The California Budget

Posted on Saturday, June 9, 2012 by Post Scripts

By MICHAEL BOSKIN AND JOHN COGAN

WSJ – California’s fiscal and governance crisis careens from bad to worse. The latest blow: a 70% increase in the state’s projected budget deficit in Gov. Jerry Brown’s revised budget, to $16 billion from $9 billion. Meanwhile, S&P warns of a downgrade to the state’s bond rating, already the lowest of any state, and the latest CEO survey ranks California’s business climate dead last.

Caught in the symbiotic financial embrace of special interests–teacher and other public-employee unions, trial lawyers and environmental extremists–Mr. Brown and the state legislature repeatedly nibble around the edges of the budget broken by costly, ineffective programs, financed by an uncompetitive, volatile tax system.

Mr. Brown colorfully but correctly calls the budget, riddled with earmarks and creative accounting, a “pretzel palace of incredible complexity.” He and the state legislature are choking on the pretzel. They’ve lost credibility by offering hopelessly optimistic projections; diverting revenue earmarked for other purposes (such as funds meant to help homeowners from the national bank-mortgage settlement) to the general fund; and gambling on Silicon Valley to produce more revenue from capital gains and stock options. Call it casino budgeting.

The governor describes his budget and November tax-hike ballot initiative as “real increased austerity” while calling on voters to “please increase taxes temporarily.” Cutting through the shifting numbers and fanciful assumptions, what is actually proposed is closer to a permanent tax hike and modest temporary budget cuts to fund a permanent spending increase.

Mr. Brown’s original bad idea, raising the state’s top marginal tax rate of 10.3% to 12.3% for five years, is now even worse: a highest-in-the-nation 13.3% on individuals and small businesses for seven years retroactive to Jan. 1, 2012, and a small increase in the sales tax for next year.

While the governor proposes cuts in social services, higher education and the courts, total spending nevertheless goes up to $91.4 billion in fiscal year 2013 from $86.5 billion in 2012, a 6% increase. Spending on K-12 education alone rises beyond constitutional requirements to $38.5 billion from $34 billion, a 13% increase.

In the past, Californians have supported more education spending on the assumption it would improve education outcomes. It hasn’t. Sadly, the state has an elementary and secondary school system that ranks in the bottom fifth of all 50 states in math scores, and a high-school dropout rate that’s soared relative to other states, especially for African Americans and Hispanics.

The prison system spends $45,000 per year per inmate–about equal to the median take-home pay of American families. Welfare and MediCal (the state’s Medicaid program) caseloads are vastly in excess of national averages.


Mr. Brown does have some good proposals. He’s bringing the state’s welfare-to-work program in line with federal rules, and he’s called for small Medicaid co-pays, which the Obama administration foolishly blocked. But his bad ideas far outweigh the good, including restricting the use of private contractors on public projects and a $68 billion high-speed rail proposal that would drain revenues from higher priorities for decades.

The governor’s one innovative program is “realignment” between the state and counties, especially of the state’s overburdened prison system. But counties worry that costs of the permanent shift of convicts from state prisons to county jails will eventually fall to them.

Unlike other governors from both parties who pushed overdue reforms, opposed by public-employee unions, through their legislatures–Wisconsin’s Scott Walker, New Jersey’s Chris Christie and New York’s Andrew Cuomo, to varying degrees–Mr. Brown has not even pressed the Democratic-controlled legislature to pass his own sensible pension proposal.

He is seeking a deal with the unions that only temporarily reduces wages and work hours by 5% each, saving 0.4% of the budget. Usually a pay cut refers to working the same hours for less pay, not a forced, unpaid vacation. Mr. Brown has not made it clear whether the reduction is for one year or longer, or even whether the compensation would be paid back later (if so, it amounts to a paid vacation, not a pay cut).

The governor has reduced the workforce by 2% and proposed further, gradual reductions. But this represents a failure of imagination. The state should replace half of the sizable number of workers who will retire in the next 10 years with technology and at the same time institute performance pay, saving a bundle and improving service delivery.

Meanwhile, Mr. Brown forges ahead with his proposal for higher taxes despite considerable evidence that states with lower tax rates grow faster than states with high tax rates. Higher marginal tax rates will speed the exodus from the state, which has a 10.9% unemployment rate, the country’s third-highest.

California’s casino-like budget reflects its highly volatile revenue system. In good times it collects almost half its income taxes from the top 1% of the population, relying heavily on capital gains, taxed at ordinary income rates, and stock options. This exposes the state to dramatic revenue collapses during recessions and stock market declines.

The state lurched from income tax growth of 54% in the two years from 1998-2000–money that was spent and built into the permanent budget base line–to a collapse that erased these revenue gains the next two years. This dysfunctional swing was repeated in the recent housing bubble and bust. Mr. Brown’s tax initiative would exacerbate the volatility.

To remedy this and other problems, two recent bipartisan California Tax Reform Commissions, one on which we served in 2008-09, recommended the state combine a broader tax base of economic activity with much lower marginal tax rates, modeled on the landmark 1986 tax reform of President Ronald Reagan and Sens. Bill Bradley and Bob Packwood–the exact opposite of Mr. Brown’s proposal.

Absent real reform, there is little likelihood the long-run budget will be balanced, and a high likelihood the “temporary” tax hikes will not only become permanent but form the new base from which even higher taxes are demanded.

California still leads the world in technology, agriculture and entertainment, but politicians in Sacramento are headed in the opposite direction from growth, prosperity and effective, affordable government. They have so far refused to live up to the demands of, let alone seize, the moment. Instead, like their counterparts in Greece and other bankrupt European nations, they seem intent on continuing the broken high-tax-and-spend welfare state experiment as long as they remain in office.

Messrs. Boskin and Cogan are, respectively, professors of economics and public policy at Stanford University, where they are both senior fellows at the Hoover Institution.

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6 Responses to The California Budget

  1. WTF says:
    Saturday, June 9, 2012 at 6:41 am

    They left out the part about where Enron took California for $20 billion in 2000. Not that it matters now . . .
    I can’t wait for the unions to be demagogued That .4% is going to make all the difference.
    I am not surprised the authors are OK with realignment–it merely shifts the costs, but doesn’t address the problem.
    They say we should go with technology to replace workers, but they do not entail what that technology would look like.
    These authors are bereft of any real solutions.

  2. Tina says:
    Saturday, June 9, 2012 at 12:10 pm

    The problem, let’s face it, is socialist (failed) government, environmental special interest (lobby), and public sector union (greed). The Democrat Party owns all of these while pretending to stand for the average worker/taxpayer, the environment, and our children/teachers in the classroom. It is a fact that their policies make a mess of all of these and bankrupt everyone in the process. The only thing they truly serve is control and power in their own hands. California is lost as long as these manipulators are allowed to make laws to further their political and special interest agenda and benefits.

    Environmentalists and California and Federal government mandates set the stage for the Enron mess and a lot more. Those interested in connecting the dots will enjoy the following excerpted from, “Wind Energy’s Ghost”.

    http://www.americanthinker.com/2010/02/wind_energys_ghosts_1.html

    From its beginnings as a slogan of the anti-nuclear movement, wind energy has always been tied to taxpayer support and government intervention. Wind farms got their first boost with the Carter-era Public Utility Regulatory Policies Act of 1978 (PURPA) which encouraged states to enact their own tax incentives. PURPA also for the first time allowed non-utility energy producers to sell electricity to utilities — the first step towards a bungled half-privatization of electricity supply which would come two decades hence.

    In the 1985 book “Dynamos and Virgins” a San Francisco based PG&E utility heir tells the story of how he joined forces in the 1970s with lawyers from the Environmental Defense Fund. Together they worked for years to obstruct coal and nuclear power plants until utilities were forced to do business with wind energy suppliers.

    Protest and litigation remain among the foremost competitive tools used by the now multi-billion dollar “alternative” energy industry. Reviewing the book, Robert Reich, a Kennedy School of Government professor who would later become Clinton’s Secretary of Labor, wrote:

    “The old paradigms of large-scale production, centralized management, and infinite resources are crumbling. We are on the verge of a new political economy.”

    The new paradigm created by the generation of 1968 is more political and less economy. Without government intervention, utilities normally avoid wind energy. Wind’s erratic power feed destabilizes power grids and forces engineers to stand by, always ready to fire up traditional generators. Wind does not fit into an electric supply model made up of steady massive low cost “base load” coal or nuclear plants backed up by on-call natural gas powered “peaker” units which kick in during high demand. No coal or nuclear power plant has ever been replaced by wind energy.

    Although carbon credit schemes often assign profitable carbon credits to wind farm operators based on a theoretical displacement of carbon emitted by coal or natural gas producers, in reality these plants must keep burning to be able to quickly add supply every time the wind drops off. The formulae do not take into account carbon emitted by idling coal and natural gas plants nor the excess carbon generated by constant fire-up and shut down cycles necessitated to balance fluctuating wind supplies.

    But with PURPA on the federal books, the State of California quickly created “Interim Standard Offer” (ISO4) contracts guaranteeing a purchase price based on utilities’ “avoided costs”–launching the first “California Wind Rush”. By 1982 turbines were sprouting from the dusty terrain of Altamont Pass, Tehachapi, and San Gorgonio. The ISO4 contracts were written with the assumption that fuel prices would continue to soar.

    But that’s not what happened.

    By 1985 oil and natural gas prices were dropping. This changed the “avoided cost” calculations to the disadvantage of alternative energy producers. ISO4 contracts no longer guaranteed a price sufficient to attract investment in wind energy. Construction of new turbines stopped. As the old ten-year contracts began to expire in the late 1980s, renewals were pegged at much lower avoided cost estimates. As a result, many California wind developers quickly closed up shop, abandoning their turbines to moan out the one note song.

    Then Enron got involved.

    Building on the foundation laid by PURPA, 1992 Energy Policy Act (EPAct) began the partial deregulation of wholesale — but not retail — electricity. Reich in 1985 had lauded the “crumbling” of “large-scale production (and) centralized management”. He got his wish. EPAct set the stage for Enron’s California energy market manipulations which led to the 2003 recall of Governor Gray Davis (D-CA). The movement started by a PG&E heir led to the bankruptcy of PG&E. Perhaps this is why some call the children of the 1960s “the destructive generation.”

    Designed to create a renewable energy trading market, EPAct — much of which took effect in 1997 — created a combination of mandates, incentives, and tax credits. These included:

    laws requiring large wind producers to be allowed to tie into the existing utility grid

    “Renewable Portfolio Standards” forcing utilities to buy intermittent wind generated electricity.

    “Renewable Energy Certificates” tradable separately from the electricity itself to sell to companies needing to meet the portfolio standards.

    A 10-year “Production Tax Credit” that now equals $.019/kWh

    Accelerated depreciation allowing tax write-off using an accelerated 5-year double-declining-balance method (40% per year).

    Wind capacity had stagnated through the mid-1990s. But Enron in January, 1997 bought out Tehachapi-based industry leader Zond Corporation – launching the second California Wind Rush.

    Four years later, Enron would implode. The company which gamed a government-crippled artificial marketplace was deconstructed as poster boy for unbridled capitalism.

    But the tax credits, mandates, and regulations which made Enron possible did not die with it. Enron Wind’s turbine manufacturing subsidiary was purchased by General Electric. Many of its wind farms went to Florida Light and Power. By 2009, the US Department of Energy estimates mandate-and-subsidy-driven wind capacity would rise to 28,635mw.

    That much coal or nuclear “capacity” would power 28.635 million homes, but wind “capacity” is calculated assuming perfect wind 24 hours a day, 365 days of the year. At the best wind sites, such as Kamaoa, newly installed turbines generate only 30-40% of “capacity”. At most sites, the figure is 20% or less. After 30 years of development, wind produces only 2.3% of California’s electricity.

    California should learn from what happened in Spain:

    …Dr. Gabriel Calzada, Professor of King Juan Carlos University in Madrid explained what Feed In Tariffs and other wind subsidies did to Spain (as well as Portugal and Greece) got into debt:

    “The feed-in tariff… would make (utility) companies go bankrupt eventually. So…the government guarantees…to give back the money in the future — when (they) are not going to be in the office any more.

    Slowly the market does not want to have these securities that they are selling. Right now there is a debt related to these renewable energies that nobody knows how it is going to be paid — of 16 Billion Euros.”

    In early 2009 the Socialist government of Spain reduced alternative energy subsidies by 30%. Calzada continues:

    “At that point the whole pyramid collapsed. They are firing thousands of people. BP closed down the two largest solar production plants in Europe. They are firing between 25,000 and 40,000 people….”

    “What do we do with all this industry that we have been creating with subsidies that now is collapsing? The bubble is too big. We cannot continue pumping enough money. …The President of the Renewable Industry in Spain (wrote a column arguing that) …the only way is finding other countries that will give taxpayers’ money away to our industry to take it and continue maintaining these jobs.”

    That “other country” is the United States of America.

    Schemes and manipulation are the playthings of Democrats who always think they are the smartest people in the room but have no practical experience from which to draw in order to predict outcomes.

    Our spiral downward will be dizzying if we continue down this path.

  3. WTF says:
    Sunday, June 10, 2012 at 5:48 pm

    David Cay Johnston has detailed the machinations of Enron and Gray Davis–it has absolutely nothing at all to do with wind energy.
    If you would like to know the truth, you can use Google to get to the links. Neither gray Davis, nor Enron would count as liberal democrats. The problem is not confined to any one party, however.

  4. Tina says:
    Sunday, June 10, 2012 at 8:59 pm

    Stewardship of the land we love is behind Republican support of environmental issues…and stupid efforts to meet in the middle in a bipartisan effort at compromise! a fools game if ever there was one. Democrat power since the sixties has grown ever more powerfully filled with extremists.

    Government control, and in this case government control of anything that is even remotely connected to the environment, is the agenda of the Democrat Party.

    The wind energy agenda, pushed in government starting with Carter, isn’t difficult to tie to Democrats…Obama and the Democrats in the first two years vowed to end fossil fuels and push for wind and solar. They followed through by using the EPA to write regulations, giving generously to wind and solar donor businesses, placing draconian regulations on coal, blocking oil and gas regulations.

    And…HELLO…talk about a connection…peace prize winner Al Gore was only the VP of these United States under Clinton for eight years before becoming the poster boy mouth piece for all things green…made a bundle too:

    http://www.humanevents.com/2009/11/06/al-gore-climate-pirate/

    Al Gores net worth (is estimated) at over $100 million — up from about $2 million when he left the White House in 2001.

    Is it sour grapes or worse, un-American, to begrudge Al Gores success — after all, isnt he a shining example of the entrepreneurial spirit and the free enterprise system?

    But the Al Gore story may not be one rooted in the ideal of a hard-worker selling for a reasonable profit a product that adds value to peoples lives. Gore is an eminently well-connected, long-time Washington, DC apparatchik who exploited the political career he inherited from his father to scare ordinary citizens and legislators into passing laws that profit him. Al Gore is no Horatio Alger: more a P.T. Barnum.

    So the green energy agenda does belong to democrats almost exclusively. Stating that Davis was no liberal democrat is laughable…and his ties to Enron are clear:

    http://archive.newsmax.com/archives/articles/2003/8/21/173923.shtml

    …according to the Sacramento Bee, Davis has received $119,500 in campaign donations from Enron, including $42,500 since becoming governor…Davis led a $200,000 trade trip to Europe for Enron. Davis traveled at California taxpayer expense with his wife for two weeks in Europe and finally in ancient Greece, lobbying on behalf of Enron for the Greek Wind Project.

    Davis also took a close-knit group of heavy campaign donors along on his trip to Greece. The group included grocery store magnate Ron Burkle, who donated $350,000 to Davis, and workers’ compensation insurance executive Stanley Zax, who donated $100,000 to Davis…The project in Greece was so important that Davis also took his good friend, major DNC donor and Sacramento developer Angelo K. Tsakopoulos…Tsakopoulos and his family are million-dollar contributors to the Democratic National Committee and Democratic candidates including Davis, Al Gore, and Bill and Hillary Clinton…Enron considered the trade trip so important that they also included a 22-page briefing paper addressed to Gov. Davis detailing the “Greek Wind Project Permitting Issue.” Interestingly, the same briefing paper made its way into the U.S. commercial section of the American Embassy in Athens…The 1999 documents are part of a long string of heavy lobbying efforts that the Clinton administration carried out to convince the Greeks to buy Enron wind products for Crete…More importantly, the facts surrounding the California energy crunch do not support Davis’ claim that Enron executives committed crimes. According to a study done by the CATO institute, the California governor is not telling the truth about Enron.

    “Records pried from the governor’s office by legal action reveal that during last year’s crisis Enron was charging less for electricity than the market average and significantly less than Davis’s own L.A. Department of Water & Power, under the direction of the governor’s ‘electricity czar,’ David Freeman,” states an article by Jerry Taylor, director of natural resource studies and Peter VanDoren, editor of Regulation, at CATO…”Enron was accepting IOUs from the power companies and the state of California rather than demanding cash upon delivery at the height of the crisis. But trusting the state to make good on its promises to pay was an example of the corporate heart ruling the head. According to energy economist Phil Verleger, the state of California ended up stiffing Enron for millions of dollars, a (dare we say ‘ruthless’?) maneuver that certainly didn’t help Enron stay out of bankruptcy,” notes the CATO institute report…The fact is that Enron supplied barely 4 percent of California’s power. Davis’ attempt to paint the power shortage in California as some sort of right-wing conspiracy is so false as to be ridiculous. (read on in the article for more information on the Clinton-Davis-Enron connection)

    Between the entire enviro scam and the failing wind industry, old Al and the Democrats have done one hell of a lot of damage around the planet…add in the corrupt practice of making loans to folk that can’t make payments resulting in a credit crisis and bank failures and you can well see that Democrats with their big government solutions have done a lot of damage in the last twenty or thirty years.

    Improvements to our beloved automobile should be efficiency driven…everyone can benefit from more bang for their buck…and their gallon of petrol!

  5. Joseph says:
    Sunday, June 10, 2012 at 9:40 pm

    Well, the Schwabettes have taken charge in France.

    Imagine what it would be like if Schwab, Hokum and the Grundler ran a country.

    You will soon find out…

    http://globaleconomicanalysis.blogspot.com/2012/06/socialists-score-well-in-first-round-of.html

  6. Post Scripts says:
    Tuesday, June 12, 2012 at 9:56 am

    Joseph, the timing could not be worse for France to revert back to a socialist form of government. Oh well… their about to get exactly what they deserve.

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