A Quick Look at How Truly Awful the Budget Is Going To Be

Recently, representatives of the Schwarzenegger administration told Wall Street investors that, absent corrective action, California’s budget would have a $3 billion gap between revenues and spending commitments by June 30, 2009. 

That estimate was ridiculously low. The governor acknowledged as much after a meeting with legislative leaders on October 27. Senate President Pro Tempore Don Perata, D-Alameda, said afterward this year’s gap is closer to $10 billion. 

Perata is probably closer to the truth but on the low side. There’s likely another hole of $9 billion or more for the fiscal year that starts July 1 of next year. 

Put simply: A potential hole on the order of $19 billion – or more — to fill between now and June 30, 2010. 

While the administration isn’t saying exactly how bad California’s financial situation is it will know more after October 28 when the state Department of Finance brings a group of economists to Sacramento for a closed-door critique of the Schwarzenegger administration’s revenue estimates – the first estimate the state has made since May. 

Whatever the economists say, it doesn’t take a Milton Friedman to conduct a cursory review of the factors that dictate how much cash the state will have in its coffers and see exactly how bag things are.

The $3 billion figure is an annual extrapolation of the cash shortages the state has experienced so far during the first quarter of the fiscal year which began July 1. While the fiscal yar began on July 1, a budget wasn’t signed until September 23, a record for tardiness unparalleled in California’s 158 years of statehood. 

This extrapolation was sought by Wall Street investors who are helping California sell up to $7 billion in revenue anticipation notes – money to smooth out the cash flow highs and lows in California’s annual revenue collections. 

California has sold $5 billion worth of the notes, which are attractive short-term investments since the state has never defaulted on a payment, even during the Great Depression. 

The four chief revenue sources for the state budget are income tax, sales tax, bank and corporate tax and property tax. 

During the first quarter of the current fiscal year, the state is approximately $1 billion below the revenue estimates the GOP governor used to create the May Revision of his initial January budget. Interestingly, that springtime revenue forecast ratcheted down earlier expectations for this year’s cash by $5.8 billion. 

The point being that forecasters weren’t bubbling over with optimism six months ago when the Dow was around 12,800. It can only be bleaker now that the Dow has shed more than one-third of its value and hovers at 8,100. 

This is good news for one person: Sen. Barrack Obama. The economy is in the tank so he’ll likely be elected president. The bad news is that the economy will probably get worse before it gets better. 

That’s not good news for California budget-writers.  

The economy affects the state budget both in cash coming in and cash going out the door.  

A sluggish, stagnant or sinking economy not only retards revenue collections but also increases spending in state social programs such as welfare and Medi-Cal, the state’s health care program for the poor. 

A suffering economy also creates higher unemployment, which, in turn, means more persons using state or local safety net programs. 

In August, California posted a 7.7 unemployment rate – the third highest rate in the country. August was the fifth month in a row the unemployment rate increased. Nationally, the rate was 6.1 percent. 

This is the highest unemployment rate California has seen in 12 years.  Last year, the unemployment rate was 5.5 percent. 

Sixty thousand salaried and self-employed jobs were lost from July to August. Since August of last year, 240,000 jobs have disappeared from California’s 17 million-person workforce. 

From August 2007 through August 2008, employment fell by 79,200 in construction, by 33,300 in financial activities, by 28,800 in manufacturing and by 24,600 in trade, transportation, and utilities, according to the Department of Finance’s October Bulletin. 

Unemployment in what once were some of the fastest growing parts of the state, such as the Inland Empire, is even higher. August unemployment in the Inland Empire stood at 9.4 percent. In Los Angeles, it was 7.9 percent. 

Those unemployed persons are neither buying things to generate sales tax collections nor are they paying taxes. 

California is already dangerously reliant on its wealthiest taxpayers. In the 2005 tax year, the Franchise Tax Board’s annual report notes that 48 percent of all tax liability was shouldered by the top 1 percent of the filers. The top 5 percent paid 68 percent. Fewer lower income filers exacerbate that reliance. 

It’s unlikely many of those high-income filers will be cashing out stock options or taking capital gains. At the peak of the Dot Com boom in the late 1990s, personal income tax revenues spiked because of option cash outs and gain takings. 

But in a market where someone bought General Electric at $30, it’s unlikely they would sell at $18. If they do anything, it will be to take losses to write off against their other income, further reducing state tax collections. 

Nor are there likely to be as many high-income filers. C.C. Meyers, the Sacramento-based rapid road repairer and developer, for example, is now in bankruptcy protection. 

The depressed housing market is going to mean a lot less income taxes from a lot of other developers, as well. 

This year’s 85-day late budget did nothing to attack the root problems of the spending and revenue gap because it did not significantly reduce spending or expand the state’s revenue base. 

What it did do was try to accelerate payments so the state would theoretically get more money sooner. But if there are fewer people employed to pay it, those collections will also fall short of estimates. 

In return for those accelerated payments, lawmakers and the governor decided that two years from now the state would increase tax breaks by more than $1 billion annually, further darkening the state’s revenue picture. 

Looking at the housing market, there were 11,033 foreclosures statewide in the first quarter of 2007. For the same period this year, it was 42,271. For the third quarter of this year there were 80,000 foreclosures – a 228.4 percent increase over last year. 

Sacramento city and county will receive $32 million as part of the federal housing bailout plan, one of the largest grants. The City of Los Angeles will get $13.3 million. Riverside and San Bernardino Counties — $18.6 million. 

These are dubious distinctions since the aid is given out based on the level of foreclosures. 

The median price of a single-family home sold in August of this year was $350,000 – down 40 percent from August 2007. 

Linked to that falling home value is the property tax base. Lower home values means lower assessed value. Fresno County is reducing the assessment on 46,000 parcels. Sacramento County is doing it for 85,000 properties, a $60 million revenue loss to the county. 

Local property tax is one of the major revenue sources for public education. Less local property tax revenue means a bigger share of support for public schools must come from state revenue. 

The state reports receiving $212 million less in sales tax in September than it expected. It also reported receiving $426 million less than anticipated in corporate taxes. Both are reflections of the struggling economy and will likely worsen in the months ahead. 

Three small examples of the larger economic mess: The Sharper Image has closed its stores. Linens ‘n Things is liquidating its inventory and following suit. 

Mervyns, which sought Chapter 11 protection two months ago, has also elected to shutter all of its 149 stores, most of which are located in California. That’s another 15,000 jobs lost and, in Sacramento alone, 700,000 square feet of empty retail space. 

Hopefully, some action will be taken during the special legislative session the governor has called for after the election. The sooner spending is reduced, the more savings accrue just as the sooner revenues are increased the sooner the spending gap is closed. 

However based on the performance of all parties during this year’s budget debacle, expectations would appear to be low for anything significant being done between November 5 and Thanksgiving to address this worsening problem. 


Filed under: Budget and Economy


  1. Gee, Greg. Thanks for the uplift. It will be instructive to see whether the respective interest groups savage one another or seek \"share the pain\" solutions based on the better angels of their nature.

    Comment by Robyn Boyer — 10.27.2008 @ 9:09 pm

  2. Greg, great perspective but just like the legislative analysts office the people who need to heed the warning will not listen nor understand. As for the special interests working together remember it is they who cause the legislature to take such un-reasonable stands on many things some of which are not remotely connected to their issues but might and I stress might remove a dollar from the table that they feel could be theirs in the future.

    Comment by Paul — 10.28.2008 @ 8:10 am

  3. great post hope to see some additional comments here…

    Comment by Tatiana — 11.17.2008 @ 12:44 pm

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