California is in desperate fiscal straits, facing a nearly unbridgeable deficit of $16 billion, the result of spending that continues to exceed estimates and tax revenue that fails to meet them. Those in better-governed states who are tempted to sniff at the Golden State’s comeuppance, however, should bear in mind that California’s position as a national trendsetter is still quite secure: What is happening in California is very likely to happen in other states — and possibly at the federal level — if action is not taken. There are lessons here for both the Left and the Right, and those who would not sink with California as it falls into a sea of red ink would do well to study them.
California’s present condition is the direct result of welfare-state governance in its full maturity. Intransigent public-employee unions use the collective-bargaining process to maintain their inflated compensation packages, while poorly administered programs for the elderly and indigent have produced a permanent dependent class with attendant expenses that are difficult or impossible to reduce: When Governor Jerry Brown attempted to impose co-pays on some recipients of medical benefits, the Obama administration blocked him. Governor Brown’s attempts to cut spending on health care by lowering some physicians’ reimbursements and subsidies for low-income Californians were blocked by the federal courts. Governor Brown has demonstrated very little that might be called fiscal responsibility, but such attempts as he has made at spending discipline have been blocked by federal authorities when they have not been blocked by Democrats in the state legislature. Those who suspect that Obamacare may turn out to be more expensive and less effective at controlling costs than its admirers have claimed should take a good long look at California to appreciate the difficulty of rationalizing out-of-control health-care spending in a single state. (And multiply by 50.)
California’s finances will not be meaningfully reformed until its public sector is reduced and disempowered, and its health-care spending is made sensible. There are significant legal roadblocks to achieving either end, which is why California’s debt-service costs are pulling away from those of the rest of the United States and heading in a distinctly Spanish direction.
Governor Brown has, in the conventional Democratic fashion, proposed raising taxes on certain high-income Californians to try to close that $16 billion deficit. California, like the nation at large, already relies disproportionately on the high-income for its tax revenue, a situation that produces inherent instability: When less than a tenth of taxpayers provide the great majority of tax income, receipts are likely to be volatile in the best of circumstances. Add to that the fact that the very wealthy — especially Silicon Valley’s cosmopolitan entrepreneurial class — have options about when, how, and where to get paid. California expects to raise $1.5 billion in taxes from a single firm, Facebook, as employees and investors realize capital gains from the company’s initial public offering of stock. But such expectations are far from assured: The Brazilian-born Eduardo Saverin, Facebook’s cofounder, has renounced his U.S. citizenship and taken up residence in Singapore, probably not for the city-state’s rich cultural milieu but because it does not tax capital gains. Others will not go so far as to cross the Pacific; for many, getting out of California will be sufficient. As California has just demonstrated, raising tax rates is not the same thing as raising tax revenue. Capital is fungible, and people are mobile.
In fact, California’s income-tax revenues are down by 21 percent, in no small part because of a decline in capital gains and other investment income. Raising tax rates and imposing new taxes, as Governor Brown proposes, would provide incentives for those gains to happen elsewhere — and, ultimately, for investment and jobs to follow them. That trend already is under way: A survey of CEOs in April ranked California dead last among the states as a place to do business.
For conservatives, the lesson to be learned from California is the danger of counting too much on economic growth. Many of California’s current fiscal problems were made worse by wishful thinking about growth and its effect on both the revenue and the expense sides of the balance sheet. During the primary campaign, the Republican presidential candidates were almost to a man heavily invested in irrationally optimistic expectations about economic growth. Mitt Romney’s tax plan, for example, in order to achieve revenue neutrality, must rely on growth assumptions that are more optimistic than current professional forecasts. Growth is of course a main goal, and its achievement is to be welcomed, but we must not use hypothetical future growth as an excuse to put off difficult taxing and spending decisions in the present.
California is one of our most beautiful states, and still one of our most enterprising and innovative. Its universities are a national treasure. That it has been reduced to this is a fearsome reminder that fiscal policy is not in the end about entries in the ledger but about the real quality of life for citizens. California has squandered its wealth, and the public-sector unions have looted the taxpayers. As goes California, so goes the nation — unless we act.