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Here’s What Reforms Are Needed as Prosperity Returns to State

MICHAEL J. BOSKIN, former chairman of the President's Council of Economic Advisers, is Tully M. Friedman professor of economics and senior fellow, Hoover Institution, at Stanford University

California’s economic turnaround has been underway for almost two years and is even starting to receive national attention. The state is not quite back to its pre-recession peak level of employment, but it is getting close. While the unemployment rate is still above the national average, it is down about 3 percentage points from its recession peak. Job growth of 2.1% over the last 12 months exceeded the national average, 1.9%, for the first time in many years. Most state economic forecasters, such as the UCLA Business Forecasting Unit, are predicting California will outpace the nation for the next two years.

While President Clinton’s Draconian defense cuts continue to be the primary economic drag on California--as I have documented in previous columns, Clinton’s additional defense cuts and tax hikes dwarf many times over his self-touted “aid” to California--even in extremely difficult times California continues to be an incubator of new businesses and jobs. The job growth has been in areas such as electronics, telecommunications, entertainment, software, business services and just about anything having to do with exports.

However, unlike some previous recessions when workers could expect to be rehired by their old employers as demand improved--a common scenario in the auto industry, for example--California’s downturn was structural, with jobs in defense and aerospace disappearing permanently. The transition for these workers is sometimes quite difficult, and funds for defense conversion have been meager, despite Clinton’s promises. So while the state is doing much better, let’s not forget that unemployment is still high, and the aggregate statistics hide the disruption in the lives of many California families.

But even the modest growth California now enjoys, due in part to a cyclical turnaround and in part to improved state policy, should not be taken for granted. California has natural advantages, but it cannot sustain long-term growth if its tax, regulatory, and tort system remains out of line with other states’. So the first order of business is for the state to press further on tax reduction and reform, lightening the regulatory burden and restricting unnecessary lawsuits. An additional major concern should be improving the quality of education.

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Governor Wilson was on the right track with his 15% across-the-board cut in personal and business taxes--the best tax reform is lower marginal tax rates (full-disclosure: I chaired his Tax Advisory Task Force). The governor should press forward and vigorously demand that the Legislature pass his tax proposal; last year it passed the Assembly but stalled in the Democrat-controlled Senate.

Every study of traditionally regulated industries, from telecommunications to energy, reveals that prices fell after deregulation. This may seem counter-intuitive. After all, the regulators are supposed to be protecting consumers. But cumulatively over time, regulation inhibits innovation and the dissemination of new technology which, together with greater competition, is a far greater force for lower prices and better quality services than a regulatory bureaucracy. Particularly pernicious, for example, is the fact that electricity rates in California are almost double those of neighboring states. Regulatory reform for electricity is now working its way through the California Public Utilities Commission: the danger is much greater that it will do too little too slowly than that it will do too much too fast.

California, perhaps even more so than the nation as a whole, is a litigious mess. Civil justice reform is badly overdue, and perhaps now that Willie Brown, the trial lawyer’s best friend, is no longer running the Assembly, Sacramento might finally shake up the state’s legal system.

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To be sure, improvements have been made in the last few years: Gov. Wilson succeeded in reducing the top two marginal tax rates back to their pre-1991 levels last year. Prior to that he enacted, with the help of the Legislature, several important tax reforms and cuts, such as tax credits on purchases of business equipment. He implemented one-stop shopping for permits and some privatization experiments are underway in transportation. The time has come for bolder experiments in private sector delivery of state services.

If the Legislature will not go along with total statewide reform, let’s at least begin with some major experiments. For example, the time has come for a large pilot program in school vouchers, so we can really test whether the benefits many of us believe would follow from greater school choice and competition actually materialize and whether the opponents’ counterclaims carry any water.

As the state’s economy expands, so will revenue: it’s already outpacing forecasts this year at a rate that could lead to a $1-billion surplus. This will provide additional resources to be used to finance pro-growth tax cuts as well as carefully chosen expenditure increases in high priority areas such as education. It is vital, however, that these expenditure increases be accompanied by sensible reforms or the money will not deliver much bang for the buck. Last year, Gov. Wilson successfully fought for a billion-dollar increase in K-12 education, restricted to purchases of books and computers to improve classroom instruction. That is the sort of leadership which, short of a massive re-engineering of the state education code and/or a much more competitive education market, has the greatest chance to improve educational outcomes and not simply fatten the paychecks of bureaucrats.

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Such a state reform agenda--spending control, tax cuts, regulatory, legal and educational reform and privatization--will go a long way toward improving the state’s job climate and ensuring that the California comeback continues. However, many of California’s problems trace to Washington, not Sacramento. More on that in my next column.


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