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California must Address Leaks in Budget before Raising Taxes

David Crane
Lecturer at Stanford University, President of Govern for California, and Former Economic Adviser to California Governor Arnold Schwarzenegger

Crossposted on Sacramento Bee

In an effort topreserve existing services, Gov. Jerry Brown has proposed a temporary tax increase to generate new revenue of $9 billion per year for seven years. The Legislative Analyst’s Office says the proposed tax increase will yield less. Either way, little of the new money will help existing services for long unless four leaks are addressed:

* The California State Teachers’ Retirement System, or CalSTRS, is seeking an extra $4.5 billion a year in pension contributions. Satisfying just that request would take 50 percent of the new revenues forecast by Brown and 66percent of the new revenues forecast by the LAO.

No one argues that CalSTRS needs the money. In fact, the only question is whether $4.5 billion per year is enough. But the state has not responded and Brown’s pension reform proposal didn’t even address CalSTRS.

Silence won’t make the problem go away. If the $4.5 billion per year is not addressed by the state, then school districts must step up and that would take up more than 100 percent of their share of the tax increase, leaving none of the new money for students. And delay is not an option because that raises the cost an additional 7.5 percent a year. One way or another, CalSTRS’ request must be satisfied.

* Rand Corp. forecasts the new federal health care law – the Affordable Care Act – will require $2 billion in new state spending starting in 2016, rising to $4 billion by 2020.

* Retiree health care expenditures currently cost the state $1.7 billion per year in cash, double the cash cost of seven years ago. But more importantly, and as Controller John Chiang recently reported, the accrual-basis cost (i.e., the real cost) of those benefits is $4.7 billion. The $3 billion difference represents new debt, which now amounts to more than $60 billion, the service of which (along with rising health care costs) will cause other post-employment benefits costs to double more frequently and, as Bill Gates illustrated in a 2011 TED speech about state budgets, to rapidly consume increasing shares of government budgets.

* State spending on the California Public Employees’ Retirement System is already forecast by CalPERS to keep rising to make up for the fact that it earned only 60 percent of its guaranteed return from 1999-2011. But few understand that even that forecasted increase assumes that CalPERS will earn its guaranteed return going forward, a return that far exceeds the returns forecast by Warren Buffett and others. To meet the guarantee going forward, the stock market must double every nine years. Anything less and the forecasted increases will rise even more.

Together, just the first three items consume more than 100 percent of the tax increase. Perhaps the governor and Legislature have a plan to address these items and thereby safeguard the new revenues for existing services. But if not, California will be following the path taken by Illinois, which enacted a large tax increase in 2010 only to see the new revenues in 2011 diverted to past bills. To add insult to injury, Illinois politicians then engaged in crony capitalism to cut special tax reduction deals with influential large corporations while unconnected small businesses and individuals were left holding the bag.

Brown is right in seeking to prevent further erosion of existing services, but a tax increase without reform won’t achieve that objective. Worse, a tax increase in the absence of reform would mask those problems, leading to even larger leakages down the road and even greater degradation of services. At a minimum, the governor and Legislature must demonstrate how the new revenues really would benefit existing services. It’s not fatal if the new money goes to those items – provided reforms are enacted to close those leakages going forward. But a tax increase without reform would be lethal.

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