Tax Analysts Blog

Sacramento Showdown, Again

Posted on Jun 25, 2009

It was scary enough in 2008. After declaring a fiscal emergency in January it took until September for California Governor Arnold Schwarzenegger and the state legislature to agree on a budget closing the state's deficit -- a record three months after the beginning of the fiscal year that began in July. That was Round One.

No sooner was the ink dry on that agreement than it was overtaken by the crumbling California economy. The bottom fell out at the end of 2008. With housing prices and the stock market plummeting and unemployment rising, California's revenues -- heavily dependent on income taxes -- kept shrinking. The governor had to call another special session. He had to renege on his no-tax pledge. And he had to twist some Republican arms to get the two-thirds majority needed in both the Assembly and the Senate to pass a tax increase. But the finally revised budget emerged in February of 2009. That was Round Two.

Believe it or not, the February 2009 agreement, like the September 2008 one, almost immediately became obsolete. It was pretty obvious that voters would not approve ballot initiatives needed to consummate the agreement, and in fact voters soundly rejected them in May. But it didn't matter much anyway because revenue projections were again falling way short of expectations.

So now we are in Round Three of California's great budget battle. A few days ago it looked like the drama might mercifully be coming to an end. The main sticking point was a proposed $2 billion tax increase in a budget that needed to close a $24 billion gap. But on Wednesday, legislature leaders failed to get the necessary two-thirds supermajority for their latest plan (see, "GOP Lawmakers Balk at Democrats' California Budget Plan," San Jose Mercury News). If there is not a budget agreement by Tuesday, California Comptroller John Chiang says the state will have to issue IOUs instead of checks to pay its bills. This will devastate the state's reputation with credit rating agencies and financial markets.

California's epic budget battle gives us a taste of what we can expect on the federal level -- if (and that's a big "if') the federal government ever puts a lid on its borrowing. California can issue debt for capital projects and to even out cash flows but not to balance the budget. The yet-to-be determined lid on federal borrowing could be self-imposed -- if really tough budget limits were put in place -- or externally generated -- if financial markets started getting nervous about Ufncle Sam's credit rating. Neither is likely anytime soon -- even though Democrats will tell you their proposed pay-go rules will get the job done.

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