How far is Sacramento from Athens? Until a few months ago, this would have been a question on a geography quiz. Today it's an urgent financial issue. Is the perilous pathway to default that Greece, 6,669 miles away, has been treading a precedent for California?
Not so long ago, this query would have seemed far-fetched. California, for all its bizarre politics and weird public finance system, has been an epicenter of growth and vitality. Boom times or bust, people moved there, made money and bought houses at ridiculous prices. Today though, California--like Greece--is watching its economic position slip. Does this suggest--as some in the media have--that California is sitting at the precipice of an implosion the way Greece is?
While these are superficial similarities between the two situations, there are deep, real-world differences in the circumstances of a beleaguered country and a hard-pressed state. Let's start with the size of the economies and the amount of debt relative to the means of repayment. California's economy--the eighth largest in the world--produces $1.81 trillion in gross domestic product; Greece's GDP is about $350 billion, which makes it a mere runt by comparison. Moreover, Greece, with a population of 11 million, has outstanding, tax-supported bonds equal to $290 billion, as compared to $83 billion for California, with its 37 million inhabitants. So Greece has about 12 times the amount of debt per capita as California. Even when one adds in the underlying California local government bonds and the overlapping U.S. federal debt, the Greek government's debt is 2.5 times greater on a per capita basis.
The greater difference, though, is in fiscal policy. Greece has had the capacity to run large deficits for many years that were artfully disguised by accounting tricks. California has undergone successive, highly publicized battles over closing the budget gaps, but the actual deficits incurred at the end of the fiscal periods have been relatively modest. In 2009, Greece's national government had a deficit of $36 billion, while California, amid painful cutbacks and tax increases, actually ended up only $5 billion short in its general fund. That's not good, but it's a whale of a lot better performance than a nation financing a huge deficit by borrowing.
Greece also is burdened by being a land where tax evasion is a national sport. About $110 billion of Greece's economic activity--nearly 30 percent--is thought to be underground and thus not reported. As a result, the country loses an estimated $30 billion per year in revenues from evaded taxes. California, on the other hand, has built a volatile tax system--the better-off pay most of the taxes, while some major taxes, like property tax, are patently inequitable--but outright evasion is relatively low. In the United States, only about 8 percent of the economy is underground.
There is another key factor: The United States, despite all current fiscal problems at the local, state and federal levels, is grounded on a tradition of governments paying their bills. The U.S. government has never defaulted on its debts. Even though one state (Arkansas) did during the Depression, the debt was restructured and ultimately repaid. Greece, on the other hand, defaulted four times in the 19th century and on its foreign-held national debt in 1931. Despite its membership in the European Union, the Greek national government is once again faced with default.
State and local governments will have a tough time ahead as they adjust to slower growth and an aging national economy. These problems will be multiplied by the federal government's structural deficit. But the 50 states have two important legacies. First, they have not borrowed improvidently, especially not to finance operating deficits. Second, they are embedded in a legal and political system that has enforced the payment of taxes and debt. That has made access to the private capital markets not only feasible, but easy and economical. In the financial world, that legacy is what makes the distance between Athens and Sacramento so great.
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