What's Wrong with California   (June 2, 2009)

California's pending bankruptcy has deep roots in tax policy, public employee costs, regulatory dysfunction and a declining real-world economy.

Standard-Issue Financial Pundits (SIFPs) like Paul Krugman ( State of Paralysis) are claiming the state's problems all stem from miserly California voters refusing to pay higher taxes. Uh, Paul, do you pay $10,000 in property taxes for a property you bought in 1992? I do, and I don't think that's a low tax.

In case Paul hasn't visited the Golden State recently, allow me the honor of introducing a funny little concept called fact to his pro-tax rant. We pay 9.5% sales tax (9.75% if you voted for various transit projects like BART) which is among the highest in the nation.

If you make a decent wage (I don't, but many do) then the state income tax is about 10% as well. That rate is also among the highest in the nation.

What we have here is not just cognitive dissonance but pathological disassociation from reality: California is a very high-tax state, with among the highest rates in the nation in virtually every category of taxation. Voters rejected the bogus tax-and-borrow-more propositions for two reasons:

1. The propositions were deceptively written and presented in a ham-handed attempt to mask the fact they weren't tax increases. Voters rejected this incredibly crass attempt to deceive them. Lesson for state politicos: if you want a tax increase, ask for it in plain English.

2. Residents already pay high taxes, and the state has already garnered $40 billion per year in additional funding over this decade. We seem to have received little in the way of improvements for the extra $40 billion a year in state spending. Even in a state with 36 million residents, that is a stupendous sum. Therefore voters desire to send more of their money to a government which has shown little fiscal restraint and precious little oversight of current spending was low.

To understand California's impending bankruptcy, we have to consider these fundamental issues:

1. State, county and city employees are paid (wages and benefits) between 50% and 200% more than equivalent private-sector employees.

2. The California economy's real-world foundations--agriculture, entertainment, technology and tourism--are all in decline or pressured by state policies.

3. Overlapping state regulatory agencies are effectively strangling real-world businesses in favor of high-on-the-food-chain enterprises like attorneys and Web 2.0 firms--businesses which create few jobs and which ultimately depend on highly profitable real-world businesses for their own incomes.

4. The Prop 13 limits on raising property taxes has saved millions from losing their homes due to escalating property taxes even as it has unintentionally created vast injustices.

Let's tackle the last item first. Pundits both in-state and out-of-state are quick to identify not bloated public-employee pay and benefits but low property taxes as the culprit. My wife and I bought our residential property 17 years ago at a cost far below current values and we still pay $10,000 a year. Is that "too low"? If that's too low, then what do these pundits think average wage earners can afford? $20,000 a year? Do they really think $1,660 per month is "reasonable" for property taxes? How much do they pay?

The injustice in the system is obvious but difficult to rectify. To understand why, let's consider the other taxes: income and sales. A rough form of justice is implicit in both: everyone who buys something regardless of their income pays sales tax. Those who buy more are presumably wealthier, hence they pay more sales taxes than those of limited incomes. (Food is exempt from sales tax in California.)

Income tax is highly progressive in California, with moderate-income folks like myself paying modest sums (I paid $513 on adjusted gross income of $30,000) while high-income residents pay a stiff 9-10%. This too carries a readily comprehensible justice: higher income residents can more easily afford higher tax rates as they have more income above subsistance.

But a tax which is $1,200 for for one house and $12,000 for the identical house next door is explicitly unjust. The problem is that the elderly resident of the house paying $1,200 a year might be scraping by on a Social Security check, while the house across the street paying $1,300 a year in property taxes might be long-owned by wealthy pensioners pulling in $10,000 a month.

Meanwhile, the young family who foolishly bought in at the top of the housing bubble next door might be paying $15,000 a year in property taxes even as 65% of their income goes to pay their mortgage and property taxes. (I have friends who pay even more than this stupendous sum for their "fixer-upper" purchased in 2006.)

The only fair way to rectify this structural injustice is to consider the total income (not just taxable income, but all income) and total assets of the residents. Simply raising taxes on low-tax properties will only create new injustices as low-income retirees are forced from their homes by suddenly steep tax increases.

On the other hand, why should residents pulling down $10,000 a month pay 10% of the tax their neighbors pay? That too is unjust.

It seems obvious that some straight-forward adjusting based on income and assets could rectify the worst of the injustices of the current system. Yes, this would require a lot of paper-processing, but isn't justice worth some paper-pushing?

How about something along these lines: if you pay property tax of less than $3,600 a year and your gross income from all sources (including tax-free bonds) exceeds $100,000 a year then your tax jumps to $3,600 a year or 90% of the county's average property tax, whichever is lower.

Look, if you're enjoying an income of $100K or more, I think you can manage $300/month instead of $150/month in property taxes.

If you pay more than $10,000 per year in property tax, the property is worth less than $1 million and your household income from all sources is less than $100,000, then your tax drops to $10,000 per year.

Whatever parameters are set, a fairly limited set of adjustments like the above would rectify the worst injustices of the current system in short order. Yes, some would still pay much less than neighbors while others would pay far more, but some modest attempt at justice would still be worth the effort.

I know all you who work for government and quasi-government agencies like water boards, transit systems and school boards will find this disagreeable, but the vast majority of public employees are paid twice as much (or more) as their private-sector counterparts when benefits are factored in. I know for a fact that clerks in school district offices are paid well over $40,000 a year, with benefits exceeding $20,000 per year, while private-sector clerks with the same skillsets are worth perhaps $22-24,000 in the real world, with minimal pension benefits.

Including rich benefits and pensions, many public-sector employees in California are paid twice or more the market-rate value of their labor.

Since labor costs make up 3/4 of all government budgets, it is obvious the only long-term solution to deficits in states already groaning beneath high taxes is to bring public employee wages and benefits in line with real-world market valuations for that labor.

To date, California's public employee unions are fiercely resisting all but the most feeble reductions in their members' pay and benefits. Given the outsized share of labor costs in all government, this recalcitrance guarantees the state will become insolvent/go bankrupt and literally be unable to meet its payroll.

It is instructive to recall that in 1932, the city of San Francisco reduced its municipal salaries by 25% and limited city jobs to one per household. Note to public-employee unions: that is a real-world start you might do well to accept before even harsher terms are offered.

Overlapping dysfunctional regulations are driving real-world businesses under. Like a prissy spoiled princess, California has turned up its nose at enterprises like making steel (smelly), surfboards (let China worry about fumes), agriculture (uses too much water which I need to keep my lawn green and pool filled), aerospace (there's never enough taxes on the military-industrial complex) and physical technology (that wafer plant is too toxic for our taste, no matter what controls you install).

Oh, and every permit application will cost you big-time. The actual permit--well, what makes you think we'll actually lower ourselves to grant you one? If we do, the fee will hit you like a sucker punch to the gut. Then we'll add inspection fees, business licenses and a swarm of other junk fees. But really, we're "pro-business" here--we love businesses dumb enough to stay here. Sadly, the ranks of sucker corporations seem to be thinning.

As a result, California now depends on top-of-the-food-chain enterprises like attorneys (sue it if has insurance, don't bother if it doesn't), tourism and the horrifically overhyped fraud known as Web 2.0 (a handful of young coders constructing a web business suposedly worth billions but the only source of revenues from now until the sun explodes is advertising). In case nobody noticed, adverts only work on people with jobs and income.

Tinseltown is tanking. The Web is dismantling the film and music industries faster than you can say "Ten bucks to see a freakin' movie?" Unemployment in the film and music industries is rampant and growing. The costs of doing business in california are simply too high to make money.

The illusion of corporate headquartering in California is like a Hollywood set facade. Behind the corporate facade, global giants like Intel are basing most of their employees overseas or in lower-tax states like New Mexico and Oregon. Yes, Silicon Valley is still the place to come for venture capital; and yes, entrepreneurs are still starting companies. But once they need to grow, they have to exit the state to prosper.

The state organs of propaganda will deny all this, but then why are tax receipts down over 40% year over year? Is that because so many new businesses are prospering and hiring people?

The pathetic truth is California got by on a mere $100 billion a year in spending not many years ago and now there is great gnashing of teeth and weeping that the state is ruined if spending doesn't stay at $143 billion a year. If this were true, then how did we get by on $95 billion a mere decade ago? The answer to cutting $42 billion is simple: all agencies must revert to their 2001 budgets.

The housing bubble provided California with one last glorious shot of fantasy. No need to tax and spend prudently--housing will keep going up and the property tax increases are stupendous. No need to make anything tangible any longer--just fill office towers with brokers, attorneys and mortgage sales staff. Property taxes and capital gains from housing will keep rising forever.

Yeah, right. Welcome to reality, California. Either fix your structural problems or prepare your bankruptcy filing.

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