Tag: deficit

No Longer California Dreamin’

The reason why I am not a liberal is because liberal means can never achieve liberal ends—and nowhere is that more apparent than in the state of California. For decades, California has been an enclave of liberalism, an experiment in liberal governance and liberal ideology. Even when Arnold Schwartzenegger was elected governor, ostensibly as a Republican, he governed as a center-leftist. The Republican Party in California has become a virtual irrelevancy, and the California Legislature is now subject to Democratic super-majorities in both houses.

And what is the result of California’s full-throated embrace of liberal policy? This article in The Washington Examiner lays the truth bare:

What are Californians getting for all this government spending? According to a new census report released Friday, almost one-quarter, 23.5 percent, of all Californians are in poverty. One-third of all the nation’s welfare recipients live in the state, despite the fact that California has only one-eighth of the country’s population. That’s four times as many as the next-highest welfare population, which is New York. Meanwhile, California eighth-graders finished ahead of only Mississippi and District of Columbia students on reading and math test scores in 2011.

Middle-class families that want actual jobs, not welfare, are fleeing California in droves. According to IRS data compiled by the Manhattan Institute, since 2000, almost 2 million Americans have left California for other states. Their most popular destination: Texas.

It is ironic that the Democratic Party champions itself as guardians of the middle class, when California shows how liberal policies have the effect of hollowing out the middle class. California has become an enclave for the super-wealthy and the super poor—those in the middle take the worst squeeze. California has become a state where income inequality is some of the highest in the country, despite the notion that liberal social and fiscal policies will create a more equitable society. Despite years of liberal policymaking, California has not become a more equitable place to live.

At the same time, California’s tax rates are some of the highest in the nation. While liberals love to argue that Proposition 13, which limited the Legislature’s powers to raise property taxes, are the reason for California’s woes, the truth is far different. California has some of the highest tax rates of any state in the country, and has a highly progressive tax structure with seven brackets. Despite having a tax system that does everything that the left argues should be done, California is a fiscal basket case.

So what is California’s real problem?:

The real cause for California’s fiscal crisis is simple: They spend too much money. Between 1996 and 2012, the state’s population grew by just 15 percent, but spending more than doubled, from $45.4 billion to $92.5 billion (in 2005 constant dollars).

California simply spends far more than it takes in, despite having some of the richest parts of the country, California’s unquestionable prosperity cannot accommodate the needs of an ever-expanding government. And the response of California’s left-wing government has been to further raise taxes, forcing an even-greater exodus of middle-class jobs to states like Arizona and Texas. What we are seeing is a state that is coasting by on past successes, but rapidly reaching the inflection point where California threatens to become a failed state.

If that seems like hyperbole, it is not. We can already see it happening on the municipal level. The city of Stockton, California has become the largest municipality in the country to file Chapter 9 bankruptcy. (Chapter 9 is a rarely-used part of the federal Bankruptcy Code that allows cities and counties to reorganize their debts in the same way that companies may file Chapter 11 bankruptcy.) But Stockton isn’t alone: three other California cities have also filed for bankruptcy protection, an almost unprecedented event.

The root causes of these bankruptcies are overly-generous public-sector pensions that are no longer sustainable, massive public spending, and tax revenues that are shrinking as the middle class flees for more sustainable climates. Yet these trends are not being fixed, they are being exacerbated as Sacramento continues to push for more and more spending and higher and higher taxes.

Indeed, California faces a fiscal time bomb that could swamp the entire state. CalPERS, the public-sector pension system in California is facing a fiscal crisis. It has even resorted to filing lawsuits against bankrupt cities to try and get additional money to remain solvent. As California’s tax base becomes increasingly polarized, the flow of money needed to give public-sector employees lavish benefits decreases. But the powerful public sector unions have a stranglehold over state government, which makes meaningful reform virtually impossible. When CalPERS goes bust, as is inevitable, the economic effects would be dire.

And that doesn’t even get to immigration: California’s lax immigration enforcement and lavish welfare benefits have created a massive Latino underclass. Illegal immigration costs California taxpayers up to $1.6 billion every year, a sizable fraction of California’s overall yearly deficit. Even if those costs are inflated, the very real cost of providing benefits to hundreds of thousands of illegal immigrants is having an effect on California’s already-precarious fiscal situation.

The California Canary in the Fiscal Coal Mine

California’s looming failure is a warning to the rest of us. California is being buoyed by its prior good fortune, it’s abundant natural resources, and its excellent climate and geography. But even these natural advantages cannot hold its decline at bay forever. Should nothing change, California will face fiscal collapse, and it could take the rest of the country down with it. A fiscal crisis in California would have massive ripple effects across the entire United States economy. But the political will for reform is simply not there. With no effective resistance to the liberal orthodoxy in California, there is nothing to slow down the stream of bad policies contributing to this mess.

But what cannot go on forever will not, and sooner or later the results of these bad policies will hit in full force. Sooner or later the unsustainable trajectory that California is on will meet the ground, and when it does, the end result will be messy at best—and that’s the most optimistic way of putting it.

What California show us is that liberalism is rife with internal contradictions. Liberalism teaches that economic inequality is dangerous, yet years of liberal policies have produced shocking inequality in California, The rich Los Angeles suburbs like Beverly Hills, Malibu, or Brentwood exist just miles from some of the most blighted urban landscapes in the country. Liberalism says that the middle class must be defended, yet California’s middle class is fleeing the state, and those that remain are getting squeezed ever tighter by high prices and high taxes. Liberalism says that government should be the solution to our problems, but California’s government is one of the most dysfunctional in the country. California is proof that liberal means can never achieve liberal ends—and each year those contradictions only grow.

What California needs is a complete reorganization. California can succeed, it has all the natural benefits in the world and still enjoys the benefits of being a center for technology, aerospace, biotech, and other fields. Despite California’s brain drain, it still has a substantial part of its educated workforce left. The ingredients for success are all there, but California’s dysfunctional government and left-wing hegemony is keeping it from success.

Restoring California’s Dream

What California needs is to reform its pension system, even if it creates massive political costs. It needs to dramatically cut unnecessary spending, including stopping giving such lavish benefits to illegal immigration. Proposition 13 may have kept California’s property taxes artificially low, but that’s been offset in some areas by insanely high property values in certain areas of the state. Property tax reform may well be necessary, but it should be combined with a simpler, flatter, and less punitive income-tax system and a reduction in both business taxes and unnecessary regulations.

California has benefitted from a highly-educated workforce, but that cannot continue so long as California’s schools are failing, both K-12 and higher education. Instead, California needs to do what the rest of the country must do: reform the educational system from a sinecure for bureaucrats into a result-driven system that teaches the skills needed for the 21st Century workforce. Right now many of the people working for California’s high-tech industries are foreigners on H1B visas—and while those workers add a great deal to the state, it’s not sustainable over the long term. Developing a better educational system will make sure that California can maintain its high-tech economy into the future. If they fail to do that, California will become an also-ran.

California demonstrates the reasons why liberalism doesn’t work: because if you do everything that liberalism says, you don’t get a more equitable or modern economy. The problem is that for many of the stakeholders in California’s broken system, there is no impetus to reform. The public sector unions have every reason to keep sucking at the teat until it runs dry. The educational bureaucracy has no desire to reform and threaten its gravy train. The ultra-rich don’t care what tax rate they pay because they have enough wealth that the difference between losing 10% to taxation and losing 5% ultimately doesn’t impact their standard of wealth. A Hollywood movie star doesn’t care what their tax rate is, they are paid an obscenely large amount of money and their finances are handled by an army of lawyers and accountants. The small business owner who can only afford a part-time bookkeeper is acutely aware of the impact of taxation. Yet the Hollywood celebrity has far more political clout than the small-business owner.

Sadly, the only way that this system will likely be reformed is when there is no other way possible. The liberal welfare state is ultimately unsustainable, but is extremely difficult to reform. California was once a symbol of America’s cultural, technological, and economic might. Yet now it is becoming a warning. If we fail to heed that warning, California dreamin’ will become a national nightmare.

The Shrinking Deficit

Megan McArdle observes that the national budget will be nearly balanced by the time George W. Bush leaves office, provided that current trends continue:

Thanks to George Bush’s amazing deficit reduction plan, the budget deficit is now only 1.2% of GDP. If this trend continues, by the time George Bush leaves office, the budget will be within a hair’s breath of being balanced. I can only hope that Democrats don’t squander this precious legacy of fiscal responsibility.

Just kidding! Not about the budget deficit, I mean, but about the reason for it. The reason the budget deficit has closed is a combination of economic growth and increasing inequality, which has allowed the government to collect more revenue on a smaller base. The rich really are different–they pay higher tax rates.

McArdle argues that it’s not Presidential policy that drives these changes, but larger macroeconomic factors. While that’s certainly true to a point, I don’t think that one can dismiss the role of Bush’s tax policies in driving those two factors of economic growth and income. The economic growth of the past few years has come in spite of the collapse of Enron and WorldCom, in spite of the aftereffects of the September 11 attacks and in spite of high oil prices. There’s a very strong argument to be made that the last few years of economic growth are attributable to a national policy of low taxes encouraging productive investment. That isn’t the whole story, but it is a very crucial part of why these last few years have seen solid levels of economic growth.

It’s also interesting that the standard Democratic argument against the Bush tax cuts is that they reduce the tax burdens on the rich. Yet the empirical evidence suggests that the tax burden is shifting the opposite way. Ms. McArdle is correct: the tax base is shrinking, and more is being gathered from a smaller subset of the population. From an economic perspective, that’s helping fuel the reductions in the deficit. Politically, such a thing can foster a sense of entitlement and dependence which is unhealthy over the long term.

The evidence indicates that the Bush tax cuts did what they were supposed to do: increase economic growth and tax revenue. The fact is that in 2003 the Congressional Budget Office predicted $2,421 billion in income tax revenues for 2007. The predicted tax revenue for 2007 now is $2,574 billion. The deficit has decreased to 1.5% of GDP, which is lower than it has been for 24 of the last 30 years. Economic growth remains strong despite the sub-prime mortgage scare and the unemployment outlook for the last few quarters has been revised upwards to show continued job growth.

All the fundamentals are working, but the real problems are spending and entitlements. It won’t matter whether we’re running a deficit or a surplus when the bill for Social Security and Medicare comes due. None of the reduction in the deficit came from cuts in spending, with spending still increasing far above the rate of inflation. The looming entitlement crisis guarantees that any advances made in the next few years will be nothing compared to the liabilities incurred when the Baby Boomers start hitting retirement age. The priorities for the next administration must be in reigning in both the out-of-control levels of spending and the equally out-of-control levels of mandatory entitlement spending. If those problems aren’t fixed, none of the progress of the last few years will matter much.

UPDATE: Ramesh Ponnuru notes that tax cuts do lower overall revenue. I would argue that it is possible to have a tax cut that pays for itself, but that would require a much higher marginal rate than we’ve had in decades. The reason why the Bush tax cuts should get some credit for the surge in revenues is because of their collateral effects. One of the biggest sources of increased revenue was on strong corporate profits, and those can be attributed to a combination of low interest rates and tax policy that is conducive to new investment.

Ultimately, federal revenues are much more dependent on the overall health of the economy than on tax policy. Worrying about maximizing federal revenue is the wrong approach; the primary concern should be in maximizing overall economic growth. The Democrats tend to obsess over the former, while the Republicans look to the latter. Tax cuts won’t necessarily bring an economy out of recession by themselves like some Republicans claim, nor will they cause one as some Democrats claim. Monetary policy has a big impact, as does productivity, the balance of trade and other factors large and small.

That doesn’t mean that tax cuts aren’t sound policy—they most certainly are, but the case that tax cuts by necessity pay for themselves isn’t the strongest.