California Dreaming Becoming The California Nightmare, Financially Speaking

Let’s get away from Federal government political class insanity and wasteful government spending for a little while. Today, let’s revisit one of our most dysfunctional states, California. We have already covered the dire state of California’s economic status in the following posts:

http://loathemygovernment.blogspot.com/2012/10/why-californias-distressed-economy-is.html

http://loathemygovernment.blogspot.com/2012/07/why-california-is-failing-while.html

http://loathemygovernment.blogspot.com/2012/07/state-level-economic-musings-california.html

These posts talked about the bad financial management skills of California politicians, most notably how they have allowed state government employees’ salaries, benefits, and pensions to escalate out of control. In an attempt to get the state financially solvent, late last year the state voters approved a flawed economic recovery plan which raised many state taxes to record setting levels.

The plan is flawed for two simple reasons:

1. California state government, like the Federal government, has a spending and cost problem, a problem that can only be solved by reducing spending and costs.
2. It cannot fix its problems by raising taxes. The amount of taxes raised is never enough to cover the ever escalating spending. Also, ever rising taxes start to force high producing individuals and businesses to leave the state for better financial conditions, further depressing tax revenue without fixing the underlying spending problem.

We have seen this happen in other states. Maryland once raised tax rates on millionaires in its state only to find that overall tax revenue from millionaires actually decreased even though the tax rates were higher:

http://loathemygovernment.blogspot.com/2012/12/day-7-eight-days-of-logic-and-sanity.html

Illinois also recently raised tax rates rather than slashing spending. It ended up giving businesses massive tax breaks to keep those businesses located in the state, putting more pressure on individual taxpayers without reducing spending or solving the deficit spending:

http://loathemygovernment.blogspot.com/2011/12/illinois-case-study-why-raising-taxes.html

Let’s take a look at what is happening with those tax increases five months after they were approved relative to education spending, based on the following facts from a March 23, 2013 Bloomberg article:

• As we discussed above, late last year California politicians persuaded voters to support a seven-year, $50 billion tax increase, promising that the money would all go to public education.
• This promise was enshrined in the first five words of the initiative’s title. “Temporary Taxes to Fund Education.”
• However, just four months after the election, the state’s Legislative Analyst’s Office has found that the California State Teachers’ Retirement System will need an extra $4.5 billion a year for 30 years , a grand total of $135 billion, or about $30 billion over the next seven years, to cover its unfunded liability for teacher pensions.
• Thus, while the original tax increase plan was to raise $50 billion for actually educating California kids, now about 60% of that will be needed not to educate kids but to shore up the teachers’ union pension plan, a classic example of bait and switch.
• The article points out that this financial mess should not be a surprise since a number of people had already pointed out the disastrous financial course the state’s financials and pension funding were on, including the article’s author, a report called the Volcker-Ravitch report, and a report/analysis done by Bill Gates.
• Unfortunately, the $4.5 billion-a-year shortfall is based on the retirement fund’s self-reported unfunded liability estimate, a shortfall which assumes that its investments in the stock market will double every ten years, a highly unlikely assumption since to attain this growth rate, the Dow Jones Industrial Average would have to be around 30,000, more than double its current level.
• Any stock market performance less than that assumption will increase the pension fund shortfall, making the $4.5 billion a year way too low.
• The article reports that economists working for the Volcker- Ravitch analysis estimated last year that under a more reasonable stock market investment earnings assumption, the cost to meet the retirement fund’s unfunded liability is closer to $7 billion a year.
• This $7 billion a year shortfall estimate would be about equal to the seven year, $50 billion tax increase that was passed in November, wiping out any education funding for the kids since $7 billion more a year would be needed just to fund the teachers’ pension liabilities.

The article goes on to point out why this happened, including intentional repression of facts, but that story is for another post.

Another ill fated attempt to fix a government spending problem by not attacking excessive spending but by ignoring the underlying cause and trying to fix it with tax increases. It seems that this approach never works since the expenses grow faster than the tax revenue needed to pay for the ever rising expense stream. The article concludes by putting the blame for this California bait and switch right where it belongs, with the California political class:

Teachers, who don’t receive outlandish wages or pensions, didn’t cause this problem, and the good news for them is that they will get their pensions because the state is legally required to back up school districts if they can’t meet their commitments.

Likewise, this problem wasn’t caused by defined-benefit pension systems, which can work perfectly fine so long as promises are funded properly when they are made.

But many politicians don’t want to fund pension promises properly. Most want to keep doing the opposite so they can keep making promises that can’t be kept, except at great expense to innocent people down the road.

There’s no free lunch here. To the extent that school districts pick up the cost, kids in school today will be hurt because more dollars will go to pension costs and fewer dollars will go to classrooms. To the extent that the state picks up the cost, residents will receive fewer services. Either way, voters will get little for the tax increase they approved in November.

No free lunch, truer words regarding politicians have never been more appropriate and have never been more ignored. Better to enrich themselves and buy votes today and not worry about fewer services and financial burdens to imposed on citizens down the road. Classic politician bait and switch, promise today, reneg tomorrow.

But this is just one financial problem facing California today. A new financial report by the California State Auditor and the Bureau of State Audits shows that California is heading quickly down the financial road of disaster:

• California now has a negative net worth of $127.2 billion.
• Which actually gets worse since although the report estimated the state's total long-term obligations at $167.9 billion, that number did not count unfunded liabilities for state employees' future pensions or the $60 billion in unfunded liabilities for retiree health benefits (see the $135 billion liability identified above by the Bloomberg article).
• These costs have been identified by the Government Accounting Standards Board and Moody's as costs that state and local governments should include in their budgetary assessments.
• If those costs were included in California’s budget sheet, the state’s net worth would decline hundreds of billions of dollars more.
• The report states that California spent $1.7 billion more in the 2011-12 fiscal year than it took in, leaving the state in arrears almost $23 billion.
• Of the $127.2 billion spent by the state that fiscal year, roughly half of it resulted from the state issuing general obligation bonds which were then distributed to local governments and school districts for public works projects. Those assets were listed on the balance sheets of the localities involved, while the state accrued the bonded debt.

Nasty reality coming home to roost in California. Politicians have been spending way beyond their state’s ability to pay. And rather than cut spending to be in line with their ability to pay, they keep raising taxes, which are now never going to be able to pay for the extravagant and probably wasteful spending.

Tax increases, at best, slightly postpone the facing of reality. The tax increases from last November, for example, did not make life better for state residents, it just went to paying off a small portion of the out-of-control spending.

To give you an idea of how bad the state’s debt is, let’s do a little math. If we take the $167.9 billion shortfall and add in the $135 billion of unfunded liabilities for the teacher pensions, and divide by the number of U.S. households, we see that if the rest of the country wanted to bailout California, each household would have to write a check for about $2,600. This would be more than 5% of every U.S. household’s gross household income. Outrageous.

We review the California situation as a forewarning of what is happening at the Federal government level. At some point, and we may have already passed that point, the exponential growth in expenses, especially interest payments on existing debt obligations, can never be overcome by raising taxes. As in California, raising taxes only slows down the march into unrecoverable debt levels, only reducing spending can solve the problem. Just ask California, Maryland, and Illinois.

Raising taxes without fixing the underlying spending problem eventually results in fewer government services for its citizens, a collapsing economy, and dire hardships for the most unfortunate in our society. But at least at the Federal level, there is a way to solve the spending problem without raising taxes and with minimal harm to most citizens. This plan would take an amazing $9 TRILLION out of the Federal government debt and spending stream without raising taxes. The details are in the following link:

http://loathemygovernment.blogspot.com/2012/12/part-8-eight-days-of-logic-and-sanity.html

The question is whether the Federal political class will follow this common sense advice or the rest of the country will be subjected to the California bait and switch fallacy of just a little more taxation will fix everything.

Note: for an insightful view of how this California spending problem is unfolding in a major California city, Stockton, take a few minutes to view the following video:

http://www.youtube.com/watch?v=dUv77v4qyrw

Stockton is the largest American city to ever declare municpal bankruptcy. It will probably not be the last or the largest when the whole financial deck of cards collpases in California and elsewhere across the country.

Our book, "Love My Country, Loathe My Government - Fifty First Steps To Restoring Our Freedom And Destroying The American Political Class" is now available at:

www.loathemygovernment.com

It is also available online at Amazon and Barnes and Noble. Please pass our message of freedom onward. Let your friends and family know about our websites and blogs, ask your library to carry the book, and respect freedom for both yourselves and others everyday.

Please visit the following sites for freedom:

http://www.reason.com/
http://www.cato.org/
http://www.robertringer.com/
http://realpolichick.blogspot.com
http://www.youtube.com/watch?v=08j0sYUOb5w