No Question: California Is in Fiscal Crisis

By Corey Marshall, Good Government Policy Director
October 18, 2012

Recent years have been filled with experts decrying the sorry state of public finance in California. And with good reason. Three California cities have filed for bankruptcy protection since June. Since 2008, local governments in California have shrunk by nearly 190,000 employees (11.2 percent) and property values over the same period declined statewide by 21.3 percent. Meanwhile, the state budget experienced consecutive annual budget deficits of $60 billion (2009-10), $19.3 billion (2010-11), $26.6 billion (2011-12) and $16.6 billion (2012-13).

What comes next?

The Institute for Government Studies at the University of California at Berkeley convened an impressive panel of experts last month to move that debate forward. Discussions covered more than the magnitude of the problem — although there was plenty to say about that. There was also talk about the factors contributing to the crisis and what we might be able to do about it.

While few disagreed about the overall state of finances in California, panelists spoke of a combination of factors that may have led the state deeper into recession:

·      Existing structural challenges have been exposed by the recession. The recession has revealedfundamental imbalances between receipts and expenditures, such as weaknesses in the financing of state and local pension plans and retiree healthcare obligations. These systems were designed to be sustained through continual growth but they had never before been tested by a downturn like the one we’ve recently experienced.

·      State actions to balance budgets may have intensified the impact on local governments. Steps taken by the governor and state legislature to stabilize state finances and limit the impacts of the economic downturn — such as the elimination of redevelopment agencies — may have compounded the impacts of the recession on local governments. The elimination of redevelopment agencies was projected to save the state up to $1.7 billion, but it has also left cities without financing for affordable housing or other redevelopment initiatives.

·      One-time solutions have been exhausted.With a sustained downturn, the collection of strategies used to weather a short-term recession have long since been used. What is left are much more painful discussions about service reductions, e.g. closure of state parks.

·      Competing traditions have left the state paralyzed.State and local governments in California have been constrained by competing traditions: an appetite for generous public services and a citizenry actively engaged in ballot-box planning. Proposition 13, the 1978 measure that capped property assessments, and Proposition 218, which requires voter-approval for new revenues, are significant barriers and have constrained the ability to generate revenues to sustain funding levels.

·      Irrational optimism is preventing necessary decisions. Worse than a “perfect storm” of economic factors is the weight of history in how California moves forward. Despite the depth of the recession and the impacts of state and local reductions, there is still an overwhelming belief that the state can grow out of this problem as it has in the past. Nowhere is that belief stronger than with the growing challenge of funding public employee pensions and retiree healthcare, with a projected shortfall of between $200 billion and $500 billion just for state pension funds, depending on the estimate. Unfunded retiree healthcare obligations add an additional $60 billion. There is little agreement about how to mitigate those challenges.

The pension issue is emblematic of the broader paralysis of the state. There is consensus on the existence of the problem, but no agreement whatsoever on just how bad it is or how it should be solved. In spite of critical funding constraints, there is no agreement over whether to raise additional revenue or to reduce benefits. Financial experts appear to agree that state and local pension systems need to revisit how pensions are calculated, but enacting changes for anyone but current employees — the bulk of the current unfunded liability — is an extremely difficult proposition. A few cities have attempted to tackle the task: San Francisco negotiated changes to its system, and both San Diego and San Jose passed reforms at the ballot; Los Angeles is still on the horizon. The pension reform proposal for the State of California, signed into law last month by Governor Brown, leaves the benefits of current employees untouched but requires them to share in the expense of increased benefit costs.

And these are exactly the types of challenges that have driven several California cities into bankruptcy — Mammoth Lakes, Stockton and San Bernardino in 2012 alone. The structural costs of labor, healthcare and pension benefits have in these cases eclipsed the ability of cities to provide core services. In some instances cities are closing recreation centers simply to retain public safety services. We have clearly arrived at a time when we must prioritize services and invest limited resources wisely.

California, both the state and to some extent its cities, is at a crossroads: Either we operate within the constraints of this “new normal” or we come to agreement on solutions that can be jointly sold to legislators and taxpayers. In the past, consistent growth and fleeting downturns have allowed California to in many ways paper over the major challenges and rely on one-time fixes to weather the occasional storm.

It’s clear that time is over.

Hear recordings of the complete panel sessions >>