Thursday, July 2, 2009

California Inc Going Bankrupt


California is paying vendors and taxpayers with IOUs today (http://www.nytimes.com/2009/07/03/us/03calif.html?hp). The government is facing a $27 billion budget deficit, and doesn’t have enough cash on hand.

The budget crisis has been brewing for a while. In May, California voters opposed budget referendums that would have increased taxes to close the gap. There does seem to be a conservative streak still in California voters even though it is heavily Democratic today. Remember, California produced Richard Nixon and Ronald Reagan. California voters also passed proposition 13 to limit property taxes in 1978, which was widely seen as a tax revolt throughout the country.

Some of the problem is surely due to the poor state of the economy. California has been hard-hit by unemployment. Other employees have had to settle for salary cuts. That means that the state is collecting less in income tax revenue. The loss in consumer spending means a loss in sales tax revenue. This comes at the same time that more people must access social welfare programs in the state. In other words, the California budget is being asked to do more with less.

But California had a sizeable deficit even before the financial crisis. In the 2006-2007 fiscal year, California still had a $4 billion operating shortfall (http://www.lao.ca.gov/2005/fiscal_outlook/fiscal_outlook_05.htm). Deficits run up in good years have only been compounded in the bad.

This leaves California with several unattractive options. It can raise taxes even further (it already has some of the highest rates in the country), but it would be doing so on a shrinking tax base. And raising taxes hardly seems like a good way to spur economic growth in the middle of a deep recession. It can issue more bonds, but this will increase the amount of money it owes in the end because of interest. It can try and make draconian cuts in education and social services that will hurt the most vulnerable members of society. Coincidentally, the state legislature has been unable to cut spending in a meaningful way thus far.

The Obama administration has rejected pleas for federal aid. So it looks like California will have to choose one of those bad options.

California is not the only state in this position. 48 states are facing budget deficits this year totaling $166 billion (http://www.cbpp.org/cms/?fa=view&id=711). Several of them will face the same tough choices California does now.

This has implications for our taxes in years to come. President Obama has pledged not raise taxes on anyone making under $250,000 a year. Even if he is able to keep that promise at the federal level, the states will have to raise taxes as soon as is practical economically. That means that in coming years, we’ll be paying higher taxes one way or the other.

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