California was America’s Greece in 2009. It had excellent wine and olive oil. But tax revenues were collapsing. The deficit ballooned. Its credit rating was cut to the lowest of any state in the US. It couldn’t borrow at reasonable rates. And when, under Gov. Arnold Schwarzenegger, it couldn’t pay its bills with real money, it sent fancy-looking IOUs to its suppliers.
Today, California is flush with money. The economy in the coastal areas has bounced back. Unemployment, while still high in some areas, continues to drop. The budget is on its second annual “surplus” in a row. Capital gains taxes from the booming tech sector, the soaring stock market, the white-hot property sector, and all kinds of other investment activities, on top of some “temporary” tax increases, triggered a flood of revenues – $6.7 billion more than Brown’s office had estimated just in January.
OK, no one can figure out how to deal with the unfunded pension and healthcare liabilities. But what the heck, lawmakers at the Democratic stronghold are now fighting over how to spend the “surplus.” They’ve got till June 15 to figure it out and pass a budget or their pay will be docked.
Gov. Jerry Brown, sworn in for his fourth and final term in January – he’d served two terms in the 1970s – is putting his stamp of frugality on the budget, trying to stem the flood of spending proposals. But lawmakers need to be reelected, votes need to be bought, special interests need to be satisfied, and so the money needs to flow.
Brown’s budget – up 6% from the current year – directs most of the “surplus,” as required by law, toward schools and a newfangled rainy-day fund. It’s also used to pay down the “wall of debt,” as he’d called it, that governments have built up over the years with deficit spending. Standard & Poor’s is watching. It currently rates California’s general obligation bonds A+. If the lawmakers don’t go overboard, it might upgrade the state back to where it was 14 years ago.
Home prices are soaring and in a number of cities have gone far beyond the peak of the prior housing bubble. Stocks are soaring. The tech boom is in full swing. Startups with multi-billion-dollar valuations and vertigo-inducing cash-burn rates are proliferating. Silicon Valley is once again changing the world for the better.
“And by the way, we don’t really compete with Texas and New York,” Gov. Brown said in a speech at the CalChamber on May 29, in reference to California’s status as the seventh largest economy in the world. “No, we’re competing with the UK and Germany. And we are ahead of India, Russia, Italy, and Brazil.” Exuberance is back.
But Brown has seen this movie before a few times. It always ends in tears. Boom and bust. Now is the boom. He told his audience at the CalChamber that in good times, as the rainy-day fund builds up, “everybody forgets the recession, and they want to start spending. And right in the middle of all that, we get a crash.”
“If we have a modest recession – not if, when we have a recession, if it’s modest – the California state budget will lose $40 billion over three to three-and-a-half years,” he added. But by next summer, the rainy-day fund would only contain up to $4.2 billion, according to legislative analysts.
In Sacramento two days earlier, he said: “The longer you’re away from a recession, the less you remember it, and all you see is money coming in. Usually at the point when the recession is right around the corner and people are feeling the best ever and they want to just spend, we crash.”
“I love all those programs I veto,” Brown explained, “because I don’t want to cut them back when we hit the next recession.”
It’s not a recession per se that will bleed California finances, but declining asset prices. The piles of money being shuffled around – in the stock market that has been soaring for six years, in the housing market that has been soaring for over three years, in the office boom, and in the startup scene – eventually become taxable events. The manna of the Facebook IPO in 2012 was of such magnitude that legislative analysts included estimates of it in their projections.
But most people in California are struggling with high costs of living and so-so incomes on their labor. Only a very small number of people get a significant portion of their income from investments – namely the “1%.” And so it’s no surprise, given this skewed wealth distribution, that the top 1% of Californians pays about half of the state’s income taxes. And when the stock market drops, when housing and office booms leak hot air, or when the whole startup mania reverts back to the mean, income tax revenues collapse.
This is what happened in 2008. The housing bubble imploded. The stock market collapsed. Tech cratered again. Stock options became worthless. Layoffs cascaded through the economy. And tax revenues simply dried up. That’s how it happens every time. And every time, it’s a “surprise”
But we don’t have anything to worry about. “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. Which is what they say every time. But Gov. Brown, who has seen these things unfold so many times before, seems to be warning about a crash in asset prices that could be uncomfortably near.
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