Direct democracy and accounting tricks

Writing in the Financial Times, Christopher Caldwell puts his finger on the real problem with the budget in California where a bill was just passed to close a $26 billion deficit.

California’s problems are those of “direct democracy”. The state’s laws are shaped by plebiscites to a degree unmatched outside of Venezuela. In voting on “propositions”, which sometimes touch on detailed budgetary matters, citizens of the Golden State have stood up consistently for two principles: the state should provide vastly more services to its citizens, and citizens should pay vastly less to the state. In 1978, Proposition 13 halved government’s take from property taxes; a decade later, Proposition 98 required the state to spend 40 per cent of its “general fund” on schools. Adding to the problem is the requirement of supermajorities for raising taxes.

If not for the enormous tax revenues produced by two housing bubbles (peaking in 1990 and 2005) along with an internet stock bubble (peaking in 2000), legislators would already have faced the tough challenges that have stymied them recently.

Unfortunately, they're probably expecting yet another asset bubble to save them again as the solutions to the state's financial woes are clearly anything but long lasting.

But much of the budget plan hammered out on Monday consists of accounting tricks. Unable to go to the banks to borrow, the state is borrowing billions from local counties and communities by simply not disbursing the money it is supposed to. If cities really want their programmes funded, they can try the credit markets themselves. A payday that was supposed to come next June has been pushed back into July, so that it will fall in the following fiscal year. Another trick is the accelerated withholding of state income tax. Instead of deducting 25 per cent of taxes per quarter, the state will deduct 70 per cent in the first six months of 2010, so that 20 per cent of revenues from the next fiscal year will be brought forward into this one. This is not a solution. This is changing your phone number so you can get some rest from the bill collectors who are dunning you.

The really bad news is that, just when there appears to be some breathing room (these budget talks went on for, what, nine months), an update to revenue projections is likely to show that there is more "work" to do to make ends meet.

Until the economy rebounds (i.e., a new bubble begins to inflate), the state is likely to be in "perpetual crisis" mode, an inkling of what the future holds provided in this report.

But Gov. Arnold Schwarzenegger and legislative leaders said they might have to deal with more red ink in a few months if the state's economy doesn't turn around.

"We are still in troubled waters; there are still uncertainties," the Republican governor said. "We don't know how much longer our revenues will drop. We don't know if we may not be back in the next six months to make further cuts."

Legislative leaders said much the same thing.

"It's entirely likely we will ultimately see further declines in revenue, which will almost certainly require further budget action," said Assembly Minority Leader Sam Blakeslee, a Republican from San Luis Obispo.

This saga of the California budget crisis is far from over.