Party Like It's 1999

California Party Time

Sacramento spends its tax revenue gusher like there’s no tomorrow.

WSJ Opinion, May 31, 2015

These are hard times for the blue-state governing model of high taxes and public unions—see Illinois, Connecticut and Maryland. But our friends on the left ignore these states and tout California as their real model, as Sacramento celebrates record tax revenue. So it’s worth noting that the Golden State may be repeating the fiscal mistakes it made before its last economic bust.

There’s no doubt the state government is on a high, with Governor Jerry Brown forecasting $6.7 billion in additional revenue beyond his January projections due to growth in capital gains and incomes among high earners. Over four years general fund revenues have risen by 40% to $117.3 billion as income-tax collections surged 55%.

This follows what has turned out to be one of the most fortuitously timed tax increases in history. Mr. Brown’s 2012 ballot measure retroactively raised taxes on individuals earning more than $250,000 and increased the top rate to 13.3% from 10.3% for those making more than $1 million. The measure passed amid the Internet boom and stock market rise.

No one wants to mention, however, that the tax hike doubled down on the state’s top-heavy tax structure that produces huge revenue swings. The top 1% of taxpayers—those earning more than $525,000—paid over 50% of all California income taxes in 2012 while the bottom four quintiles earning less than $90,000 paid a mere 10%. The Golden State has lost middle-income jobs in manufacturing to other lower-taxing Western states, but it has assets like Silicon Valley that other blue states don’t.

The resulting revenue boom has politicians partying like it’s 1999, the height of the dot-com bubble. The boom has been especially sweet for teachers unions because under the state constitution schools are entitled to most of the haul. Over the past four years state spending on K-12 and community colleges has grown by 45% to $68 billion this year.

But now other liberal interest groups want to join the party. So Mr. Brown is proposing to extend Medicaid to illegal immigrants granted permanent residency by President Obama. California’s Medicaid expansion under ObamaCare has already added four million beneficiaries at a cost of $17 billion. National taxpayers are picking up $15.5 billion of the tab for now, but California’s share will grow after 2016.

Mr. Brown also wants to create another entitlement by inaugurating a state version of the earned-income tax credit for two million low-income Californians. That comes on top of next year’s increase in the minimum wage to $10 an hour, and $15 an hour by 2020 in Los Angeles.

Yet despite the government’s efforts to help the poor, California has the nation’s highest poverty rate at 23.4%. And nowhere in the U.S. save perhaps New York City is income inequality greater than San Francisco, which has been a hothouse for progressive policies such as a $15 minimum wage and mandated paid sick leave. All that income redistribution doesn’t seem to be the secret to equality.

Meantime, projected revenues from California’s cap-and-trade auctions have swelled by 150% in the last year to $2.2 billion. Mr. Brown wants to spend $400 million of that windfall on affordable housing; $350 million on low-carbon transportation (i.e., electric car subsidies that go mainly to the well off); $365 million on public transit and intercity rail; and $500 million on the L.A. to San Francisco bullet train that is already short of funding.

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The danger is that this gusher of new spending will set up the state for another budget bust. Last November voters did approve a ballot referendum aimed at imposing some spending discipline, strengthening the porous rainy day fund. Under the new law’s formula, the state must spend $1.9 billion this year to pay down “debts and liabilities.”

But Mr. Brown has construed it broadly to include payments to schools and special funds that politicians had previously raided. He’d also create a new liability by proposing to seize $96 million from the rainy day fund to shore up University of California pensions. Yet Mr. Brown’s budget doesn’t even begin paying down the $191 billion unfunded liability for state worker and teacher retirement benefits.

At the end of 2015 the rainy day fund will have a meager $3.5 billion, and the Governor cautions that the “budget remains precariously balanced and faces the prospect of deficits in succeeding years.” Last year the state Legislative Analyst’s Office warned that a modest dip in income growth could trigger multibillion-dollar deficits due to built-in spending increases, particularly in education.

The paradox of Jerry Brown has always been that he’s smart enough to recognize the severity of the state’s fiscal problems, yet he can’t seem to restrain his prodigal legislature or even help himself. The revenue boom is making California’s economy and budget look better than they are. The reckoning will arrive when the next economic downturn does.