California's Greek Tragedy
No one should write off the Golden State.
But it will take massive reforms to reverse its economic decline.
Long a harbinger of national trends and an incubator of
innovation, cash-strapped California
eagerly awaits a temporary revenue surge from Facebook IPO stock options and capital gains. Meanwhile, Stockton may soon become
the state's largest city to go bust. Call it the agony and ecstasy of
contemporary California.
California's rising standards of living and outstanding public schools and
universities once attracted millions seeking upward economic mobility. But then
something went radically wrong as California
legislatures and governors built a welfare state on high tax rates, liberal
entitlement benefits, and excessive regulation. The results, though
predictable, are nonetheless striking. From the mid-1980s to 2005, California's
population grew by 10 million, while Medicaid recipients soared by seven
million; tax filers paying income taxes rose by just 150,000; and the prison
population swelled by 115,000.
California's economy, which used to outperform the rest
of the country, now substantially underperforms. The unemployment rate, at 10.9%,
is higher than every other state except Nevada
and Rhode Island.
With 12% of America's
population, California
has one third of the nation's welfare recipients.
Partly due to generous union wages and benefits,
inflexible work rules and lobbying for more spending, many state programs and
institutions spend too much and achieve too little. For example, annual
spending on each California
prison inmate is equal to an entire middle-income family's after-tax income.
Many of California's
K-12 public schools rank poorly on standardized tests. The unfunded pension and
retiree health-care liabilities of workers in the
state-run Calpers system, which includes teachers and
university personnel, totals around $250 billion.
Meanwhile, the state lurches from fiscal tragedy to
fiscal farce, running deficits in good times as well as bad. The general fund's
spending exceeded its tax revenues in nine of the last 10 years (the only
exceptions being 2005 at the height of the housing bubble), abetted by creative
accounting and temporary IOUs.
Now, the bill is coming due. After running a $5 billion
deficit last year and another likely deficit this year, Gov. Jerry Brown's
budget increases spending next year by $7 billion and finances the higher
spending with income and sales-tax hikes. Specifically, he's proposing a
November ballot initiative raising the state's top income tax rate to 12.3%,
making it the nation's highest, and raising the basic state sales tax rate,
already the nation's highest, to 7.75% from 7.25%.
While Mr. Brown deserves credit for some earlier spending
cuts to reduce a large inherited budget shortfall, the budget fails to address
long-run structural problems, counting on a cyclical economic recovery and
stock bubble for a bailout until the next self-inflicted crisis. Moreover, he's
thus far failed to embrace a bold reform agenda to save money, improve
services, and restore confidence among the state's beleaguered taxpayers and
bond holders.
The ballot initiative's $31 billion, multiyear
"temporary" tax increase is larger than the "temporary"
hike it replaces and its income-tax hike is retroactive to Jan. 1, 2012. Worse,
it doubles down on excessive reliance on high-income taxpayers, especially
their stock options and capital gains, which are taxed as ordinary income.
During economic good times, it's not unusual for the state to collect one-half
of all income-tax revenue from the top 1%. This extreme progressivity
leads to boom-bust cycles of rapidly rising revenue followed by complete
collapse. Not surprisingly, the revenue is all spent on the upswing, forcing
disruptive "emergency" cutbacks on the way down.
The state's progressive tax-and-spend experiment is
broken, threatening basic services, from courts and parks to education and
health care for its most vulnerable citizens. Mr. Brown's tax initiative only
exposes the state to an ever more dangerous roller-coaster ride.
No wonder many Silicon Valley CEOs say they won't expand
in California
because of high taxes and burdensome regulation. And no wonder net migration
has recently reversed, with hundreds of thousands of workers and their families
leaving the state in search of better opportunities.
California still ranks first in technology, agriculture
and entertainment among the 50 states. But it is near the bottom in business
and tax climate and state bond ratings. It's a complex picture, but at its core
is the high-tax welfare state run amok.
Many Americans fear the federal fiscal train wreck will
turn us into Greece.
But, barring major change, they need look no further than California to see what this future portends.
Relying on ever-higher taxes to fund payments to an outsized population of
benefit recipients is a recipe for exporting prosperity. That is one California trend that
other states emulate at their peril.
No one should write off California. It still has great strengths.
And it can turn some of its short-term challenges, such as the pressures from
ethnic and linguistic diversity (the state is now 37% Hispanic and 13% Asian),
into long-term strengths in the global economy. But the political class must
face up to the reality that services will have to be far more carefully
targeted; the tax system overhauled with lower rates on a broader base of
economic activity and people (almost half of all Californians pay no state
income tax); and inefficient state programs reformed to spend less and produce
far better outcomes.
Mr. Brown is a man of ideas, having run for president in
1992 on a bold flat-tax agenda. Instead of still more antigrowth tax hikes, he
should break the grip on the state legislature of his party's special
interests—public employee unions, trial lawyers, teacher unions and extreme
environmentalists.
A California renaissance—building on the best reforms in
budgeting and taxes, education and welfare, crime prevention and pensions by
such leaders as Rudy Giuliani, Jeb Bush, Chris
Christie and Andrew Cuomo—is still possible. What it requires is a governor
with the vision, determination and political will to see it through.
Messrs. Boskin and Cogan are,
respectively, professors of economics and public policy at Stanford University,
where they are both senior fellows at the Hoover
Institution.
A version of this article appeared Mar. 13, 2012, on page A13 in some U.S. editions of The Wall Street Journal, with
the headline: California's
Greek Tragedy.
http://online.wsj.com/article/SB10001424052702304537904577277242682364690.html