‘Yes’ and ‘Yes’: the Best Way to Deal With the State Debt

California faces a financial crisis. The state has run up a debt of at least $15 billion, the result of spending far more than even its considerable revenues. Because debt cannot be wished away, the only question is how it can be financed and paid off.

Two steps are necessary. They have been proposed by Gov. Arnold Schwarzenegger and endorsed by the state Legislature.

Proposition 57 would refinance and pay down the accumulated debt of $15 billion in an orderly fashion. This bond proposal is no different from a household’s plan to refinance its home mortgage, or, perhaps more appropriately in the current circumstances, a repentant sailor’s plan to consolidate his credit card debt after a three-month shore leave. And the benefits will be the same: lower annual interest payments and a manageable repayment schedule.

Why would interest rates be lower? Because under Proposition 57, repayment of principal and interest charges would have first claim on state government revenues, and this would give bond buyers the assurance they need to keep the bond’s interest rate low.

Proposition 58, the balanced budget requirement, would make it unconstitutional for the Legislature to run deficits from now on. Currently, the California Constitution requires only that the governor propose a balanced budget. The Legislature has been free to do whatever it has pleased -- and what has pleased the Legislature is spending.

Proposition 58 closes this loophole. Not only must the governor propose a balanced budget, but the Legislature must enact one.

A little history is in order. Last June, in a desperate move to finance their overspending, then-Gov. Gray Davis and the Legislature authorized the issuance of $11 billion of debt. Then, between June and November, before Schwarzenegger took office, the state had to borrow an additional $3 billion. By the time Schwarzenegger took the oath of office, in other words, California was $14 billion in debt and counting. That debt was financed by short-term borrowing. If Proposition 57 is rejected, similar borrowing would run into lots of questions.

What would happen if voters rejected the bond initiative? Strictly speaking, the governor and the Legislature would be required to pay off the state’s entire accumulated debt and close next year’s projected budget gap in a single year.

The inevitable result would be a truly massive tax increase. Why? Because eliminating the inherited debt in a single year by cutting spending alone would require an across-the-board cut of about 30%. We know of no government entity -- federal, state or local -- that has ever managed to make such a reduction. And it is hard to imagine such cuts coming from the current Legislature, which is not exactly full of Ronald Reagans. So a vote against the bond authorization would be a vote for a tax increase.

Any such tax increase is bad for California’s economic health. It would inflict damage on our economy just as the state is beginning to recover from the recession. The result would be additional job losses -- and, for those fortunate enough to keep their jobs, lower take-home pay.

Such an increase would ultimately prove self-defeating. Giving the state Legislature more tax money would only encourage it to continue its reckless spending. As the economy faltered, the revenues would fail to materialize.

Another alternative would be an effort by the state to borrow the $15 billion without voter approval. A host of budgetary and legal questions would cloud any bond issued without voter approval. Bond buyers would ask: Where’s the money to repay the bond? And any such bond would almost certainly be challenged in court as unconstitutional on the ground that it violated the plain language of the state Constitution, which limits severely the amount the state can borrow without prior voter approval.

Already, one court has ruled a similar bond to be unconstitutional. The result would be a constitutionally dubious bond issued by a state with no visible ability to repay the principal, a formula for junk bonds.

Financial markets do not like uncertainty. If the voters reject Proposition 57, the market will almost certainly charge the state a large premium.

Propositions 57 and 58 are legally linked -- the bond cannot be issued unless the balanced budget proposition passes, and vice versa. So voters should not split their votes by, for example, voting for one and against the other.

Voters should say yes to both Proposition 57 and Proposition 58. Working together, the two would address the state’s inherited deficit while preventing such deficits in the future. “Yes” and “yes” to clean up the mess.