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Rising Pension Costs, Falling Revenues Lead to a $179 Million Budget Deficit in San Diego

adam.summers@reason.org (Adam Summers) — Mon, 19 Oct 2009 14:38:00 EDT

The City of San Diego has released its 5-year forecast—and the future is not pretty. The city is facing a record $179 million deficit this year, followed by additional projected annual deficits of at least $150 million for several years.
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San Diego Mayor Jerry Sanders addressed the sobering news in a press release:

As we begin putting together a solution to close our budget gap, we will examine every responsible alternative to cutting services. But make no mistake about it, there will be cuts and the public will feel them.

As the San Diego Union-Tribune reported:

The city has generally closed recent budget gaps by eliminating vacant jobs, increasing fees and tapping reserves. Those decisions largely avoided controversial cuts such as laying off employees and closing libraries. That will no longer be possible, Sanders said.

A deficit this size is so significant that we can no longer shield the public from its impacts,” he said.

The city's budget deficits have been exacerbated by the economic recession but began when past leaders chose to increase employee pension benefits without identifying a way to pay for them.

While governments at all levels are experiencing falling revenues due to the recession, San Diego's outlook is particularly dire because of egregious missteps the city made regarding its pension system. San Diego's pension problems stem from pension deals reached in 1996 and again in 2002 which led to the city underfunding the system by increasing pension benefits without setting aside enough money to cover the additional costs. The city is still paying for its mistakes today. In addition to an extra $57 million that the city will have to pay from its general fund to cover pension investment losses—an increase in the city's pension contributions of approximately 34%—San Diego must pay $32 million as part of the McGuigan legal settlement to remedy its past pension underfunding.

If this picture is not bleak enough, consider that San Diego's fiscal situation is actually even worse than the 5-year projections because, as Councilman Carl DeMaio notes, the city did not include the costs of its retiree health-care benefits or deferred maintenance, such as street, sidewalk, and storm drain repairs that must be made, in its budget forecasts. The city is planning to pay $43 million next year for retiree health care—barely one-third of the estimated $120 million needed to adequately pay for the benefits. The city is already running a $1.3 billion unfunded liability for retiree health care.

In a speech given to the San Diego County Taxpayers Association last month, Sanders said, "We will make our full pension payment, to the penny. The Mayor and City Council do not determine the amount of the payment, nor should we. Nor should we repeat the mistakes of our predecessors and shortchange the retirement system so we can avoid making tough decisions." Yet, when it comes to San Diego's retiree health-care obligations, it appears that the city is set to repeat the same mistakes that got it into so much trouble with the pension system.

San Diego has implemented some pension reforms in recent years, but they were likely "too little, too late." In 2006, voters approved a measure to require voter approval of future city employee benefits increases. And beginning July 1, 2009, the city implemented a lower tier of benefits to new city employees. The new retirement plan is a hybrid plan that includes a 401(k)-style "defined-contribution" component to shift some of the risk of retirement investments from the city to the employees.

Nonetheless, lawsuits to undo the arguably illegal pension deals of 1996 and 2002 have proven unsuccessful, and the considerable debts that have already been racked up must be paid. The results will be severe negative impacts on city services, and only bold and significant reforms may prevent these service cuts from lingering for many years or keep the city from going bankrupt.

The city should switch to a pure defined-contribution retirement system for all new employees, with compensation levels comparable to those received in the private sector. Savings from this pension reform would be long-term, however, and the city needs some more immediate relief.

To that end, there are many government services that could be performed more cheaply and effectively by the private sector. Forcing the government to compete with the private sector to provide services could result in significant cost savings while maintaining or improving service quality. A 2007 study done by Reason Foundation and the San Diego Institute for Policy Research conservatively estimates that the city could save between $80 million and $200 million a year by implementing managed competition for services such as:

Water and wastewater treatment,
Trash and recycling collection,
Vehicle fleet maintenance,
Street maintenance,
Parks and recreation (including city-owned golf courses),
Library operations,
Permitting,
Facilities maintenance,
Information technology, and
Printing and copying.

Voters saw the wisdom in this "managed competition" approach, and overwhelmingly passed a measure in November 2006 to amend the city charter to allow the city to implement it. But city labor unions have tied up the process, and nearly three years after the voters passed Proposition C, the city is still without a managed competition program.

If labor unions continue to hold the city hostage, they will drive San Diego to the same fate as the City of Vallejo, California—into bankruptcy.

Other resources:

» Reason pension reform study: The Gathering Pension Storm: How Government Pension Plans Are Breaking the Bank and Strategies for Reform (see pages 33-40 for a case study on the City of San Diego)

» Reason-SDI study on managed competition in San Diego: Streamlining San Diego: Achieving Taxpayer Savings and Government Reforms Through Managed Competition

» Reason's privatization research and commentary

Adam Summers is a policy analyst at Reason Foundation.

The Gathering Pension Storm: Now It Is Raining

adam.summers@reason.org (Adam Summers) — Mon, 19 Oct 2009 00:00:00 EDT

Louisiana has $12 billion in unfunded pension liability.

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Don't Blame Voters for California's Budget Woes

Fri, 09 Oct 2009 15:50:00 EDT

The Wall Street Journal

With the Golden State still struggling to balance its books, politicians from both sides of the aisle have come up with a nifty way to avoid responsibility for the mess: Blame the voters.

Gov. Arnold Schwarzenegger, a Republican, summed it up for his fellow pols recently by telling a reporter: "All of those propositions tell us how we must spend our money. . . . This is no way, of course, to run a state." State Senate President Pro Tem Darrell Steinberg, a Democrat, has made similar comments in denouncing "ballot-box budgeting."

Their indictment is false. Voters aren't tying lawmakers' hands too much, but too little. Here's the background:

For decades, state officials have habitually proposed deep cuts to the most popular programs unless voters agree to higher taxes. Tired of being manipulated, voters have used the ballot initiative to put some programs off-limits.

Nevertheless, a 2003 analysis by John G. Matsusaka, president of the Initiatives and Referendum Institute at the University of Southern California, found that no more than a third of California's appropriations that year were locked in by voter initiatives so stringent that legislators couldn't override them. Most of the appropriations—about $30 billion in 2003—were for Proposition 98, which passed in 1988 and mandates funding for K-12 education.

Even this overstates the case against ballot-box budgeting. K-12 spending has remained remarkably stable at around 40% of the budget pre- and post-Prop. 98. Today, California is 24th among the 50 states in terms of the percentage of its general funds it devotes to K-12. This suggests that education spending is not grossly out of line. Prop. 98 aside, Mr. Matsusaka found that only about 2% or 3% of California's budget is frozen as a result of ballot initiatives.

Mr. Matsusaka's analysis was affirmed last month by the Legislative Analyst's Office, a nonpartisan outfit that advises the legislature. It looked at all the restrictions on the state's budget—not just those imposed by ballot initiatives—and concluded that: "Despite these restrictions, the legislature maintains considerable control over the state budget—particularly over the longer term."

So what happened this year that got the politicians and others so upset with ballot-box budgeting? California faced a $42 billion budget deficit. After a round of spending cuts and $12 billion in new taxes, the governor and the legislature called for a special election and placed a number of propositions on the ballot that would have increased taxes an additional $16 billion and allowed for billions more in borrowing and fund shifts. Voters shot those measures down in May.

After much bickering, lawmakers nearly closed the deficit with severe cuts, but left the governor with a $1 billion deficit to close on his own. He did so by using his line-item veto to strike, among other things, $500 million for in-home care, transportation assistance and other social services.

Now the governor is being sued by a whole host of special-interest groups, including a coalition of organizations representing the disabled. Those organizations (along with Mr. Steinberg, who has filed a separate suit), claim that the governor cannot constitutionally cut spending beyond what the legislature has already cut. The suits ignore that the governor is bound by a constitutional requirement that the state's budget be balanced—but in any case have nothing to do with spending that is mandated by ballot initiatives.

In looking for the causes of the state's budget mess, a good place to start is with the unionized public employees, who have filed their own lawsuit against the budget. Public union ranks have grown a whopping 37% since 1990 and consume about one-third of the $85 billion budget in wages and benefits. California also faces a total unfunded future liability of about $110 billion for pensions and health-care benefits. Still, the state's chapter of the Service Employees International Union and other unions are suing the state because their members are being asked to take a few days of furlough to save the state about $1.5 billion. The unions say this is an illegal pay cut. Regardless of whether it is, ballot initiatives are not the issue.

True enough, some lawsuits are driven by ballot initiatives. The California Redevelopment Association is attempting to stop the state from raiding $2 billion in local redevelopment funds. Sixty years ago voters passed a constitutional amendment to prevent such raids, but the state government has found ways around that prohibition. But restoring the will of the voters in this case is essential for sound budgeting, because local development funds are used to pay for bonded contracts for roads and other infrastructure projects. If the state is allowed to grab these funds, the credit ratings of cities and counties will plunge and their borrowing costs will rise.

Whatever the wisdom of ballot initiatives that protect some programs from cuts, they are not the root cause of California's fiscal disaster. That cause is the government's spending addiction. From 1990 to 2008, California's revenues increased 167%, but total spending soared 181%.

This problem won't be tamed by letting lawmakers get their hands on more tax dollars by scrapping Proposition 13, which limits property taxes, as Mr. Steinberg and other lawmakers have suggested. Rather the solution is to restore the Gann Spending Limit that restricted state spending increases to population growth and inflation and required that anything left over be returned to taxpayers.

Such restrictions kept the state from slipping into a cycle of fiscal chaos in the 1980s by checking government expenditures and forced lawmakers to rebate $1.1 billion in excess revenue in 1987. But voters diluted Gann in 1990, when they passed Proposition 111, exempting infrastructure projects, disaster spending and a number of other state expenditures from the spending limit.

Prop. 111 freed politicians in Sacramento to use the revenues that gushed in during the dot-com boom and housing bubble to grow the state budget to unsustainable levels. If Gann hadn't been neutered, a Reason Foundation study found in February, California would have been rolling in a $15 billion surplus this year.

The Golden State's problem is not overly controlling voters—but out-of-control politicians.

Ms. Dalmia is a senior analyst, Mr. Summers a policy analyst, and Mr. Moore a vice president at the Reason Foundation.

Public Pension Problems Mount for Local CA Governments

adam.summers@reason.org (Adam Summers) — Tue, 22 Sep 2009 10:00:00 EDT

California’s public pension system is broken. A decade of fiscally irresponsible behavior by state and local policymakers has left the state with a massive unfunded public pension liability. Unless government officials muster up the political courage to implement reforms that would make government pensions and retiree health-care benefits sustainable, the cost of government services will continue to be inflated and growing pension costs could threaten the very solvency of state and local governments.

Under the state’s “defined-benefit” pension system, workers receive a pension determined by a formula based on the number of years the employee works, a fixed multiplier, and his or her final (or highest) salary. The amount needed to pay the costs of these benefits is determined using assumptions about what the average pension fund investment return will be, how long retirees will live, how much salaries and inflation will increase, etc. These assumptions are projected out decades into the future, which creates a whole other set of problems and allows for fudging of the assumptions to determine how much must be contributed to the system. The benefits are paid for by a combination of employee contributions, employer (in this case, the government) contributions, and pension fund investment earnings.

Currently, the state owes an estimated $63 billion in unfunded pension benefits to government employees. Governor Schwarzenegger’s administration estimates that this figure could rise to as much as $300 billion if state pension funds continue to perform below their anticipated returns. Unfunded retiree health-care and dental benefits are estimated at an additional $118 billion.

The trouble has not been confined to the state level. Many local governments are being hit hard by the latest downturn in the economy—and, as a result, their pension fund investments are seeing lower returns than anticipated. When those investments return less than the rate assumed by the pension board, government employers have to contribute more to the pension fund to make up the difference. Underperforming returns may be smoothed out over a period of years, but the losses experienced over the past two years are so deep that governments across the state will need to significantly increase their contributions to pension funds at a time when their budgets are already strained.

According to a recent Press-Enterprise article, the Riverside and San Bernardino County pension funds each lost about $1.5 billion—roughly a quarter of their value—in the last fiscal year. Riverside County will have to pay an estimated $119 million a year more than its current $144 million pension contribution—about an 83% increase—starting in fiscal year 2013. Similarly, San Bernardino County will have to contribute an additional $100 million to its pension system.

The situation at the local government level is a microcosm of what is going on across the state. The state’s main pension system, the California Public Employees’ Retirement System (CalPERS) (which also administers the retirement systems of numerous local governments) lost $56.2 billion, or approximately 24% of its total holdings, last year. The California Teachers Retirement System (CalSTRS) lost $43.4 billion, about 25% of its portfolio.

Much of the pension trouble can be traced back to the late 1990s and early 2000s, when state and local governments decided to significantly increase pension benefits while contributing little to nothing to pension systems. Pension fund investments were experiencing unusually high returns due to the “dot-com” bubble. Assuming pension funds could depend on extravagant earnings indefinitely, CalPERS and labor union officials convinced lawmakers that the state could afford benefit increases. In 1999 the legislature passed SB 400, which increased state workers’ pensions by as much as 50% and made the benefit increases retroactive. This action quickly proved to be short-sighted when the dot-com bubble burst and pension investment returns plummeted.

CalPERS had encouraged local governments that participate in its plan to match the state’s benefit increases by offering to reduce their required contributions to the system in exchange for their adoption of the higher benefit levels. Thus, many local governments matched state benefit increases in the early 2000s. For example, Riverside County increased public-safety officials’ pension benefits by as much as 50%, allowing employees with 30 years of experience to retire as young as 50 years old with 90% of their working salaries.

“This situation was caused by the actions taken by the state 10 years ago and it rippled out to local governments,” said Riverside County Supervisor Marion Ashley. “We’ve created an ongoing gilt-edged system that is far beyond our wage earners in this county to support,” added fellow Supervisor Bob Buster. For an example of those “gilt-edged” pensions, consider that, according to the California Foundation for Fiscal Responsibility, there are 5,115 retired state and local government employees currently earning annual pensions of over $100,000. There are an additional 3,090 retired educators earning pensions that big.

Even governments that resisted large benefit increases have found themselves in trouble. Ventura County did not increase its benefit levels, yet its required pension contributions have more than tripled over a 10-year period. The county’s contributions, currently about $140 million, are expected to double again over the next five years.

This prompted a Ventura County Grand Jury report entitled, “Ventura County Pension: An Uncontrollable Cost,” which was released in June. The Grand Jury report included some recommendations that government officials in Ventura County and around the state should take to heart. They include:

Locking away “excess earnings” realized during good investment years to balance out the bad years, instead of using them to pay greater benefits;
Requiring voter approval of future government employee benefit increases, as San Francisco and, more recently, Orange County and the City of San Diego, do, and;
Studying private-sector compensation and a switch from the current defined-benefit system to a more affordable and predictable 401(k)-style, defined-contribution retirement system, which the private sector has been doing for the last 30 years.

Unfortunately, the Grand Jury’s main recommendations have so far largely been rejected or ignored by the county. There are some signs of support, however. “When you get into defined benefit pensions, you are putting huge debt burdens on the public,” said Ventura County Supervisor Peter Foy. “We’ve seen these pensions get so far out of control and out of the realm of our ability to pay for them—the market just exaggerated the problem—what I look at is at that point we need to have the public who’s going to be paying these costs with tax increases—they should have the right to vote on any increases.” Foy also supports a lower benefit tier for new employees, and is also open to a defined-contribution plan.

At the city level, Ventura Mayor Christy Weir even went so far as to write in a recent column for the Ventura County Reporter, “[T]he statewide pension system for state, county, school district and local governments is not financially sustainable. I believe Ventura can be a leader in pension reform. That likely means moving from ‘defined benefit’ plans (which guarantee a certain retirement income and are increasingly costly to taxpayers) to ‘defined contribution’ plans (which are more fiscally feasible) for new employees.”

During the late 1990s and early 2000s, when government coffers were flush with tax revenues, it was easy to approve benefit increases that would not have to be paid for until many years later. Now that the bills are coming due, state and local officials, as well as taxpayers, are increasingly realizing that the more we spend to ensure the comfortable retirement of government employees, the less we have to spend on the programs and services citizens expect from their governments. We are finally reaching a day of fiscal reckoning. It will take some political courage to admit that current government pension and retiree health-care benefits are unsustainable--and even more to implement the significant reforms needed to restore fiscal responsibility—but this fortitude is necessary to get California state and local governments back on the right path.

Adam Summers is a policy analyst at Reason Foundation.

California Parks Need User Fees

adam.summers@reason.org (Adam Summers) — Tue, 01 Sep 2009 11:43:00 EDT

Has the budget crisis in California reached the point where state officials “have” to close state parks? Officials warn that budget cuts to the tune of $14.2 million could lead to the closure of approximately 100 of California’s state parks for up to two years. The final decision about which parks are to be closed is expected shortly after Labor Day.

Closing these parks isn’t necessary. Increasing park user fees to reflect the actual operating costs, as well as the rising demand, could allow the state parks to remain open.

California has recently imposed some minor park fee increases, yet they are still well below the amount needed—in the absence of additional reforms—to make the parks self-sustaining. Only 13 of the 279 parks and beaches in the California State Park System are financially self-sustaining.

In recent years, at all levels of government, user fees have provided an attractive alternative to general appropriations funding. User fees provide a fairer funding source since they ensure that those who actually use government services are primarily responsible for paying for those services, reducing tax dollars and giving people more choices.

User fees also offer practical benefits such as increased park management flexibility—allowing park managers to adjust to economic conditions or changes in park visitors’ recreational preferences—and greater financial accountability. States such as Vermont, New Hampshire and Texas have realized significant park services cost savings through user fees.

Opening up park management and maintenance services to a competitive bidding process, and turning these operations over to private-sector or non-profit groups, could further reduce costs and help to make the parks self-sufficient while addressing maintenance backlogs.

Some have voiced concerns that increasing fees might unfairly price the poor out of the state parks experience altogether. Beginning August 17, state parks across the state increased day-use and camping fees in order to partially address funding holes left by budget cuts. Those fee increases are expected to raise an additional $200,000 in revenue this year, and a total of $5 million over three years. But, according to a California State Parks press release, “It should be noted that these increases do not raise park revenues to the level of self-sufficiency for the system. Doing that would require steep increases that would price people out of their public park system.”

But how do officials know that self-sustaining park fees would price people out of the park system? It is not as though the state has ever tried to find market prices for park services. In fact, prior to the recent fee hikes, it hadn’t increased fees since 2004. Some parks do not charge day-use fees at all.

Numerous news reports indicate that demand for state parks remains high despite the recent fee increases. The state park system “is currently packed with the highest visitation rates ever recorded,” according to state parks director Ruth Coleman, “because with the economy in the tank, people can’t afford to go anyplace else.”

“Reservations are through the ceiling,” added Jerry Emory, a spokesman for the California State Parks Foundation. “It’s a very viable economic alternative for friends and families to get out and enjoy some quality time.”

If user fees go up, some will say that the state is pricing out the poor. But there are ways to accommodate all income groups. The demand for park services is not constant year-round, or even throughout the week. Parks that use market pricing would have an incentive to reduce fees during times of low demand and increase fees during times of high demand. Thus, anyone who wanted to save money on recreation fees could do so by visiting parks during off-peak days or seasons.

If that’s not enough, the state could set aside an allotment of passes each day to distribute on a first-come, first-served basis. This method would allow anyone willing to get in line early for tickets to pay with their time instead of their dollars.

California doesn’t “have” to close its parks. By increasing user fees to make state parks self-sustaining and contracting with private-sector or non-profit groups to manage and maintain the parks, California can prevent the threatened park closures. Leveraging volunteer assistance and seeking out tasteful corporate sponsorships to generate additional revenues should also be part of the solution.

As the experiences of other state park systems show, the benefits of recreational user fees and park self-sufficiency are not merely theoretical. A market-based approach to the parks would ensure the future of the park system and offer greater preservation of the state’s natural wonders.

Adam Summers is a policy analyst at Reason Foundation.

California Budget Deal Is a Bad Band-Aid

adam.summers@reason.org (Adam Summers) — Wed, 29 Jul 2009 16:38:00 EDT

California’s budget plan, now signed by Gov. Arnold Schwarzenegger, may help address the state’s fiscal crisis in the very near-term, but what is not included in it is just as important as what is. After voters soundly rejected several measures that were part of the previous budget deal, the governor and some policymakers seemed to get the message that Californians are already taxed to the hilt and are unwilling to accept tax increases or borrowing schemes. Thus, the good news: the new budget package contains no new tax or fee increases.

The budget plan claims to rely upon a reported $15.5 billion in cuts to plug the $26.3 billion deficit. Regrettably, the rest is made up through accounting gimmicks, borrowing schemes, and raids of local government funds. One of the gimmicks: Delaying a payday for state workers by one day, from the last day of the current fiscal year to the first day of the next fiscal year. That may put off the bill, but it does nothing to reduce costs. What happens next year when the economy is still struggling and the state now has to account for that extra $1.2 billion payment?

It seems that legislators and the governor are hoping that the economy will suddenly snap back and that economic growth will bring in enough revenues to bail them out of the current budget crisis. But that hope is just that: wishful thinking, especially given California’s burdensome tax and regulatory climate. Experts, including those in the state government, expect the recession to drag on for some time. The state’s unemployment rate remained at 11.6 percent in June, which is even higher than the 11.0 percent rate achieved during the peak of the 1982-83 recession. According to the Department of Finance (DOF), things are not expected to get much better real soon. DOF forecasts call for double-digit unemployment through at least 2011. So assuming the state’s economy does not rebound quickly, and corporate, income, and sales tax revenues remain depressed, the state will continue to operate in budget crisis mode until it recognizes that stop-gap measures alone cannot fix its fiscal problems and embarks on some true structural reforms.

Over the past 11 years (FY 1997-98 to FY 2008-09), General Fund spending increased nearly 80 percent. If the state had just held spending increases during that period to the average annual growth rate of inflation plus population, it would not have any budget deficit at all. In fact, there would be a small surplus of a couple of billion dollars. Moreover, there would have been no need for the $12 billion in tax increases imposed by the February budget deal.

Since legislators and the governor have shown that they are incapable of restraining spending on their own, it is imperative that the state adopt a real spending and revenue limit. One might not know it, given the state’s recent budgetary dilemmas, but California actually does have a spending limit in place. The state appropriations limit, also known as the Gann limit, was approved by voters in 1979, just a year after Proposition 13 was passed. The limit was adjusted for population and cost-of-living factors, and any state revenues that exceeded the limit over a two-year period were to be returned to taxpayers. It worked well at first, but was gutted over the years as the calculation of the limit was altered and numerous exemptions were carved out. As a result, it has become irrelevant. It is time to restore a true spending and revenue limit to prevent the kinds of budgetary imbalances that the state has experienced in recent years from happening yet again in the future.

One major element of controlling spending will be controlling how much state employees are paid in wages and benefits. California’s pension costs ballooned when a measure passed in 1999 increased state workers’ pensions by as much as 50 percent. The state will be paying for those increases for decades to come. Government workers not only receive significantly greater benefits than their private-sector counterparts, but higher salaries as well. As part of a real, long-term budget solution, the state should abandon the unsustainable defined-benefit retirement system and adopt a 401(k)-style defined contribution system with compensation rates comparable to those in the private sector. Taxpayers should not have to pay for more and more generous pensions for government workers while they are seeing their own retirement benefits cut during difficult economic times.

Finally, in addition to controlling the state’s spending, California must change the entire budget process to make it more rational and effective. The existing line-item budgeting process is purely arbitrary, leading to even more chaos. Government programs should all be evaluated based on outcome measures so their performance can be determined objectively. Performance-based budgeting and prioritization should be built into the budget process so that ineffective and low-priority programs can quickly be identified and named as the first to go during a fiscal crunch.

California’s latest budget package is a Band-Aid on a wound that needs some serious medical attention. The state will continue to bounce from one budget crisis to the next until policymakers get serious about addressing unsustainable state spending and implementing the long-term, structural reforms needed.

Adam Summers is a policy analyst at Reason Foundation.

Recap of California Voters' Rejection of Special Election Measures

adam.summers@reason.org (Adam Summers) — Mon, 20 Jul 2009 13:40:00 EDT

Budget & Tax News

With the state government in deep financial straits, California voters resoundingly rejected, by nearly a 2-1 margin, the main propositions Gov. Arnold Schwarzenegger and the state legislature had billed as "budget reform measures" in the state's May 19 special election.

The rejected measures all attempted to raise more tax money, borrow, or move funds from other programs into the general fund.

The special election resulted from a February budget deal that attempted to plug an estimated $42 billion budget deficit over 18 months.

In a sign of Californians' frustration and anger toward their elected officials, the only measure to pass was Proposition 1F, which prohibits the governor, members of the legislature, and other statewide constitutional officers from receiving pay raises in years when the state is projected to run a budget deficit. It passed by a 3-1 margin, 74 percent to 26 percent.

"I think this was a stunning victory for California taxpayers and ordinary citizens," said Jon Coupal, president of the Howard Jarvis Taxpayers Association, based in Sacramento. "They spent $35 million and we spent $650,000 and trounced them pretty bad. It sent a message that Californians are taxed enough and that our legislature needs to do its job in prioritizing spending."

Played Both Sides

Proposition 1A was probably the most significant and controversial of the ballot measures. In an attempt to appease both sides of the political aisle-particularly the politically powerful public employees' unions on the left and tax fighter groups on the right-the measure would have extended the tax increases imposed in the February budget deal for up to two years, enhanced the state's rainy-day fund, and enacted a new spending limit.

In the end, the measure's provisions upset both sides. The unions feared the impact of a spending limit, and fiscal conservatives balked at the estimated $16 billion of additional tax increases. The measure failed by a vote of 66 percent to 35 percent.

Proposition 1B would have guaranteed the state would spend an additional $9.3 billion on education to "make up" for the money it was not spending because of the current fiscal crunch. Proposition 1B would have gone into effect only if Proposition 1A also had passed, in an obvious attempt to buy the support of the teachers' unions for Proposition 1A or at least keep them from campaigning against it. The proposal ultimately failed anyway, and the measure went down by a 63-37 vote.

Lottery Borrowing Rejected

Proposition 1C would have allowed the state to borrow against the future revenues of the California State Lottery. According to the February budget deal, the state was relying on the passage of 1C for $5 billion in such funds, although the measure did not place any limit on the amount that could be borrowed, so the state could have borrowed even more from the lottery in the future.

Voters apparently thought it was too much of a gamble for a state already drowning in debt, and the measure failed by a 64-36 vote.

Funds Diversion Defeated

Propositions 1D and 1E both sought to take money from dedicated funds established previously by voter initiatives and transfer them to the General Fund to help address the budget shortfall.

Proposition 1D would have redirected up to $608 million in funding currently dedicated to children's health and human services programs in FY 2009-10, and $268 million a year from FY 2010-11 through 2013-14. Proposition 1E would have redirected approximately $230 million a year for two years from funds currently dedicated to mental health programs.

As with Proposition 1C, the February budget deal assumed these measures would be approved by voters. Instead, voters rejected the measures by votes of 66-34 and 67-33, respectively.

California now faces a projected budget shortfall of $24 billion. Schwarzenegger supported the plan even though he entered office speaking with much fanfare of "blowing up the boxes of government" and "cutting up the credit cards." Schwarzenegger was elected to office during the recall election of former Gov. Gray Davis, who was ousted chiefly for his fiscal mismanagement.

Governor Vowed No More Trouble

In 2004, while campaigning for Proposition 58, which established a state rainy-day fund, Schwarzenegger argued, "By voting yes on Proposition 58, you are basically taking the credit cards, cutting them up, and throwing them away so that the politicians over there [at the Capitol], those big spenders, will never, ever, get the state into this kind of trouble again." The proposition passed by a big margin, gaining nearly 72 percent of the vote.

During the same election, the governor lobbied voters to approve $15 billion in "Economic Recovery Bonds" (Proposition 57) offered as a one-time fix to get California out of a budget hole so the state's fiscal woes could be solved once and for all, with promises the state could start anew. Five years later, the state is in an even bigger fiscal mess.

State budget analysts and policy researchers have pointed out that if California had simply held spending to the rate of growth in population plus the cost of living since former Gov. Pete Wilson first came to office in fiscal year 1990-91, the state would have been sitting on a $15 billion surplus instead of the $42 billion deficit it faced earlier this year.

Coupal cited this as one reason millions of Californians believe the state's lawmakers "are incapable of being fiscally responsible. The margin of defeat [of the Propositions] is as important as the victory for taxpayers. The governor, the unions, and most major corporations supported the propositions, yet the people rejected them. This sent a huge message."

Adam B. Summers is policy analyst at Reason Foundation. This column originally appeared in Budget & Tax News.

California Must Control State Pension and Benefit Costs

adam.summers@reason.org (Adam Summers) — Mon, 22 Jun 2009 15:12:00 EDT

California has been struggling with multi-billion-dollar deficits (and even deficits in the tens of billions of dollars) for many years. It is now facing a $24.3 billion deficit and another possible downgrade of its already worst-in-the-nation credit rating. With State Controller John Chiang recently estimating that California was "less than 50 days away from a meltdown of state government" and the White House putting the kibosh on a federal bailout, the state's fiscal picture is looking as bleak as ever.

But perhaps California can turn calamity into opportunity. Perhaps now, on the brink of financial collapse, state leaders can finally amass the will to make the necessary dramatic changes to the inordinate amount of money that it spends on its employees.

The urgency in plugging the significant budget shortfall should lead to a number of short-term spending cuts (see Reason's California Citizens' Budget study and the report of the California Performance Review Commission for an extensive list of recommendations), but California will not be able to maintain any semblance of fiscal responsibility and prevent another crisis next year or in the years that follow without addressing its biggest long-term costs: government employee compensation.

Perhaps a generation or two ago it could be argued that government employees required greater benefits than their private-sector counterparts because governments could not match salaries in the private sector. That clearly is not the case today. Now government workers typically earn not only significantly higher benefits than those in the private sector, they also receive higher wages. According to the most recent U.S. Bureau of Labor Statistics "Employer Costs for Employee Compensation" report, average state and local government employee compensation is approximately 44 percent higher than private-sector employee compensation ($39.51 an hour versus $27.46 an hour). This includes average wages that are nearly 34 percent higher and benefits that are almost 69 percent higher.

Even as the economy contracts, the trend has continued to be for higher and higher benefit levels for government employees. Thus, private sector workers are forced to pay more and more to compensate public sector workers, even as their own benefits are being cut. Moreover, as the Sacramento Bee reported in January, the state continued to advertise for thousands of job openings in spite of a budget deficit pegged at over $40 billion. Something is seriously wrong with this picture.

While pension benefits cannot be cut for current state workers, California can bring some fiscal sanity to its retirement systems by closing its existing defined-benefit plans to new workers and adopting a 401(k)-style defined-contribution system for them instead. Switching to a defined-contribution system would not necessarily cure all of the state's pension ills, however. Depending upon the size of the government's contribution rate, benefits could be the same, higher, or lower than they are now. Thus, the state should establish a contribution rate commensurate with those typically found in the private sector.

California could also help to control state workers' compensation by adopting a voter approval requirement for future government employee benefit increases. This has been done at the local level in San Francisco. Despite its liberal reputation, San Francisco has utilized such a provision successfully for more than a century. As a result, its pension system has fared much better more conservative areas like San Diego and Orange County - prompting those two jurisdictions to pass their own voter approval measures in 2006 and 2008, respectively. Since legislators have not been able to resist the unions' charms and restrain state employee compensation costs, it makes sense that the taxpayers act as a final check on decisions that will be significantly impacting their pocketbooks.

Finally, the state must put an end to its overly generous retiree health benefits. Chiang announced earlier this year that California is facing an unfunded liability of over $48 billion for state retiree health and dental benefits offered through the California Public Employees' Retirement System (CalPERS). Currently, the state pays 100 percent of the health care costs for retired state workers, and 90 percent of costs for spouses and dependents. It is only fair that the state start requiring retirees to pay a reasonable portion of these costs.

A government job does not need to offer a king's ransom in salary and benefits to lure workers. Sure, most government employees work hard, but so do the people in the private sector. It is those private sector workers who are ultimately footing the bill for those high salaries and lavish benefits at state jobs. California's taxpayers shouldn't have to make state employees richer and richer as they themselves are getting poorer and poorer.

Adam Summers is a policy analyst at Reason Foundation. His recent policy examining California's spending and budget problems is here.

Is America Following the Policies that Caused Japan's "Lost Decade"?

Wed, 10 Jun 2009 00:00:00 EDT

The scenario was eerily familiar. A long real estate bubble that had expanded extra rapidly for the previous five years suddenly burst, and asset prices came crashing back down to earth. Banks and financial institutions were left holding piles of worthless paper, and the economy soon headed south. The national government responded to the crisis by encouraging more lending and spending previously unfathomable amounts of money on public works projects in an effort to stimulate consumer spending and restart growth.

But that stimulus did not save the Japanese economy in the 1990s; far from it. The ensuing period came to be known as the Lost Decade, characterized by multiple recessions, an annual average growth rate of less than 1 percent, and a two-decade decline in stock prices and corporate profits.

The Japanese government’s easing of credit rates, instead of spurring real demand, created artificial demand. Federal loans and stimulus spending were not economically productive, and they vastly increased the nation’s debt and prolonged the economic malaise. Worse, businesses spent critical time on the sidelines, waiting for government bailouts and other centralized actions, instead of speedily consolidating their losses, clearing their balance sheets of bad investments, and reorganizing.

The United States in 2008–09, unfortunately, has started down the same path. Federal intervention and the expectation of additional government action are removing firms’ incentive to clean up their balance sheets by selling “toxic” assets. Why accept pennies on the dollar if a deep-pocketed new bidder (i.e., the state) looms large on the scene? The Japanese experience shows that when the government is an active participant in the market, many firms would rather accept state support than initiate the inevitable financial reckoning. Such a status quo does not provide a sustainable foundation for the economy. Instead, it restricts economic growth and creates a cycle of stagnation.

How Bubbles Form—and Burst

The Japanese asset bubble grew out of a long postwar economic boom that accelerated in the latter half of the 1980s, spurred in part by the central bank’s loosening of monetary policy. With access to easy credit, businesses sped up the country’s transformation into an economy based on technology, most prominently in the consumer electronics, telecommunications, and finance sectors.

The ensuing demand for new and better technology products, combined with increased living standards, fed an asset investment craze referred to as the Heisei boom, after the emperor who took the Japanese throne in 1989. The value of the yen increased during this time, due primarily to the 1985 Plaza Accord, an agreement reached at an international conference in New York that depreciated the dollar against the yen, and Tokyo became a major financial services center. The Japanese Stock Market grew enormously, with the Nikkei 225 (an index similar to the Dow Jones Industrial Average) more than tripling between 1985 and the end of 1989.

Times looked so good that U.S. bestseller lists were sprinkled with anxious tracts about Japan eclipsing the country that had defeated it militarily less than half a century before. But a more real threat was hiding in plain sight: Japanese asset prices, after rising precipitously, were about to come crashing down to earth.

The late-’80s Japanese bubble and the mid-’00s American bubble had similar causes that are worth pondering:

Overaggressive financial institutions and poor risk management that ignored traditional economic fundamentals. In both Japan and the U.S., excessively optimistic expectations led to bad investment decisions from Wall Street to Main Street and a pervasive culture of denial that there was any bubble at all.

Japanese asset inflation was fueled by a 51 percent average growth rate in housing prices and an 80 percent increase in average commercial property values between 1985 and 1991. This spike created an overconfident climate in which investors failed to adequately prepare for a correction. Since that peak, asset values in Japan have fallen by more than 40 percent as of 2008.

Japan was flush with capital in the 1980s, in part due to an export boom that started the decade before. The country was becoming an increasingly important player in the world financial system, and international investors came looking for a stake. In the preceding years, Japanese individuals and firms had built up a large pool of savings and begun investing those resources in real property. This rapid rate of investment pushed the value of land, buildings, and other capital investments higher, encouraging even more investment, and in turn speculation, based on the belief that values and returns would keep rising.

Riding this asset appreciation, Japanese banks borrowed nearly ¥200 trillion ($3.4 trillion in today’s dollars) from foreign markets. This sum sloshed throughout the Japanese economy. The lending was further fueled by tiny debt-to-equity requirements, a relatively recent development that encouraged financial institutions to heavily leverage their bets. By 1991 Japanese banks held reserves of only ¥3 trillion to cover the ¥450 trillion they had lent. Normally, such a lopsided portfolio would have triggered widespread concern. But the economic climate in Japan back then was often described as “euphoric.” Prudence was not in vogue.

The American housing bubble was bigger, although values have yet to fall as much as those of Japanese real estate. Between 2000 and 2006, average home prices in the U.S. grew by 90 percent, and commercial property values rose at the same rate. Since the peak in July 2006, home prices nationwide have declined more than 30 percent, and certain regions have experienced even sharper drops. Prices were still falling as of press time.

After the twin shocks of the dot-com bubble bursting and the September 11 attacks, the Federal Reserve repeatedly slashed interest rates. And like Japan in the 1980s, the U.S. was seen as an attractive destination for international investment. With more investors using more money to chase high returns, Wall Street began aggressively “securitizing” home mortgages by bundling and reselling bits of loans and doing likewise with the insurance contracts underwriting them. New subprime mortgages became increasingly available to home buyers with spotty credit histories. Because of the risk, subprime loans brought a higher rate of return. But since they were bundled with safer loans, the entire packages received ratings from credit agencies that were higher than warranted.

Investment patterns suggest that most Americans thought rising stock values and AAA ratings on securitized mortgages were safe financial bets. This overconfidence led most major Wall Street firms to decrease their capital ratios, taking on more debt and decreasing the amount of cash on their balance sheets. By 2007 the investment bank Lehman Brothers was leveraged 30 to 1, meaning just a 3.3 percent decline in asset values would wipe out its capital—which is in fact what happened.

Stock market bubbles. In both the U.S. and Japan, the rapid rise in property values fueled gains in the stock markets. The Japanese stock index Nikkei 225 rose from 13,000 in 1986 to an intraday high of 38,975 by the end of 1989. But the implosion of the property market sent the index crashing. It had dropped to 15,025 by July 1992, and it continued a steady decline throughout the Lost Decade. By April 2003, the Nikkei had fallen to 7,603, less than 20 percent of its peak.

Similarly, the Dow Jones Industrial Average went from 7,489 in July 2002 to an intraday high of 14,115 in October 2007. After that high point, the market began a modest decline, reaching 10,850 on September 30, 2008, then plummeting to 7,552 by November 20. The Dow continued to fall over the ensuing months and closed at 6,547 on March 9. (It has since rallied to just over 8,000.) In the U.S. as in Japan, the quick run-up in stock valuations lured people to invest money they did not have. The result was inadequate risk management, over-leveraged investments, and fragile capital reserves. Investors did not adequately plan for any contingency other than continued high growth and largely ignored those who warned that such growth was not sustainable.

Monetary policy errors. Although private financial institutions played a key role in the booms and busts of both Japan and the U.S., monetary policy was a critical root cause. In both cases, the central bank helped set off a boom in asset prices by expanding credit and driving interest rates to artificially low levels. This encouraged individuals and businesses to take on debt they otherwise would not have accepted and make investments they otherwise would not have considered.

When a central bank inflates the money supply and drives interest rates below those that would exist in a free marketplace, it sends a false signal to businesses to borrow and invest more in capital projects and goods than they otherwise might. Similarly, consumers respond to the signal by taking on higher mortgage and/or credit card debt, saving less, and spending more. Credit binges cannot last forever; when interest rates increase again, the bad investments are revealed, and it becomes painfully clear that much of the outstanding credit cannot be paid back.

Between January 1986 and February 1987, the Bank of Japan cut its discount rate—the interest rate charged by the central bank on loans to its member banks—from 5 percent to 2.5 percent, leading to an increase in real estate and stock market prices. Realizing a bubble was forming, the central bank then raised rates five times in 1989 and 1990, to a high of 6 percent. This increase revealed that many investments were built on extensive, unsustainable debt. Stocks began their long and painful slide.

When a recession began to set in after the 1990 stock market crash, Japan responded by reversing its tight money policy, cutting rates to 4.5 percent in 1991, 3.25 percent in 1992, 1.75 percent from 1993 to 1994, 0.5 percent from 1995 to 2000, and as low as 0.1 percent in September 2001.

A similar pattern took place in the United States. From 2000 to 2002, the Federal Reserve slashed the target discount rate from 6 percent to 0.75 percent. Fearing irrational exuberance, to borrow Alan Greenspan’s famous phrase, the Fed then raised the rate as high as 6.25 percent in June 2006. But now that the bubble has burst and the economy contracted, the Fed has cut the discount rate 12 times, lowering it to the current 0.5 percent. Federal Reserve Chairman Ben Bernanke has repeatedly stated that he sees interest rate cuts as a way to “support growth and to provide adequate insurance against downside risks.”

In both the Japanese and the American cases, post-bubble policy makers believed that lowering interest rates would make credit easier to obtain, thus recreating the environment that had spurred economic growth to begin with. But this meant that the supposed cure for a bubble created by easy credit was to extend even more easy credit.

These rate cuts only perpetuated the distortion of economic decisions and prevented savings, investment, and consumption from realigning with true preferences, as opposed to the illusory ones created by easy credit and artificially low interest rates. The lesson is that when monetary policy is used to “smooth” or “tweak” the market, it inevitably causes unintended consequences that in some cases can be very damaging to long-term economic growth.

Regulatory Responsibility

The current American debate often falls into broad-brush discussions about whether the nation had “too much” or “too little” regulation. The real issue is how the existing regulatory order helped spawn the financial crisis. We see it doing so in at least a couple of areas:

Capital reserve requirements. In 1988 the Basel I Accord between the Group of 10—which then included the U.S., Switzerland, Japan, Germany, France, and the U.K., among others—set new capital requirements for banks around the world. But the requirements were focused on loan amounts and did not factor in a debt’s underlying risk. In other words, a loan to a sound borrower required the same percentage of capital to be set aside as an equal amount lent to a high-risk borrower. There was already a developing atmosphere of heavy lending and insensitivity to risk, but the Basel requirements rewarded firms for making loans to shaky borrowers because they could earn higher interest rates that way without having to set aside any more capital than they would for loans to safe borrowers.

The chief problem was not that the requirements were too low. It was that the rules created a false sense of security for investors and lenders. Banks were meeting their legal requirements, although it was never clear what kind of debt they were holding capital to cover. Without a standard or competing standards for transparently measuring the value and risks of portfolios, Basel I proved ineffective at preventing systemic rot.

In the United States, when firms calculated their reserve requirements, they were required until recently to mark many assets “to market,” i.e., value them at the price they could be sold for immediately. When asset values started falling, and categories of assets stopped trading, firms scrambled to find capital to shore up their shoddy-looking reserves. The collapse of the government-created mortgage behemoths Fannie Mae and Freddie Mac suddenly devalued mortgage-backed securities, and that meant banks holding large swaths of these assets had to come up with millions in cash overnight to meet their capital ratios. Many of the worst or most toxic mortgage-backed securities could not be sold immediately because their values were hard to determine. Under “mark to market” accounting rules, they were in effect worth nothing for the time being.

The market needed time to reassess the mortgage market, given the new information it was facing from the Fannie and Freddie debacle. In the meantime, banks watched the numbers on their balance sheets go from millions to zero. Unable to find sufficient capital to meet the requirements demanded by mark-to-market accounting, institutions such as Lehman Brothers, Washington Mutual, and Citigroup fell prey to their debt. Easing the mark-to-market rules at the onset of the crisis, instead of a year later, would have bought firms precious time to recapitalize their balance sheets in a more stable manner. The banks still would have lost money, but they might not have gone bankrupt and caused a negative ripple effect throughout the economy.

Government housing policy. Both Japan and the United States had explicit government policies that encouraged an unhealthy appreciation in land and housing prices. A 2003 report from the Bank of Japan blamed tax and regulatory policies for an unnatural rise in asset values. In America the Federal Housing Administration has for years encouraged the expansion of mortgage lending, including subprime lending, particularly through Fannie Mae and Freddie Mac. This was done to expand homeownership by low-income families. Such policies span administrations of both political parties, from the Community Reinvestment Act passed during the Carter administration in 1977 to George W. Bush’s efforts to create an “ownership society.”

The push to expand homeownership had two big effects. First, it greatly increased the number of buyers, driving up housing prices. Second, it provided mortgages to a large number of people who had a high risk of default.

Recession Responses

By early 1992, realizing that the economy was not going to rebound quickly, the Japanese government hurriedly enacted its first recession-fighting stimulus package. Government spending and loans during the next several years propped up failing Japanese financial firms, but the companies’ lack of vitality and perpetual operating losses earned them the moniker “zombie businesses.”

Given the similar source of the U.S. bubble, American officials should take a careful look at Japan’s ineffectual and massively expensive response to ensure that the United States does not duplicate the following mistakes:

Government lending to poorly managed firms. The Bank of Japan tried to ease economic pain by loaning large amounts to businesses. But the attempts to recapitalize the market ignored underlying management problems in the dying firms. It was a costly mistake. Intense lobbying from special-interest groups representing various sectors of the Japanese economy perpetuated the ill-fated loans and funneled government money to zombie businesses.

The United States has already begun to copy this policy, lending billions of dollars to financial institutions and auto companies and buying up billions more in bank equity in an effort to recapitalize the marketplace. The effect has been to keep poorly managed firms alive with taxpayer money.

Just months after a $25 billion investment in Citigroup, the government had to step in with a second bailout of $20 billion. Despite the infusions, Citigroup is now breaking up its holdings, a process that could have been started months earlier if the authorities had not used tax dollars to feed the zombie firm. Instead of letting the Big Three automakers go bankrupt, the administration has kept them on life support with tens of billions in loans to buy enough time for...likely bankruptcy.

Conflicts of interests. With all those loans, the Japanese government found itself deeply entwined in the market, skewing its policy incentives. Daniel I. Okimoto, former director of the Shorenstein Asia-Pacific Research Center at Stanford University, points out that Japan’s banking industry and economic bureaucracies were too interdependent. Studies from Okimoto’s center and the Bank of Japan concluded that data revealing the scope of the economic malaise were suppressed and that regulations were developed with governmental interests in mind. At the height of financial industry bailouts, there was little transparency or public accountability.

The United States has ventured into the same dangerous waters. In an attempt to recapitalize the banking industry, the Treasury Department forced the major banks to take bailout funds from the Troubled Asset Relief Program, in exchange for which the government took equity stakes. The federal government now owns a majority of the American International Group insurance company, as well as major chunks of General Motors and Chrysler. The dangers of interconnectedness have already become apparent.

With taxpayer money on the line, elected officials feel emboldened to prescribe the marketing, compensation, travel, and other business policies of companies taking government money. Members of Congress and White House staff have criticized specific spending decisions by participating firms. Concern over bonuses to AIG employees led the House to pass an arbitrary tax on a standard business practice that lost public favor. President Obama himself has delved into such business minutiae as whether General Motors should be focusing more on brand consolidation. And a bill now in the Senate would give the Treasury Secretary power to set the salary of all employees, not just executives, at any firm with bailout money burning in its pockets.

Lawmakers’ incentives are to serve their constituencies or their own political careers. This can put them at odds with the businesses they are suddenly attempting to manage. The more the government is involved in directing business activity, the less likely those firms will succeed in maintaining long-term growth, and the more likely they will turn into Japanese-style zombies.

Short-term, static political vision. You can blame the length of Japan’s asset deflation, recession, and liquidity struggles on an unwillingness to choose hard but necessary policies, such as allowing banks to fail and the market to reset itself. Politicians bent on retaining their power and showing the public they were doing something took actions without regard to their long-term effects.

There was little effort to clean up the banking system or get rid of harmful regulations. The government refused to acknowledge the breadth of Japan’s economic troubles, and the Ministry of Finance went so far as to order banks to hide their toxic loans to create the appearance of success. This approach was largely due to fear of the keiretsus, the powerful alliance of Japanese businesses that propped each other up with cross-shareholding and loans. Taking swift action would have upset the traditional way of business and forced the government to admit mistakes.

The principle of creative destruction—the economic mutation that continuously breaks down old forms and creates newer, more productive and efficient ones—was ignored in the hope that legacy corporations could somehow save Japan. From Wall Street to Detroit, under both George W. Bush and Barack Obama, the American government has been equally unwilling to let once-formidable companies fail.

Bad tax policy. In different periods, Japan tried to climb out of its economic mess by both cutting and raising taxes. There were two major tax cuts during the Lost Decade: a ¥5.8 trillion ($69 billion in today’s dollars) income tax cut in 1994 that lasted for one year, and a ¥4 trillion ($46 billion) income tax cut in 1998 spread over two years. The problem was that these tax cuts were not permanent and thus did not increase long-term aggregate consumption.

From 1994 to 1995, the Japanese economy began experiencing modest growth, partially due to the first tax cut. But deflation in 1995 reduced government revenues. In an effort to stem surging national debt, the consumption tax was increased from 3 percent to 5 percent in 1997, which slowed the economy again.

President Obama and Republicans in Congress have proposed various tax cuts and tax credits to stimulate the American economy. The American Recovery and Reinvestment Act (the “stimulus” bill) included the president’s signature “Making Work Pay” $400-per-taxpayer ($800-per-family) tax credit that eliminates all federal income taxes for up to 18 million Americans. The legislation also increased the amount of losses that businesses may write off on their taxes while providing tax credits to new homeowners, students, and efficient energy developers.

Other ideas, such as the GOP push for reductions in capital gains taxes, have been tossed aside.

As welcome as tax cuts are, without a decrease in spending they will require an increase in taxes later to cover the lost revenue and pay off the debt incurred.

Japan found that temporary tax rate cuts combined with increased spending did not spur economic growth. Neither did an attempt to increase government revenues through tax increases. Reducing taxes for businesses—permanently, not until the next shortfall—allows firms to keep more revenue, which in turn lets them reinvest that money to innovate and expand their business, hire new workers, pay out dividends, or just be inspired to continue their hard work. Tax rate cuts for individuals—all individuals, including those with income over the arbitrary $250,000 threshold—give people more control over their income, allowing them to pay down debt, save, invest, or increase consumption. Those tax policies are the quickest way to stem a recession.

Government infrastructure “investment.” In an attempt to encourage growth, the Japanese embarked on a massive, multi-billion-yen infrastructure program. They built roads, bridges, and airports, all with the goal of creating jobs and reviving the economy. This didn’t work either.

During the 1990s, Japan passed 10 fiscal stimulus packages, focused largely on public works, totaling more than ¥120 trillion ($1.4 trillion in today’s dollars). When one construction plan failed to stimulate economic growth, another was tried. Those plans did not succeed in reviving the economy, but they did saddle the nation with a mountain of IOUs that helped postpone recovery for years. Including “off-budget” borrowing, Japan’s debt was estimated to exceed 200 percent of GDP in 2001.

Construction plans often set job growth targets but rarely focused on project prices. From 1992 to 1999, the Japanese government spent more than $500 billion (in today’s dollars) on public works projects. Yet the construction jobs were not long-term and did not lead to sustained economic growth. Public debt sky-rocketed, unemployment actually doubled from 2.3 percent to 5 percent, and the economy remained stagnant. As Gavan McCormack, a historian at Australian National University, noted in his 1996 book The Emptiness of Japanese Affluence, “The construction state is in some respects akin to the military-industrial complex in Cold War America (or the Soviet Union), sucking in the country’s wealth, consuming it inefficiently, growing like a cancer and bequeathing both fiscal crisis and environmental devastation.” The government failed to properly identify which projects should be pursued, ignoring demand signals that the private sector is better at recognizing and responding to.

The United States has started down a similar path. In February, Congress passed nearly $100 billion in transportation and public works spending. Naturally, political interests, not economic viability, are determining how this money is being spent.

An American Lost Decade

The Japanese government’s monetary expansion and poor regulation, coupled with the risky behavior and ineptitude it encouraged in the financial sector, led to distortions in private investment instead of economic recovery. Recessions are the unavoidable costs of unsustainable booms fostered by government policy. While politicians would like to stave off the negative effects they create—business failures, unemployment, falling housing prices—bankruptcies and corrections are necessary steps in realigning consumer preferences and the structure of production.

The U.S. government is repeating many of the same mistakes that created Japan’s Lost Decade, becoming entangled with the business community through bailout equity purchases and trillions of dollars in loans and guarantees to keep failing American firms alive. This policy is making the recession worse, extending it further than it would otherwise last.

Any attempts to artificially spur a credit expansion through either low interest rates or “fiscal stimulus” will only add to the economic distortions and make the market correction longer and more severe. Spending hundreds of billions of dollars on infrastructure, broadband Internet, and the like may provide some short-term benefits for some Americans, but as Japan discovered the hard way, it won’t rescue the economy. The history lessons from Japan are plentiful and clear. If the American government continues its pattern of intervention, the United States may soon be trapped in a zombie business economy and a lost decade of our own, ensuring economic stagnation for a long time to come.

Anthony Randazzo is a policy analyst at the Reason Foundation. Michael Flynn is president of Marengo Strategies. Adam B. Summers is a policy analyst at the Reason Foundation. This column first appeared in Reason magazine.

California's May 2009 Special Election

adam.summers@reason.org (Adam Summers) — Thu, 14 May 2009 00:14:00 EDT

The six measures on the special election ballot represent an attempt by legislators and the governor to right the state’s fiscal ship. They assert that passage of these propositions will balance the state’s budget. The bills presented by legislators all have the same goal of increasing the General Fund, which legislators can spend as they see fit.

Propositions 1A and 1B increase the General Fund directly through taxation, and Proposition 1C increases the General Fund via borrowing. These propositions provide a one-step process for increasing unrestricted funds. Propositions 1D and 1E take funds that taxpayers voted to spend on mental health services and children’s services and reroute those monies to pay for services that are currently paid out of the General Fund. By freeing up the General Fund from having to pay for these services, these propositions effectively redirect money to the General Fund where it is unrestricted, the same money that voters had approved specifically for mental health and children’s programs.

These propositions present a two-step process to increasing unrestricted funds: first encourage voters to approve increased taxes for specific causes like mental health and services, then ask voters to approve redirecting those funds into the General Fund.

Unfortunately, passage of these propositions will not bring any meaningful reform or solve the state’s structural deficit, but will impose higher taxes on the already overburdened backs of taxpayers.

Getting California Back on Track

adam.summers@reason.org (Adam Summers) — Wed, 22 Apr 2009 17:51:00 EDT

Before delving into the regrettably long list of things that are wrong with California, perhaps we should begin by reminding ourselves what is right with California:

The state has one of the best and brightest labor pools in the country to draw from;
There is a large and diverse set of industries that offer numerous economic opportunities;
Overall quality of life remains very high;
Of course, the weather is great and it's simply a desirable place to be.

But the state government is not right. Despite all of the things that California has going for it, the state has been choked by excessive spending, borrowing, and taxes. Late budgets and the paralysis caused by the need to resolve massive structural budget deficits have become an annual occurrence. There are two sides to the budget equation: revenues and spending. California's problem has clearly been on the spending side.

The Problem is Spending, Not Revenue

California has some of the highest taxes in the nation and, for many years (until recently), state revenues have grown significantly. The problem is that whenever there is a period of economic boom and the state's coffers are overflowing, policymakers spend as though the good times will never end. When the inevitable correction comes, they are always shocked-shocked!-that revenues cannot keep pace with their unrealistic assumptions, and so we have another fiscal crisis.

If California had simply held spending to the average population growth plus the average increase in the cost of living during the past three gubernatorial administrations-starting with Gov. Pete Wilson in fiscal year 1990-91 and covering the Gray Davis and Arnold Schwarzenegger administrations-the state would have been sitting on a $15 billion surplus instead of having to plug the recent $42 billion deficit. That's a difference of $57 billion. In fact, after adjusting for inflation, California spends nearly 20 percent more per capita than it did at the start of Gov. Wilson's first term 18 years ago. I seriously doubt that many would argue that the state government is 20 percent better today than it was back then. Add to all this California's enormous debt burden, which has helped to earn it the dubious honor of having the worst state credit rating in the nation, and you have a recipe for fiscal disaster.

Poor Business Climate

California's high tax, high regulation environment has severe consequences, as it is driving many of its most productive people and businesses from the state. The American Legislative Exchange Council recently released a report entitled Rich States, Poor States, which analyzes the 50 states based on 16 policy variables, including top marginal personal and corporate income tax rates, property and sales tax burdens, state minimum wage, and the number of public employees per 10,000 residents. California ranked near the bottom, 41^st overall, because it has the worst personal income tax progressivity in the country, the second-worst top marginal personal income tax rate, the second-worst average workers' compensation costs, and a high minimum wage.

"Despite warm weather, sandy beaches and the Pacific Ocean, Californians are leaving in droves to escape the state's oppressive tax burden," the authors of the report concluded. They added, "No state has ever taxed its way into prosperity."

Chief Executive magazine's 2009 "Best and Worst States" survey similarly exposed California's poor business climate. The survey asked 543 CEOs to assess their states based on issues such as regulation, tax policies, education, infrastructure, quality of living, and proximity to resources, and to grade each state on three criteria: 1) Taxation and Regulation, 2) Workforce Quality, and 3) Living Environment. California ranked dead last for the fourth year in a row.

As one CEO put it, "Michigan and California literally need to do a 180 if they are ever to become competitive again. California has huge advantages with its size, quality of work force, particularly in high tech, as well as the quality of life and climate advantages of the state. However, it is an absolute regulatory and tax disaster."

So, how is the state going to do a 180 and get on the right track?

California Performance Review

A good place to start would be the California Performance Review. In 2004, Gov. Arnold Schwarzenegger solicited government reform ideas from state and local government leaders, the business and labor communities, public policy experts, and members of the public. As a result, the California Performance Review Commission detailed over 1,400 recommendations with potential cost savings of approximately $31 billion over five years, including $10 billion in savings from the General Fund. These recommendations included such common-sense ideas as eliminating some of the hundreds of state boards and commissions, consolidating programs and government functions that are duplicative or overlapping, and selling off surplus property, such as state-owned golf courses, the Los Angeles Memorial Coliseum, and the MTV beach house in Malibu.

Unfortunately, hardly any of the suggestions have been implemented and the California Performance Review has largely been filed away as another blue ribbon commission report to be ignored. But if the administration already has so many ready-made, nonpartisan solutions, why not put them to use, especially now?

Pension Reform

Another worthy reform that was abandoned was the state's pension system. Once upon a time, perhaps a generation or two ago, it could be argued that government employees needed greater benefits and job stability than private-sector workers because the government could not match salaries in the private sector. That clearly is no longer the case. Now government employees typically earn higher salaries and much greater benefits than their private-sector counterparts. Unfortunately, an effort to switch new state employees from the state's generous traditional pension plans to 401(k)-style defined-contribution plans more in line with the private sector was scuttled when some sloppy wording in the proposal led to fears that the widows of slain public safety officers would be denied disability pensions. Nevertheless, there is a reason that the private sector has been switching to defined-contribution plans for the past 30 years: traditional pensions are simply too volatile and unaffordable.

Spending Limit

Since legislators have proven time and again that they are unable to restrain spending, California needs a strict spending and revenue cap, although they should not be forced into a Faustian bargain where they would have to agree to impose an additional $16 billion in taxes on themselves, as Proposition 1A on the May 19 ballot would do. California passed the Gann Spending Limit in 1979 with over 70 percent of the vote. The Gann Limit basically prevented state spending from growing by more than the growth in population and inflation, and any tax revenues collected above the limit were to be returned to taxpayers via tax rebates. Unfortunately, the Gann limit was gutted by Proposition 111 in 1990 and hasn't been effective since.

Budgeting Reforms

The very way the budget is crafted cries out for serious reform as well. Instead of the current line-item budgeting, which makes incremental adjustments to last year's budget for various spending categories, oftentimes with little or no justification, California should adopt performance-based budgeting. Under performance-based budgeting, legislators could use outcome measures adopted by agencies to link funding decisions with program performance. This would shift the focus from line items and object codes to programs and results.

Some states have taken this concept even further. Washington and South Carolina utilize a Priorities of Government (POG) budget process, under which government services are identified by activity, rather than by agency, and categorized according to a set of pre-established goals. The activities are then ranked in order of priority and effectiveness and funded from the top of the list down until all available revenues run out. One of the greatest benefits of the Priorities of Government system is that it makes priority and trade-off decisions clear to everyone.

Privatization and Outsourcing

Finally, the state should make much greater use of privatization and contracting with private-sector vendors to provide services. There are certain government services that can be provided more cheaply and effectively by the private sector, or that the government just shouldn't be performing in the first place. Hence, a comprehensive "Yellow Pages" test should be applied to state government. Simply put, if there are businesses listed in the Yellow Pages that are performing the same services as the government, the government should either put those services up for competitive bids for performance-based contracts or eliminate the service altogether.

Conclusion

California holds much promise, and we have a lot to be thankful for, but overregulation and the failure to contain borrowing, spending, and taxes have diminished our liberties, our economic opportunities, and our prosperity. There are numerous viable solutions to the state's budget problems, but vital reforms will take leadership and political willpower.

It is time for Californians and their elected representatives to undertake a serious re-evaluation of the proper role of government. Government has simply gotten too big and too intrusive. In order to put California back on the road to recovery and return to a state of fiscal sanity, we must break the state's spending addiction.

Adam Summers is a policy analyst at Reason Foundation.

State Governments Face Deficits and Fiscal Trouble Because of Spending

adam.summers@reason.org (Adam Summers) mike.flynn@reason.org (Michael Flynn) — Thu, 09 Apr 2009 11:32:00 EDT

Reason magazine

Of the $787 billion in “stimulus” money President Barack Obama authorized with his pen on February 17, at least $144 billion was earmarked for a particularly unstimulating purpose: covering the budget deficits of state governments. The 12-digit sum, touted as “state and local fiscal relief” on the administration’s glass-half-full website recovery.gov, quickly exposed a fault line between the nation’s governors. On one side were a handful of fiscal conservatives, led by Republicans Bobby Jindal of Louisiana and Mark Sanford of South Carolina, arguing that bailouts and federal mandates create moral hazards and unfunded liabilities requiring future tax hikes. The other, more powerful side was represented by moderate Republican Arnold Schwarzenegger of California.

“Gov. Sanford says that he does not want to take the money, the federal stimulus package money,” Schwarzenegger told ABC’s This Week on February 21. “And I want to say to him: I’ll take it. I take it because we in California…need it.”

But does California, or any other state, really “need” federal money during this economic downturn? Only if you accept the premise that state budgets should roughly double every decade.

When Gray Davis, a Democrat, became California’s governor in 1999, the state’s budget was $75 billion. Tempted by dot-com windfalls and beholden to public-sector unions, Davis bumped that number to $104 billion in four short years of boom and bust, after which he was bounced out of office for his fiscal irresponsibility and replaced by a Milton Friedman–quoting action hero who promised to bring “fiscal sanity” back to Sacramento. Five years later, after facing another boom, another bust, and a series of bruising political defeats at the hands of public-sector unions, Schwarzenegger had hiked the budget to an astonishing $145 billion. In 10 years, state spending in nominal terms increased 92 percent.

One good way to measure fiscal stewardship is to see whether state spending growth exceeds the rate of population growth plus inflation. Under Davis, budgets rose an average of 6.7 percent a year, as opposed to a population/California price index growth rate of 4.8 percent. Under Schwarzenegger, spending has increased 6.8 percent annually, compared to a population/inflation rate of just under 5 percent. A governor who was swept into office by damning Davis’ $38 billion budget deficit, vowing not to raise taxes, and mocking his predecessor’s vehicle license fee hikes announced on February 20 that he would address his own $42 billion budget deficit by raising taxes and doubling those same fees.

Asked to explain the contradictions on This Week, Schwarzenegger praised the federal stimulus (“a terrific package”), urged Republicans to be “team players” for Obama (who, he said, was doing a “great job”), and unleashed a spectacular metaphor in favor of abandoning a limited-government philosophy. “You’ve got to go beyond just the principles,” he said. “You’ve got to go and say, ‘What is right for the country right now?’ I mean, I see that as kind of like, you go to a doctor, the doctor’s office, and say, ‘Look, can you examine me?’ The doctor says, ‘You have cancer.’ What you want to do at that point is you want to see this team of doctors around you have their act together, be very clear, and say, ‘This is what we need to do,’ rather than see a bunch of doctors fighting in front of you and arguing about the treatment. I mean, that is the worst thing. It creates insecurity in the patient. The same is with the people in America.”

But if the people in America have fiscal cancer, it’s just the latest in a long series of relapses.

There They Go Again

In 2002 the National Governors Association issued a press release saying the “states face the most dire fiscal situation since World War II.” In 1990 The New York Times reported that states and cities faced a “fiscal calamity.” Fire up Google, pick almost any year, and you’ll find plenty of stories about a “fiscal crisis” around the nation.

For decades statehouses have followed a predictable schedule. In good economic times, they collect a lot more tax revenue than they really need. But instead of giving the money back to taxpayers or putting it in a rainy day fund, they pretend the good times will never end. When the good times do inevitably come to a close, governors plead poverty and either ask the federal government for help or raise taxes on their beleaguered citizens. Eventually, the economy rebounds and the vicious cycle starts again.

In the 2009 version, the liberal Center on Budget and Policy Priorities warned in February that governors faced a combined funding shortfall of $350 billion, causing “at least 40 states to propose or enact reduced services to their residents, including some of their most vulnerable families and individuals.” That same month, Corina Eckl, fiscal program director for the bipartisan National Conference of State Legislatures, described the budget figures as “absolutely alarming, both in their magnitude and the painful decisions they present to state lawmakers.” Across the country, newspapers have been filled with stories of closed parks, furloughed state workers, cigarette tax increases, and even, in California, IOUs instead of tax refund checks. “The easy budget fixes are long gone,” Eckl said. “Only hard and unpopular options remain.”

Is that true? Consider the boom cycle preceding this latest recession. In the five years between 2002 and 2007, combined state general-fund revenue increased twice as fast as the rate of inflation, producing an excess $600 billion. If legislatures had chosen to be responsible, they could have maintained all current state services, increased spending to compensate for inflation and population growth, and still enacted a $500 billion tax cut.

Instead, lawmakers spent the windfall. From 2002 to 2007, overall spending rose 50 percent faster than inflation. Education spending increased almost 70 percent faster than inflation, even though the relative school-age population was falling. Medicaid and salaries for state workers rose almost twice as fast as inflation.

Recessions exert a great deal of pressure on state budgets. As economic activity declines, governments collect less tax revenue. As people lose their jobs or suffer drops in income, there is more demand for services such as job training, health care support, welfare, and unemployment compensation. The combination, it is often argued, throws state budgets out of balance and, because states are generally required to enact balanced budgets, often leads to tax increases, dramatic cuts in services, or both. These actions, it is argued, further dampen consumer demand and worsen the economic situation. The chief rationale for federal support of state budgets is to counter this cycle.

By studying the period from 2002 to 2007—that is, the period that began as the economy came out of the mild 2001 recession—we can judge how states spent money when times were better and their services weren’t as desperately needed. In this period, unemployment dipped to around 4 percent, a historic low in modern times; gross domestic product posted steady gains; and most economic measures pointed upward. Meanwhile, the states indulged in fiscal irresponsibility from which no taxpayer should feel eager to bail them out.

Total Revenue

The top-line figure for state funding is total revenue. It encompasses every dollar available to state governments: tax revenue, money from the federal government, income from trust funds, earnings from investments, even state employee contributions to pension systems. In 2002 total combined state revenue was $1.097 trillion (see Figure 1). In 2007 this figure had risen to almost $2 trillion. That’s an 81 percent increase, at a time when prices plus population increased 19 percent. So total revenue increased more than four times faster than inflation and population growth.

Here’s a hypothetical that puts this trend in a more understandable context. In 2002 you and your friend (call him “Mr. State Government”) come out of the recession with jobs paying $50,000 a year. During the next five years you receive cost-of-living adjustments from your employer, so by 2007 your salary is $59,500. Your pal, on the other hand, has jacked his annual earnings up to $90,500.

But the 81 percent increase over five years only tells part of the story. Since 2002 total revenue collections have been well above the levels needed to maintain services each year. This windfall has a cumulative impact. In just five years, taking inflation into account, the states collected $2.2 trillion more than they would have needed to maintain revenues at 2002 levels.

Let’s put this another way. After 2007 we were clearly experiencing an economic downturn. If the states had merely maintained their existing programs between economic downturns, they would have been able to deliver a $2 trillion tax cut at the end of 2007. Imagine the impact that might have had.

General Fund Revenue

Some will argue that total revenue isn’t the appropriate focus. Since a portion of that money is out of the direct control of elected officials, the argument goes, it doesn’t truly reflect the choices they have faced or the decisions they have made.

The general fund better reflects the day-to-day activities of state government. It includes all the programs we traditionally associate with states: education, Medicaid, road building, departments of motor vehicles, etc. Money in the general fund comes mainly from tax revenue and federal funds.

In 2002 states’ general fund collections were $1.062 trillion (see Figure 2). By 2007 general fund revenue had risen to almost $1.5 trillion, an increase of 37 percent, or almost twice the national growth rate of inflation plus population. Of the 50 states, only one (Wisconsin) saw its general fund expand at a rate below the state’s population growth plus inflation. Alaska and Wyoming led the charge with 91 percent and 74 percent, respectively, compared to rates of population growth/inflation of 20 percent and 18 percent. Even in Mark Sanford’s South Carolina, the general fund grew by 45 percent, compared to a 21 percent rate of population growth plus inflation.

Intergovernmental Funds

About 30 percent of state general fund money comes from the federal government. These funds support federal initiatives in education, road building, and Medicaid, among other uses. Given the well-publicized increase in federal spending during George W. Bush’s administration, it is worth examining whether states shared in the windfall.

Interestingly, this is one area where federal spending rose relatively modestly, at least in comparison with other priorities. In 2002 states received $335 billion in revenue from the federal government (see Figure 3). In 2007 they received $430 billion, a 28 percent increase. It is noteworthy that in examining government financing, a 28 percent increase over five years now seems modest. It is worth remembering that this increase is still 50 percent faster than the rate of inflation and population growth.

Taxes

About half of state general fund revenues come from taxes. In 2002 states collected $535 billion in taxes; by 2007 that had grown to $749 billion, an increase of 40 percent, or more than twice the rate of inflation and population growth (see Figure 4).

The robust growth in state tax revenue during this five-year period is only part of the story. The pace of this growth is notable: rising slowly out of the recession, increasing rapidly, and then beginning to taper off in advance of the general economic slowdown. In 2002–03, the rate was 2.4 percent. By 2004–05, it had leaped to 10 percent. In 2006–07 it was down to 5.4 percent—a more moderate level, but still far ahead of inflation.

The decline in the rate of tax revenue growth ought to have sent a signal to state budget drafters. Instead, they seem to have looked beyond the data and assumed continuing strong revenue growth. State budgets for fiscal year 2008, which were drafted toward the end of the period analyzed here, called for more than an 8 percent annual spending increase on average. Small wonder states had to make mid-year adjustments to their budgets in the middle of 2008 as the economy began to cool.

Golden Failure

In fiscal year 1990–91, California took in more than $38 billion in general fund revenues. In 2008–09 revenues are $102 billion. If the state had simply limited spending increases to the 4.4 percent annual average growth in consumer price index plus population, the state would be sitting on a $15 billion surplus this year instead of a $42 billion deficit.

A significant portion of California’s spending increase stems from the growth in state employees. Today there are more than 356,000 workers on California’s payroll, or 9.3 state employees for every 1,000 residents. The biggest hiring binges came during Gray Davis’ dot-com exuberance, and then again during the pre-recession Schwarzenegger administration (see Figure 5).

This increase in personnel is important because so much of the budget is devoted to employees’ wages and benefits, and because their pension benefits, which are locked into place for all current employees, are both colossal and precarious. The California Public Employees’ Retirement Security System, which until last year was the largest public pension fund in the United States, lost a staggering 20 percent of its value in just three months of 2008 (see “The Next Catastrophe,” February).

By chance, the National Governors Association held its annual meeting in Washington, D.C., the weekend after both the stimulus and California’s new budget were passed into law. Mark Sanford and Bobby Jindal, both considered possible future leaders of the GOP, drew early headlines with their Hamlet-like deliberations on whether they would accept stimulus money. (In the end, they narrowed their considerations to the unemployment insurance component of the federal mandate, a comparatively trivial sum.) Schwarzenegger, always a media darling, regained the initiative with his Obama praise and Sanford baiting on This Week. Pundits speculated hopefully that perhaps the new president would give Arnold a job once his term expires in 2010.

Martin O’Malley, Maryland’s Democratic governor, dismissed Sanford as “fringe.” Sanford shot back in The National Journal. “There is a larger problem if we get so Balkanized with ‘you-don’t-want-yours-give-it-to-me,’ ” he told the magazine. “That means nobody is minding the store.” On Fox News on February 22, Sanford described the stimulus as sounding “like the Soviet grain quotas of Stalin’s time—X number of jobs will be created because Washington says so.” He added that “one of the real issues here is we have $52 trillion in accumulated debt in Washington, D.C. And we don’t have a giant piggy bank that we can now raid now that times are tough. All this money is going to be borrowed from the future—from future generations, from Social Security. So in essence, we’re digging yet another hole for ourselves with regard to unsustainable spending.”

For more than two centuries, the states have been the laboratories of democracy. Whether they become laboratories of sound economics depends largely on whether Sanford’s words become real-world deeds.

Adam B. Summers is a policy analyst at Reason Foundation. Michael Flynn is director of government affairs at Reason Foundation. This column first appeared in Reason magazine.

California's High Taxes and Burdensome Regulations Drive People and Businesses Away

adam.summers@reason.org (Adam Summers) — Thu, 26 Mar 2009 17:29:00 EDT

Last month, California legislators and Governor Arnold Schwarzenegger proclaimed that they had successfully plugged the estimated $42-billion deficit through June of 2010 and boasted that they had resolved the crisis. It was a short-lived victory.

As the Los Angeles Times recently reported, the state’s nonpartisan Legislative Analyst’s Office announced that economic conditions and revenues have deteriorated to the point that the budget is already facing an $8-billion shortfall. Legislative Analyst Mac Taylor projected a $12.6 billion deficit through mid-2011 that could grow to an estimated $26 billion hole by mid-2014. “Given these budgetary pressures, the state could experience recurring cash flow pressures in the coming months and years,” Taylor said.

Taylor’s comments echoed those of the bond rating companies. After Standard & Poor’s cut its rating on the state’s debt in February, Moody’s Investor Service and Fitch Ratings both followed suit last week. California now has the worst credit rating of any state in the nation, making borrowing and bond financing even more expensive than it already was.

Policymakers have taken the easy path by enacting tax increases to cover for their lack of fiscal discipline. The February budget deal increased taxes nearly $13 billion, and Proposition 1A on the May 19 special election ballot would add another $16 billion in taxes. (The measure would impose a spending cap, but would also extend the “temporary” tax increases two more years.)

California is already one of the most heavily taxed states in the nation, and its high tax, high regulation environment is driving many of its most productive people and businesses out of the state. More evidence of this came in the form of two economic indexes of the states issued last week.

The American Legislative Exchange Council released a report entitled, Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index, which analyzes the 50 states based on 16 policy variables, including top marginal personal and corporate income tax rates, property and sales tax burdens, state minimum wage, and the number of public employees per 10,000 residents.

California ranked near the bottom, 41st overall, because it has the worst personal income tax progressivity in the country, the second-worst top marginal personal income tax rate, the second-worst average workers’ compensation costs, and a high minimum wage.

“Despite warm weather, sandy beaches and the Pacific Ocean, Californians are leaving in droves to escape the state’s oppressive tax burden,” the authors of the report concluded. “No state has ever taxed its way out of prosperity.”

Chief Executive magazine’s 2009 “Best and Worst States” survey similarly exposed California’s poor business climate. The survey asked 543 CEOs to assess their states based on issues such as regulation, tax policies, education, infrastructure, quality of living, and proximity to resources, and to grade each state on three criteria: 1) Taxation and Regulation, 2) Workforce Quality, and 3) Living Environment. California ranked dead last for the fourth year in a row.

One CEO surveyed put it, “Michigan and California literally need to do a 180 if they are ever to become competitive again. California has huge advantages with its size, quality of work force, particularly in high tech, as well as the quality of life and climate advantages of the state. However, it is an absolute regulatory and tax disaster.”

Far from being the solution, higher taxes will only drive more people and businesses from the state, thus eroding the tax base further while reducing net income, employment, and the incentive to work. Clearly, the problem is not that taxes are too low in California; it is that spending is too high. In fact, until very recently, and for many years, state revenues have grown significantly. But whenever there is a period of economic boom and the state’s coffers are overflowing, legislators spend as though the good times will never end. When the inevitable correction comes, they are always “shocked” that revenues cannot keep pace with their unrealistic assumptions, and voila, the state has another fiscal crisis.

If California had simply held spending to the average population growth plus the average increase in the cost of living during the past three gubernatorial administrations—starting with Gov. Pete Wilson in fiscal year 1990-91 and covering the Gray Davis and Schwarzenegger administrations—the state would be sitting on a $15 billion surplus instead of that $42 billion deficit today. That’s a difference of $57 billion.

California will never return to a state of fiscal sanity until it learns to kick its spending addiction.

Adam Summers is a policy analyst at Reason Foundation.

Innovative Solutions Needed to Fix L.A.â��s Budget

adam.summers@reason.org (Adam Summers) — Mon, 23 Feb 2009 12:40:00 EST

Los Angeles Business Journal

It is no secret that economic conditions are tough, and the City of Los Angeles is certainly feeling the pinch. The city is facing a $450 million budget deficit and, according to Mayor Antonio Villaraigosa, massive city layoffs may be necessary. In an encouraging sign, however, the mayor recently indicated that the city will be considering innovative budget solutions, such as turning to public-private partnerships to save money operating the Los Angeles Zoo and the L.A. Convention Center.

With a significant budget deficit and more difficult economic times ahead, implementing public-private partnerships is going to be an essential part of any long-term budget solution. Looking to the private sector to operate the zoo and convention center should just be the start.

State and local governments across the country are increasingly recognizing the value in partnering with private-sector vendors to provide better, more cost-effective services to taxpayers.

Municipal governments have assets they may not have given a second thought to that are ripe for these partnerships. Chicago Mayor Richard Daley, a Democrat, recently announced a 75-year lease of the city’s downtown parking meter system. In exchange for an upfront payment of $1.16 billion, Chicago Parking Meter LLC—a consortium led by Morgan Stanley Infrastructure Partners—will maintain the city’s downtown parking meters, be responsible for collections, and implement technology upgrades to allow for both cash and cashless payments at the meters. The city will continue to write tickets, and retains the right to change the number of meters and their hours of operation.

“This is the best thing that has happened for us in regards to getting out of this business,” said Mr. Daley. “This is not the core business of the City of Chicago.”

Given the similar sizes of the two cities’ parking meter systems—L.A. has roughly 40,000 parking meters generating approximately $20 million in annual revenue, compared to Chicago’s over 36,000 meters and $19 million in revenue—this would appear to be a great opportunity for Los Angeles, and the city could reasonably expect a similar price for such a lease.

Mayor Daley is providing an excellent blueprint for Mayor Villaraigosa. Chicago recently negotiated long-term public-private partnership leases for several downtown parking garages that will bring the city over $563 million. A few years ago, Daley leased the Chicago Skyway, a 7.8 mile toll road, and got an upfront payment of $1.8 billion for the city. And now Chicago is in the process of leasing Midway International Airport for $2.5 billion.

Cities have experienced success privatizing human resources, information technology, vehicle fleet maintenance, landscaping and grass cutting, parks and recreation management, building maintenance and janitorial services, water and wastewater treatment, library operations, trash and recycling collection services, and landfill operations.

Mr. Villaraigosa should look at all of the options. The question should not be, “What services can be contracted out?” but rather “What services can’t be contracted?”

It’s time for Los Angeles’ leaders to differentiate between the “core” services that government provides, and the services that are more commercial in nature. Providing public safety through sworn police officers, for example, would be considered a core government function. Janitorial services, cutting the grass at city buildings, operating golf courses, and providing IT technical support are not core functions.

Public-private partnerships are a means of providing better services at lower costs, but they are not a panacea. If those cost savings are simply frittered away on other parts of the government, not much has been accomplished. During this recession, taxpayers and consumers have been forced to cut back. It is time the government scaled back as well.

Mr. Villaraigosa’s move towards partnering with the private sector is much-needed and should be applauded. The mayor should ask all of his department heads to use the “Yellow Pages” test: if companies listed in the Yellow Pages are providing the same services as the government, the government should not be in those businesses in the first place.

Adam B. Summers is a policy analyst at Reason Foundation, a nonprofit think tank based in Los Angeles.

Avoiding an American Lost Decade

Fri, 20 Feb 2009 00:00:00 EST

The current economic uncertainty in the United States, and the government’s response to it, is eerily similar to that of Japan’s “Lost Decade” according to a new Reason Foundation report.

The study finds that Japan’s housing prices rose by 51 percent and commercial real estate values rose 80 percent between 1985 and 1991. In the U.S., commercial real estate and housing prices both skyrocketed 90 percent from 2000 to 2006.

The Nikkei, Japan's stock index, fell from 38,975 in 1989 to just 18,934 by the end of 1999. During the continuing economic malaise, it dropped even further to 7,603 in 2003. The Dow Jones Industrial Average hit 14,115 in October 2007. On February 19, 2009, the Dow closed at 7,465, its lowest finish since 2002.

President Barack Obama recently signed a $787 stimulus package that includes over $60 billion for infrastructure and transportation projects. Japan passed 10 stimulus packages in the 1990s that would equal $1.4 trillion in today’s dollars. From 1992 to 1999, Japan spent over $500 billion (in today’s dollars) on public works projects. Despite this infrastructure spending, Japan’s unemployment rate more than doubled and the economy remained stagnant.

California's Spending by the Numbers

adam.summers@reason.org (Adam Summers) — Wed, 18 Feb 2009 00:00:00 EST

Since former Gov. George Deukmejian's final budget in Fiscal Year 1990-91, California's spending has skyrocketed 181 percent. Spending nearly tripled from $51.4 billion in FY 1990-91 to $144.5 billion in FY 2008-09. Are California's taxpayers getting higher quality services than they did in the 90s? They should be. In FY 1990-91 the state spent $1,350 per capita. Today, the government spends $2,644 per person.

Politicians often blame falling revenues for California's budget woes, but state revenues jumped 167 percent between 1990 and 2008. In FY 1990-91, the state took in over $38 billion in General Fund revenues. By FY 2008-09 revenues were $102 billion. If California had simply limited its spending increases to the 4.38 percent average increase in the state's consumer price index and population growth each year since FY 1990-91, the state would be sitting on a $15 billion surplus right now.

The Fallacy of "Fiscal Stimulus"

adam.summers@reason.org (Adam Summers) — Mon, 02 Feb 2009 00:00:00 EST

The trouble with conventional wisdom is that it is not always wise. The recent calls for government bailouts and an "economic stimulus" package-by which advocates mean pouring hundreds of billions, or even trillions, of dollars into failing industries and into public works projects-is an excellent case in point.

Congress has already authorized enormous bailouts for banks, insurance companies, mortgage companies, the 'Big Three' U.S. automakers, and so on. These actions have enriched those in failing businesses at the expense of more productive businesses and everyone who pays taxes.

Now state and local governments are asking the federal government for a bailout of their own.

Last month, the National Governors Association estimated that the states have $136 billion in infrastructure projects ready to go. Gov. Arnold Schwarzenegger's office has said that California has $28 billion in projects the federal government could fund during President Barack Obama's first 120 days in office (ignoring the fact that the state's voters approved $42 billion in infrastructure bonds just two years ago).

Not to be outdone, the United States Conference of Mayors recently presented its own wish list of 11,391 "shovel ready" pork-er, "infrastructure"-projects totaling more than $73 billion. The list of projects includes such critical infrastructure needs as sports complexes, museums, tennis courts, bike paths, and median landscaping.

But when Uncle Sam has racked up so much debt that the fiscal house of cards inevitably collapses, who will bail out the American taxpayer? The truth is that the idea that government spending can somehow cure economic ills does not work. It didn't work during Japan's "Lost Decade" of the 1990s, it didn't work during the Great Depression, and it will not work today.

In the 1990s, after a real estate and stock market bubble burst in Japan, the Japanese government passed 10 fiscal stimulus packages in an attempt to turn the economy around. The programs focused largely on public works and cost more than 100 trillion yen ($1.1 trillion in today's dollars). Those plans didn't succeed in reviving the economy, but they did saddle the nation with a mountain of debt that helped postpone any recovery for years.

Even the mother of all stimulus plans, President Franklin Delano Roosevelt's New Deal, which actually had its roots in the Hoover administration, did not work to "stimulate" the economy. Despite all that spending and all those make-work programs, unemployment remained extremely high. In 1929, the unemployment rate stood at a little over 3 percent. By 1933, it had risen to 25 percent. Yet, even after years of New Deal programs, unemployment remained around 15 percent or higher through 1940. It was not until World War II that unemployment dropped back down to the low single digits.

But if all this borrowing and spending will really bring the recession to an end, why stop there? Why not borrow $10 trillion or $1 quadrillion to really get the economy purring again? Because it doesn't work. Because government can print money, but it cannot create wealth. It can only give what it has already taken (or will take in the future)-after skimming a bit off the top to keep the bureaucracy going.

Prior to 1929, it was generally acknowledged that the federal government should not try to manipulate the economy to mitigate the effects of economic downturns. Not coincidentally, even the more severe recessions/depressions were short-lived, typically resolving themselves within a year or two. Today, allowing the economy to liquidate the malinvestments that were made when the Federal Reserve drove interest rates to artificially low levels would surely cause some short-term pain, but doing so is necessary if the economy is to get on the right track. Perpetuating poor economic decisions through "stimulus" programs will only prolong the recession and make the inevitable correction even more painful in the end.

As difficult economic conditions drag on and more and more people clamor to bail out various industries, or request hundreds of billions of taxpayer dollars to "stimulate" the economy, let us remember where all that money is coming from-us! Money taken for the purpose of "saving" industries or "protecting" jobs is money diverted to less productive ends. Ultimately, bailouts and economic stimulus bills will only result in less wealth production and a lower standard of living.

California's Spending Addiction

adam.summers@reason.org (Adam Summers) — Mon, 26 Jan 2009 00:00:00 EST

California is facing a historic budget crisis and has only itself to blame. State lawmakers have been on a spending binge for years and voters have added to the problems by approving massive bond measures and multi-billion-dollar boondoggles like high-speed rail that they cannot afford.

The state's projected budget deficit is expected to balloon to $42 billion over the next 18 months. It has now eclipsed the enormous deficit the state experienced under then-Gov. Gray Davis, a feat of fiscal mismanagement which in large part led to Davis being recalled.

In his 2009 State of the State Address, Gov. Arnold Schwarzenegger described the enormous deficit as a "rock upon our chest," and announced that the state "faces insolvency within weeks." To make matters worse, Standard & Poor's recently cut California's general obligation bond credit rating-tying the state with Louisiana for the worst credit rating in the nation-and placed it on a negative credit watch for another potential downgrade. This means it will be expensive if and when the state borrows more money to pay its bills.

In truth, California never really recovered from the last economic downturn. The state was riding high during the late 1990s, projecting record revenues as far as the eye could see, and spending every penny of them-and then some. Then the "dot-com" bubble burst and the state was caught off-guard and unprepared. By fiscal year 2003-04, officials were projecting a deficit of between $26 billion and $35 billion over 18 months. Some slick accounting moves and relatively minor measures pared the deficit somewhat, and a $15 billion "economic recovery bond" (Proposition 57) was passed by the voters in March 2004. The passage of the bond was a radical departure from typical government financing practices. General obligation bonds are usually reserved for large infrastructure projects that will benefit those that have to pay them off for years down the road. In this case the bonds were saddling future generations with debt to pay for today's day-to-day expenses. It's like using your credit card to buy groceries and pay your rent.

Not surprisingly, less than five years after the passage of the $15 billion bond, California found itself facing another $15 billion deficit, which has since grown to $42 billion.

With much fanfare, and after a record delay of nearly three months, the state budget for the 2008-09 fiscal year was signed by Gov. Schwarzenegger on September 24, 2008. Despite the fact that it was clear by then that the economy was getting even worse, the budget deficit was largely ignored. Policymakers just papered over the problems, kicking the can down the road for another year - again.

When Gov. Pete Wilson took office in 1991, the state budget was $51.4 billion. When he left eight years later, it was $75.3 billion. After five years of Gov. Davis's administration, the budget had jumped to $104.2, and after another five years under the stewardship of Gov. Schwarzenegger, it has continued to increase significantly to its present level of $144.5 billion. In just the last 10 years state spending has nearly doubled, increasing approximately 92 percent.

A good rule of thumb in government budgeting is that the rate of spending increases should not exceed the rate of population growth, plus inflation. California's last three governors have not fared so well by this metric. Gov. Wilson managed best, holding average annual General Fund spending increases to 4.88 percent, compared to population plus inflation growth of an average of 3.72 percent a year. Under Gov. Davis, spending rose an average of 6.73 percent a year versus population plus inflation growth of 4.83 percent. Spending has grown slightly higher under Gov. Schwarzenegger-even considering that spending in the current fiscal year was basically held flat-increasing 6.75 percent a year, compared with population plus inflation growth of 4.98 percent a year. Over the entire 18-year period, state spending grew at an average annual rate of 5.91 percent, while population plus inflation grew only 4.38 percent a year, on average.

California can't blame its huge deficit on the recession, tax revenues, the stock market or any other excuse lawmakers might come up with. The Golden State has pushed tough fiscal decisions down the road, used accounting gimmicks to shift and hide deficits, and relied upon borrowing and bonds to pay the bills and finance projects.

Gov. Schwarzenegger and state lawmakers won't fix the underlying budget problems until they admit the state has a spending addiction.

Hair Braiders, Barbers and Interior Designers Need Licenses in Missouri

info@reason.org (David Stokes) adam.summers@reason.org (Adam Summers) — Wed, 10 Dec 2008 00:00:00 EST

"First in shoes, first in booze, and last in the American League" people used to say about the St. Louis Browns. Statewide, Missouri might not be first in booze and shoes, but at least there is one category in which the state can be proud to rank lowest in the United States: the total number of occupational licensing regulations. According to a 2007 Reason Foundation study, Missouri requires licenses for the least number of occupations, out of all 50 states. This is significant, because fewer licensing regulations means that goods and services are cheaper for consumers, and fewer job seekers have to ask the government's permission before working in the occupations of their choosing.

Occupational licensing regulations require those who wish to practice in a particular profession to obtain some type of special permit or license, beyond a general business license, from the government. The Reason Foundation's report on this subject last year found that Missouri requires licenses for only 41 occupations, compared to a national average of 92. Further research has revealed that Missouri's actual number of licensed occupations is somewhat higher than reported, but because the state placed last by a significant margin, and because it's also difficult to determine an exact number in each of the other states, Missouri's position is secure. There are fewer instances here in which someone who merely wants to be productive first needs a permission slip from a board or commission.

The examples of occupational licensing in Missouri range from the common (surgeons and lawyers) to the unnecessary (interior designers), to the silly (barbers), to the ridiculous (auctioneers and hair braiders). It is abject lunacy that young women who would like to perform African-style hair braiding in Missouri must first undergo hundreds of hours of cosmetology training for skills they will never need to use. Absolutely nothing is gained by such regulation, other than protecting the interests of established cosmetologists by enacting barriers to those wishing to perform only hair braiding for a fee. That protectionism is precisely the point.

Licensing laws are virtually always enacted, or made more stringent, because existing practitioners of a profession lobby for the regulations, not because customer complaints or safety concerns necessitate them. Moreover, current practitioners are typically "grandfathered" in, so that they do not have to meet the new stricter standards that are imposed on their future competitors. These regulations increase the costs of entering a profession, so existing practitioners can charge higher prices - and earn higher profits - than they otherwise would in a truly free market. Thus, occupational licensing laws are born of special interests, not the public interest. In short, licensure raises prices and harms consumers.

Some worry that practitioners without a government-granted license would tend to be more reckless, endangering consumers, but numerous economic studies have shown that government licensing standards do not improve consumer health and safety. In fact, licensing often causes consumer safety, and the quality of products or services, to decrease. This is because licensing requirements are often arbitrary and not necessarily related to practical job skills or knowledge, and the false sense of security that a license provides can cause customers to be less discriminating. In addition, the artificially higher prices that licensed practitioners charge have marketwide consequences, causing some people to resort to more dangerous do-it-yourself work, reduce their medical visits, or resort to black markets. This explains why, for example, electrocution rates are higher in places with stricter electrician licensing laws, and why states with stricter dental licensing laws have a higher incidence of poor dental hygiene.

Fewer occupational licenses means more opportunity for employment, lower professional entry costs, more competition, and greater choice for consumers. In this distressed economic climate, it is more important than ever to encourage entrepreneurship and remove regulatory barriers to work. State and local officials should refuse future attempts to license other professions, and should make every attempt to reduce the number of occupations that are currently licensed. This would lead to even more freedom and prosperity for Missourians.

Just Say 'No' to More Bond Debt

adam.summers@reason.org (Adam Summers) — Thu, 23 Oct 2008 00:00:00 EDT

Orange County Register

Not only is the era of big government not over, the era of paternalistic government rules the day, as lawmakers and bureaucrats dictate to their "children" subjects how they should live their lives, whether it be how they should save for retirement, what kind of health care they should be afforded, what kind of education their children should be given, or even what types of light bulbs they should be allowed to use.

Sometimes, however, the roles are reversed. Sometimes the taxpayer has to play the strict parent and tell the government "No" when it asks to borrow more money.

Voters will have the opportunity to do just that Nov. 4. Despite the California Legislature's chronic inability to balance the budget and the current economic calamity of the housing and credit crisis, several bonds totaling nearly $17 billion are on the ballot. In this age of bailouts, the Legislature and the governor are using the bond measures as a sort of budget balancing bailout. They could not afford to include the programs in the normal annual budgeting process, so they are hoping the taxpayers will bail them out by approving even more debt.

Gov. Schwarzenegger recently sent a letter to U.S. Treasury Secretary Henry Paulson warning that California may need a $7 billion emergency loan from the federal government just to cover its short-term, day-to-day operations. If the state couldn't even afford to pay for its current services, how in the world can we even consider taking on more debt?

Like many individuals and families, California has increased its borrowing significantly in recent years. In fact, the amount of general-obligation bonds authorized has more than tripled in six years, from $42 billion in 2002 to $135 billion today.

The state's debt-service ratio, the percentage of the state's general fund that goes to paying the interest on the bonds the state sells, is estimated to surpass 6 percent in a couple years. According to the independent Legislative Analyst's Office, the investment community gets nervous anytime a state's debt-service ratio exceeds 5 percent to 6 percent. We're already about to break that upper limit. Obviously, if more bonds are approved in this election, that ratio will get worse.

The worsening economy means that the state government's already fragile fiscal condition will also deteriorate. In passing the recent budget, lawmakers largely papered over a $15 billion budget deficit, pushing much of it onto next year (and perhaps several more years to come). Only three months into the fiscal year, the state treasurer is projecting that revenue will fall $3 billion below the estimates built into the budget.

Add to this rosy picture the $16.8 billion in bonds on the ballot next month. They include:

Proposition 1A – $9.95 billion for a down payment on a boondoggle 800-mile high-speed rail system that is likely to cost much more than advertised and attract fewer riders than proponents claim.
Prop. 3 – $980 million for capital improvement projects at children's hospitals (despite the fact that about $350 million of the $750 million from a bond passed for the same purpose just four years ago still hasn't been spent).
Prop. 10 – $5 billion for various renewable energy, alternative fuel, energy efficiency, and air emissions reduction programs, most of it going to subsidize the purchase of alternative-fuel vehicles.
Prop. 12 – $900 million for the veterans' farm and home loan program (despite the fact that housing markets are crashing, and we simply can't afford it right now).

Given the current condition of the economy in California, even the best bond measures should be rejected in the name of fiscal sanity. The proposals on the Nov. 4 ballot do not even meet this standard. Legislators and the governor have shown they are adept at quibbling like children, but incapable of making sound fiscal decisions. It is time for taxpayers to be the responsible adults and simply say "No" to more borrowing and spending.

California's High-Speed Rail Plan Is Flawed

adam.summers@reason.org (Adam Summers) — Mon, 06 Oct 2008 00:00:00 EDT

Los Angeles Business Journal

Californians are being asked to consider a $10 billion bond measure to build a high-speed rail system, but the proposal is critically flawed and should give voters serious pause, especially in the current economic climate.

Proposition 1A would authorize $9.95 billion in general obligation bonds to start building an 800-mile high-speed rail system linking Southern California with the Bay Area and Sacramento, including the backbone Los Angeles-San Francisco segment. There are crucial questions about the financing of the project, however. For starters, where will the rest of the money come from?

The $10 billion bond would cover less than one-quarter of the projected $45 billion project cost. Proponents hope that they will be able to coax one-third of the cost ($15 billion) from the federal government, which has budget problems of its own and is currently struggling with a planned $700 billion bank bailout and a possible $25 billion bailout of the auto industry. The remainder (about $20 billion) is supposed to come from the private sector, and there is similarly no guarantee that this money will ever materialize. Furthermore, a business plan that the California High-Speed Rail Authority (CHSRA) was required by law to submit by September 1 still has not been completed, and, conveniently enough, apparently won't be available until after the election.

The project cost estimates themselves are highly suspect. A recent analysis of the high-speed rail proposal published by Reason Foundation, Howard Jarvis Taxpayers Foundation, and Citizens Against Government Waste estimates that actual costs will be between $65.2 billion and $81.4 billion. This would hardly be unusual for such a large infrastructure project. Boston's notorious "Big Dig" project was announced with great fanfare in 1989 with an estimated cost of less than $4.5 billion, 90 percent of which was to come from the federal government. Nineteen years later, the total cost is estimated at $22 billion, and three-quarters of the amount has had to come from the state, diverting money from numerous other state and local infrastructure projects. Closer to home, Los Angeles's Blue Line light-rail project ended up costing more than three times the original estimates (even after adjusting for inflation).

The CHSRA's ridership projections are also unrealistic. The Authority estimates that as many as 117 million passengers will utilize the high-speed rail system by 2030. To put that in perspective, consider that Amtrak s high-speed Acela service, which serves a larger, denser market consisting of Washington, D.C., New York, and Boston, has an annual ridership of a little over three million. In fact, the entire Amtrak system, which covers over 500 destinations and 46 states, serves only about 26 million passengers a year.

Unfortunately, such examples are the rule, not the exception. Danish professor Bent Flyvbjerg conducted a worldwide study of 258 rail, bridge, and road projects. He found that 90 percent of projects came in over budget, and the vast majority of these suffered drastic cost overruns. Another analysis showed that ridership of the average transit system is less than half that of original projections. Flyvbjerg's conclusion: the difference is due to political pressures to exaggerate the numbers to gain project approval.

Then there is the question of what effect the high-speed rail system would have on existing transportation systems. The fact is, for longer trips between northern and southern California, air travel would be quicker and often cheaper (even assuming the CHSRA's optimistic ticket price assumptions, which are largely affected by the aforementioned ridership projections). For shorter trips, automobile travel is quicker, cheaper, and offers greater mobility since you can go wherever you need to go, rather than having to take a taxi or a bus to and from the few rail stations. In other words, the high-speed rail system will not get Californians to abandon their cars in large numbers or make any significant reduction in highway and airport congestion.

In the current economic climate, where the housing/credit crisis has wrought havoc and lawmakers have performed their best Harry Houdini impersonation to paper over a $15 billion deficit, even the most sound high-speed rail plan should be rejected in the name of fiscal responsibility. The CHSRA's proposal, with its low-balled cost estimates and inflated ridership projections and other benefits, does not even meet this standard.

Analysis of California's Propositions 8: Limits on Marriage

adam.summers@reason.org (Adam Summers) — Wed, 01 Oct 2008 00:00:00 EDT

Executive Summary

Once again gay marriage has emerged as a hot-button issue in California. Back in 2000, voters approved Proposition 22, which declared that the state would only recognize marriage between a man and a woman. But earlier this year, in a surprise decision, the California Supreme Court ruled that marriage was a fundamental civil and human right, and that the state could not deny it to anyone based on sexual orientation. In response, gay marriage opponents revived the Prop. 22 language, this time in the form of a constitutional amendment known as Proposition 8. ProtectMarriage.com, the leading group pushing the measure, and No on 8, Equality for all, the chief opposition organization, have raised a total of more than $41 million to fight it out through Election Day.

According to public opinion polls, Californians remain deeply divided about gay marriage, although the polls reflect a belief that gay couples should at least be able to form unions and obtain marriage-like benefits, even if the union is called some name other than “marriage.” There seems to be some cognitive dissonance over the question of the definition of marriage, for what difference should the name of the relationship or institution make if the rights afforded to those involved are the same?

In its May In re Marriage Cases ruling, the state Supreme Court definitively asserted, “[T]he right to marry is not properly viewed as simply a benefit or privilege that a government may establish or abolish as it sees fit, but rather that the right constitutes a basic civil or human right of all people.” [emphasis in original] The court was correct to recognize marriage as a fundamental right, for the decision to pledge one’s love, devotion and fidelity to a significant other is one of the most personal and important decisions an individual can make. What is more, a gay couple’s decision to marry does not infringe upon a straight couple’s right to do so, or vice versa.

Part of the problem with the issue is that the government has inserted itself into such a personal issue in the first place by conferring certain benefits on married couples, and then establishing the definitions and rules that determine whether or not one is eligible for such benefits. In the absence of government intervention, all people would be free to define marriage however their religious, moral or philosophical compass might dictate, without affecting the rights of others to do the same.

Since the choice to extricate government from marriage is not on the ballot, however, the broader definition of marriage established by the California Supreme Court’s decision, which effectively ended the undesirable “separate but (almost) equal” status of straight “marriage” and same-sex “domestic partnerships” in the state, is the next best alternative.

Drowning in Debt: Bond Measures Threaten California's Already Precarious Debt Situation

Wed, 01 Oct 2008 00:00:00 EDT

Executive Summary

California has many infrastructure needs, but the four bond measures on the November ballot are unaffordable and unnecessary. If approved, the measures—Propositions 1A, 3, 10, and 12—would authorize a total of over $16.8 billion in general obligation bonds. After factoring in the cost of paying interest on the bonds, the total cost would be approximately $33.1 billion, resulting in debt service of over $1.1 billion a year.

The state’s borrowing is simply not sustainable without significant increases in taxes or reductions in service levels. California’s debt has nearly tripled in just the past six years, from $42.1 billion in fiscal year 2001-02 to $120.1 billion in FY 2007-08. The debt-service ratio—the portion of the state’s annual revenues that must be set aside for debt-service payments on infrastructure bonds— currently stands at 4.4 percent and is projected to rise to 6.1 percent in FY 2011-12 as more bonds that have already been authorized are sold. This will surpass even the high rate of 5.4 percent the state maintained during the early 1990s. As the Legislative Analyst’s Office notes, the investment community considers a debt-service ratio of more than 5 or 6 percent to be a red flag. No wonder the state holds the second-worst credit rating in the nation, ahead of only Louisiana. Should more bonds be passed in November, the state’s debt-service ratio will only get worse.

Roughly 50 years ago, nearly 60 percent of the budget for capital projects came from the General Fund and special funds. Today, nearly all state improvements are financed through borrowing. As the state, and the economy at large, struggles to manage its mountains of debt, it is time to re- evaluate California’s borrowing binge and ensure that high-priority projects and programs are paid for in the annual budget.

The legislature and the governor have proven time and time again that they have enough difficulty balancing the budget without the imposition of other significant costs such as those contained in the bond measures on the November 2008 ballot. If California is to return to a state of fiscal responsibility, it must put an end to its borrowing and spending binge. Californians must carefully consider the details of the bond measures discussed herein, and consider whether they, or their children, will be able to afford the ultimate bill.

Swimming in Red Ink, California Wants to Borrow More Money

adam.summers@reason.org (Adam Summers) — Tue, 09 Sep 2008 00:00:00 EDT

If you think the consumer credit crisis is bad, just take a look at the debt problem the State of California is facing. The budget deficit is estimated at around $15 billion, and, more than two months into the new fiscal year, legislators and the governor still have not figured out a way to address the imbalance (although massive tax increases seem to be a likely "solution").

To put the $15 billion budget deficit in perspective, consider that the entire General Fund budget is just over $100 billion. For most of us, the thought of borrowing more when we already owed 15 percent of our total earnings for an entire year would be unconscionable, yet that is precisely what the Legislature is doing with all the bond measures on the ballot.

On the November ballot, there are four bond measures which, if passed, would add a total of over $16.8 billion in debt. The bond measures are:

Proposition 1A - $9.95 billion to start building an 800-mile high-speed rail system.
Proposition 3 - $980 million for capital improvement projects at children's hospitals.
Proposition 10 - $5 billion for various renewable energy, alternative fuel, energy efficiency, and air emissions reduction programs.
Proposition 12 - $900 million for the veterans' farm and home loan program.

The state's budget woes have already led to proposals to raise taxes by some $8 billion.

How much higher will taxes have to be to pay off even more debt?

In just the past six years, the amount of general obligation bonds authorized has nearly tripled, from $42.1 billion in FY 2001-02 to $120.1 billion (well more than the state's total General Fund budget) in FY 2007-08. According to the nonpartisan Legislative Analyst's Office, as of June 1, 2008, California had about $53 billion of infrastructure-related General Fund bond debt outstanding, and an additional $68 billion in bonds had been authorized but not yet sold.

Bonds are an expensive way of financing things. In addition to the principal cost of the bonds, the state must pay interest, which typically doubles the cost. Even after adjusting for inflation, bond financing costs about 30 percent more than pay-as-you-go financing. In other words, total bond costs are about $1.30 for every $1 borrowed.

General Fund debt payments for infrastructure-related bonds totaled $4.4 billion in FY 2007-08, and are expected to rise to $9.2 billion in FY 2017-18, as currently authorized, but not yet sold, bonds are put on the market. The state's debt-service ratio is already rather high. It has risen from less than 3 percent in FY 2002-03 to 4.4 percent today, and is expected to peak at 6.1 percent in FY 2011-12, eclipsing the most recent high of 5.4 percent during the early 1990s. (Note that these numbers relate only to infrastructure bonds and do not even count the 2004 $15 billion budget deficit bond.) These numbers will only worsen if the bond measures on the November ballot pass.

Long-term bonds should never be used to pay for day-to-day government operations because it is unfair to saddle future generations with debt for our expenses today. These expenditures should be included in annual budget appropriations bills. We have already made this mistake once by approving a $15 billion bond (Proposition 57) in March 2004 to pay off the budget deficit. This is like taking out a mortgage to pay off your credit card bill. Moreover, it obviously did not work. Less than five years after passing a $15 billion bond to pay down the budget deficit, here we are again with a $15 billion budget deficit and more tax and bond proposals.

If history serves as any guide, putting bond measures on the ballot only relieves the Legislature from having to make budget trade-off decisions that would normally occur during the annual appropriations process, leading to even more spending. Instead of relying upon taxpayers to bail them out, legislators should be forced to do the job they were elected to do and prioritize spending based on the revenue available.

Just two years ago, Californians approved $42.7 billion in bonds. Given the state's current financial straits, the state simply cannot afford to take on up to $16.8 billion in additional debt.

California's Budget Crisis Continues

adam.summers@reason.org (Adam Summers) — Wed, 03 Sep 2008 00:00:00 EDT

It shouldn't come as a surprise that the state of California is facing a massive budget deficit (between $15 billion and $17 billion, depending on the source), or that a politician has broken a promise. We in California have certainly been accustomed to both, for many years. But that doesn't make it any less frustrating or infuriating.

After promising to fix California's structural budget deficit and reform government not merely by thinking outside the box, but rather by "blowing up the boxes" of state government, Gov. Arnold Schwarzenegger has, during his tenure, offered such innovative solutions as more borrowing, more taxes, and more fees.

Gov. Schwarzenegger has now proposed increasing sales taxes across the state one additional percent. (This, on top of more than $8 billion in tax increases that Democrats in the legislature have already proposed.) This "temporary" tax increase would be scheduled to last three years, after which time it would be reduced 1.25 percent to a minimum of 7 percent (the sales tax rate is higher in some counties that have approved additional local sales taxes on top of the state rate). Nobel Prize-winning economist Milton Friedman once said, "Nothing is so permanent as a temporary government program." That goes double for "temporary" taxes.

On the plus side, the governor's proposal is coupled with a constitutional measure to implement a rainy-day fund, into which the legislature would be required to contribute three percent of state general fund revenues per year until the fund reaches 12.5 percent of the general fund budget. Those funds could be tapped in a fiscal emergency. Given the state's budgetary history, a little fiscal prudence would certainly be a welcome thing, although a stronger measure, such as one that would cap spending at the rate of population growth plus the rate of inflation and require the return of all excess revenues to taxpayers, would be an even better solution.

There was a time, not so long ago, when Gov. Schwarzenegger did actively seek out innovative solutions to improving the budget situation and reducing waste and inefficiency in state government. In 2004 he solicited reform ideas from state and local government leaders, the business and labor communities, public policy experts, and members of the public. As a result, the California Performance Review Commission detailed over 1,400 recommendations with potential savings of approximately $31 billion over five years, including $10 billion in savings from the general fund. These recommendations included such common-sense ideas as eliminating some of the hundreds of state boards and commission, consolidating programs and government functions that are duplicative or overlapping, and selling off surplus real estate, such as state-owned golf courses, the Los Angeles Memorial Coliseum, and the infamous MTV beach house in Malibu.

Unfortunately, the California Performance Review has largely just been filed away as another blue ribbon commission report to be ignored. But if the administration has so many ready-made solutions, why not put them to use, especially now?

Another worthy reform that was abandoned by the administration was that of the state's pension system. Once upon a time, it could be argued that government employees needed greater benefits and job stability than private-sector workers because the government could not match salaries in the private sector. That clearly is no longer the case. Now government employees typically earn higher salaries and benefits than their private-sector counterparts. Unfortunately, an effort to switch new state employees from the government's generous traditional pension plan to a 401(k)-style defined-contribution plan more in line with the private sector was scuttled when the sloppy wording of the proposal led to fears that the widows of slain public safety officers would be denied disability pensions. Nevertheless, there is a reason that the private sector has been switching to defined-contribution plans for 30 years: traditional pensions are simply too volatile and unaffordable.

Despite the numerous reforms mentioned above, California will never return to a state of fiscal responsibility until policymakers acknowledge that the state's woes are due to a spending and borrowing problem, not a revenue problem. General fund revenues have increased more than 34 percent since Gov. Schwarzenegger took office, but spending has outpaced even former Governor Gray Davis, who was recalled from office largely because of his lack of fiscal discipline.

If the past is any indication of the future (and the California government's penchant for making the same budgetary mistakes over and over makes it a good predictor), higher taxes will just lead to more spending-and we'll still be left with a huge budget deficit.

California taxpayers and consumers should not be punished for legislators' profligacy and irresponsibility. It is no secret that Californians are facing a tough economy. The housing and credit crises persist, consumers are struggling with high gas and food costs, and the state's unemployment rate has hit 7.3 percent, a 12-year high and currently fourth-highest in the nation. In addition, a recent Forbes report ranks California 40th on its list of the best states for business (including a ranking of 45th for regulatory environment and dead last for business costs). Higher taxes in such an economic climate will only suck more money from the private sector, where its investment is badly needed, and hurt taxpayers (who really do have to balance their checkbooks) even more.

Some will say that the budget cannot be balanced with spending cuts or other budgetary reforms and that increasing taxes or more borrowing are the only answers, but that's the same thing they have been saying for years (all the while spurning any serious efforts to cut waste and inefficiency from state government).

For years, those who must balance their personal budgets have entrusted the state treasury to those who are apparently unable to do so. No one said the budgetary tradeoff decisions would be easy, but it's time for legislators and the governor to do the job they were hired to do by reining in spending and returning California to a state of fiscal sanity.