State Budget: The Governor Pulls a Rabbit From the Hat

California’s annual fiscal follies commenced in earnest last week with the release of Gov. Arnold Schwarzenegger’s revised budget. Most criticism is coming from the right, but, in fact, the budget is a better expression of conservative fiscal values than those of his Republican predecessors.

Schwarzenegger inherited a significant deficit, born from a mix of recession and recent profligacy. At $15 billion -- almost 20% of the general fund budget -- it is eclipsed only by the deficit of more than 30% that Pete Wilson inherited in 1991.

Like many candidates, Schwarzenegger ran on a promise not to hike taxes. But most observers assumed that he would raise them anyway -- as GOP Govs. Ronald Reagan, George Deukmejian and Wilson all did. He hasn’t so far, which is great for California’s economy and politically astute for Schwarzenegger.

The pressure to do so is not insignificant. The 2001 recession and 2001-03 “jobless recovery” hit high-tech states such as California hard. Furthermore, Gray Davis’ rollback of many pro-competition initiatives from the ‘90s revived the “anywhere but California” attitude among corporate investors. Raising taxes has long been the state Legislature’s knee-jerk response to its own overspending. But Schwarzenegger appears to understand that this would only compound the problem, like a medieval doctor treating anemia by bleeding the patient.

The other major achievement of this budget is simple but profound. It truly balances, without hidden gimmicks. The $15-billion shortfall was closed partly with proceeds of recently enacted bonds, partly through luck (a recovering economy that provided a $1-billion positive surprise), but mostly through the governor’s aggressive use of his political momentum.

Schwarzenegger is exploiting his star power to essentially make the Legislature incidental, first with ballot Propositions 57 and 58, then with workers’ compensation reform. Now he has negotiated cost-saving deals with several groups that normally look to legislators for political cover -- the universities, the K-12 system, local governments and employee unions. In the past, these groups held virtual veto power over a Republican governor through their legislative protectors, whose campaigns they paid for.

But these politically brilliant deals also are the budget’s biggest problem. Schwarzenegger has solved the short-term problem but has not resolved the inherited long-term structural deficit, estimated at $5 billion to $7 billion a year. In fact, he has probably made it worse by offering future increases to pay for lower spending now.

It’s a safe bet that despite Schwarzenegger’s reluctance, some taxes, probably excise taxes, will end up being raised after the 2006 election.

Like most past budgets, this one also relies on optimistic assumptions. It assumes, for instance, that the prison guards union will give back some of the double-digit raise with which the Davis administration bought its support in the recall election.

Despite these caveats, the budget has broad virtues. It preserves the governor’s hard-won successes in making California competitive again, and it restores the responsibility that was missing from fiscal policy for the last five years. That is certainly more than most of his predecessors can claim.

Philip Romero, former chief economist to Gov. Pete Wilson, is a at the Pacific Research Institute and dean of the University of Oregon’s business school.