Governor’s Rose-Colored Glasses Tint the Budget

Schwarzenegger is outspending Gray Davis, ignoring state's major fiscal woes

As the details emerge on California Gov. Arnold Schwarzenegger’s proposed budget, you might have the impression that the fiscal affairs of the golden state are once again in order ­ that the river of red ink, deficits off into the foreseeable future ­ has all but evaporated. Sadly, this couldn’t be farther from the truth.

Certainly the governor does deserve some credit for his latest budget. For instance, Schwarzenegger’s plan includes changes to state welfare payments similar to successful federal welfare reforms. His budget also honors the public’s desire to see sales taxes on gasoline purchases directed toward improving our roads and puts on indefinite hold a massive general obligation bond to construct a questionable high-speed rail system.

But beyond that the budget begins to enter a sort of fantasy world characterized by rosy assumptions, undue optimism, and an utter disregard for the reform agenda that propelled him into office.

Fiscal conservatives are facing the sad truth that the governor they supported has actually increased state spending more than the governor they ousted. Since Schwarzenegger assumed office, general fund spending has increased by an astonishing 31 percent. As Sen. Tom McClintock reports, Schwarzenegger’s annual rate of spending increase has been 7.9% compared with Davis’ 7.1%. On top of that, the state’s debt service, the percentage of the state budget dedicated to just paying off debt, will increase to 8 percent next year, up from 3 percent only three years ago, and will ratchet up more in coming years as more bonds are approved.

A good starting point for a budget is balancing expected revenue changes with expected expenditure changes. Rose-colored glasses are all the rage in Sacramento these days, and the proposed budget relies on optimistic revenue projections rather than confronting increasing spending. With payments on the state debt increasing dramatically, a smart budget would look to match that increase with billions in cuts to match. The last decade of state budgets have taught us that revenue growth simply won’t keep up with a spendthrift legislature.

But the raw numbers do not tell the entire story of this budget proposal, which is laced with optimistic projections about future revenues. For instance, the Schwarzenegger’s budget is built upon rosy revenue assumptions that have already begun to unravel.

Recent tax revenue numbers reveal that personal income tax payments are already a billion lower than what was anticipated in crafting the budget plan. These personal income tax figures are often seen as a harbinger of things to come at the April tax filing deadline and led Legislative Analyst Elizabeth Hill to call the news “an early warning sign that we want to be really cautious.”

Not only does the budget not heed this caution, but the governor’s budget also makes a number of other optimistic assumptions about state revenues. For one, Schwarzenegger is already banking on $500 million if the legislature approves a series of compacts that he has negotiated to expand gaming at Indian Casinos in Southern California. This proposal, which would allow Indian-operated casinos to add 22,500 new slot machines to their facilities for a share of the revenue, has been greeted by skepticism. The Legislative Analyst’s Office has cautioned that little supporting evidence has been provided by the administration to justify this revenue estimate and the question remains if the legislature will even adopt the compacts.

Similarly, Schwarzenegger’s budget assumes that the state will be able to pay some of its obligations to fund the state public employee pension system with a $500 million pension obligation bond that has been mired in court battles since the governor took office in 2003. There is no sign that the courts will reverse their opinion that such a bond is unconstitutional without a vote of the public.

In an unrelated court battle, the governor’s budget also assumes a reversal of court decisions that mandated a cost of living increase in the Cal-Works Program. This decision, due in February, could cost the state another $530 million. Combined, Schwarzenegger’s budget is banking on more than $1 billion in budget solutions that are wholly dependent on court action and where prospects for victory look dim at best.

But the governor’s budget also suffers from the same misstep that Sacramento routinely commits in the annual budget process.

Put simply, California revenues are incredibly volatile ­ particularly from personal income taxes, and lawmakers from both parties find it terribly uncomfortable to acknowledge this volatility.

In December, the so-called “Taxpayer X” surprised the state with a $200 million tax payment ­ yes from one individual taxpayer ­ and this single payment was credited with helping the state’s revenue projections to stay on track. A month later, personal income tax revenues are down to the tune of a billion dollars below projections.

What these two unrelated stories should tell us is that we tend to underestimate the fluctuations in state revenues. Bad years tend to be worse than we thought and good years tend to be better, as we saw last year with an influx of $8 billion in unanticipated revenue. Instead of trying to learn from this volatility and tamping down on spending, Sacramento produces a budget, year after year, that can’t cope with a decline in revenue.

Faced with such volatility, Schwarzenegger ought to produce a budget that doesn’t hope against hope that elusive revenues will materialize or that court decisions will suddenly go his way. Instead, he should be prepared to budget, assuming that none of this revenue will arrive. How different that picture would look.

Ultimately, we elected Schwarzenegger to make tough choices and lead change ­ something that a chief executive is expected to do. That means turning a critical eye to how the state spends its money and demanding results.

When the governor commissioned his comprehensive California Performance Review in 2004, we thought we were getting a results-driven governor. 2,000 pages later, you could literally count on one hand the number of major CPR initiatives that have actually been pursued and none have been the big money saving exercises including selling unneeded state assets, realigning the bureaucracy to cope with the expected wave of state worker retirements (doing more with less), or eliminating unneeded boards, commissions and sundry other state entities.

Over the past few years, Schwarzenegger has learned that reforming a state government as large as California’s is very difficult. And it appears he has become content to commit the same crime of pushing problems off into the future with a flurry of new state borrowing, overly optimistic budgets, and a disregard for the painful reality that California will eventually face a downturn in the business cycle. When it does the pain will certainly be more pronounced than anyone in Sacramento is prepared to admit.

George Passantino is a partner in Passantino Andersen Communications and a Senior Fellow at Reason Foundation. An archive of his work is here. Dr. Adrian Moore is Vice President of Research at Reason Foundation. An archive of his work is here. Reason’s California research and commentary is here. This column first appeared at