Governor Schwarzenegger’s well-delivered State of the State speech last week won accolades from observers worldwide. The Los Angeles Times went so far as to call it “masterful.” But despite the media hordes and the expected references to the governor’s illustrious film career, the stage is far from set for a Hollywood ending when it comes to California’s looming budget disaster.
If the $15-billion bond measure the governor succeeded in putting on the March ballot is not passed by California voters, the state could face bankruptcy as early as June. Behind the scenes, the governor is advancing what he appears to see as his safety net–the $10.7-billion bond package former governor Gray Davis signed into law last summer. But those bonds are facing a constitutional challenge, which is why Schwarzenegger was forced to put his bond measure on the ballot in the first place. If the challenge is successful, and the ballot measures fail, Governor Schwarzenegger may end up presiding over the biggest public-sector bankruptcy in history.
To understand what California is up against, one has to understand how the state got into this mess in the first place. The state constitution requires only that the governor propose a balanced budget; it does not require that the legislature enact–or that the governor or legislature operate within–one. Because of this, the four-year period from 1999 to 2002 saw the liberal-controlled legislature, with then-Governor Davis’s acquiescence, spend at a rate ten-percent greater than incoming revenues. To put it another way, after exhausting the $12-billion surplus in the state treasury when 1999 began, they continued spending above revenues until they had accumulated an unprecedented debt of $38 billion by the end of 2002.
Annual deficits during that period were covered through short-term loans, repayable under the next year’s budget. Finally, last summer, Davis and the Democratic majority leadership decided that an infusion of new revenue was necessary to cover their voracious overspending. When Republican legislators unanimously refused to go along with tax increases, Governor Davis and the majority members did two things: First, Davis unilaterally tripled the car tax (annually, $4 billion in revenue), and second, the legislature enacted a $10.7-billion long-term deficit-reduction bond measure.
The problem with the bond measure, however, is that it’s prima facie unconstitutional. California’s constitution, going back to the original version of 1849, prohibits the legislature from–”in any manner”–creating a state debt exceeding $300,000 without a two-thirds vote of each house, and approval by a majority of voters at a statewide general or primary election. Either because they feared the “deficit-reduction” bond measure would highlight their reckless overspending, or because it might not garner voter approval, the Democrats and Davis, despite warnings, refused to submit the bond measure to the voters.
In September 2003, the Pacific Legal Foundation filed suit, challenging the bond measure for violating the state constitution’s call for voter approval. This pending challenge received substantial media coverage during the Davis recall election campaign, with most legal analysts predicting its success. Immediately following the election, and several times during the transition period, Governor-elect Schwarzenegger expressed his intention to also utilize bonds, but to first submit them to the voters at California’s primary election slated for March 2, 2004.
Upon taking office on November 17, Governor Schwarzenegger called the legislature into special session and announced his plan to keep California afloat in the short term, consisting primarily of a $15-billion, 30-year bond measure, and a firm constitutional cap on future state spending. Nothing induces heartburn for spendthrift legislators like an effective spending limitation, which made the governor’s spending-cap proposal the centerpiece of the special-session negotiations. His opening demand was a general fund base-year (FY ‘04-’05) spending lid of $72 billion (which would require a $14 billion reduction from current year spending), and unilateral authority to cut further if a mid-year deficit emerged.
The Democratic leadership, however, would accept nothing less than an $83-billion base-year spending cap. (For purpose of comparison, Governor Pete Wilson’s last budget–FY ‘98-’99–was $57 billion.) Recognizing the new governor’s need to get his bond measure on the March ballot with the required two-thirds legislative vote, the liberal leadership played its leverage to the hilt: Their members voted to reject the governor’s proposed spending cap and went home. Within two hours, Moody’s dropped California’s bond rating to near the bottom of its investment grades–at the same level as the District of Columbia and Lithuania.
Adding to the pressure building on the governor, the secretary of state was repeatedly warning that he statutorily could not accept measures for the March 2 election ballot after December 5. While there was some flexibility in this deadline, the governor believed that if he pushed too hard or too long for his $72-billion base-year spending cap, he might not get his bond proposal on the March ballot.
Schwarzenegger decided to compromise. By the end of the following week, both houses had voted to place a $15-billion, nine-year pay-off bond measure on the March ballot (Proposition 57). In return, the governor agreed to the legislature’s watered-down spending cap, requiring only that future annual spending not exceed annual revenues (with no base-year reductions), and including a rainy-day fund for unexpected emergencies (Proposition 58).
But nothing in politics is as straightforward as it appears, and this compromise is no different. Sacramento political commentator Daniel Weintraub has observed that “all three elements (of the deficit-fix compromise) are flawed, perhaps fatally so.” The spending-cap element alone, he points out, contains “a loophole large enough to let future legislators and governors drive a California-sized mortgage through.” His opinion of the deal’s other two elements is no more optimistic.
Yet, as difficult as it was getting the $15-billion debt-restructuring bond measure on the ballot, getting voters to approve the historic measure will be no slam dunk. Financial analysts at Bloomberg News characterize the measure as “the biggest-ever U.S. sale of a corporate or municipal bond.” State Treasurer Phil Angelides, whose job it is to sell the bonds if approved by voters, warns against using such a large bond to address the state’s accumulating debt, calling it “reckless” and a “huge mistake.” A likely Democratic candidate for governor in ‘06, Angelides has indicated his intention to continue campaigning against the use of bonds.
Of greater concern, the respected, nonpartisan state legislative analyst Elizabeth Hill, the legislature’s top budget adviser, cautioned that, with bonds, “future taxpayers will be paying for past spending.” “Borrowing,” she warned, “fails to address the underlying problem the state of California is facing.” Hill urged the painful, but only true solution to that problem: “Bring current law expenditures and current revenues into line.” Several conservative Republican legislators have indicated their firm opposition to the use of bonds for the same reasons. And now, for purely political reasons, some Democratic legislators are openly expressing their opposition to the March-ballot bond measure, despite having voted for it just a few short weeks ago.
To further complicate matters, voters will be confronted–perhaps to the point of confused inaction–with two other significant measures on the March ballot. Proposition 55, the Kindergarten-University Public Education Facilities Bond Act of 2004, asks the voters to approve $12.3 billion in general-obligation bonds. “General-obligation” bond payments come from the state’s general fund, the same fund from which the governor’s $15-billion bonds would be repaid. Even without considering the billions in outstanding “G.O.” bonds that already are being repaid from the state’s general fund annually, payments on the Prop 55 bonds, together with the governor’s $15-billion bonds, would make for an unprecedentedly large hit on the state’s general fund for the next several years.
Also slated for the March ballot is Prop 56, the so-called Budget Accountability Act. This proposition would significantly modify one of Prop 13’s primary achievements by reducing the number of legislative votes necessary to raise taxes, and pass the annual state budget, from a “supermajority” of 66 percent to 55 percent. Prop 56 is heavily supported by the same legislative big-spending Democrats responsible for the state’s current fiscal mess, and would allow them to raise taxes solely within their own caucus. With $60 billion of tax-increase proposals currently pending in the legislature, Prop 56’s passage would wreak havoc on any economic recovery the governor hopes to generate.
With all these competing measures and messages, voter approval of the $15-billion bond measure is far from certain, which is why Governor Schwarzenegger used his State of the State speech to kick off an intensive 10-week campaign to win voter approval. What Governor Schwarzenegger didn’t mention in his address was that he has asked Attorney General Bill Lockyer (another likely Democratic candidate for governor in ‘06) to seek court approval of the earlier-enacted $10.7-billion bond measure that was never submitted to the voters. Why? Schwarzenegger spokesman Rob Stutzman told the Sacramento Bee: “We’ve always said we’ll defend this bond. It’s part of the current budget, and it’s a part of the plan you have to proceed with until you have an alternative plan…”
Whichever way the lower court rules, the certain appeal goes directly to the California supreme court. But if the state supreme court rules that the $10.7 billion in bonds are invalid without a vote of the people, Governor Schwarzenegger’s “backup plan” goes up in smoke. The earliest the legislature could put them on the ballot is the November 2004 general election–far too late to rescue the state from the impending fiscal abyss.
On the other hand, if the court somehow finds the bonds constitutional, it would be the first time in history that such indebtedness was allowed without approval of the people who would bear the burden of paying it. Even worse, such a ruling would dash to the scrap heap of history the invaluable safeguard the old ‘49er constitution’s drafters wisely provided for the people–the opportunity, by vote, to protect themselves and their children from politicians lacking fiscal integrity and discipline.
California, it seems, needs a real-life Hollywood ending.
–M. David Stirling is vice president of the Pacific Legal Foundation.