Plugging the gap

California’s lawmakers finally reach a deal to close the state’s gaping budget deficit

Published on The Economist, by staff, July 21, 2009.

… Municipal leaders were more animated in their criticism of the budget deal, which will temporarily take away almost $5 billion of the cash usually doled out to cities and counties. Some of this will be repaid later with interest, but many say that all the money is needed now. Antonio Villaraigosa, the mayor of Los Angeles, said this was “a moment of shame” for the state. Zev Yaroslavsky, an effusive Los Angeles county supervisor, thundered that the agreement “stinks” and that it would “hurt a lot of people that don’t deserve to be hurt”.  

The anger at the local level may be understandable, but the pressure on lawmakers in Sacramento to agree on a budget had been cranking up in recent weeks, and the state was running out of options for short-term funding. California’s bonds have been downgraded by rating agencies to leave them dangerously close to junk status because of the long-term fiscal outlook. The state controller had recently resorted to issuing IOUs to creditors, to keep the government running until the end of July. But some big banks, including Citigroup, Bank of America and Wells Fargo, balked at accepting IOUs, mainly because of worries that the process for cashing them in had not been set up properly.

Yesterday’s deal may solve California’s immediate budgetary problems but it does little to address the structure of the underlying revenue-raising and budget-setting process, which are the cause of perennial strife for the state. A recent report by the Public Policy Institute of California looking at the budget until 2013-14 projects increasingly large shortfalls. Part of the problem, according to PPIC, is California’s high dependency on personal and corporate income tax, a volatile source of revenue that fluctuates with the economy.

Reformers have called for a repeal of the state law, passed after a taxpayer revolt in 1978, that severely curtails increases in property taxes, which might bring in more stable revenues. But the chances of overturning the law remain almost nonexistent given its popularity.

Special interest groups may wince at the other measures that the budget deal will introduce. Environmentalists will probably shout the loudest over a proposal to grant California’s first lease in four decades to drill for oil off the coast near the wide sandy beaches of Santa Barbara. The lease will eventually bring in a much needed $2 billion. Given California’s dire financial straits, the protests of California’s legions of enraged greens may go unheeded. (full text).

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