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

State's credit rating is worst in nation and businesses say it is the worst place for entrepreneurship

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.