Saturday, 28 February 2009

California's dysfunctional budget

If California was an independent country, it would be the seventh largest economy in the world. With a Gross State product of $1.5 trillion, its a larger economy than India. Its head of state would certainly attend the G7 and G20 summits. For an economy of its size, the state budget is so dysfunctional, that it beggars belief. I would even trade India's budget, which I had commented upon here and here, for something as dysfunctional as California.

Firstly the numbers. Like all governments, California also follows a single entry system of accounting - there is no balance sheet and revenue and capital is mixed up. This year, they just passed the budget two days ago after the annual spectacle of brinkmanship. As presented originally, it has a $42 bn hole - expenditure higher than revenue by $42 bn. The approx numbers were $101bn in revenue and $ 143 billion in expenditure. Pause for a moment and consider this shortfall. The shortfall is higher than the entire expenditure of every other state in the US bar New York. The shortfall is higher than the GDP of 100 countries in the world. To the credit of the lawmakers, they at least tried to part plug this hole. They raised taxes by $ 15bn and cut expenses by $ 13 bn. There is still a huge gap.

Why did this come to this ?

On the revenue side, California depends largely on personal income tax and corporation tax for its revenues. As the financial crisis bit in 2008, revenues have plummeted.

On the expenditure side, California is an example of democracy sometimes gone wild. Citizen initiatives that are directly voted on by the electorate can decide what is to be spent, without any reference to the budget situation. Consider the following

  • Proposition 98 in 1988, perhaps the most famous of the initiatives, has locked $30 bn for education. Nobody can touch that even if theoretically revenues fall below 30bn.
  • Proposition 10 in 1988 has locked $ 522 m for childhood development
  • Proposition 71 earmarks $ 3 bn over 10 years for stem cell research
  • Proposition 12 of 2008 mandates a cost of $ 1.8 bn over 30 years to fund veterans to purchase farms and houses
  • Proposition 1A of 2008 mandates $10bn in bonds to cover a high speed rail link mainly from San Francisco to Los Angeles (what has the world come to - a Los Angelite to travel by train instead of a car ?)
Each is a separate proposition where a voter says yes or no. What do you expect - you can't seriously vote no for veteran's welfare. Who's going to foot the bill is not the voter's problem.

One of the most famous Propositions is Proposition 13 in 1978 whereby property taxes are mandated to be no more than 1% of assessable value which cannot be increased by more than the rate of inflation (doesn't matter whether there is a property boom or not).

Californians should not allow this to go on. No "single entry" Proposition should be passed - if there is a proposition to spend more, included in it must be where the money will come from (not from borrowings). If there is a tax limiting proposition, included in it must be what expenditure will be cut.

And on the governance side, California requires that the budget is passed by a two thirds majority of the Legislature. Neither the Republicans nor the Democrats will have a two thirds majority. California now has a Republican governor and a Democrat majority in the legislature. Just in case nobody has noticed, bi partisanship has gone out of fashion . Hence the annual spectacle of brinkmanship - no compromise, governor threatens to sack all employees, some last minute compromise after sleepless nights is reached and the cycle starts all over again.

But its not for nothing, that California has some of the most dynamic people in he world. In 2008, they did pass Proposition 58, requiring a balanced budget - its why in the latest round taxes did go up and expenditure did get cut down. If not for this, I don't think there would have been any cuts at all.

In the Nov 2008 round of propositions, about $ 227m was spent on campaigns for the 12 Propositions that were on the ballot. I suggest to the Californians that they consider scrapping the citizen initiatives and put this money into the budget pot. That might help !


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