California And Bust, Indeed

Many reasons have been put forward to explain California's expanding fiscal disaster. Many have pointed to the California Assembly, a string of spendthrift governors, mandated spending due to voter initiatives, public employee unions, and, believe it or not, air pollution. But it all boils down to hubris.

But one of the biggest reasons has to be the the exploding and unsustainable level of spending at the local level, where safety services (police and fire departments) and the educational systems took up bigger and bigger portions of town and city budgets, particularly when it came to entitlements like pensions. It finally reached a breaking point when the national and state economies went into deep recession and tax revenues turned from a torrent to a trickle.

From 2002 to 2008, the states had piled up debts right alongside their citizens’: their level of indebtedness, as a group, had almost doubled, and state spending had grown by two-thirds. In that time they had also systematically underfunded their pension plans and other future liabilities by a total of nearly $1.5 trillion. In response, perhaps, the pension money that they had set aside was invested in ever riskier assets. In 1980 only 23 percent of state pension money had been invested in the stock market; by 2008 the number had risen to 60 percent. To top it off, these pension funds were pretty much all assuming they could earn 8 percent on the money they had to invest, at a time when the Federal Reserve was promising to keep interest rates at zero. Toss in underfunded health-care plans, a reduction in federal dollars available to the states, and the depression in tax revenues caused by a soft economy, and you were looking at multi-trillion-dollar holes that could be dealt with in only one of two ways: massive cutbacks in public services or a default—or both. Whitney thought default unlikely, at least at the state level, because the state could bleed the cities of money to pay off its bonds. The cities were where the pain would be felt most intensely. “The scary thing about state treasurers,” she said, “is that they don’t know the financial situation in their own municipalities.”

So demands from the state also added to the economic troubles facing the municipalities at a time when they had no spare funds to expend, adding an even greater burden on them and on the taxpayers supporting them. Another issue that hurt was the collapse of housing prices, meaning property tax revenues would oscillating, but with a downward trend, as tax rates fell behind the change in property values. Some property owners just stopped paying their taxes as they had no means of paying them or their mortgages as they saw their jobs disappear, and with them, their incomes. It was a “perfect storm” of economic problems that drove the municipalities and the state towards the fiscal brink. In California it was even worse because it is so dependent upon income taxes, one of the most volatile of taxes. Very high sales taxes also added to the burden, driving many people to cut back on their discretionary spending in an effort to keep their families clothed, housed, and fed. Revenues plunged even farther.

But California, at all levels, didn't seem to be willing or able to do the one thing that might have helped make ends meet – cut spending. We certainly haven't seen it at the state level, with the California Assembly making a lot of noise about cutting spending, but increasing it and a number of taxes at a time when neither will solve the problem.

And so the path to fiscal destruction is becoming steeper and the juggernaut that is default is picking up momentum. It seems such an unfitting end to a state that once held so much promise.