California’s Financial Ills Call for Drastic Medicine

What should California do to end its chronic budget crises? It should change rather than raise many of its taxes--lower the rate, broaden the base and amend Proposition 13. It should change its Constitution.

Its citizens--all of us--should come to a consensus about what kind of state this is to be and then pursue serious policies to achieve those goals.

California should repent and reform, in short. If some recommendations being made by citizens groups and credit experts sound like a 12-step program to fiscal health, that’s understandable. To the world that lends California money, the state these days looks like a credit card junkie whose word and good intentions are no longer trusted.

The state tries to borrow $4 billion today, partly to roll over some of the chronic budget deficits it has run since 1990. The notes, called revenue anticipation warrants, will probably sell briskly because a consortium of banks led by Bank of America--itself a survivor of near-bankruptcy in the mid-1980s--is acting as co-signer.

For a fee of about $30 million, the banks are guaranteeing Sacramento’s credit, and the state has also pledged that if it doesn’t meet budget targets in the next two years, across-the-board cuts in spending will be imposed.

Such terms are more fitting to a less developed country than a state of 30 million people with an advanced economy larger than that of most nations. But California’s economic standing ain’t what it used to be.

The major credit-rating agencies, Moody’s, Standard & Poor’s and Fitch Investors, lowered California’s bond rating again last week. In three years, the rating has fallen from AAA, the highest, to A, the rank above speculation. That may add $30 million in interest to the state’s yearly bill for servicing $9 billion in general obligation debt.

So, along with the banks’ fee, the lack of budget discipline will cost California taxpayers an extra $60 million this fiscal year, even though the state’s economy is improving.

That’s just the point. “The fact that the economy is improving underscored the state’s lack of willingness to address critical budget issues, which is the real reason for downgrading,” says George Leung, vice president of Moody’s Investors Service.

But darkest before dawn may be the applicable cliche here. We should keep in mind that the state’s problems can be solved with good sense and good will. So it’s encouraging that citizens groups working on well-reasoned remedies are a statewide phenomenon right now.

Several suggestions would raise revenues to cover this year’s $3-billion deficit--in a $40-billion budget--and the accumulated deficits from recent years, which total more than $4 billion.

A leading suggestion is that the state extend the sales tax to services, where now it is imposed only on merchandise. That could raise $1.7 billion a year and makes good sense. It’s goofy to tax payments for the mops and brooms people buy to clean their own houses but not to tax payments made for housecleaning services.

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An even better idea than simply raising a tax would be to broaden the sales tax to include services but lower the tax rate to give a break to merchandise, and be revenue-neutral. That way the budget would get not just a quick fix, but more intelligent and equable financing long-term.

A similar approach could reform Proposition 13, which has limited property taxes since 1978. “It’s a profound disincentive to new business,” says Stephen Levy, chief economist of the Center for the Continuing Study of the California Economy in Palo Alto. “New business owners must pay higher property taxes than competitors who are grandfathered in.”

A solution would be to change Proposition 13’s limits on property tax increases but broaden the base by reassessing taxes on old properties. Such a reform could spur real estate activity as well.

Current and past deficits are not the thorniest problem. With political will, cuts can be made in some Medicaid services that go beyond federal requirements, or in prison expenditures.

The Citizens Budget Commission, a bipartisan group, will suggest later this month that the accumulated deficit be financed with a onetime, long-term municipal bond. That way costs of the recent recession can be paid over a decade or so.

But dealing with the so-called future deficit is harder. That’s the estimated $2 billion that California has been underspending on infrastructure and higher education--so that its once proud university system is now frayed and crumbling.

It’s difficult to come up with public money for such purposes--despite support from the business community--because there is no consensus among people and politicians.

“People are unwilling to vote any money to the politicians, because they don’t trust the government,” says Eugene Smolensky, dean of the school of public policy at UC Berkeley.

To break that impasse, a state commission is deliberating constitutional revision. It is taking up such questions as whether a two-thirds legislative majority should be required for all tax measures, whether to amend Proposition 13 and how to adapt California’s initiative system to the needs of a contemporary economy.

In place of debate about what kind of California its people want, the state right now is receiving demagoguery, as in Gov. Pete Wilson’s attacks on immigrants. Nobody can be for illegal immigration--the border must be controlled. But some recognition is needed that the children of immigrants are a resource to be educated for the state’s future.

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That’s not sentiment. When the credit-rating agencies see political escapism, they get nervous and downgrade the state’s bonds.

When they see decision making and policy, they raise a state’s ratings. Massachusetts, which went through a severe recession and made significant budget cuts, has come back to an A rating from Baa. New Mexico, which suffered in the energy downturn and as a result diversified its economy, has recovered a bond rating higher than California’s.

What should California do? Get serious, or get poorer.