Dark clouds in the Golden State

May 15, 2012

In a YouTube address released last Friday, California Governor Jerry Brown shocked his constituents with an announcement that the state’s projected revenue shortfall had increased to $16 billion. This followed very weak April state income tax collections, which deepened the budget hole from the $9 billion that Brown had originally forecast in January. The new deficit is a result of a reduced revenue outlook for California, higher school funding costs, and decisions by the federal government and courts to block certain budget cuts. New cuts that Brown floated yesterday will reduce General Fund spending as a share of California’s economy to its lowest level since 1972‑73.

The $92 billion budget that Brown had proposed in January for the fiscal year 2012-2013 (which starts on July 1) looked like this:

With the new revenue shortfall, almost every area of the state budget has been targeted for cuts; education, which accounts for 53 percent of General Fund spending, is the only category that was spared. In his revised proposal, Brown substantially increased K‑14 spending (i.e., includes two years of community college or vocational training) and protected the University of California and California State University from further, deeper cuts. School spending is mandated by Proposition 98, which requires that California pass through a substantial portion of state revenues to local governments to fund education.

Overall, Brown proposed that half of the budget hole should be plugged with spending cuts, 35 percent with tax hikes and 15 percent with financial gimmicks. Brown’s preferred budget cuts (pages 5-7) total $8.3 billion and include a $1.2 billion reduction to California’s medicaid program (Medi-Cal), an $880 million reduction to welfare (Temporary Assistance to Needy Families payments) and a 7 percent reduction in hours to in-home supportive-care-services providers.

These monies are the lifeline that millions of Californians rely on. It’s hard to get a sense of the human side of this, but it’s enormous. And without additional revenues, deeper cuts will be required.

Reuters’ Jim Christie picks up the story here:

In California, where local property taxes are limited by law, and local services, including schools, are thus largely funded by the state, the most important source of government revenue by far is personal income taxes. Capital gains income from the state’s wealthy residents helps fill the state’s coffers in good times, but falls sharply in bad times.

California’s larger-than-expected deficit did not faze traders in the $3.7 trillion U.S. municipal debt market, said Gary Pollack, managing director at Deutsche Bank Private Wealth Management in New York.

“The market is taking it in stride for the time being,” he said.

California bonds have been trading a little better over the last few weeks, aided by rising prices and falling yields in the overall municipal market, Pollack said.

California, the muni market’s biggest borrower, has about $80 billion in outstanding obligation debt, compared with its $1.9 trillion in economic output.

California has about $10 billion in borrowing capacity available, but it must balance its budget. The state continues to suffer from the aftermath of the financial crisis and real estate bust. At the same time, demands on the state have increased while resources have shrunk. There are dark clouds in the Golden State, and they are not likely to pass soon.

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