It is becoming increasingly clear that the structural deficit in California cannot be solved by any means available to the legislature, by economic growth, or by just plain luck. It is time to think the unthinkable: that the only way for California to get its financial house in order is through bankruptcy.
A few decades ago, California was a Republican state. It was growing like crazy, had great roads, top public schools, top universities, and a vibrant growing economy. Drawn by the nice weather, a business friendly environment and all sorts of creative capital formation, entrepreneurs in technology, biology, engineering, health, and you name it flocked to the state. The universities turned out well educated graduates that stayed in the state and fed the almost insatiable hunger of the business community for intelligent, trainable employees. People young and old flocked to California which they rightfully perceived as a land of opportunity.
Things started to change in the seventies. Opposition to the Vietnam war had been strong in California and as the war wound down, that opposition, already organized around radical principles, began to assert itself as voters, electing ever more liberal local and statewide politicians. Gradually, the state became majority democratic and the legislature and many of the municipal entities became Democrat controlled. A left wing anti-business tax and spend regime gradually took hold and became firmly rooted.
The peculiar way in which the legislature organizes itself gave the Speaker of the Assembly almost dictatorial power and hidden away in Sacramento, there is essentially no fourth estate scrutiny over legislative activities. A succession of Speakers starting with Phillip Burton, then Willie Brown etc. came from San Francisco and the Bay Area, long a liberal bastion, and they were able to control the ebb and flow of legislation such that left wing constituencies were rewarded, municipal unions were strengthened and the teachers’ unions gained complete control over public education. Regulation after regulation was imposed on business and a vast array of social welfare and related programs were enacted. It is estimated that regulations in the state currently cost nearly $500 billion per year. As long as the revenue was there, the legislature could find ways to spend it. Gradually, funding was shifting away from infrastructure maintenance and away from education and toward a miasma of social programs. Deferred infrastructure maintenance grew and grew. State government insinuated itself into nearly all aspects of life. Businesses large and small began to move from the state to escape these burdens.
Special interests have always been excessively influential in Sacramento and in fact, the initiative process was amended into the state constitution as a way for the people to overcome special interest influence. Recently, the initiative process has backfired on its original intentions. Various interest groups learned how the initiative process could be used to preempt the legislative funding mechanisms and to shift tax burdens. Proposition 13, which capped what was becoming a meteoric rise in real property taxes was an early example. While Proposition 13 is perennially vilified by the left, it is perhaps the only area of taxation where the state has not gone completely overboard and the citizens have benefitted.
A series of initiatives have been passed that earmark percentages of the state’s revenues for particular purposes thereby removing these funds from the budgetary process. Without setting out a litany of these, at present nearly half of the state’s revenue is committed for particular purposes as a result of initiatives. Thus, the legislature has very little leeway even if it were disposed to be frugal.
At the same time, there has been an almost unbelievable rise in municipal and state compensation levels. At one time there was a perceived tradeoff between the security of civil service positions and a compensation level that was less than in private industry. That has completely reversed. As a group, state employees and municipal employees are compensated at levels that far exceed those in the private sector. The state has literally thousands of employees whose salaries are in six figures and that does not include a benefit load that exceeds fifty percent. It has been estimated that the state’s unfunded benefit burden is north of $62 billion. As these unions gain ever more legislative support, the state has lost any ability to reduce headcount or to reduce compensation levels. There are any number of boards and commissions which have no substantive functions other than to provide income to electorally defeated Democratic politicians. There are hundreds and hundreds of water districts, transportation districts, etc. each with its own taxing power and budgets, none of which are subject to public scrutiny. BART is a prime example where train operators start at $89,000 and fares are continually rising as BART is unable to match expenditures and revenues.
Finally, the state has financed much of its operations by incurring bonded indebtedness. Whether it is a few billion for stem cell research, or ten billion for high speed rail, or eighty billion for a constellation of infrastructure projects, the bonded debt has reached a point where nearly ten billion in annual revenue must be devoted to debt service. The state’s credit rating has been falling and there is no end in sight. Still, the legislature proposes even more bond issues.
In all of this, the state has acquired structural deficit that simply cannot be reduced. The legislature lacks the political will to honestly tackle this problem and the governor has no power to do so without legislative support. Last fiscal year, the deficit was about $25 billion and that gap was “filled” by accounting legerdemain, payment timing tricks, and other wishful thinking. Taxation was increased by $12.5 billion, $6 billion was borrowed, and the books were cooked in various ways to cover that deficit. This fiscal year the deficit is projected at another $21 billion and there are few if any more games available to play. If Obamacare is enacted, the state will incur another $3+ billion in MediCal expenses. MediCal is California’s version of Medicaid. Every tentative effort to reduce expenditures precipitates howls of protest from the affected Democratic constituencies and the legislature backs down.
The only response of the legislature has been to raise taxes. The sales tax is nearly 10%. The income tax is higher than all but a few states (Michigan and New Jersey, both of which are in similar difficulty). The nonpartisan Tax Foundation ranked California 48th among the states on business-tax competitiveness. California once had a vibrant manufacturing economy, but it is estimated that as a result of high taxes and excessive regulation, California lost nearly 80,000 manufacturing jobs between 2003 and 2007. Toyota has just determined to close the NUMI plant after GM abandoned the partnership. That means another 4,500 lost jobs directly and probably as many again from the many suppliers to that plant. Had California had a more healthy business climate, it is a certainty that Toyota would have stayed as the plant is modern, well located and supplies one of Toyota’s largest markets.
Meanwhile, the demand for services from a culturally dependent population continues to grow. Nearly 1/3rd of the nation’s welfare recipients live in California. The unemployment rate exceeds 12% and there is no end in sight. The California housing market was walloped in the latest downturn. The taxpaying population is shrinking as higher income people flee the state for more favorable locals while the population of government program consumers increases.
Reality must dawn soon. The state cannot continue as it has, but as long as the Democrats control the legislature, there simply is no hope for any short or long term solutions other than the cleansing bath of bankruptcy.
A bankruptcy could allow the state to void all of the excessive union contracts, could allow it to restructure its indebtedness, could allow a trustee-like entity to reexamine the distortions caused by the abuse of the initiative process, and could allow a restructuring of the budgets so that the revenue and outflows would be in balance. Fiscal control would be removed from the legislature and placed in the hands of a trustee-like body that would be able to avoid the special interests and rationalize the process so that the state could start on the path to fiscal sanity. The excessive employee head count could be reduced to rational levels. Salary levels could be reduced to private sector levels. The argument that the state would lose many of its “talented” employees is pure malarkey, for where would they go?
All of this would be plowing new ground. We have no precedents and we have no experience with either a state bankruptcy or even a bankruptcy of this magnitude. I have confidence however, that the quality of the Federal bankruptcy judges and the creativity of the public interests that would emerge would, under the Court’s guidance, be able to devise the entities and the structures that would effectively manage the process. In the meanwhile, the shock and embarrassment that the body politic would feel might just be enough to encourage the restructuring of the state Constitution so as to bring an end to the abuses that have brought us this far.
I don’t say it is easy and I don’t say that it will be smooth. But, I ask, does anyone have a better solution??