Monday, July 19, 2010

The Bear Bones Era Take 2: "Stupid is as stupid does" - Forrest Gump

In January the pun "Bear Bones Era" was introduced here to describe the state of the State of California. The Gubernator in his annual State of the State Message had just offered up his depressing budget recommendation for the fiscal year running from July 2010 through June 2011.

Since then the Legislative Analyst also has offered revenue projections for 2010-11 that are somewhat more optimistic by about $1.4 billion. Building on that, a committee in the State Senate and a committee in the State Assembly each prepared a draft budget reflecting different ways of "optimizing" available cash to support spending programs.

Californians have yet to face the fact that the cash truly available is at the bare bones level meaning "the irreducible minimum; the most essential components." Existing proposals in the Legislature to spend cash are not at the most essential components and by any rational standard are not at the irreducible minimum.

Now we have in Assembly Speaker John A. Pérez, the voters' perfect legislator. Pérez was first elected to the Assembly in 2008, his first job in State and local politics. So, reelected in 2010 and having that really significant two years of experience - ironically more than many of the newly elected Assembly members filling seats where incumbents have been termed out by voter mandate - the Assembly Democrats elected him Speaker.

Favoring the "Progressive" point of view, his budget game plan relies on more taxes and borrowing, and limited cuts to schools and social services. He has strong support from the state's most powerful labor unions. And he shares their ignorance of reality, so has no problem pressuring Senate President Pro Tem Darrell Steinberg whose first goal is to find a way to adopt a budget that works.

Steinberg has a real disadvantage. He has the knowledge gained from experience - as a Sacramento City Council member (1992-1998), an Assembly member (1998-2004), and the Senate (2006-current). He appears to know there is a real problem.

So in the Assembly, we have a leader adhering to the "Progressive" point of view and a Republican block larger than one-third adhering to a rigid "no new taxes or tax increases" point of view. It's the perfect storm of voter accomplishment - a two-thirds requirement for budget adoption and a room full of legislators with no experience representing ideologically firm to mostly ignorant constituencies.

This situation is exacerbated by "hope," mostly the optimistic belief that the underlying economy will improve substantially within a year or two. This causes many to believe that if we can just find some money to borrow to be paid back in ...say... 2015, it will all work out.

In other words, the prevailing mantra is "let's just all ignore the fact that no reason exists to believe that the economy will improve significantly before 2015." California needs to acknowledge we are in a "Bear Bones Era", the first since the 1930's. And by "era" I mean at least a decade.

We needed a "statewide reality check" last year, before the State Budget was adopted. The situation is even more critical now.

The "Cash Flow In" Reality

The starting point is that total cash flowing in to support governmental functions including education will be near the 2004-05 fiscal year level as can be seen on this graph (as with many graphics here, click on it to see a full size version) which includes cash in from temporary and permanent sales and income tax increases plus increased withholding tables, all adopted since 2004-05:

You won't see a graph elsewhere that includes half of the statewide revenue from the 1% property tax rate (set by Proposition 13). The fact is that the State must fund K-12 which means making up the difference between spending and property tax revenue received by the schools.

According to the August 2006 State Board of Equalization publication California Property Tax: An Overview:

The property tax raised more than $43.2 billion for local government during 2006-07. These funds were allocated as follows: counties 17 percent, cities 11 percent, schools (school districts and community colleges) 53 percent, and special districts 19 percent.

It is obvious that changes in property tax revenue are just as important to the State budget as changes in sales tax revenue. A downward change in the trend of property tax revenue has occurred that will impact school funding for at least three fiscal years - the year just completed, 2009-10; the current fiscal year, 2010-11; and the 2011-12 fiscal year.

The average increase in the assessed value, and the corresponding revenue from 1% property tax rate, in the period beginning July 2000 and ending June 2009 was 8.6% a year. In fiscal year 2009-10, the assessed value statewide dropped 2.4%, it likely will drop another 3±% in 2010-11, and (my estimate) drop by 2±% in 2011-12. California has not seen a graph that looks like this since the 1930's:

Any income, sales, or property tax revenue increases of any significance are just not going to happen in the next decade because "it's the economy, stupid," to use a phrase from Clinton's 1992 election campaign.

The Underlying Reality: Our Economy

The second basic reality check is the economy within California. No "recovery" from The Great California Slump will occur any time soon.

First, Californians and their economic experts must acknowledge that it does not matter how well multinational corporations are doing - if that corporate "economy" has begun a recovery, that's nice but nearly irrelevant. Economists point to growth in the world and U.S. economy based on revenue growth reported by multinational corporations. In the U.S. those numbers are included in the Gross Domestic Product (GDP).

But almost no Californian lives for free in a home owned by such a corporation, eats meals prepared daily in that home by employees of such a corporation, dresses in clothing provided by such a corporation, and a large number don't receive health care provided by such a corporation.

The success of an "economy" must be measured in terms of the number of people it benefits through jobs, as argued here previously.

The only important economic question is: "How many Californians are earning from jobs?" The graph below shows 35 years of data - the size of the workforce and the number of jobs in California. Click on the graph to examine a full size version.

The red line indicates that despite fluctuations from month-to-month and year-to-year, the growth of the workforce in our state continues at a fairly predictable, consistent level. The green line shows that beginning in late 2007 the number of jobs plunged to near the level it was in 2000 (purple line).

Simply, the entire decade from 2000-2009 was a private sector jobs-creation zero for California, though many California-based multinational corporations have grown revenue beyond imagination. As I noted previously, this was the first "Lost Decade" of the 21st Century for California's economy. No reason exists for the next decade to be any different (except possibly for the lack of an artificially created employment bubble). Having lost over a million jobs (with more to come as government pares down), there is no reason to believe that income tax and sales tax revenue will increase at any significant rate over the next ten years, if at all.

Property tax revenue will not increase either. As noted above during the period beginning July 2000 and ending June 2009 property tax revenue 8.6% a year and has now begun a decline because of the home price bubble crash. Although more stable than the other tax bases, it has begun a slow decline because of the following:

And while there was a slight increase from 2009 to 2010, the expiration of the federal new home buyer tax credit resulted in a 2.9 percent drop in the median price in June as new home sales plummeted a record 32.7%, largest drop the since the government began collecting such data in 1963.

While it is reasonable to discuss the idea that California has a revenue problem because of declining bases - declining personal income, declining taxable sales, declining home prices - it isn't likely that the voters will allow any revenue rate increases in the near future. This is particularly true with regard to property tax revenue controlled by Proposition 13. Property taxes should be adjusted upward. Which brings us to the crux of California's problem - the voters have mandated costs well beyond the State's revenues. Voter mandated expenditures far exceed what the voters are willing to pay. This isn't surprising as overall voter personal expenditures exceeded what they made in recent decades. Deficit spending is a Californian's way of life but apparently we don't understand that our State and local governments cannot join us, unlike the federal government.

The "Cash Flow Out" Reality - Voter Overspending

California voters have been involved in school funding (Proposition 98 - California Mandatory Education Spending), our prison system (the Three Strikes Law), and a whole host of bond acts, some of which are listed below along with measures to fund anything which were voted down:


1988G 98 California Mandatory Education Spending P
1998G 1A Public Education Facilities Bond P
2000G 39 School Facilities Bonds P
2002G 49 After School Programs P
2004P 55 Public Education Facilities Bond Act P
2006G 88 $50 per parcel property tax; provides public school funding for K-12 F


1994G 184 Sentencing Repeat Offenders P
1994G 189 Denial of Bail; Felony Sexual Assault P
1996P 195 Punishment with Special Circumstances P
1996P 196 Punishment for Murder P
1996G 205 Funding for Incarceration Facilities F
1998P 222 Murder - Punishment P
2000P 18 Murder; Punishment P

1996P 192 Seismic Retrofit Bond Act of 1996 P
1996G 204 Water Bond P
2000P 12 Park Bond P
2000P 14 Library Bond P
2002P 40 Clean Water and Parks Bond P
2002G 46 Housing Bond P
2002G 46 Housing Bond P
2004P 57 Economic Recovery Bond Act P
2006G 1C $2.85 billion bond for low-income housing and shelters P
2006G 1E $4 billion bond for levee improvements and flood control P
2006G 84 $5 billion bond for safe drinking water, flood protection and park improvements P
2008G 3 Children’s Hospital Bond Act. Grant Program P
2008G 1A Safe, Reliable High-Speed Passenger Train Bond Act P

1996G 217 Top Income Tax Brackets F
2004P 56 State Budget, Taxes, & Reserve F

In fiscal year 2001-2002 the effects of the "Dot-com" bubble bursting were seen in the revenue decline of the State, but actual expenditures were almost in line with revenue that year. Since then the Legislature has been blamed by an thoroughly ignorant press for all the subsequent deficits.

In fact, the voters are directly responsible for the spending mess of the State government since 2001-2002. In the three areas where the voters have assumed responsibility for micromanagement, by 2007-08 spending exceeded reasonable increases to keep pace with inflation and population growth by a whopping $33.8 billion. In the remaining areas controlled only by the legislature, increase have been kept under inflation and population growth by $3.6 billion. The chart below lays this out (click on the chart to see a large version):

This year the only real option regarding expenses is to roll back expenditures to near 2004-2005 levels, particularly the Department of Corrections which went up 44% between 2004-05 and 2007-08 and local schools (K-14) which went up 30% in the same period. This would require the voters of California to give up trying to micromanage the criminal justice system with such things a the Three Strikes Law and mandating annual school system funding increases.

The something-for-nothing-mentality that has plagued California government because of voter attitude must stop. The only honest balanced budget for the current fiscal year 2010-11 would be as suggested below.*

The problem, of course, is that such a budget would violate two voter spending mandates, one for local schools and one to overcrowd prisons and jails. At some point after 1970, governing this State became impossible. Some drastic action must be taken to resolve the problem. Continuing to act in a stupid manner just makes us a stupid people. Or as Forrest Gump said: "Stupid is as stupid does."

My solution is to divide the State into three states - see Three Californias.


*Unfortunately, voter approved General Obligation Bond issues require that payments continue to increase and the increase in All General Fund Other State Operations includes the State absorbing into its budget the cost of local courts a few years ago as well as unavoidable costs for supplies and services from the private sector. Also, the year-to-year variation in Resources expenditures results mostly from costs for fighting wildfires.

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