology bubble burst.  Business and personal taxes are onerous, drawing low rankings nationwide for the statewide business climate.  Huge tax burdens from increased government spending during boom times soak the top bracket to the tune of 10.55%.  The top 1% of individuals contribute 50% of California's income tax receipts.

Yes, some of the elements in the recent budget compromise were probably a long time coming... for example, new oil extraction off the coast of Santa Barbara.  The problem is, California will probably be hurting again in the near future.  California's problems are rooted in an increased demand for government with no way to pay for the massive increases in spending.  In fact, the $15.5 billion in cuts only rolls California back to 2005 spending levels.  11.6% unemployment certainly doesn't help matters much.

Permanent Solutions

Two possible solutions have started to gather some press, one much more likely than the other.  The first is a

Kicking the Can? (Fabio Venni)
Kicking the Can? (Fabio Venni)

Constitutional Convention.  The second is major tax reform.

A constitution convention would allow California to rewrite the state's constitution.  Since new programs can be created with a majority vote yet new taxes require a 2/3 majority, there is a disconnect between government programs and funding for those same programs.  If this weird voting gap could be cleared, the fact spending would have to increase might decrease the appetite for these programs.  I worry this may work in reverse... with increased taxes, more and more of the people the burden falls upon higher income families, who find it easier to move.  Don't think it's a legitimate problem?  From 2004 to 2007 there was a net emigration of 1.16 households making over $110,000 for every household that immigrated.

A more likely solution that is most likely a necessity even with a Constitutional Convention is a major tax overhaul.  California's highly progressive tax rates would be whittled down into a single or a couple of brackets.  Like I said earlier, this would reduce the burden on high income tax households and the boom/bust cycle of California tax receipts (a major issue is the amount of funding California taxes in from capital gains taxes... there is no concept of long term capital gains on stock in California's state tax).  Imagine a California with no corporate or sales taxes, a business net receipts tax, and a 6% flat tax rate.  Sounds great!  Where do I sign?

Any change is going to have to move people off the public dole and reduce taxes.  Hopefully California can be a leader again, as it was as recently as 8 years ago.  Here's to tough, necessary choices...

Fire thumbnail sourced from www.flickr.com/photos/68076636@N00/490908797, shot by Atwater Village Newbie.


PK started DQYDJ in 2009 to research and discuss finance and investing and help answer financial questions. He's expanded DQYDJ to build visualizations, calculators, and interactive tools.

PK lives in New Hampshire with his wife, kids, and dog.

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