Over-selling California’s recovery

By Cate Long
January 12, 2013

The Golden State, under the leadership of Governor Jerry Brown, has done a remarkable job of managing its finances through the worst economic period since the Great Depression. Because the state was the epicenter of the housing bust, its fiscal meltdown was one of the most severe in the nation. Although three California cities have declared bankruptcy (with others to possibly come) the state deserves a lot of credit for getting through a very rough period.

The governor held a press conference touting the state’s recovery. However, fireworks and champagne to celebrate recovery would be a little premature. Adam Nagourney of the New York Times reported:

“The deficit is gone,” Mr. Brown proclaimed, standing in front of an array of that-was-then and this-is-now charts that illustrated what he said were dramatic changes in California’s fortunes.

“For the next four years we are talking about a balanced budget,” he said. “We are talking about living within our means. This is new. This is a breakthrough.”

California’s 2014 budget would show a $21 million surplus, according to the Times. Meanwhile, Paul Krugman trumpeted that the fiscal struggles of California were over, based on his blog research:

Guess whose state budget crisis seems to be over?

As best I understand it, what’s going on in CA is a microcosm (a pretty big microcosm, actually — maybe more of a mesocosm or something?) of what’s going on at the national level.

But is California’s budget in surplus or balanced? Or are Jerry Brown and Paul Krugman just talking positively for political purposes? Projecting budgets and accounting for a state of California’s size is tricky, since cash flows are inconsistent and political objectives are often shifting. There are general funds, special funds, cash deficits, unfunded liabilities, debt service and the political reality of satisfying multiple constituencies. Managing a state is like juggling – you have to keep everything moving.

According to Mac Taylor, California’s legislative analyst, the state’s fiscal problems have been stabilized.  In contrast to Governor Brown, though, Taylor’s office projects a $1.9 billion deficit for 2013/14, and a small operating surplus of just over $1 billion for 2014-15.

There are a host of macro-economic assumptions that California’s leaders have made to achieve the balanced budget. They have assumed a moderate economic climate will continue (although the fourth quarter of 2012 was lowered to the range 0f 0.7 percent by investment banks last week). More critically, they assumed that the fiscal cliff will be resolved with no substantial cuts to federal grants that the state receives for Medicaid, education and other programs. The projections also assume no inflation in the budget and the state will put no reserves aside.

The 800 pound gorilla for the state is a host of unfunded retirement liabilities. Weighing in at $181 billion, or about double the annual budget, these are expenses that the state has neglected to cover for years that are contractually due to current and future retirees. Taylor says that the state should be contributing $3.5 billion, or 2 percent of the liabilities, every year, to get these funds up to solvency. At that pace, it would take California about 51 years to cover its unfunded liabilities.

But the real pressure on these predictions is the political climate in California, now entirely controlled by Democrats. There are already some moves to restore social services that were cut in the last few years. The NYT gives reports:

Democrats now control two-thirds of the Assembly and Senate, and some of them have talked about restoring at least some of the social service cuts, like dental care for the poor, that were imposed to bring the state to this point, Mr. Brown said he understood the impulse to repair broken social services, but he warned against returning to a boom-and-bust pattern of spending during the good years, only to later struggle through debt.

Krugman’s point that California is a microcosm for what is going on at a national level is true, but in a way he is probably not aware of. California, having cut its general fund spending and raised taxes, has achieved some fiscal solvency. But the broader social contract promised to state employees, retirees and constituents has no long-term realistic fiscal foundation. Promises are made for future commitments, but never funded. Does California have a balanced budget? No more than the federal government does.

VIDEO: California Legislative Analyst Mac Taylor discusses the 2013 and 2014 Budget.

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