Thursday, June 30, 2011

Five Predictions About California's Future

Now that California has managed (sort of) to resolve its annual financial crisis by passing a budget, many thinkers and pundits are turning their sights to the future. Since we like a good thought piece as much as anyone, we thought we'd offer our thoughts on where the state is heading, and what sorts of political developments we could see in the next few years. So, without further ado, here are five predictions for the future of California.

1. Pension costs will decimate governments at all levels, and it might happen sooner than you'd think. While underfunded pensions are a problem in many, many local governments in California, we couldn't help but be struck by Wayne Lusvardi's latest piece over at Cal Watchdog. Discussing a recent New York Times article on California pensions, he notes that many studies estimate that the state will need to designate $28 billion toward pensions in the very near future. Keep in mind that the entire general fund budget was $86 billion this year. Needless to say, this would obliterate government services at all levels. And this isn't even taking into account a point we keep raising: through questionable accounting practices, public funds like CalPERS almost certainly believe they have more cash and smaller liabilities than they actually do. We expect to see pension reform proposals on the ballot next year, but keep in mind that the courts generally view pensions as "vested benefits." As such, even if voters approve dramatic measures to claw back public retirement benefits, the measures will almost certainly end up in court, and they may not stand up to the challenge. So the Legislature's fateful 1999 decision to award "3-50" pensions to most state workers is probably not something we can get out of.

2. Austerity at the local level will become the norm, not the exception. We wrote recently about the grim future facing the city of San Jose, as it continues to shed services and employees in anticipation of a towering tsunami wave of pension debt. In the likely event that Mayor Chuck Reed's proposal to pull back retirement benefits by a ballot initiative is unsuccessful, San Jose is facing the prospect of laying off most of its workforce. If the worst-case scenario plays out (and again, most public pensions make rosy assumptions), Reed offers this description of how the country's 10th-largest city could look in 2016: "A volunteer fire department, a mostly volunteer police department, and not much else. All libraries except Martin Luther King would be closed. All community centers, most likely closed." While this might sound extreme, San Jose just laid off over 500 workers and demoted almost 100 others, while imposing a 10% pay cut, to close its most recent budget deficit. Meanwhile, the cities of Half Moon Bay, Sacramento and Costa Mesa just laid off dozens of employees, Compton may still do so, and other cities, including Oakland, Montebello, and Chowchilla, are flirting with outright insolvency. Still others (San Diego and San Francisco come to mind) have largely waved their hands at the structural weaknesses of their finances. Which is all to say that, as time goes by and the pension math becomes even more intractable, the situation playing out in San Jose might become much more common. You can ask yourself how much you want to pay the same heavy taxes to a government that offers little to nothing by way of services in return. And speaking of taxes . . .

3. Taxes will go up. It's not much of a prediction since, you know, Jerry Brown and Democratic lawmakers have already declared their intention to seek higher taxes via the ballot next year. We're fairly confident the voters will beat them back (they were never receptive to them this year, in spite of all the ink that was spilled supporting them), but keep in mind that the next election is likely to bring a Democratic supermajority in the Legislature. After that, we think all bets are off. Two votes in each house were the only reason why higher taxes weren't imposed by lawmaker fiat this year; without that hurdle, our guess is that new taxes will become the Legislature's first go-to option for meeting revenue shortfalls in the future. They might even go for the Holy Grail of pro-tax liberals in the state: reform of Prop 13, most likely in the form of the so-called "split roll," in which the law's protections for commercial property are removed.

4. Recession will become a permanent reality, and California will continue to hemorrhage population. What we've mentioned before might sound pretty bad, but it's important to remember that politics has a human cost. Higher taxes and reduced public services make it harder for average Californians to make much of a life for themselves here. More to the point, a Prop 13 split roll would cripple many employers in a state already struggling with 12% unemployment. That we're even discussing the split roll, of course, points to a more basic problem: while governments everywhere impede the proper functioning of free markets, California's seems uniquely committed to annihilating free enterprise within its borders altogether. The most recent example of this, of course, is the Amazon Tax, which shows us that Sacramento is willing to destroy thousands of California jobs in order to seize more private wealth. To say nothing of the chilling effect it's likely to have on web-based business development moving forward. But it's hardly the only example. In a year and a half, we'll be taking the Great Leap Forward into the California of AB 32, which is likely to strangle the state's economy in order to marginally reduce its emissions of greenhouse gases. Meanwhile, a slew of bills are moving through the Legislature that also stand to destroy jobs in the state, whether by workplace mandates, tax hikes, employee benefit mandates, regulations, and new liability costs. The point being that it's tough for private business to flourish under a government with this much contempt for the free market.

5. Debt downgrade and default will occur everywhere. Meanwhile, with local government finances coming under greater scrutiny (Illinois' Cook County, which includes Chicago, recently suffered a debt downgrade) and Meredith Whitney continuing to warn about widespread municipal default and bankruptcy, the ratings agencies are closely watching governments in California. S&P has released its analysis of California's newest budget, and it's not positive; according to analyst Gabriel Petek, "Unlike the governor’s original and revised budgets, this approach would not appear to make much improvement to the state’s fiscal structure, meaning there is a fairly predictable budget gap to deal with for next year already. I’m not aware that the budget package involves any reforms of the state’s pension plans, and it adds to the state’s deferrals for part of the solution." While noting that the rating agency will carefully watch the state's cash flows to see whether the $4 billion in new revenues materializes (and whether the cuts realize the projected savings), Petek said the budget "may allow the state to avert a liquidity shortfall of the kind we have seen in recent years by accommodating cash-flow borrowing. The key here will be in the details." In other words, California's outlook is unlikely to be bumped up from "negative," and its credit rating could still be subject to downgrade. Keep in mind, the cities of Modesto, Chowchilla, Montebello, and San Francisco have all had bonds downgraded recently, and the cities of Compton, Oakland, and San Jose are openly flirting with bankruptcy. This might sound like academic noodling, but a further deterioration of bond ratings could be catastrophic, as it would exacerbate the above problems: a debt downgrade means that borrowing becomes more costly, and a great deal of the operating cash flow of California's governments comes from short-term debt. And all of those costs are ultimately passed on to taxpayers.

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