Deficits Up, Revenues Down, The History of a Mess
by Sheila Kuehl
July 9, 2011

Now that California's 2011-12 budget has gone into effect, at least until some revenue assumption proves wrong and triggers more cuts, this set of essays reviews the history of that budget's progress over the last six months, culminating in a report on the final budget, as signed.  This essay is the second in the series, and sets forth a short history of decisions made in the first ten years of the 21st century which have brought California to the brink of fiscal crisis.

Further essays will describe ongoing changes to the original budget made in quickly called Budget Committee hearings in both houses, the budget presented by the Conference Committee, the contentious issue of putting the tax extensions up for a vote of the people, the May Revise, the June budget, the veto, the final budget document, the budget after the Governor wielded his blue pencil, an explanation of "re-alignment" and a final essay on the winners and the losers.      

The 21st Century so far: a Roller Coaster in California
Every November, the Legislative Analyst's Office (LAO) presents a report on the condition of the General Fund, along with a five-year projection of where our finances will end up,  if no changes are made.  The LAO looks at expected revenue and continuing expenditures and projects whether there will be an "operating surplus" or an "operating deficit".

In November of 2000, the LAO projected an ongoing operating surplus of about 3 billion dollars.  Everything was rosy. As you will see below, tax credits and expanded spending abounded.  Unfortunately, it was very short lived.  In each year since 2000, the LAO's projection has revealed an ever-increasing operating deficit.

These sudden ups and downs were essentially caused by three events:  two big "bubbles" that brought in a lot of money and then, suddenly, didn't;  the economic recessions that followed the bubbles and the "let's throw everything at this and see what sticks" kind of budget actions taken in response to both of these.  Add to these circumstances the over-dependence of the state on a narrow set of revenues, and it's inevitable that big changes in those revenues bring big changes to the condition of the budget. 

I'm Forever Blowing Bubbles
The first bubble was the "dot-com" boom during which share values of technology stocks shot up in value and then plunged.  The NASDAQ stock market index (which is home to a lot of the tech stocks) went from 1500 in the fall of 1998 to over 5,000 in the spring of 2000 and then fell below 1500 in late 2001. 

The second bubble occurred because of a housing market that saw increased median resale values for single-family homes shoot up from $262,000 in 2001 to $560,000 in 2007, before falling back to $275,000 in 2009.  The state, which greatly depends on income tax and capital gains tax for revenue, as well as increases in property taxes upon the sales of homes (many large corporate properties, for some reason, have escaped reassessment, even when they change hands), was tied in the car for a dizzying roller coaster ride.

1999-2001
For most of the years prior to the dot-com swell-and-shrink, the budget was more or less in balance without adopting too many tricks or gimmicks.  As soon as we had a burst of new revenue, however, Democrats insisted that the ongoing needs of increases for schools, the poor, the elderly and the sick simply to keep up with inflation had to be undertaken.  Republicans saw the bubble differently, and, insisted on throwing some tranquilizers to the ongoing clamor of radio talk-show hosts for tax relief.  Both of these solutions would be permanent, but the bubble would not.

The biggest ticket item for the budget was the cut in the vehicle license fee (VLF) which reduced the personal property tax on automobiles from 2% of vehicle value to .65%.  Since this money had gone directly to local governments to pay for fire and police services, the state had to "backfill", that is, replace, all the lost revenue out of the General Fund...to the tune of about $6 billion each year.  At the time, this was not meant to be a permanent action, but only a year-by-year reduction until the Governor declared that the budget had dropped sufficiently to reinstate the tax.  It was supposed to be automatic.  There was also a tax credit granted to families based on the number of children in the household, more generous pension benefits for state employees, and an expansion of the Healthy Families program to provide health insurance to several thousand additional children.

2002-2004
The whole thing went "boom" when the dot-com companies began to melt down and, in November of 2002, the LAO projected an operating deficit of over $12 billion at the end of the five-year forecast period.  The following year, it was even worse, when the LAO pegged the deficit number at $15 billion.  The legislature began to cut the budget, with both permanent and temporary reductions, as well as trying to find some temporary revenue.  The party lines were hardening, however, all over the country, and there were few votes for any new taxes.  When Arnold came into office, he made the reduction in the Vehicle License Fee "permanent" and largely tried to resolve the deficits through borrowing.  Convincing the electorate that this was a good idea (after all, credit cards are free money, right?), he added $15 billion dollars in new bonds just to pay the state's debts.  Unfortunately, such large-scale borrowing simply meant that the money paid on borrowed funds would balloon and eat up more and more of the General Fund.

2005-2007
As the value of houses swelled, even though the state continued to see projected budgetary shortfalls, the size of the operating deficit began to shrink.   In November 2004, the LAO projected an operating deficit of about $6 billion at the end of the five-year forecast period, and in the November 2005 Fiscal Outlook, the LAO pegged the number at under $1 billion.  Treating the breather as though it were going to last, the Governor and the Legislature were reluctant to adopt permanent cuts.  The 2/3 vote requirements on raising taxes made it impossible, in the new hard line of party differences, to seek new permanent revenue.  The solution was simply to try to keep the state's nose above water with cuts, cuts, cuts, but not the most bloody, and borrowing, borrowing, borrowing.

2008-2010
Then, it all went "boom" again.  Housing values dropped precipitously as the inflated mortgage securities scams fell apart.  State revenues plummeted as houses lost value, foreclosures abounded and people lost their jobs.  The largest operating deficits in the history of the state began, and the last three LAO Fiscal Outlook projections have all shown operating deficits of about $20 billion at the end of each five-year forecast period.  With the anti-tax forces now solidified and buttressed with threats from Washington anti-tax think tanks (and visits from Grover Nordquist to the Republican caucus to keep them in line), there were no permanent solutions available except cuts, cuts, cuts.  The 2009-2010 budget hacked away at social services and education.  Dental benefits for MediCal recipients were entirely eliminated for the first time, along with many other services.  In the current wave of anti-state worker sentiment, most have ignored the fact that most pension benefits were rolled back to where they had been a decade before, and were further cut back last year.

Although all the spending reductions are permanent, there has been no ability to get agreement to any permanent revenue.  In 2009, a temporary boost in the sales tax and the VLF was enacted that ended on June 30, 2011.  The VLF was lowered from 2% to .65% at the beginning of the decade and was raised to 1.15% of the value of a car for 2009-11 only.   In addition, the state adopted new permanent tax cuts that greatly benefited large corporations, including an optional "single sales factor" apportionment for multi-state corporations, which have been worth about $6 billion in savings each year in the aggregate to those corporations.

Current Problem: 2011 and Beyond

Because there was so much reliance on borrowing during Arnold's terms, the operating deficit has gotten worse, and attempts to fill it with cuts alone, brought about by Republican intransigence on taxes, has devastated public education, services, public safety and health. Additionally, the pace of the national economic recovery is slow and, with manufacturing and other stalwarts of employment mostly off-shored, the unemployment rate remains high.  The budget situation is further exacerbated by the end of federal stimulus funds that were coming to the state.

The issue of "government restructuring", which generally means, "Who's taking in my tax money and who has the authority to decide how to spend it" has taken center stage.  In the early 1990s, there was an attempt to bring services more into the local government sphere and it looks like that may be one of the proposed solutions again.  However, if this simply results in starving counties and cities further by allocating responsibility to them without adequate funding, along with giving them no ability to raise their own taxes or keep what they collect, the solution may be distinctly useless.

Next:  Hurry Up and Wait, Separate Assembly and Senate Budgets Go To Conference