Friday, July 2, 2010

Budget Facts vs. the Governor’s Fiction

As discussed on this blog, the governor has painted a creative picture of our economic woes to suit his ideological budget agenda. But we can get past his spin to the substance of the challenges we face by looking at how California compares with other states.

The Federal Reserve of San Francisco recently issued such a report reviewing the economic and fiscal crises befalling the 50 states. It is a helpful assessment of where we’ve been and when we are likely to see economic improvement.

The most obvious cause of California’s economic crisis is the profound macroeconomic shock that hit all the states, not to mention much of the rest of the world. According to the report, the recent recession was one of the sharpest economic contractions in U.S. history. Nationwide, real GDP fell by 3.8% while non-farm employment fell by 6.1%, or about 8.4 million jobs, from peaks registered around the start of the recession until they bottomed out. The unemployment rate more than doubled, from 5% at the beginning of the recession to a high of 10.1% in October 2009. However, states like California had greater exposure to the housing downturn. Therefore, we suffered more dramatic economic decline.

With historic economic decline comes great budget challenges. The combined budget gap states faced heading into fiscal year 2009 was $110 billion, around 15% of total state general fund budgets. The gap heading into fiscal 2010 was $200 billion, or roughly 30% of general funds.

Some states are worse off than others. The report cites California as one of the worst off, mainly because of our 2/3 vote requirement for budgets and taxes. The report compares California and Oregon:
“Leading up to fiscal year 2009, which began on July 1, 2009, California had a budget gap of 37%, while Oregon’s gap was just 7%, according to the Center on Budget and Policy Priorities. What explains the difference? To gauge the severity of the economic shock state by state, we ask what would each state’s 2009 gap have been if they had kept per capita expenditures constant from 2007 onward as revenue fell. It turns out that Oregon’s and California’s budget gaps would have been roughly the same, around 20%. However, Oregon in 2008 curtailed expenditure growth, enacted some notable tax increases, and tapped into its rainy-day fund to reduce its budget gap. On the other hand, California saw expenditure growth barely slow at all, enacted only limited tax increases, and had nothing in its rainy-day fund coming into the recession. Much of California’s limited policy response reflected institutional constraints on the ability of lawmakers to change fiscal policy. For instance, tax increases in California must be approved by a two-thirds majority of the legislature, and voter propositions approved in the past greatly limit the legislature’s ability to curtail spending growth in many areas.” (Emphasis mine.)

The Federal Reserve believes states will not see much economic improvement for quite some time. Citing estimates from the Center on Budget and Policy Priorities, the report says that significant state budget gaps will likely persist through at least 2012. And, the Federal Reserve believes fiscal conditions are likely to get worse before they get better as the federal stimulus diminishes in 2011 and ends in 2012. Making things worse, California has borrowed and used smoke and mirrors to balance our budget, and recent judicial decisions have rendered some budget cuts and fund shifts off limits.

As negotiations continue for a budget solution in California, let’s not forget this conclusion from the Federal Reserve:
“The solutions states employ to close projected budget gaps will have painful effects on state residents and businesses but pose a more modest risk to the national recovery. Historically, the health of the national economy determines the health of state finances, not the other way around. Sustained improvement in the national economy is essential for states to grow their way out of their current problems and improve their fiscal conditions.”