THE NEXT CRASH

As lead­ers draft spend­ing plan, ques­tion lingers of whether state is pre­pared for an­other down­turn

Los Angeles Times - - CALIFORNIA - By Chris Mege­rian

SACRA­MENTO — Even as Cal­i­for­nia’s lead­ers pre­pare a new state bud­get that is f lush with cash, Gov. Jerry Brown has in­creas­ingly raised the specter of an­other re­ces­sion that could undo years of hard-won fi­nan­cial progress.

When he re­leased his lat­est spend­ing pro­posal last month, he said a down­turn was “around the cor­ner.” In a speech to busi­ness lead­ers, he said the ques­tion was “not if, when.” And he told county gov­ern­ment of­fi­cials that even a mod­er­ate down­turn could cost the state $40 bil­lion in rev­enue over three years.

The gover­nor’s warn­ings may seem over­wrought, given that econ­o­mists see no sign of trou­ble on the hori­zon. And state rev­enue has rou­tinely ex­ceeded even the most bullish pro­jec­tions in re­cent years.

But the ques­tion is whether Cal­i­for­nia has done enough to guard against an­other bud­get cri­sis, and ex­perts say that the an­swer is a re- sound­ing no.

“Is the state pre­pared for a medium re­ces­sion?” said Jerry Nick­els­burg, a UCLA econ­o­mist. “State gov­ern­ment is not.”

Cal­i­for­nia’s rainy-day fund was strength­ened by vot­ers in Novem­ber, re­quir­ing of­fi­cials to stash away a por­tion of Cal­i­for­nia’s rev­enue each year. By next sum­mer, it could con­tain up to $4.2 bil­lion, ac­cord­ing to an es­ti­mate from leg­isla­tive an­a­lysts.

But if a down­turn oc­curs then, those sav­ings would cover only a tenth of the po­ten­tial rev­enue loss un­der the gover­nor’s re­ces­sion sce­nario.

“That fund is not go­ing to be large enough,” Nick­els­burg said. “It could get wiped out pretty quickly.”

Fi­nance ex­perts say that the gover­nor has done lit­tle to ad­dress Cal­i­for­nia’s un­der­ly­ing fi­nan­cial prob­lem — its tax sys­tem.

The state pulls about half of its in­come tax rev­enue from the top 1% of res­i­dents, whose in­comes ebb and flow with the un­pre­dictable stock mar­ket. Even mild eco­nomic rip­ples can cause big waves in Sacra­mento.

So although Brown frames the bud­get de­bate as a choice be­tween his fru­gal­ity and law­mak­ers’ largesse, Cal­i­for­nia re­mains vul­ner­a­ble ei­ther way, an­a­lysts say.

“The cy­cle is not bro­ken,” said Jeff

Cum­mins, a Cal State Fresno po­lit­i­cal science pro­fes­sor who has writ­ten a book about the Cal­i­for­nia bud­get, aptly ti­tled “Boom and Bust.”

Brown has said over­haul­ing the tax code — ex­pand­ing the sales tax to some ser­vices or re­duc­ing re­liance on the wealthy — may not be po­lit­i­cally pos­si­ble in Demo­crat-ruled Cal­i­for­nia, be­cause it would in­crease levies on the less wealthy.

“Jerry Brown is a very suc­cess­ful gover­nor, but there are cer­tain things even he would have a hard time do­ing,” said Jack Pit­ney, Clare­mont McKenna Col­lege po­lit­i­cal science pro­fes­sor. “It’s a tough sit­u­a­tion.”

If the next re­ces­sion comes rel­a­tively soon and is rel­a­tively se­vere, it could cause new bud­get short­falls, force cuts in gov­ern­ment ser­vices again and de­rail the state’s ef­forts to tackle some of its deep-rooted fi­nan­cial prob­lems.

In short, it could present a sit­u­a­tion like the one Brown in­her­ited when he took of­fice in 2011.

It’s a thorny po­lit­i­cal prob­lem for the gover­nor, who be­gan his fi­nal term in of­fice in Jan­uary and has been widely cred­ited with steer­ing the state out of a se­ries of dam­ag­ing bud­get crises.

He faces con­stant pres­sure from ac­tivists and fel­low Democrats to in­crease spend­ing on such pro­grams as state-sub­si­dized child care, but he does not want to add a lot of per­ma­nent ex­penses that may not be sus­tain­able.

The gover­nor has of­fered some new as­sis­tance, such as a tax credit for poor fam­i­lies. But he is try­ing to beat back other re­quests, such as higher pay for doc­tors who par­tic­i­pate in the public health­care pro­gram.

“I love all those pro­grams I veto,” Brown said re­cently, “be­cause I don’t want to cut them back when we hit the next re­ces­sion.”

The dead­line for law­mak­ers to pass a bud­get is Mon­day. The gover­nor has earned praise from fi­nan­cial an­a­lysts for keep­ing a tight- er grip on the purse strings than some Democrats want and fo­cus­ing on pay­ing off debt in­curred dur­ing the last re­ces­sion.

A re­cent re­port from Stan­dard & Poor’s, the Wall Street rat­ings agency, said Brown’s lat­est bud­get pro­posal could help the state “with­stand weaker con­di­tions.”

“We are in a much bet­ter po­si­tion to­day to deal with that eco­nomic down­turn when­ever it oc­curs than we have been in the re­cent past,” said H.D. Palmer, a spokesman for Brown’s Depart­ment of Fi­nance.

Cal­i­for­nia’s cur­rent eco­nomic re­bound has lasted longer than the five-year av­er­age, said Gabriel Petek, who tracks the state’s fi­nances for Stan­dard & Poor’s. How­ever, he said, that doesn’t mean a down­turn is im­mi­nent.

“An eco­nomic ex­pan­sion doesn’t nor­mally die of old age,” he said. “There’s usu­ally a pre­cip­i­tat­ing fac­tor. And right now, we’re not re­ally see­ing that.”

Tech­nol­ogy com­pa­nies in Sil­i­con Val­ley have driven a lot of the state’s growth in the last few years.

Face­book’s ini­tial public of­fer­ing in 2012 was so big that leg­isla­tive an­a­lysts took the un­usual step of in­clud­ing the com­pany as a fac­tor in their fi­nan­cial es­ti­mates.

Other ar­eas of the econ­omy have also bounced back, and the state’s un­em­ploy­ment rate con­tin­ues to fall.

But econ­o­mists con­ceded that it’s hard to see down­turns com­ing.

“No­body saw the depth of the 2008 re­ces­sion un­til the whole hous­ing bub­ble had un­rav­eled,” said Steve Levy, direc­tor of the Cen­ter for Con­tin­u­ing Study of the Cal­i­for­nia Econ­omy in Palo Alto.

“Re­ces­sions usu­ally catch us by sur­prise.”

The state Se­nate’s Bud­get chair­man, Mark Leno (D-San Fran­cisco), said it doesn’t make sense to plan the state’s bud­get around po­ten­tial fi­nan­cial catas­tro­phe.

Cal­i­for­nia could ab­sorb mild down­turns, he said, with such steps as re­duc­ing debt re­pay­ments.

In­deed, a re­ces­sion could also dam­age the state’s abil­ity to tackle some of its other long-term li­a­bil­i­ties, such as re­tire­ment benefits and over­due main­te­nance on state roads.

Dur­ing the last bud­get cri­sis, law­mak­ers plugged bud­get holes with fees in­tended for road re­pairs.

Ef­forts to re­turn the money to its in­tended pur­pose — and help chip away at the es­ti­mated $59 bil­lion in up­grades needed for high­ways and bridges — would be­come more dif­fi­cult if the state faced new short­falls.

“If you can put off some of those longer-term is­sues,” Cum­mins said, “that’s what you’re go­ing to do.”

Mark Boster Los An­ge­les Times

CAL­TRANS SU­PER­VI­SOR Howard Mead stands amid cracked pave­ment near the 5 and 60 Free­ways. Dur­ing the last bud­get cri­sis, law­mak­ers plugged bud­get holes with fees in­tended for road re­pairs.

Mark Boster Los An­ge­les Times

EF­FORTS to chip away at the es­ti­mated $59 bil­lion in up­grades needed for high­ways and bridges will be­come more dif­fi­cult if the state faces new short­falls.

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