California Woes

You’ve probably heard about the doom and gloom regarding California due to the current recession. Although the problems are grave, they represent the persistent growing pains that California has gone through since becoming one of the United States. As far as California is concerned, everything looks big, both good and bad. Let me give you some perspectives:

With a GDP valued at $1.85 trillion in 2008, California ranks the eighth largest economy in the world, behind Italy ($2.3 trillion) and ahead of Russia ($1.68 trillion).

California remains at the forefront in many areas including: most populous state of the US with 37 million people and growing; most racially diverse population; greatest concentration of high-tech firms in Silicon Valley; prestigious public and private universities; entertainment capital of the world in Hollywood; highest auto pollution standard in the US; first state to pass a law to control carbon emissions (known as AB 32); and fast emerging industries such as electric cars, solar power, bio-technology, and nano-technology. In agriculture, California leads in the production of grapes, almonds, strawberries, oranges, walnuts, lettuce, tomatoes, carrots, and many others.

California’s biggest asset is a vast land with varied geography and climate, where one can surf in the morning and ski in the afternoon. The gold rush long ago attracted the first wave of settlers, followed by the opening of the trans-continental railroad and highway system.

Since then, California continues to attract immigrants from all over the world, resulting in the largest melting pot of people from diverse background and ethnicity. One can easily find engineers and scientists coming from elsewhere in the US; and also from China, India, Europe and Russia working side by side in high-tech companies located in Silicon Valley. This diverse mix of talents constitutes the second biggest asset of California.

The third biggest asset results from the dynamism and creativity originated in the California dream where anything can be made to fly, and failure is considered the mother of success. This has enabled the state to survive many crises before. The gravest one is the contraction of the aerospace industry and the closing of military bases in the early 1990s resulting in some two million people leaving the state for jobs elsewhere. However, the decline of one major industry saw the explosion of another, which is the personal computer and the Internet that continue to change the world today. Californians do not sit and watch opportunities go by. They grab them and create them if possible.

The fourth asset is California’s integration with the fast growing emerging economies of the Pacific Rim. This has contributed to the cross-fertilization of investments, trade, talents and culture. The benefits of this integration to California’s industries and society as a whole are invaluable and beyond measure.

I have so far described the big good things. What about the big bad things? In short, the problems arise out of the difficulties for the government and a conservative segment of the population to adapt to the fast pace of change. In other words, California’s institutions have difficulties in keeping pace with its unique and extraordinary progress.

The most obvious problem is gridlock in the legislature. The lawmakers increasingly fail to produce a working state budget on time, even facing the urgent task of reducing a $20 billion deficit. The passage of the budget for 2010 was three months late, the 23rd time of being late. The obstacle lies in the outdated two-thirds majority requirement for passage, which in fact allows a minority of legislators to hold the budget hostage. To solve this problem, a new law, Proposition 25, has been passed in November 2010 that restores the passage requirement to a simple majority.

Regarding government revenues, the shortfall is partly circumstantial because of the current deep recession, but the main problem is structural. The following illustrates the major sources projected for next year (based on the San Jose Mercury News dated 12/09/10):
Personal income tax: $44 billion
Sales and use tax: $25 bn
Corporation tax: $9 bn
Insurance tax: $2 bn
Estate tax: $2 bn
Note that the California government relies too much on personal income tax. To share the burden, taxes on corporations, insurance, and estates should be increased. However, corporate lobbying against tax increase has prevented such a move even at a time when corporations are making excessive profits.

On the expenditure side, the following shows the major sources under similar projections:
Education, primary through secondary: $34 billion
Medi-Cal: $18 bn
Prisons/rehabilitation: $9 bn
Infrastructure debt service: $7 bn
Public university system: $5 bn
Development services: $3 bn
Public works: $3 bn
Social security supplement: $3 bn
The item that stands out is prison expenditure that even exceeds university education. This is insane! The legislators must have a twisted mind in thinking that prisons are better investments than universities. Is there any corruption involved? The people should demand an investigation and a big cut in prison expenditure. You will also notice that despite people complain about too much being spent on welfare and social security, those are relatively small items compared with the important investments of education and health care.

Another big problem unique to California is immigration especially regarding the Latino population, a significant number of whom are illegal residents. Due to large influx from out of state, the composition of California’s population has been altered permanently. The current picture is: white 42.3% and falling, Latino 36.6% and growing, Asian 12.5% and growing, and Black around 6.7 % stable. To many conservative whites who think that America belongs exclusively to them, this is equivalent to a foreign takeover. This led to the passage of Proposition 187 orchestrated by former Republican Governor Pete Wilson that sought to deny public services to illegal immigrants. This has driven a wedge between the Republican Party and the Latino population, and resulted in less Latino voter support for the party.

The big change in the population structure of California also has political consequences. According to the Field Institute, between 1978 and 2009, the share of whites has dropped from about 70% to 40% of the state’s population. However, their voters’ share had declined much slower, from 83% to 65%, still holding on to a big voter majority. This means lesser voter representation for the Latino and Asian groups right now. It also casts doubts that election results will sufficiently serve those ethnic groups when they are under-represented.

Any big change in population presents problems for society such as jobs, health care, welfare, income distribution, etc. The income distribution of California has already been skewed toward whites and Asians due to their higher education level. There is concern that a permanent underclass is developing for Latinos and Blacks who take up most of the manual jobs.

From the above, you can see that many of California’s problems are growing pains that will continue into the future, and will be aggravated when the economy dips. As the economy improves, taxes flowing into government coffers will improve, and the state deficit will be reduced. However, the structural problems in California’s institutions still remain.

Many discussions have been conducted about how to fix the state’s structural problems. The following describes three major ones:

California has been addicted to passing many initiatives voted directly by the people that put a rigid specific limit on government spending and the ability to raise revenues. The consequence is that the initiatives gradually erode the flexibility for legislators to pass a reasonable budget that balances expenditures against revenues. The most controversial one is Proposition 13 passed in the early 1970s that limits annual tax increases for residential and commercial properties regardless of market value. The consequences continue to be felt today, including the loss of billions of dollars of revenues every year to city and county governments. Another initiative, Proposition 4, passed in the late 1970s, limits state government spending and requires any annual surplus to be returned to the people as tax refunds. This essentially guarantees no government surplus except deficit, because the surplus in a good year cannot be used to balance the revenue shortfalls in lean years.

Regarding voter representation, the current system is unfair where legislators are allowed to draw their own election districts (known as gerrymandering) that keep their existing constituents. This guarantees job security for the legislators but kills competition from other leaders who have better ideas to represent the interests of the people. A number of proposals have been advanced to set up an independent commission for redrawing the boundaries of election districts. The latest one, Proposition 20, has been passed in November 2010.

One proposal to fix the state deficit sounds interestingly original: to form your own bank. It is recommended that California should form its own state chartered bank where the government deposits its tax revenues. The state bank cannot print dollar bills as prevented by the US Constitution. But it can use its own “checkbook” money as credits. The amount depends on the government’s assets to be limited by the capital requirement that applies to all banks across the US. What are the assets of the California government? They consist of basically, the stream of tax revenues, plus the lands and properties that the government owns across the state. This can easily amount to hundreds of billions of dollars in assets. At the current capital requirement of 8%, the assets of the California government can easily generate hundreds of billions of dollars in credits, enough to wipe out the current annual deficit of $20 billion. Will that work? All you need is to look at North Dakota and Montana that have formed their own state chartered banks for many years, and these two states do not incur deficits.

(December 2010)

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