The California State Budget Shortfall

The state of California had disappointing tax revenues in April, which were $3.6 billion or 26% below the estimate.  Earlier, California had expected an $18.6 billion shortfall of revenue for their 2010-2011 budget, but this has now grown to $19.1 billion.  The 2007-2008 budget was $103 billion.  Then California had a $60 billion shortfall on the budget in the 2009-2010 budget.  California increased sales and income taxes on a temporary basis.  It also made "payments" with IOUs.  Gov. Schwarzenegger has called for budget cuts for the last three years and did win some in 2009-2010 after a hard-fought battle.  On Friday, he called for $12.4 billion in cuts and called upon the federal government for much of the remaining $6.7 billion.  Part of that remainder is to be covered with "funding shifts" according to the Wall Street Journal, but other sources claim that federal payments are hoped to be as high as $6.9 billion, though the federal government has so far only guaranteed payments of $3 billion.

Schwarzenegger's proposed cuts will produce a state general-fund 2010-2011 budget of $83.4 billion, which is 81% of the 2007-2008 budget.  Education spending is nearly 50% of the budget.  Health and Human Services spending is 25%, and Corrections and Rehab is 9%.  The Governor wants pension, budget, and tax reform in the new budget.  He is not calling for tax increases, which will only drive more businesses out of the state already known for its high taxes.  He says he wants to eliminate the CalWORKS welfare program to save $1 billion and eliminate child care funding except for pre-school and after-school programs to save $1.2 billion.  Many earlier attempts to save money in the Health and Human Services part of the budget were ruled against by courts.  The Democrats are criticizing the Governor for being anti-child, while claiming he should increase taxes and eliminate $2 billion of planned corporate tax breaks.  Of course, this ignores the fact that children survived before California got heavily into the child care business and that California has a great problem with businesses leaving the state.  Of course, we know that a school voucher program would save California a huge sum of money over the next few years given the post on wasteful government-run schools of 12 April 2010.

California's tax revenues break down as 52% from personal income taxes, 28% from sales and use taxes, and 11% from corporation taxes.  The share of the corporation tax has fallen to about half of what it was in 1981.  Corporations faced with high taxes will find ways to operate that minimize those taxes.  In California's case, this has often meant that corporations have fled the state.  The collapse of the real estate and financial markets has been particularly severe also in California.  As I have often pointed out, this is in good part due to the widespread restrictions on land use and building in California, on which Dr. Thomas Sowell agrees.

All of this is very important, because California is now considered to be one of the top ten most likely to default governments in the world!  Financial experts are saying it has a 20.07% probability of defaulting over the next 5 years.  Their evaluation is given in the table below:

The last time a state of the United States defaulted was in the 1840s!  It might be very chaotic if California defaults.  The Mid Spread rating means that if you hold $10 million of California bonds and you want to fully insure them against loss for 5 years, the annual insurance premium will be ($10 million) (254.1/10,000) = $254,000.  For a much less risky state, the corresponding cost might be about $25,000.  It is a very sad commentary that Hezbollah has not managed to make Lebanon quite as risky as the Democrats have managed to make California.  On the other hand, with so many Democrats admiring Hugo Chavez, they may have their sights set on the lofty 50.79% default probability estimated for Venezuela!