ORANGE COUNTY IN BANKRUPTCY : California’s Faulty Tax System Lies at the Root of the Mess

Now that the loss in Orange County’s investment fund has been estimated at $2.02 billion, or 27% of its original $7.4-billion principal, city managers and superintendents of school districts that lost money can begin looking for ways to make up the shortfall.

But they don’t have far to look. For most, fund losses that may logically clip 27% from each city or district’s investment will mean yet more tightening of the belt and making do.

It will be the fourth year of downsizing for local government in California, a state where predatory public finance has become routine and a screwed-up tax system qualifies as a root cause of the Orange County disaster.

In fact, voters in national elections who favor downsizing government--or “reinventing government,” as the nobler phrase has it--should look at California to see what distortions can result from abrupt, unthinking tax changes.

Gullibility can result. One reason city managers were so unquestioning of the exaggerated returns in Treasurer Robert L. Citron’s Orange County investment fund is that they needed the money.

Local community governments in Orange County and throughout California have been surrendering revenues to Sacramento for years as the state has tried to balance its own budget, so far unsuccessfully.

Most local property taxes no longer are available to finance police and fire departments because a ballot initiative four years ago directed their use increasingly for schools and because the state has taken them away to alleviate its own budget problems.

“People continue to expect first-class police and fire services because they pay their property taxes,” says one city manager. “They don’t realize the property tax no longer pays even police salaries.”

Shares of cigarette taxes and various fees that used to finance local communities have been transferred to the state budget. The state has transferred responsibilities to local communities but only a share of the sales taxes with which to pay for them.

And sales taxes themselves, as they have become popular with government at all levels in the 16 years since Proposition 13 limited the growth of property taxes, have made public services in California more vulnerable to recession.

That’s one reason the state’s credit rating fell during the recession from AAA, the highest, to A, a rank that adds $30 million a year to interest charges.

Indeed, what is happening to local government is only the cutting edge of a fiscal decline in California. A state that once boasted greater-than-average public revenues and expenditures long ago fell below the national average on investment in roads, education and public services, according to a report of the California Business-Higher Education Forum, a panel of industry and university leaders.

California has become a model of the anti-government state, favoring less public investment and strict limits on the power of elected officials and civil servants, explains John Elwood of UC Berkeley’s School of Public Policy.

Whether this has “helped or hurt California,” Elwood says, depends on your political philosophy. As California has fallen below other states in public investment, “individual Californians have been able to retain a greater percentage of their personal income than they did before.”

But before Californians decide that this trend is just dandy, they should keep two things in mind. One is that the current trend to deny funds for public service is a repudiation of a tradition dating to Gov. Hiram Johnson and the 1911 Reform movement that launched California on the road to greatness.

And the second is that whatever your political philosophy, the current tax system--which has resulted from more than a decade of ballot initiatives and competition for funds among various levels of government--is an inefficient, often counterproductive mess.

You only have to listen to local government officials in Orange County to realize that.

Most see three to four years of cutbacks and compromises to rebuild financial reserves lost in the county fund. All have cut back city employment in recent years but without cutting municipal services.

“Finance in this state is such a complex matter now that all we really do is put a new Band-Aid on every year,” says James Armstrong, city manager in Fullerton.

“Voters really have no idea where the property tax is going now,” says Richard Barnard, a Huntington Beach administrator.

But all report that voters don’t want to see cutbacks in public services. So instead cutbacks happen by default, and Southern Californians will endure a public landscape that is a little poorer for the freeway not widened, the school class not offered. “We’ll be stretching out public projects further,” says David Ream, city manager of Santa Ana, which has $150 million in the county fund.

Is there a better solution? Sure. Conscious choices by an informed electorate and government officials. “I hope Orange County leads to a real effort at reform, with the governor and Legislature and local bodies sitting down and working out a more intelligent tax system,” says Fullerton’s Armstrong.

Unfortunately the only response from state government so far is a lock-the-barn-door call by grandstanding politicians to restrict investments by local government officials. Dealing with symptoms won’t cure the illness.

But will real reform come? “Maybe, maybe not,” says Eugene Smolensky, UC Berkeley’s dean of public policy. “How long after an earthquake do the good intentions last?”