Remember how a few weeks ago the governor of California, Jerry Brown, was making the media rounds to talk about how he had managed to balance his budget? I heard him on NPR explaining how a mix of tax increases and spending cuts was the secret of his state’s new fiscal health. The Economist even had an editorial on the governor’s surprising announcement:
CALIFORNIA’S governor, Jerry Brown, has never bothered to disguise his irritation with those who mock the Golden State as America’s answer to Greece. So it was with some relish that he strutted before journalists, on January 11th, to announce that California had eliminated its budget deficit. The general fund (which accounts for about two-thirds of state spending, bar federal transfers) would, he predicted, end the 2013-14 fiscal year $851m in the black. Surpluses of varying size were projected for the next three years.
Even better, the provisional budget he unveiled did not, for the first time in years, take an axe to public services. Instead Mr Brown was able to increase spending on schools and universities by around 5%, and to avoid cuts in most other areas. Money was found to help the state meet its new obligations under Barack Obama’s health-care law. Listening to the governor giving the news was like “waking up from a nightmare”, said a San Diego college official.
I am sure that I wasn’t the only one not quite buying it. In fact, even The Economist added:
On January 14th the independent Legislative Analyst’s Office (LAO), which in November had forecast a $1.9 billion deficit in 2013-14, said that the books were “roughly in balance” without quite agreeing that the deficit had gone. Mr Brown’s numbers are no more than best guesses: he must revise his budget in May after 2012’s tax returns come in. But this is a solid achievement for a governor who just last May took to YouTube to announce that “much greater” cuts were needed to deal with a deficit that had ballooned to $16 billion.
Today, the Examiner’s Conn Carroll has a piece exposing some of the reasons why this fiscal health may be just an illusion:
Brown’s budget not only assumes $1.1 billion in higher income and sales tax revenues than the November projections, but it also takes advantage of an additional $1 billion in revenues that will supposedly be created by the state’s new cap-and-trade program and the elimination of certain development tax breaks.
But Brown was hardly in a position to make such assumptions. Before his speech, the first round of cap-and-trade auctions had already taken place, producing only 14 percent of expected revenue. In addition, California’s state controller had already released numbers in December showing that actual tax collections were 10.8 percent below projection.
Will any of Brown’s magic new revenue actually materialize in state coffers? History suggests it won’t. A recent California Common Sense study showed that, since the recession began, governors’ budget projections have overestimated revenue by an average of 5.5 percent. Apply that average to Brown’s 2013 projections, and California’s budget would suddenly go from $1 billion in the black to $3.9 billion in the red.
Budget projections that seem too good to be true should, obviously, be taken with a grain of salt. This is especially true considering California’s long-term fiscal problems. It means that a balanced budget in the short run won’t be enough to fix the state’s over-commitment or under-funding of its public employees’ pension and health care costs .
We can’t be sure what will happen yet, of course, but California may also provide another example of a balanced approach to deficit reduction that has gone bad. If that’s the case, we shouldn’t be surprised. The academic world has already produced great insights into what can be done to help a country or a state reduce its debt problem. The data show that countries that try to address their debt problems with lots of tax increases and little spending cuts fail. The ones who adopt fiscal-adjustment packages consisting mostly of spending cuts successfully reduce their debt to GDP ratio.
Carroll’s piece is here.