Surprise! California Can Improve Its Tax Climate

Californians have been treated to a bruising debate over the wisdom of raising taxes to resolve the budget deficit. But recent actions to improve the state’s economic competitiveness have mostly played out behind closed doors, leaving citizens with the incorrect impression that making tax policy in pursuit of economic development is too messy or obscure for democracy.

When the California economy begins its eventual recovery, our best hope for a strong resurgence in job creation will be to ensure we can compete for high-value, high-skill jobs that are in demand on the world market. But for companies who make decisions based on the tax climate – which include much of the high tech, biotech and entrepreneurial sectors – California has not been in the game.

How to solve a thorny tax problem

While debate rages in Washington, DC over the size and extent of the economic stimulus legislation, a similar discussion is taking place in Sacramento behind closed doors: If California receives five-, ten-, or twenty-billion dollars in federal stimulus aid, how should it be used?

The Administration supports using the stimulus funds to repay or offset any borrowing needed to balance the budget.

Legislative Democrats and interest groups want to use the stimulus money to offset program cuts.

But the most economically effective and fiscally responsible use of part of the stimulus funds would be to offset one of the most egregious tax increases from last year.

Home sales rebound as prices continue freefall

California home prices continue their freefall. This week, Standard and Poor’s released its monthly index of metro home prices, and California registers another record year-over-year drop. The composite average for San Francisco, Los Angeles and San Diego prices dropped in November by 28 percent from the previous year, the same as last month’s year-over-year drop – the largest ever recorded by the state, and exceeded only by the Sunbelt cities of Phoenix and Las Vegas.

According to this index, California’s composite home prices are equivalent to where they were in 2002 or 2003, depending on the region of the state.

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We’re trading down in the job market

California’s highest-skilled and best paying jobs have been steadily eroding, and are being replaced by government employment. While many government jobs provide competitive wages, they do not produce anywhere near the economic benefit and societal wealth that the very best private jobs provide.

The three best-paying, highest-skilled industries in California are the information, financial services and manufacturing sectors, which pay average annual salaries of $90,000, $69,000 and $64,000, respectively. Government jobs on average pay $55,000.

Since 1990, those three high-value industries have lost more than 400,000 jobs in California. During that same period, the government sector has more than filled the void, adding more than 450,000 jobs.

How bad is this recession?

The worst since the Great Depression? Since the early 1980s? In our lifetimes? It’s too early to tell, of course, but so far in California this recession has been neither the mildest nor the worst during the past several decades. However, none of the economic signs on the horizon are encouraging; most of the leading indicators point south.

Employment is a lagging indicator of recessions, so the worst is probably yet to come. One-year into the downturn, California’s employment losses have been material, but not nearly as bad as the two most recent recessions. Ultimate job losses from the 1990–93 recession amounted to a stunning 4.1 percent of employment from the 1990 peak. To reach that level of employment, California would have to lose another 365,000 jobs, about half-again the number lost so far.

Selflessness and, well, something else

President Barack Obama, January 20, 2009:

For as much as government can do and must do, it is ultimately the faith and determination of the American people upon which this nation relies. It is the kindness to take in a stranger when the levees break, the selflessness of workers who would rather cut their hours than see a friend lose their job which sees us through our darkest hours.

California Controller John Chiang, January 21, 2009:

Democratic State Controller John Chiang said Wednesday he will refuse to reduce state worker pay as demanded by Gov. Arnold Schwarzenegger, possibly sparing more than 200,000 public employees from furloughs and pay cuts.

The Anti-Stimulus

The state budget abyss draws closer, and the first victims – surprisingly – are not public employees or school children or poor people, but instead are working men and women, many with union cards.

State construction projects are grinding to a halt, triggered by a decision last month by a crucial state finance agency to halt working capital for state-financed projects. This has led to a cascading effect on state construction projects, placing at risk more than 5,700 projects valued at $22.5 billion.

Does California have a revenue problem or a spending problem?

The answer is probably “both,” but it is usually informed more by ideology than analysis. The following may be useful in guiding policy makers’ decisions on how much in new taxes versus program cuts to implement:

1. Over time, California has stepped up its spending, after adjusting for population growth and inflation. That is, the absolute level of public services has generally increased over time. The following chart shows that inflation-adjusted per capita spending over the past thirty years – since the passage of Proposition 13. For the first couple decades, spending ranged from $900 to $1,100 per capita, over the past decade, spending has averaged $1,100 to 1,300 per capita.

Growth in General Fund SpendingGrowth in General Fund Spending

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Housing continues slide in California

The bottom to the California home price free-fall is still not in sight. Last week Standard and Poor’s released its monthly index of metro home prices, and California still registers a growing year-over-year drop. The composite average for San Francisco, Los Angeles and San Diego prices dropped in October by 28 percent from the previous year, the largest year-over-year drop recorded by the state, and exceeded only by the Sunbelt cities of Phoenix, Las Vegas and Miami. As you can see from the chart below, the trend is accelerating.

According to this index, California’s composite home prices are equivalent to where they were about five years ago, in the summer of 2003.

?California Composite Home Price IndexCalifornia Composite Home Price Index

Save the Columbus Day holiday!!

While we should expect that public sector labor would defend every privilege they have gained for their members, it is still astonishing that state unions and their patrons would consider their positions immune from the ravages of the state’s budget debacle.

With every other politician claiming we are in the worst economic downturn since the Great Depression, state unemployment rising to 8.3%, and consumer confidence falling to an all-time low, since when are reductions in state government personnel costs off limits? Indeed, Gov. Schwarzenegger has proposed what are probably the least harmful approaches to the current state workforce to minimize layoffs by a combination of furloughs, salary reductions, and reducing some state holidays, like Columbus Day.