Fiscal Policy

The California Budget Loot That Won't Stay Stolen

Mark Paul — Thu, 24 Jul 2008 21:52:00 -0400

One of the prime uses of the California initiative process is budget theft: a special interest, unhappy with its cut of state spending, passes a ballot measure to increase or fence off its budget. But sometimes the loot doesn’t stay stolen.

Just ask the road lobby. Alarmed by reports that Republican legislators want to grab dollars from transportation accounts to paper over the state’s budget deficit, it has launched a radio ad campaign to defend its booty.

The loot at issue is the portion of the state’s sales tax revenue derived from the sale of gasoline.
Until this decade, the state, for tax purposes, treated gasoline like any other purchased good. California levied the normal state sales tax on sales at the gas pump and put the money into the general fund, along with the revenue from sales of surfboards, Steely Dan records, and other goods. This money helped pay for schools, health care, and prisons. (The sales tax should not be confused with the separate 18-cents-a-gallon state excise tax on motor fuels, a levy on road users exclusively dedicated to fund road maintenance and improvement.)

But as the new century rolled around, the road lobby had a problem. The revenue from the gasoline excise tax, last increased in 1994, was being eaten away by inflation and more fuel-efficient cars. The inflation-adjusted gas tax revenue per mile driven fell by about 20 percent even as the number of cars and miles driven increased by about 20 percent. California no longer had enough gas tax money coming in to maintain and improve roads.

There was, of course, a tried-and-true solution available for this problem: raise the fuel excise tax on road users and index it to inflation. User-pay has been the central road financing mechanism for the better part of a century. But telling voters that they must pay for driving is against the California way –– remember, Californians drive on freeways, not highways. And with the Internet boom at its peak, California was rolling in revenue.

So the road lobby stole some of that money, fair and square. In March 2002 it convinced voters to pass Proposition 42, shifting the state sales tax on gasoline purchases out of the General Fund and earmarking it for transportation.

But like the tax cuts California enacted during the dot-com stock bubble, the road lobby’s raid was built on an illusion. Once the hot Internet money evaporated, the raid threatened to add another $1.4 billion to the state’s growing budget gap. To prevent that, the Legislature and Governor stole the money right back, suspending Proposition 42.

Not for long. In November 2006 the road lobby got voters to pass Proposition 1A, which limits how often the sales tax shift can be suspended and requires any suspension to be treated as a loan, to be paid back to transportation accounts, with interest, on an accelerated schedule.

Where’s the high moral ground in this budget border war of raid and counter-raid? Both sides have plausible claims. California is in no fiscal shape to shift general fund revenues away from schools, colleges, and health care. But it has also failed to adequately fund transportation. (For the moment, let’s give the road lobby a pass on the Loony Tunes nature of earmarking the sales tax, a general tax on consumption, according to the kind of goods being purchased. Other than to ask, What’s next? Dedicate the sales taxes collected on condoms and Victoria’s Secret lingerie to family planning services?)

What’s indefensible is having a two-track budgeting system: a main legislative track where budgeting is a matter of priorities and trade-offs; a second ballot-box budgeting track where voters decide every question in isolation, without the discipline of having to make the needed trade-offs for what they want. It is hard to see how California can ever escape budget hell unless it changes the initiative process to require every measure submitted to the voters to include its own funding source.

The Rich Will Always Be with Us

Mark Paul — Mon, 12 May 2008 22:26:00 -0400

Like generals who are always fighting the last war, California's pundits are still fighting their way out of the last budget crisis. Latest case in point: George Skelton of the Los Angeles Times, who recently complained again that California's income tax "depends too heavily on the wealthy." In Skelton's world, the wealthy are just like those men mothers always warn their daughters about: they'll show you a good time, and then disappear, leaving you heartbroken. "Their incomes rise and fall steeply with the economy," he writes, "and therefore so do state budget deficits."

Except that's not why California has a budget crisis. As the state controller reported on May 9, personal income tax collections for the first nine months of the current budget year are $1.4 billion over the estimate in Gov. Schwarzenegger's January budget and within a whisker of the amount budgeted last summer. Through the first nine months California revenues are up 1.2 percent over a year ago, thanks entirely to the income tax, which has more than made up for the decline in sales tax revenues caused by the housing crash.

The pundits' obsession with the volatility of income tax revenues is a holdover from the past. In 1999 and 2000 the incomes--and income tax payments--of the wealthy, powered by huge capital gains and stock option grants during the Internet stock market bubble, soared. Then they fell back to earth in 2001 and 2002, dragging California into a budget crisis. But as I've explained in more detail elsewhere, the bubble and its subsequent popping were an unprecedented event. Just look at the chart below, showing California's four largest sources of general fund tax revenue over the last three decades.

Uploaded with plasq's Skitch!

Take out the bubble years, and revenues don't resemble a "roller coaster," as Skelton puts it. They rise when the economy grows and flatten out when it shrinks, as it did in the sharp recession and restructuring that hit California in the early 1990s. Charts of federal revenue, also dependent on income taxes, show the same pattern. The Internet boom was an anomaly.

But let's suppose for a moment that it wasn't. What would the pundits do so that California no longer "depends too heavily on the wealthy"?

Raise taxes on the poor and middle class? According to an analysis done for the California Budget Project by the Institute on Taxation and Economic Policy, low- and middle-income households already pay a higher percentage of their incomes in state and local taxes than do those in the top 1 percent.

Cut income tax rates on the wealthy? California has already done that. The state had top marginal rates of 10 percent and 11 percent on the wealthy through the 1970s, most of the 1980s, and some of the 1990s, but lowered them to 9.3 percent (in 2004 voters added, by initiative, an extra 0.7 percentage points on incomes over $1 million, with the funds earmarked for expanded mental health care.) Yet the amounts collected by the income tax continue to grow.

Why? Because of an underlying economic shift the pundits rarely mention: California gets an increasing share of its budget from income taxes on the wealthy because that's where all the money is. According to California Franchise Tax Board data, in 1979 the top 10 percent of taxpayers had about one-third of the state's total adjusted gross income. In 2005, their share had grown to roughly half.

If the pundits know a way to balance the budget, reduce the share of taxes paid by the wealthy, and not widen this growing income gap between the wealthy and everybody else, they should let us in on the secret.

Budget Confusion in California

Mark Paul — Wed, 07 May 2008 20:25:00 -0400

As usual, California faces a budget crisis. And just as predictably, Californians are mired in budget confusion.

How big is the crisis? a conscientious citizen might ask. The answer is: As big as you want it to be. Just take your pick. An "$8 billion budget shortfall," reports the San Jose Mercury News. "A $10 billion gap," says the Sacramento Bee. Gov. Arnold Schwarzenegger uses a more technical description: "$20 billion out of whack," he recently said.

This cacophony of numbers and nouns is a big piece of California's budget problem. Not only does California routinely fail to balance its budget, it can't even talk straight about its finances.

In normal accounting and common understanding, a budget is balanced when spending doesn't exceed revenues in a budget year. If revenues are greater than spending, the difference is a surplus; if spending exceeds revenues, the difference is a deficit. Revenues are the proceeds of taxes, fees, and interest on investments.

But not in California. Here, state leaders (and the press) variously and promiscuously refer to the state's budget problems as a "shortfall," a "hole," a "gap," and a "deficit." Sometimes they actually mean to talk about the annual deficit. More often than not, though, they are referring to an amalgam of the state's cash reserve at the beginning of the current year, a current year deficit, a projected budget year deficit, and the desired reserve for the budget year. As UCLA Prof. Daniel Mitchell, who's campaigned tirelessly (and, alas, so far unsuccessfully) for budget transparency, points out, California's bad habit of talking about this "shortfall" confuses a stock (your savings account) and a flow (your paycheck), obscuring the true size and nature of the state's deficit. Most households understand that if they earn $50,000 a year and spend $100,000, making up the difference from their savings, they don't have a balanced budget. California doesn't. Even if it spends more than it collects in taxes, California counts the budget as balanced if has sufficient cash reserves to make up the difference.

To understand how badly confused California is, just imagine what national budget discussions would be like if the same loose terminology were used in Washington. News reports would be talking about Washington's "$5.5 trillion budget shortfall": the $350 billion deficit for the current year and the projected $200 billion deficit for the 2009 budget year, all topped off by the $5 trillion of outstanding public debt rung up by Congresses and presidents since they powdered their wigs and buckled their knee britches.

California is also confused about the meaning of "revenues." For example, at a recent budget conference, Thomas Sheehy, a deputy director of California's Department of Finance, was asked whether Schwarzenegger would consider raising revenues to balance the budget. Sheehy replied that the governor's budget, in fact, already included new revenues: $3.3 billion from the sale of deficit bonds!

Don't try this at home. The cash advance you take out on your credit card isn't revenue. It's debt. And so, of course, is California's borrowing to cover up deficits. When the top people in the state's finance department think debt is revenue, you know California's fiscal problems go all the way to the bone.

Getting the accounting right isn't just a cosmetic nicety. It's essential to making good decisions. In 2003, former Gov. Gray Davis hyped the size of the state's budget problem, talking about a $38 billion "shortfall." He apparently believed the bigger the stated challenge, the more likely California would be to tackle it. He was half right. Californians were indeed appalled by the size of the "shortfall." But they responded not by supporting Davis' proposed solutions, but by recalling the feckless leader who'd let the problem grow so big.

Now Schwarzenegger seems to be taking the same path, talking about a budget that's "$20 billion out of whack," the equivalent of one dollars out of every five in the general fund budget. He apparently hopes to bludgeon lawmakers into budget action. It's more likely, though, that exaggerated figures will only make Californians throw up their hands in hopelessness.

In fact, California's real problem is more manageable: an annual deficit of about $5 billion to $8 billion a year. That amounts to about a half penny on a dollar of state output and is about the same magnitude as the state's annual cost ($6.1 billion) for Schwarzenegger's car tax reduction in 2003. Schwarzenegger has spent much of the year trying to sell Californians on various kinds of budget reform, most of them with little relevance to the crisis at hand. But he doesn't need anyone's consent to insist on budget transparency and clarity. Budget reform could start right at his own desk.

Any Levers Left?

Sam Sherraden — Tue, 04 Mar 2008 19:39:00 -0500

It is unclear what response, if any, will right the U.S. economy. Chairman of the Federal Reserve, Ben Bernanke, gave a speech today calling for "a vigorous response" to the mortgage crisis and suggested reinvigorating government-sponsored enterprises, like Fannie Mae and Freddie Mac, with increased regulation and possibly writing down the principal on home mortgages. Treasury Secretary Henry Paulson said in a speech yesterday, "Let me be clear: I oppose any bailout." It appears policy makers, officials, and economists still cannot agree on appropriate solutions to the mortgage crisis.

Snapshot asks, what policy will get the U.S. economy out of its current slump and not threaten long run growth?

Bloomberg - U.S. Stocks Fall on Bernanke Plan
Ben Bernanke - Reducing Preventable Mortgage Foreclosures
Morgan Stanley - If Monetary Policy Can’t Do the Job, Then What?
David Greenlaw - Leveraged Losses: Lessons from the Mortgage Market Meltdown
Henry Paulson - U.S. Housing and Mortgage Market Update before the National Association of Business Economists