Last Wednesday brought news of jubilation to California’s Golden Dome – the LAO has officially given word that California will see fiscally happy days through FY 2020.
While the LAO is a very valuable entity in Sacramento, all too often it doesn’t fully take into consideration some of the Golden State’s most challenging fiscal issues, which enables our elected officials to continue to ignore those challenges.
According to the LAO, for FY 2014, it is now projecting a $2.2 billion surplus rising steadily to $3.2 billion in FY 2015, $5.6 billion in FY 2016, $8.3 billion in FY 2017, $9.6 billion for FY 2018 and FY 2019 and $9.8 billion in FY 2020. The LAO doesn’t think the Proposition 30’s tax increase expiration will affect the budget’s bottom line. And if you look deeply, you’ll notice that the LAO’s total surplus projection for the duration of Proposition 30’s tax increases exceed the Department of Finance’s Proposition 30 revenue estimations by almost $3 billion. This makes one wonder, then, whether the massive tax increases were necessary at all.
In response, Senate President Pro Tem Darrell Steinberg has determined the surpluses means California can “expand worthy programs for people and our economy” and Assembly Speaker John Perez wants to make “smart use of one-time money and stronger revenues to reinvest in California families” (i.e. increase spending). Both these statements showcase our elected leaders’ short-sightedness and ignorance of the past.
When describing its economic projections, the LAO says “our forecast assumes steady, moderate economic growth.” However, the LAO is expecting the California economy, relative to the nation as a whole, to be better than the dot-com boom. From 1997 to 2000, California’s unemployment rate was, on average, 1.1 points above that of the national average. Between 2014 and 2020, though, the LAO expects California’s unemployment rate to be an average of just 0.4 points above the nation’s. This is not “steady, moderate” growth. The last period California had a ratio like this was in the 1980’s. If the economic predictions are incorrect, then the surplus easily vanishes (due in no small part to California’s dependence on the volatile income of high net worth taxpayers).
However, even if the LAO’s projections do materialize, their analysis fails to fully factor in California’s fiscal challenges.
One unfunded liability rarely discussed is California’s Unemployment Insurance Fund indebtedness to the federal government. Since January 2009, this debt has ballooned from a meager $347 million deficit to a high of $10.63 billion in February 2013. As of August 2013, California still owes $8.68 billion to the Feds; enough to wipe out the combined projected surpluses for FY 2014, FY 2015, and part of FY 2016.
However, the elephant in the room are CalPERs and CalSTRs obligations as well as the state’s unfunded retiree health benefits.
State Controller John Chiang estimates the unfunded retiree health care benefits total about $64 billion. Currently, California contributes just $1.8 billion annually, an increase of 45% since 2008. However, to fully pre-fund these benefits, the Controller estimates another $1.7 billion annually is needed, which still is likely an under-estimate as it assumes an unrealistic 7.61% rate of return.
CalSTRs has an unfunded liability ranging from between $71 billion to $167 billion. According to the LAO, the state should be adding, initially, an additional $4.5 billionin annual contributions rising in future years (30 year total additional contributions of $240 billion). This, alone, would wipe out near-term surpluses and roughly halve the future surpluses. But still, these numbers are likely under-estimated. 1) The $4.5 billion estimate is based on a 7.5% rate of return (twice CalSTRs actual average 2000-2012 rate of return) and 2) these projections are based on the $71 billion liability; the $167 billion deficit would warrant even larger additional contributions.
Finally, the LAO fails to adequately address CalPERs unfunded liability. Official estimates put the unfunded obligation at around $80 billion, but Joe Nation, a Stanford professor and former State Assemblyman from Marin County, pegs the actual unfundedness at closer to $170 billion. While not all of this is the state’s responsibility, to plug this hole, the state still needs to significantly increase its contributions.
On top of all of this, California still has its “wall of debt” to payoff and the variety of special funds that were raided to plug budget holes to repay (like the $500 million taken from the cap-and-trade account). It’s no wonder then, that despite the bevy of supposedly good news coming out of Sacramento, a recent Hoover Institution-YouGov Golden State Poll found 74% of Californians thinking state tax rates would increase a little or a lot over the next 3 years.
History has shown us all that Sacramento is largely incapable of sound fiscal stewardship. Unfortunately, as Steinberg and Perez both indicated, our elected officials will only take the LAO’s projections at face value meaning these impending fiscal challenges will not only persist, but will continue to get worse. Let’s all not forget how fleeting these surpluses can be.
Carson Bruno is a research fellow at the Hoover Institution who primarily studies California public policy, electoral politics, and public opinion. His central interest is in developing market-efficient policies that complement California public opinion and spur economic growth, advance personal liberty, and improve economic mobility within the state. Follow Carson on Twitter: @CarsonJFBruno