Bitter Medicine : Fiscal Cures Could Further Weaken Business Climate

The state’s budget doctors may resolve the current fiscal crisis eventually, but business leaders worry that the cures could worsen the state’s long-term economic health.

Nearly everyone agrees that it’s a choice between bitter medicines. Cuts in education and other services concern executives mightily because they could weaken the economy’s underpinnings.

But, having weathered a crippling downturn during which businesses had to pare payrolls and expenses, most executives are inclined to favor service reductions over an obvious alternative. Read our lips, they’re saying. No new taxes. On that they have the firm backing--for now--of Republican Gov. Pete Wilson.

Executives say raising taxes to close the $10.7-billion budget gap would exacerbate the very economic and business problems that helped cause it in the first place. They add that higher taxes could further fray the state’s already tattered image as a good place to do business and might spur fence-sitting companies with an eye toward expansion to seek greener--or at least cheaper--pastures elsewhere.

“The state’s in a no-win situation,” said David G. Hensley, director of the UCLA Business Forecasting Project. “If you raise taxes to fund the programs, that hurts the business climate. If you keep taxes down and cut the programs, that hurts the business climate. What seems to be missing is . . . consensus as to what (the state’s priorities) are. It’s paralyzing this whole process.”

Indeed, many economists and business people fret that the contentious and embarrassing budget process itself is harming the state’s image, signaling that California is fiscally out of control.

Moody’s Investors Service, a major debt-rating firm, last week reduced its rating on California’s general obligation bonds and criticized the state for running out of cash and being forced to issue IOUs to pay its bills. Then on Wednesday, Standard & Poor’s followed suit, lowering its rating on California bonds by two notches, pushing the state below 36 others in terms of creditworthiness.

Long the nation’s engine of growth, California now resembles a runaway train hurtling toward catastrophe. Cutbacks in aerospace and defense, financial services and construction have cost more than 600,000 jobs and millions of dollars in tax revenue during the two-year recession, with no recovery in sight. Meanwhile, the populations most in need of services--particularly school-age children, the elderly, welfare families, AIDS patients--have burgeoned.

The irony of today’s cash shortage is that, just five years ago, former Gov. George Deukmejian and state legislators were wrangling over what to do with a $700-million surplus. Lawmakers proposed giving the money to schools, but Deukmejian insisted that it be returned to taxpayers.

“It was very shortsighted,” said Goetz Wolff, a Los Angeles economist. “The money should have been plowed back into education, or anticipating the needs for long-term economic development.”

What turned the Golden State so quickly into the Broke State?

“The short answer is the recession,” said Stephen Levy, director of the Center for Continuing Study of the California Economy in Palo Alto.

A year ago, Levy noted, Wilson and legislators worked out a $14-billion budget bailout designed to solve structural problems for at least a few years. The solutions were evenly divided between service cuts on one hand and sales taxes and levies on the rich on the other.

The problem was that the budget fix was based on the assumption--reasonable at the time--that California would begin an economic recovery in mid-1991 and that revenue would pick up. Instead, the recession has droned on and revenue from personal income taxes, bank and corporate taxes and sales taxes has fallen far short of expectations.

“When the economy collapses, the revenue from those sources collapses, and that’s exactly what happened,” said Jeffrey I. Chapman, director of USC’s Sacramento Center of the School of Public Administration.

Granted, economists and Sacramento insiders point to other causes for the imbalance. There is widespread agreement that the problem has its roots in the 1978 passage of Proposition 13, the landmark taxpayer revolt initiative that slashed local property taxes and led to a variety of other tax limitations.

Although many businesses benefit from caps on property taxes, California businesses say they suffer because the state has imposed hefty fees and other kinds of taxes--such as taxes on factory equipment--to help make up the difference.

At the core of Wilson’s current budget proposal are a $2-billion cut in education spending, the state’s single largest budget item, and another $2-billion cut in health and welfare spending.

Wilson’s budget strategy has focused on cuts in education and social services, in part to avoid new taxes, in part because the state Constitution restricts the state’s ability to cut elsewhere and in part--critics argue--because the constituencies affected by such cuts are less powerful.

But such proposals have little support in the Legislature. Many Democratic legislators have backed a suggestion by the Commission on State Finance, a nonpartisan group in Sacramento, that the shortfall be balanced over more than one year.

Kevin Scott, executive director of the commission, pointed out that bank and corporate taxes have barely grown in recent years. From fiscal 1987 to fiscal 1990, they grew by 4.2%, to $5 billion, while the economy grew by nearly 30%.

Business leaders oppose the idea. “The Democratic plan of trying to roll over the debt and hide your head in the sand would be disastrous and destroy whatever faith and credibility we have in the financial well-being of the state,” said Don Butler, president and chief executive of the 4,100-member Merchants and Manufacturers Assn., a Los Angeles-based trade group.

In any case, economists argue--and some business leaders agree--that drastic cuts in the education budget are shortsighted and could hurt the state’s long-term economic prospects. “To the extent we do things that reduce our investment in the future--in infrastructure, education, public safety--we are harming our future,” Scott said.

More specifically, industry officials fear some potential budget actions may have unintended negative effects.

One proposal would slash funding for the Department of Alcoholic Beverage Control by 50%, or $10 million. But John Shields, president and chief executive of the Trader Joe’s specialty market chain in South Pasadena, cautioned that such a cut could actually reduce revenue.

He points to the experience of a proposed Trader Joe’s store in Encinitas, the opening of which has been delayed five months because of a licensing staff shortage in the department. That delay has meant the loss of millions of dollars of sales--and substantial revenue for the state--while six full-time and 30 part-time workers remain idle.

Port officials, meanwhile, warn against Gov. Wilson’s proposal to tap half of the profits from the state’s maritime operations, including the ports of Los Angeles and Long Beach.

“If they’re talking about 50% of our net revenues for the next couple of years, it would cost us about $35 million” a year, said Yvonne Avila, a spokeswoman for the Port of Long Beach. The money would come out of budgets for capital improvements of port facilities, including improvement of rail transportation links.

And that could cost the port international shipping business--part of the international trade many economists believe is a promising growth area for the state’s economy.

Not all executives support Wilson’s spending cuts. Larkin Teasley, president and chief executive of Los Angeles-based Golden State Mutual Life Insurance Co., argues that balancing the budget at the expense of social spending is counterproductive.

“I think that the governor’s making a big mistake,” he said. “There was a time that a governor felt that, during recessionary times, the wisest course of action was to continue to make government expenditures at a level equivalent to those prior to the recession.

“We’re in a recession now, and with all the cuts that he’s planning to make, it’s going to push us further in,” Teasley said.

Lee reported from Los Angeles and Groves from San Francisco.

Golden State’s Exploding Deficit California has been plagued by annual deficits for the last few years. These back-to-back deficits accumulate as government attempts to hold down spending, but revenues continue to fall short of expectations. Unless steps are taken to reduce the budget gap, the shortfall could reach more than $12 billion by the 1993-94 fiscal year. (in billions of dollars) Year / Surplus/Deficit 81-82z: +$0.1 82-83: -0.5 83-84: +0.5 84-85: +1.4 85-86: +0.7 86-87: +1.8 87-8: +0.2 88-89: +1.1 89-90: +0.4 90-91: -2.8 91-92: -3.9 92-93*: -8.1** 93-94*: -12.5 * Projections assume that the state does not take steps to reduce the deficit. **The State Department of Finance has put the shortfall at $10.7 billion. Source: Commission on State Finance