California Budget Is Harbinger of National Problem

Washington Matters

California Budget Is Harbinger of National Problem

If California is any indication, other states are in for big trouble as they try to craft new budgets.

The 15-week struggle to close a $42-billion budget gap nearly brought the state government to its knees as lawmakers were unable to agree on how to close the deficit. Tax refunds were being withheld, construction projects were nearly halted, massive layoffs were in the works, and contractors were about to receive IOUs. The state ran out of cash, and its borrowing was hindered by receiving the lowest bond rating of any state.

Even with such dire consequences on tap, Republicans refused to go along with the budget worked out by the governor and legislative leaders. Democrats had to give away the store to one Republican, who finally provided the deciding vote in the state Senate Thursday morning.

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When the dust cleared, the final solution wasn't pretty...a warning to other states:

  • A temporary 1-cent increase in the sales tax.
  • An almost doubling of vehicle licensing fees.
  • A .25% increase in state personal income tax rates.
  • A reduction in the dependent care credit.
  • A 10% drop in spending on prison medical care.
  • An $8.6 billion decline in K-12 education spending over two years, probably leading to massive layoffs and delays in construction and textbook purchases.
  • A 10% cut to the university system, once a model for the rest of the country. (Disclosure: I am a product of it.)
  • Monthly furloughs and reduced holidays for state workers.
  • Big cuts in health care for the poor and in senior programs.

But the holdout by Republicans brought some big tax breaks for businesses, including tax credits for hiring new workers. Movie studios won tax credits for filming in-state.

California is one of the first states to make big cuts because its housing market was one of the first to fail and because it relied on subprime loans during the housing boom at mid-decade. A home building spree was taking place in the Central Valley and in Riverside and San Bernardino counties, where prices were lower than on the coasts. When these homes went into default, construction stopped, real estate became paralyzed, jobs were lost and the tax take fell. And because of Proposition 13 property tax limits, the state is highly reliant on the personal income tax. In good times, the state runs up spending, but with any hint of recession, the take drops dramatically.

California is unique in requiring a two-thirds majority to approve a budget, but the polarity of its political parties is hardly unique. Because incumbents design district boundaries, most figure they are safe in their custom-designed districts. Those with extreme views tend to win in the solidly Democratic and Republican districts, and when they take office they feel no need to compromise. And even though Gov. Arnold Schwarzenegger is a Republican, GOP lawmakers don't figure they need to listen to him, either.

Ironically, the tax increases will take some of the oomph out of the federal stimulus program. Where President Obama cuts taxes, some states will increase them, though not as much as they might have without the stimulus.

Also in bad shape are other states hit by the subprime housing bust, such as Florida, Arizona and Nevada. Also hurting are New York, Georgia, South Carolina and Rhode Island. Although none is contemplating as drastic changes as California, they will probably be squeezed further by the worsening economy.