Why Is California in Economic Trouble?

by: Eric Falkenstein

If you feed them they will keep coming back until you have no food, and then you are the food.

California is asking for a federal guarantee of their debt, because they are cash strapped and don't want to pay the extra money investors are demanding. As they face a 33% shortfall in revenues and expenditures, they have a lot of work to do. But never fear, in their words:

California already has cut $15 billion and raised taxes by nearly $13 billion this year. Schwarzenegger has proposed cutting nearly $20 billion more, including eliminating California's welfare-to-work program and getting rid of health insurance for 930,000 poor children.

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That's funny. Their payroll keeps rising, so too total spending. The 'cuts' are hypothetical cuts from projections, sort of like when my wife saves us $50 by buying a pair of shoes yet foresaking a nicer pair.

Paul Krugman sees the problem as a lack of taxes:

The seeds of California's current crisis were planted more than 30 years ago, when voters overwhelmingly passed Proposition 13, a ballot measure that placed the state's budget in a straitjacket.

Even more important, however, Proposition 13 made it extremely hard to raise taxes, even in emergencies: no state tax rate may be increased without a two-thirds majority in both houses of the State Legislature.

A theory clearly 'too good to check'. State spending in the past two decades, as this Reason Foundation report (.pdf) spells out, has increased 5.37 percent a year (and nearly 7 percent for the past decade), compared to a population-plus-inflation growth rate of 4.38 percent. If the budget growth rate had been limited to the population-inflation growth rate, the state would be sitting on a $15 billion surplus right now. The California tax burden is not unambiguous because it comes from a variety of sources, making it multidimensianal, but on almost all measures it is among the highest of the 50 states, in contrast to the theory proposed by Krugman.

Just as the investment frauds are not revealed in good times, bad governments are not exposed until recessions. And so too Nobel-prize winning economists.