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California's IOU to the World
The budget crisis that has paralysed America's wealthiest state could be a taste of what's in store for the rest of us
In recent months, a number of reports by risk-analysts, insurers and intelligence agencies have highlighted the possibility of political instability following in the wake of the global economic turmoil. Most of the potential trouble spots have been identified as being in poorer parts of the world. Last week, Lloyds, for example, highlighted the risk of instability in Latin America.
Over the past few weeks, however, tremendous political chaos has emerged in some of the most affluent parts of the globe. In the UK, the government is teetering on the edge of collapse and a tsunami of somewhat inchoate rage at the shenanigans of politicians of all stripes is rolling in on parliament. In Italy, Silvio Berlusconi's peccadilloes are adding fuel to the fires of discontent. And in California, America's wealthiest and most populous state, an extraordinary political stalemate around how to deal with a yawning budget deficit risks essentially catapulting the state into insolvency, devastating social programmes and education alike, and igniting massive popular anger. As of today, California has started issuing billions of dollars in IOUs to its creditors.
California's crisis contains the most lessons for how economic collapse might play out in the arena of public services in wealthy regions over the coming years. For it represents a colossal clash of visions that have co-existed (albeit uncomfortably) for decades but are now increasingly incompatible.
Vision number one: a certain sense of social liberalism when it comes to obligations to the poor, the hungry, the vulnerable. We like programmes that feed the poor, that provide mental health services, job training, drug treatment and so on. We like good schools and first-rate public universities that allow people from down-to-earth backgrounds to carve out successful niches for themselves within the American dream.
(More conservatively, but also tied into big government, we like building up police forces to the hilt and funding ever-more prisons to house evermore prisoners. That's been one of the more destructive leitmotifs of American politics in recent decades.)
But then there's vision number two: a deep unease with big government and with funding big government to meet the extent of its ambitions through property, income and business taxes. We routinely block tax increases, at the same time as we limit local governments' ability to determine what property tax rates ought to be (Proposition 13, passed by California's electorate in 1978, essentially capped property taxes at a lower rate than exists in most other states in the country).
These are, to some degree, national trends. There have been anti-tax revolts across America since the 1960s. Like so many other social phenomena, they are, however, magnified in the Golden State.
Last year, the California Budget Project released a report that found Californians were spending 0.34% of their income on sales taxes in 2007, compared to 0.55% 40 years earlier. The share of corporate income paid in taxes fell from a high of 9.6% in 1981 to a little over 5% today. All told, tax cuts enacted since the early 1990s, the CBP calculated, were now costing the state between $11bn and $13bn annually.
In California's case, the two visions have, over the past several decades, produced a deeply schizophrenic political reality. Essentially, voters have approved one unfunded social programme after the next, while at the same time hamstringing legislators' ability to raise taxes as well as the ability of local government to raise adequate funds via property taxes. It's as if the state's left hand is taking cues from, say, Massachusetts or Sweden, while the state's right hand is responding to stimuli sent forth from Mississippi or Alabama.
California is the only state in America to require a two-thirds "supermajority" of legislators to support both tax increases and also the passage of a state budget. It's also the only state to let huge financial obligations and tax rollbacks be decided on, with no limitations, by popular initiative.
The result? Almost like clockwork, in the spring and early summer, politicians in Sacramento stalemate during budget negotiations, the state heads toward chaos and then at the last minute back-door deals are done, band-aids are applied, more funds are somehow borrowed to cover the shortfalls and the state staggers on until the next crisis strikes.
In the past couple months, however, the scale of the revenue shortfalls caused by the state's plummeting economic condition and chronic inability to raise needed tax revenues has actually pushed California pretty much beyond the tipping point. Education spending is already the lowest per student of any state in America. Now it's slated to decline by several billions dollars more. Meanwhile, the public university system - once the jewel in California's governmental crown - is being asked to absorb vast cuts, and the university is responding by raising fees for students and pushing for an 8% across-the-board pay cut for staff and faculty.
Thousands of prisoners are likely to be released early, with no funds allotted to help them reintegrate into the community. Most state employees are already being furloughed a few days a month, meaning they are absorbing 10-15% pay cuts. At a county and city level, mental health facilities are closing, medical clinics are turning people away, police officers in some areas are having to take salary cuts, firemen are being fired, state parks are being shuttered.
Outside the Capitol in Sacramento, different interest groups and coalitions arrive each day, banners flying, megaphones brandished like weapons, to demand protection for their particular jobs or programmes or constituencies. Inside the building, nobody seems to be listening: there's an almost palpable sense of disaster in California's corridors of power these days.
For those with resources, and transferable skills, California is busily creating a set of conditions that are almost guaranteed to trigger a brain-drain - academics, state-employed lawyers, environmental experts and so on will either start migrating elsewhere or will abandon the state sector and find shelter, post-recession, in the private sector. For those less mobile, on the other hand, California is essentially laying trip-wires that will throw progressively more middle-class workers into the ranks of the near-poor, and already poor workers and the unemployed into conditions approaching destitution.
As more and more state and local governments fall on financially desperate times, California's dilemma will likely become more common. Will politicians be willing to risk political capital attempting to sell much-needed tax increases (or simply roll-backs of tax breaks passed during more flush times) to constituents in order to preserve vital social programmes and public infrastructure? If not, will the political process become increasingly balkanised as scores of interest groups compete to preserve their slices of shrinking governmental pies? Will states lose their ability to attract and retain skilled workers? And what sort of societal fissures will emerge as states and counties default on their obligations to preserve their social safety nets?
These are the questions now coming to the fore. They're not limited to poorer parts of the world. Instead they're determining the contours and quality of life in some of the most privileged regions on earth.