California is flush with cash. So why the warnings to prepare for recession?

As leaders draft next year's budget, Gov. Brown and economists say state is unprepared for recession

Even as California's leaders prepare a new state budget that is flush with cash, Gov. Jerry Brown has increasingly raised the specter of another recession that could undo years of hard-won financial progress.

When he released his latest spending proposal last month, he said a downturn was "around the corner." In a speech to business leaders, he said the question was "not if, when." And he told county government officials that even a moderate downturn could cost the state $40 billion in revenue over three years.

The governor's warnings may seem overwrought, given that economists see no sign of trouble on the horizon. And state revenue has routinely exceeded even the most bullish projections in recent years.

But the question is whether California has done enough to guard against another budget crisis, and experts say that the answer is a resounding no.

"Is the state prepared for a medium recession?" said Jerry Nickelsburg, a UCLA economist. "State government is not."

California's rainy-day fund was strengthened by voters in November, requiring officials to stash away a portion of California's revenue each year. By next summer, it could contain up to $4.2 billion, according to an estimate from legislative analysts.

But if a downturn occurs then, those savings would cover only a tenth of the potential revenue loss under the governor's recession scenario.

"That fund is not going to be large enough," Nickelsburg said. "It could get wiped out pretty quickly."

Finance experts say that the governor has done little to address California's underlying financial problem — its tax system.

The state pulls about half of its income tax revenue from the top 1% of residents, whose incomes ebb and flow with the unpredictable stock market. Even mild economic ripples can cause big waves in Sacramento.

So although Brown frames the budget debate as a choice between his frugality and lawmakers' largesse, California remains vulnerable either way, analysts say.

"The cycle is not broken," said Jeff Cummins, a Cal State Fresno political science professor who has written a book about the California budget, aptly titled "Boom and Bust."

Brown has said overhauling the tax code — expanding the sales tax to some services or reducing reliance on the wealthy — may not be politically possible in Democrat-ruled California, because it would increase levies on the less wealthy.

"Jerry Brown is a very successful governor, but there are certain things even he would have a hard time doing," said Jack Pitney, Claremont McKenna College political science professor. "It's a tough situation."

If the next recession comes relatively soon and is relatively severe, it could cause new budget shortfalls, force cuts in government services again and derail the state's efforts to tackle some of its deep-rooted financial problems.

In short, it could present a situation like the one Brown inherited when he took office in 2011.

It's a thorny political problem for the governor, who began his final term in office in January and has been widely credited with steering the state out of a series of damaging budget crises.

He faces constant pressure from activists and fellow Democrats to increase spending on such programs as state-subsidized child care, but he does not want to add a lot of permanent expenses that may not be sustainable.

The governor has offered some new assistance, such as a tax credit for poor families. But he is trying to beat back other requests, such as higher pay for doctors who participate in the public healthcare program.

"I love all those programs I veto," Brown said recently, "because I don't want to cut them back when we hit the next recession."

The deadline for lawmakers to pass a budget is Monday. The governor has earned praise from financial analysts for keeping a tighter grip on the purse strings than some Democrats want and focusing on paying off debt incurred during the last recession.

A recent report from Standard & Poor's, the Wall Street ratings agency, said Brown's latest budget proposal could help the state "withstand weaker conditions."

"We are in a much better position today to deal with that economic downturn whenever it occurs than we have been in the recent past," said H.D. Palmer, a spokesman for Brown's Department of Finance.

California's current economic rebound has lasted longer than the five-year average, said Gabriel Petek, who tracks the state's finances for Standard & Poor's. However, he said, that doesn't mean a downturn is imminent.

"An economic expansion doesn't normally die of old age," he said. "There's usually a precipitating factor. And right now, we're not really seeing that."

Technology companies in Silicon Valley have driven a lot of the state's growth in the last few years. Facebook's initial public offering in 2012 was so big that legislative analysts took the unusual step of including the company as a factor in their financial estimates.

Other areas of the economy have also bounced back, and the state's unemployment rate continues to fall.

But economists conceded that it's hard to see downturns coming.

"Nobody saw the depth of the 2008 recession until the whole housing bubble had unraveled," said Steve Levy, director of the Center for Continuing Study of the California Economy in Palo Alto. "Recessions usually catch us by surprise."

The state Senate's Budget chairman, Mark Leno (D-San Francisco), said it doesn't make sense to plan the state's budget around potential financial catastrophe. California could absorb mild downturns, he said, with such steps as reducing debt repayments.

Indeed, a recession could also damage the state's ability to tackle some of its other long-term liabilities, such as retirement benefits and overdue maintenance on state roads.

During the last budget crisis, lawmakers plugged budget holes with fees intended for road repairs. Efforts to return the money to its intended purpose — and help chip away at the estimated $59 billion in upgrades needed for highways and bridges — would become more difficult if the state faced new shortfalls.

"If you can put off some of those longer-term issues," Cummins said, "that's what you're going to do."

chris.megerian@latimes.com

Twitter: @chrismegerian

Copyright © 2016, Los Angeles Times
88°