California: Paying the Price for Indulging Citizens

The Golden State's voters opted for more schools, roads and research, but then refused to pay for them.
September 2009
John E. Petersen
By John E. Petersen  |  Columnist
John E. Petersen was GOVERNING's Public Finance columnist. He was a Professor of Public Policy and Finance at the George Mason School of Public Policy.

When New York Tribune editor Horace Greeley advised ambitious young men to "Go West" in the 1850s, he was urging a coast-to-coast migration. He was asking them to head to California, the land of the future.

It's hard to imagine anyone seriously offering that advice today. California is in a tailspin unseen since the Great Depression. With a 5 percent loss of jobs over the past year, housing prices plummeting at a 20 percent annual rate, and unemployment heading to 12 percent, the long-standing deficiencies of the state's fiscal structure are in bold relief.

California's $92 billion budget adopted in late July had to close a $26 billion hole. Spending cuts account for $16 billion of it, with the biggest slices coming out of education. The remaining $10 billion was filled with one-shot accounting gimmicks and internal borrowing. That means those reductions have been forestalled to the next budget--if the state is lucky. Already short of cash this past spring, California has issued about $1 billion in warrants to pay its bills, a practice that it used briefly in the 1990s.

Nobody wants to raise taxes. The California general sales tax is the second-highest in the country, the income tax fourth-highest, and aimed at the rich. The top 1 percent of households pay 40 percent of the state's income taxes. All taxes are high except for the property tax, and that tax is a major part of the fiscal problem.

For years, California put itself in an increasingly vulnerable position, propelled along by countless amendments to its constitution through the initiative process. Voters lined up to pull the lever for measures to favor schools, sell bonds for roads, undertake research projects and tackle environmental problems. At the same time, they voted to cut taxes and sap the ability of the state and localities to pass budgets. The initiative process has led to an incoherent patchwork of conflicting, highly entrenched special interests that have drained the state's governance of any semblance of accountability or clarity. With everybody supposedly in charge, California now finds that nobody is.

The poster child for the fruits of the initiative process is Proposition 13, the celebrated 1978 "Jarvis-Gann Amendment" that created a uniquely destructive system for taxing property. The populace voted to restrict the local property tax rate to 1 percent and base property value on the original cost of acquisition, an assessed value that subsequently was not allowed to grow at a rate of more than 2 percent a year.

The implications are clear. Local governments lost their ability to be fiscally self-sufficient. The constrained property tax became an inflexible, state-controlled tax that is highly inequitable and that has weakened the role of local government. The bizarre impacts of this went all the way to the U.S. Supreme Court, which held that California's citizens could tax property any way they wanted so long as they followed democratic procedures. What the court could not rule on was the self-inflicted wound of a state deciding to favor long-term property owners over newcomers. Recent polls show that Californians have no desire to change the property tax system despite the problems it has created.

Were Greeley still around, he might think there is a national lesson in the travails of California. Great promises are not enough. Free people need to figure out how to exercise restraint and recognize their limitations in times of uncertainty.