Californification, Part One

California has long been considered a bellwether for the nation – politically, economically, demographically, culturally, you name it.  In the post-WW2 boom, this was arguably a Good Thing.

Is it any more?

Consider the state’s finances.  Larry Greenfield went into detail below.  Let me just add some macro-perspective.

California indeed gouges its residents with high tax rates – 6^th highest in the nation, overall.  It is also, unusually among the states, disproportionately dependent on income taxes, particularly on taxation from the very highest income earners.

Fortunately for California, it has a lot of them.  It’s not just that’s it’s a big state.  It’s also home to two of the world’s most notoriously high-paying industries: Hollywood and high-tech.  Then there are the big banks, law firms and consultancies of downtown LA and San Francisco, the giant agribusiness concerns of the Central Valley, the winemakers in Napa and Sonoma (really, pretty much everywhere these days), the rump of the aerospace industry, and the many lucrative outposts of the state’s vast tourism empire.  All those big houses in Seacliff, Pebble Beach, Montecito, Pacific Palisades and La Jolla?  Real people live in them, and they pay taxes – a lot of taxes.

The result is that the state is disproportionately dependent on those high earners.  In 2004, for instance, 3% of Californians paid an astonishing 60% of all state taxes.

Now, you may think this is “fair” in the sense that many, though by no means all, of those 3% are fabulously wealthy by any standard.  They can afford it.  Right?

Maybe.  But can the state?

What happens in California is a recurring boom-bust cycle, the fiscal equivalent of earthquakes, except more frequent and totally self-inflicted.  Since most of the plutocrats work in volatile industries, their incomes can vary wildly.  In a good year, the state’s coffers swell to the bursting point.  In a bad year, Governors stand on Capitol Mall with a tin cup.

Leaving the fairness question aside, this is a stupid way to run a state.  As a practical matter, here is how it works in California.  A boom comes, for whatever reason: Big year at the box office, fabulous new product from Silicon Valley, global expansion floods the state with tourists, whatever.  Receipts soar.  Politicians in Sacramento spend every last time.  New budget record is set.  This becomes the new “floor” below which we dare not spend without starving children and denying old people life-saving care.  Or something.  Then a recession hits.  Tax receipts fall by as much as 1/3 – an enormous sum no matter how you look at it.  Politicians panic, and come up with a menu of modest cuts, some job attrition here, some IOUs here, and lots of new taxes and fees.  Then, eventually, the good years return, and it’s lather, rinse, repeat.

And this is not to mention the auto-pilot aspect of much of California’s budget, thanks to measures like Proposition 98, which sets “minimum” (read: ever-rising) education spending in the state.  Nor am I giving any thought to all the job-killing effects of all those new taxes and fees, and the consequent outmigration of Californians to other states. Because, frankly, the politicians in Sacramento don’t think about them either.  They just fix their eyes on Burbank and Palo Alto, clasp their hands together, and pray that soon the money spigots will be turned back on any day now.

And, so far, they always have.  This is the third time the state has undergone this cycle in the last 20 years.  Each time, the diversity and strength of the economy gets weaker, but the big boys always find a way to make up for it.  Will that happen forever?  You don’t have to believe in the Laffer Curve to understand that taxes cannot be raised with impunity forever before economic activity finally ceases altogether.

When the 1991 budget fiasco hit, the total state budget was a little over $40 billion.  Now the deficit is that big.  18 years later!  The budget is more than three times as large.  Is the state three times larger?  Three times a better place to live?

(By the way, everything I have written about California applies in spades to New York, especially the City; you just need to change the examples.  Wall Street for Hollywood, Big Media for Silicon Valley, etc.)

Why is this important if you don’t live there?  Because the finances of the United States are heading in the same direction.  President Obama wants to take an increasing number of people off the income tax rolls forever.  Analysts say that already fewer than 50% of Americans pay income taxes.  As that figure goes down, reliance on the few payers must go up.

The President also says that he wants to introduce more “fairness” into the system, i.e., tax high earners more.  Again, leave aside for the moment whether this is truly fair or not.  Is it wise?  Do we want to bet the finances of our country on one volatile source of revenue?

Then there is auto pilot spending: plenty of that in the federal budget.  Entitlements’ share are now about 60%, almost twice as much as 50 years ago.

So all the elements of a recurring California-style fiasco are in place at the federal level.  Why would we choose this for ourselves?

The feds have two luxuries that California doesn’t.  They can print more money, or they can borrow it to close the gap.  Right.  How has that been working out for us lately?