String of deficits might finally end

By Daniel Weintraub

For as long as many Californians can remember, it seems, the state government has been struggling with budget deficits. Year after year, lawmakers and governors adopt a budget that is supposedly balanced, only to discover – shocking – that the assumptions behind the spending plan were fanciful, or conditions changed, and the red ink overflowed.

Amazingly, this sad history might be coming to an end. Don’t bet your house on it (if you have any equity left with which to bet). But it really does look like change is afoot.

An improving economy, voter-approved tax increases and, yes, spending restraint in Sacramento are combining to give revenues a chance to catch up to spending in the years ahead. Soon the debate in the Capitol might not be about what to cut, but about how to spend a surplus.

The decade-long string of deficits began with the burst of the dot-com bubble in 2001. All through the late 1990s, the technology boom fueled a red-hot California economy. Soaring incomes, investment returns and corporate profits produced more tax revenue than legislators knew what to do with.

That didn’t stop them, though. They spent this “found money” as if it would flow at that rate forever, starting new programs and shoring up old ones. They also cut taxes for business and families.

Then the bubble burst. Tax collections collapsed, but the new spending was on auto-pilot, programmed to continue indefinitely. The tax cuts were mostly locked in place, too, shrinking the tax base. A chasm opened up between revenues and spending that has, for the most part, lasted ever since.

Former Gov. Gray Davis used the last of the 1990s surplus to try to close the gap, but that was good for only one year. He used his executive powers to return the car tax to the rates in place before legislators had reduced it. But the voters then recalled Davis from office and elected Arnold Schwarzenegger, who pledged to reduce the car tax again. He did, and the deficits continued.

The housing boom in the mid-2000s almost got the state back in the black. Schwarzenegger and lawmakers claimed that they had balanced the budget a time or two. But that was mostly with smoke and mirrors, debt-financing and wishful thinking, and the collapse of the housing market ended any chance Schwarzenegger ever had of ending the deficits. The gap between the money the state was taking in and how much it was spending each year persisted.

Enter Jerry Brown. Brown, at 74 years old and doing his second tour as governor, said he had no interest in kicking the budget can down the road again. He wanted to solve the problem. But he also said he would not raise taxes without a vote of the people.

So he clamped down on spending, cutting university budgets, holding K-12 education to the minimum, and slashing health and social service programs. And he gathered signatures for a ballot initiative to raise income taxes on the wealthy and increase the sales tax by a quarter-cent on the dollar.

Brown cobbled together a coalition of interest groups, including labor, and, to a limited extent, business, and persuaded Californians to pass his measure. It will add about $6 billion to the state’s coffers each year after it takes full effect in 2013.

But even that won’t be enough to balance the budget next year. More bad assumptions – about how much the state could take from local redevelopment agencies, and about how much tax the newly enriched owners of Facebook would be paying the state – mean that there’s still a $2 billion shortfall looming in the fiscal year that begins next July 1.

But that gap tiny compared to the scope of the problem that legislators and the governor have been dealing with. And California’s usually sober legislative analyst has projected that in the year after next, a small surplus will sprout. And grow.

By 2018, the analyst says, current spending and revenue trends will combine to produce annual surpluses in the $9 billion range. And that’s after paying for caseload growth in health and public assistance programs, more inmates in the prison system and cost-of-living increases for the schools. In fact, the five-year estimate shows school funding growing by $13 billion even though enrollment will be essentially flat.

The biggest risk to this forecast comes from Washington, D.C. While steady employment growth, solid export numbers and new life in the housing industry suggest that California’s economy is on the mend, most experts agree that the national economy will fall back into a recession if Congress and President Obama do not reach an agreement on the federal budget. If they don’t, on January 1 a series of tax increases and spending cuts are scheduled to take effect that could smother the weak recovery that’s underway.

But if the economy does continue to recover, then California lawmakers and the governor will have to decide how to deal with surpluses beginning around this time next year.

One option would be to set some money aside in a rainy day fund, beginning with the 3 percent annual shift required by Proposition 58, approved by voters in 2004. A healthy reserve would be especially important for two reasons.

First, the taxes voters approved this month are largely targeted at the wealthy, and history shows that revenue from that source is highly volatile. If the economy does slump again in the next five years, the state’s tax collections will dive even more dramatically than they have in the past.

Second, those same taxes are temporary. The sales tax increase expires in four years and the income tax hike is scheduled to go off the books in 2018. If lawmakers build a lot of new spending into the budget now, they will all but guarantee a deficit later, when the tax increases expire.

Other options for spending the money: paying down debt, of which the state still has plenty, shoring up the underfunded public employee retirement systems, and beginning to set money aside to pay for billions in retiree health care costs.

Beyond that, paying for infrastructure out of annual surpluses might be a good idea since construction spending can be turned on and off a bit more easily than spending that is built into government programs. Public works spending not only creates jobs, it has the same effect as a reserve in the way it checks the growth in ongoing obligations.

But these are questions for another day, or another year. The state is still looking at a very real deficit in the coming year, and projections of surpluses on the horizon, while more realistic than every before, remain little more than the best educated guesses of the people who are paid to peer into economic crystal balls.

Daniel Weintraub has covered California public policy for 25 years. He is editor of the California Health Report at

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