“Smoothing” Today Makes For Bumpy Road Tomorrow

David Crane
Lecturer and Research Scholar at Stanford University and President of Govern for California

This week, the board of the California Public Employee Retirement System (CalPERS), the largest pension fund in the country, will be asked to approve a “smoothing” proposal designed to provide short- term cash flow relief to local and state governments by deferring pension contributions.
If that sounds to you like a free lunch, you’re right. Such an offer is tempting to governments facing harsh budget troubles, but CalPERS should reject the proposal as at best imprudent and at worst dangerous to future generations.

From Enron to AIG, we have seen the consequences when complex financial engineering and mystifying terminology is employed to obscure simple truths. In AIG’s case, “credit default swaps” masked transactions that in reality were unregulated insurance contracts. In CalPERS’s case, what is unthreateningly framed as “smoothing” is in reality a negative amortization borrowing of the type that recently led so many homeowners down the garden path to foreclosure.

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Governor’s Executive Order Will Create Commission To Propose New Tax Model

David Crane
Lecturer and Research Scholar at Stanford University and President of Govern for California

All across the country, states are facing declining revenues as a result of our troubled economy. Yet, California is uniquely burdened because our revenues swing from extreme to extreme – boom or bust – more than other states. For example, the state of Washington is projecting a revenue shortfall of less than 1%, while our state may face a shortfall of nearly 10%. The difference is that our state’s tax revenues reflect Wall Street’s economy more than California’s economy.

This is because more than 50% of California’s personal income tax revenues come from the just 1% of taxpayers (fewer than 150,000 taxpayers), and that 1% of taxpayers gets a substantial amount of their taxable income from Wall Street investment gains. When there are big investment gains, California’s budget picks up revenue. When there are no investment gains, California’s budget suffers even if California’s economy is still growing.

For example, during the last economic slowdown in 2001, the economy in California grew 1.1% but tax revenues fell 17%. On the other side of the coin, when the economy grew 8.7% in 1999, tax revenues rose twice as fast. Simply put, our tax revenues are too decoupled from our economy and too volatile for our state.

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Lack of a budget means Governor Schwarzenegger must conserve state funds

David Crane
Lecturer and Research Scholar at Stanford University and President of Govern for California

California still doesn’t have a budget for the current fiscal year, which commenced on July 1. Without a budget now for nearly a month, California faces additional pressure to conserve cash. The following explains why.

Though often (and perhaps conveniently) forgotten, as a general rule our state Constitution prohibits expenditures in the absence of a budget. Because of that limitation, a great deal of spending – for childcare centers, health care providers, centers for the developmentally disabled, many county services, contractors, and more — was already suspended as of July 1.

However, notwithstanding that general rule, the Constitution as well as federal law and public safety require some spending whether or not there’s a budget. Examples of such mandated or essential service spending include certain funds for public schools, debt service, child welfare programs, public safety, disaster relief and more. Those activities require cash and therefore the state must always have ready access to cash sufficient to meet those essential or mandated requirements.

Moreover, if we run out of cash, we will be forced to access the Revenue Anticipation Warrant (RAW) market for that cash. To understand the nature of the RAW market, one must first understand its cousin, the Revenue Anticipation Note (RAN) market.

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The State Infrastructure Shortfall

David Crane
Lecturer and Research Scholar at Stanford University and President of Govern for California

California is the richest state in the richest country in the world and we lead the world in entrepreneurship and innovation.

But when it comes to infrastructure, we are neither rich, entrepreneurial nor innovative.  States and countries with a fraction of our wealth provide their citizens with far superior infrastructure services. People elsewhere travel on more convenient and comfortable transportation systems, study in better school facilities, live behind more secure levees, drink from more secure water systems, and more. California’s environment, quality of life, workers, students and innovators all suffer as a result of our infrastructure deficit.  

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