Mon, Jul 30, 2012 - Page 9 News List

Losing touch with
California’s soul

The state’s economy, once one of the world’s largest, is struggling — like many regions — to survive desperate economic circumstances

By Michael Boskin

Illustration: Yusha

While central governments’ fiscal problems plague many economies, a parallel crisis is enveloping several subnational governments around the world. From Spain to China to the US to Italy, these governments — regions, states, provinces, cities and towns — face immense fiscal challenges. Higher levels of government are “on the hook” to bail out local insolvent governments, and may even suffer bond downgrades as a result; in Spain, Italy and China, that role falls to the national government, and for US cities and towns, to their states.

There are many similarities within and among countries in terms of the nature and causes of these local fiscal calamities. Local officials used growing revenues during the boom to fund pet projects or boost pay and benefits, with little regard to future costs. In the downturn, revenues and subsidies from the central government collapsed and the bills came due. Creative accounting gimmicks masked the full extent of the problem. Now comes the reckoning.

To finance local businesses, Chinese local governments use local-government financing vehicles (LGFVs) to circumvent bans on direct borrowing. In Spain, housing and employment collapses have hammered revenue. Rumors of an imminent default swirl around Sicily, whose governor has resigned as borrowing soared after cutbacks from Rome. A new report from a task force co-chaired by former US Federal Reserve chairman Paul Volcker indicates that unfunded pension and health-care costs make many US states’ medium and longer-run fiscal prospects bleak.

California’s fiscal crises may also provide lessons for subnational governments around the world. Three California cities have recently declared bankruptcy: Stockton, the largest US city ever to do so; San Bernardino, the second-largest bankrupt city; and Mammoth Lakes. Compton is rumored to be next; most observers expect more to follow.

The state faces another large budget deficit, yet California Governor Jerry Brown’s budget this year includes a substantial spending increase. Brown’s ballot initiative in November would raise the state’s top personal income-tax rate to 13.3 percent, the nation’s highest. According to Brown, the tax hike would be temporary, yet it would last seven years. Meanwhile, he claims to be tough on California’s notoriously well-paid and powerful public-employee unions by negotiating a 5 percent pay cut. However the details reveal a net 1.6 percent pay cut in exchange for a 5 percent reduction in work hours.

Cities are declaring bankruptcy to escape the pressure of exponentially rising pension and health costs. In contrast to the state, cities have even cut back essential services, including 20 percent reductions in police and fire personnel.

Bankruptcy should allow local governments to renegotiate their bond debt and, perhaps, their retired employees’ pension and health-care costs (that is up to a bankruptcy judge). The state would be expected to take over essential public services from bankrupt local governments. However the state itself is in dire financial straits; one of the cities’ problems is the sharp curtailment of state funds to localities.

Despite these problems, Brown has committed California to a San Francisco-to-Los Angeles high-speed rail boondoggle. To get the cost projections down to US$68 billion from a US$100 billion estimate, some existing low-speed rail will be used, likely doubling the time it takes to travel from Los Angeles to San Francisco to five to six hours. California will most likely be unable to pay for the entire project, leaving little use for the first segment in the sparsely populated Central Valley. If the project somehow is completed, it will be a not-so-high-speed rail that will drain badly needed resources from other essential government services for many decades.

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