Editorial
The Budget Deficit of California
by Fred E. Foldvary, Senior EditorThe budget deficit of the State of California will be as high as $35 billion, 45 percent of its general fund and greater than the total deficits of all other States. State spending has grown much faster than revenues. California government chiefs will probably raise fees for State universities and increase taxes on automobiles, but more significant changes are needed to cure the problem. A new legislative committee is considering ways to reform California's public finance, but unfortunately, some of the ideas floating around will do more harm than good.
Proposed spending reductions include cutting public works projects. Postponing public works can backfire, because this can delay the economic recovery. California metropolitan areas are choking with traffic, and badly need expanded highways and more transit. Congestion will get even worse if the economy ever recovers, and that will crush investment and employment.
There is also a proposal to release prisoners, a good idea if they were locked up for committing victimless crimes such as growing or using marijuana. But if thieves are released, this is false economy, since when they steal again, that is in effect a tax on the public. A burglary is not really non-violent, since the thief does use force, acting against the will of his victim.
California could save many billions of dollars annually by privatizing the energy industry completely and absolutely. The failed phony "de-regulation" of the 1990s was really a vast increase in State intervention. Get the State out of the electricity business, and then the costly contracts the government has made for electricity would no longer impose a burden. The elimination of restrictions on generating plants would bring competition into the electricity industry, including small micro-turbines for local use. The State could tax monopoly profits in the short run and rebate the funds to consumers facing high charges, until new plants emerge.
There is talk of taxing goods bought via the Internet, which now escape the State sales and use taxes. Once all Internet and catalog sales are taxed, this will become permanent and would create a heavy excess burden on the economy, especially hurting California's high-tech industry. More extensive sales taxes would also create a greater underground market for goods, which would then require more intrusive State enforcement.
There are also proposals to raise taxes on commercial real estate with a split-roll property tax. This would actually help economic growth if the additional tax is only on the land value, with improvements exempt, since it would spur construction on underused sites. The State should also put in a congestion tax on all highways just high enough to eliminate congestion. California could also tax pollution. Taxes on land, congestion, and pollution would collect substantial revenue and while actually helping the economy, in contrast to taxing cars, gasoline, income, and sales, which would hurt consumers, workers, and enterprise.
Spending cuts and extra revenues will still leave a budget gap. To further reduce the deficit, lawmakers must think outside the box. Have the State issue compound consols, perpetual bonds that never mature, paying interest in tax-free consols rather than cash. Replace the entire California debt with consols, and the huge cash interest expense would be shifted to the future.
Suppose a consol is issued that pays 5 percent on the face value of the bond. The face value is the price the State pays when it redeems the bond. If the face value is $100 and the bond pays a $5 dividend each year, which would be in the form of a new consol worth $5. The State would redeem or buy back the consols in the future, when it again gets a budget surplus. Since the timing of the buy-back is uncertain, the market price of the consol would not be $100, but less. Suppose the market price is $50. The $5 dividend provides a 10 percent tax-free return, not bad nowadays. The State would sell the consols at the market price, $50.
The State would have an incentive to buy back the consols before too long in order to protect its credit rating and also from political pressure by the bondholders. This is not an ideal long-term way of borrowing money, but it would take the State out of its severe budget crunch.
Californians will have to suffer hardships if their elected officials stay stuck in conventional thinking and politics. As Henry George said, we imprison ourselves mainly with mental chains. But just maybe, someone will whisper "consols" to a legislator who then convinces the others. Californians, email your legislators today. Tell them to use consols. Eureka! If they get thousands of messages, maybe they will get curious and take action.
Copyright 2002 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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