California Needs to Address Long-Term Problems to Avoid More Budget Crises

As of this writing, the California State Senate has approved the approximately 30 bills that comprise the latest budget package, and the Assembly has largely followed suit, passing all but two of the measures. The legislation now heads to Gov. Arnold Schwarzenegger’s desk for approval. The Assembly rejected an attempt to borrow $1 billion a year for two years from local transportation funds and a bill that would have permitted oil drilling off the Santa Barbara coast that was expected to generate $100 million in additional revenues.

My colleague, Len Gilroy, noted in a previous post how this budget deal is rife with accounting gimmicks and deferrals. The lack of details released to the public or the holding of any legislative hearings prior to the votes (presumably in an attempt to rush passage before there can be any mobilized public opposition) also make it suspect. While the lack of any more tax or fee increases is certainly welcome (it seems that legislators finally got the message that taxpayers in this highly-taxed state will not tolerate any more tax increases), policymakers’ myopic focus on short-term fixes assures that we will continue to be in budgetary crisis mode for the foreseeable future, especially as the recession drags on.

Even if all of the cuts in the budget plan can be implemented, the state will still find itself several billion dollars in the red due to a couple of recent court decisions. Earlier this month, the Ninth U.S. Circuit Court of Appeals ruled that the state acted illegally when it tried last year to cut Medi-Cal fees by 10% for doctors, pharmacists, and other practitioners who treat poor patients under the program. The cuts were estimated to save the state $500 million a year. Then the state’s 3rd District Court of Appeal ruled that state raids of local transportation district funds to the tune of $3 billion over the last three years were illegal. So even if the budget deal is approved, the state will already find itself at least $3.5 billion in the hole.

Then there are the deferrals. The state is taking about $2 billion from local governments, which are already struggling with their own budget problems. The money is supposed to be repaid, with interest, in three years. Education cuts of $9.5 billion are similarly supposed to be repaid. This sounds a lot like the kind of borrowing and credit card financing that helped get us into this mess in the first place. And what if the recession continues to drag on, or if economic conditions a couple of years from now are not much better than they are today?

The fact that there are no signs of a rapid economic turnaround don’t bode well. 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.

If California is to avoid going from one fiscal crisis to the next in the future, it must get control of its spending. This means implementing a real spending and revenue limit tied to increases in the growth in population plus the cost of living. It also means addressing long-term problems like the unsustainability of the state’s pension system. Government employees’ wages are now greater than those of comparable employees in the private sector, and their benefits are significantly greater. Add to this an estimated $48.2 billion unfunded liability for retiree health and dental care and the fact that the state’s two main pension funds, CalPERS and CalSTRS, lost $100 billion over the last year, which means that the state will have to make significantly higher contributions in years to come to make up for the shortfall. Since the nature of the defined-benefit retirement system is to rely on public pension fund performance to make contributions to the retirement system, market downturns mean that the state has to kick in more contributions during the very times it can least afford to do so. Thus, the state should follow the lead of the private sector, which has been abandoning defined-benefit plans for the last 30 years, and switch to a 401(k)-style defined-contribution plan for all new hires.

Sure, California is in crisis mode and it is easier to focus on short-term fixes, but the state will not get itself back on solid fiscal footing until it also addresses its long-term structural imbalances.

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