Haas questions received wisdom on fiscal crisis

Haas School of Business | 15 October 2003

California’s budget crisis has been dominating the news — especially in the midst of the state’s gubernatorial recall election — but most of the ideas for fixing it are based on myths and will not improve the state’s fiscal outlook, according to a new report by Kenneth Rosen, chair of the Fisher Center for Real Estate and Urban Economics at the Haas School of Business.

The report, “Anatomy of the California Fiscal Crisis: Facts and Figures Do Matter,” attributes the current crisis to the unsustainable tax revenue increases related to the boom in the financial markets in the late 1990s. By treating this revenue surge as permanent and locking in higher spending, the report says, the state General Fund spending grew by 15 percent in 2000 and by another 13 percent in 2001.

“Wrongly blaming the economy, high tax rates, or too large a government sector will not solve the real budget issues facing California,” says Rosen. “Those criticisms of California simply do not stand up under close scrutiny of the facts and figures. It will take some imagination for elected officials to correctly diagnose the problems, and then to design measures to deal with those issues.”

California’s job loss is often credited for the problems in the state’s budget. However, the authors point out, during the period in which the fiscal crisis developed, California’s employment situation was actually marginally better than the nation’s.

California also has the reputation of having a large number of state government employees, according to the report. But, says Rosen, “This is simply not true, if we normalize by population. In fact, among the ten largest states, California has the third smallest number of state employees per capita, after Florida and Pennsylvania. We just don’t have a big state government.”

Another myth concerns California’s tax rate. When the burden of all state and local tax sources are pooled, says the report, California’s tax rate does not particularly stand out. Among the 10 largest states, California’s total tax rate relative to gross state product is about in the middle, according to the authors.

To remedy the crisis, the authors suggest that temporary revenue ought to be treated as such, so that expenditures are not geared upward to reflect those temporary revenues. For the current situation, they say, there is no choice but to decrease expenditure growth or raise taxes until the budget situation is again stable. The authors also consider a reform of Proposition 13, passed by California voters in 1978 to keep property taxes aligned with a property’s purchase price.
The report, co-authored by Daniel Van Dyke and Elisa Beller of the Rosen Consulting Group, is available through the Fisher Center at 643-6105.