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California’s Budget “Surplus” Ignores Crushing Debt Burden

California’s new governor, Gavin Newsom, delivered an inaugural address earlier this week that accurately reflected the mentality of his supporters. Triumphalist, defiant, and filled with grand plans. But are these plans grand, or grandiose? Will Governor Newsom try to deliver everything he promised during his campaign, and if so, can California’s state government really deliver to 40 million residents universal preschool, free community college, and single payer health care for everyone? It’s reasonable to assume that to execute all of these projects would cost hundreds – plural – of billions per year. Where will this money come from?

While California’s budget outlook currently offers a surplus in excess of $10 billion, that is an order of magnitude less than what it will cost to do what Newsom is planning. And this surplus, while genuine, is the result of an extraordinary, unsustainable surge in income tax payments by wealthy people. California’s tax revenues are highly dependent on collections from the top one-percent of earners, and over the past few years, the top one-percent has been doing very, very well. Can this go on?

To illustrate just how unusually swollen California’s current state tax revenues have gotten, compare state tax collections in FYE 6/30/2017 (our most recent available data) to seven years earlier, in 2010. Back in 2010, California was in the grip of the great recession. Total state tax revenue was $94 billion, and $44 billion of that was from personal income taxes. Skip to FYE 6/30/2017, and total state tax revenue was $148 billion, and $86 billion was from personal income taxes. This means that 80 percent of the increase in state tax revenue over the seven years through 6/30/2017 was represented by the increase is collections from individual taxpayers, which doubled.

It isn’t hard to figure out why this happened. Between 2010 and 2017 the tech heavy NASDAQ tripled in value, from 2,092 to 6,153. In that same period, Silicon Valley’s big three tech stocks all quadrupled. Adjusting for splits, Apple shares went from $35 to $144, Facebook opened in May 2012 at $38, and went up to $150, Google moved from $216 to $908.

While California’s tech industry was booming over the past decade, California real estate boomed in parallel. In June 2010 the median home price in California was $335,000; by June 2017 it had jumped to $502,000. Along the California coast, median home prices have gone much higher. Santa Clara County now has a median home price of $1.3 million, double what it was less than a decade ago.

As people sell their overpriced homes to move inland or out-of-state, and as tech workers cash out their burgeoning stock options, hundreds of billions of capital gains generate tens of billions in state tax revenue. But can homes continue to double in value every six or seven years? Can tech stocks continue to quadruple in value every six or seven years? Apparently Gavin Newsom thinks they can. Reality may beg to differ.

Just a Slowdown in Capital Gains Will Cause Tax Revenue to Crash

The problem with Gavin Newsom’s grand plans is that it won’t take a downturn in asset values to sink them. All that has to happen to throw California’s state budget into the red is for these asset values to stop going up. Just a plateauing of their value – which, by the way, we’ve been witnessing over the past six months – will wreak havoc on state and local government budgets in California.

The reasons for this are clear enough. Wealthy people, making a lot of money, pay the lion’s share of state income taxes, and state income taxes constitute the lion’s share of state revenues. Returning to the 2017 fiscal year, of the $86 billion collected in state income taxes, $28 billion was from only 70,437 filers, all of them making over $1.0 million in that year. Another $7.3 billion came from 131,120 filers who made between a half-million and one million in that year. And since making over $200,000 in income in one year is still considered doing very, very well, it’s noteworthy that another 807,000 of those filers ponied up another $15.1 billion in FYE 6/30/2017.

There is an obvious conclusion here: if people are no longer making killings in capital gains on their sales of stock and real estate, California’s tax revenues will instantly decline by $20 billion, if not much more. And it won’t even take a slump in asset prices to cause this, just a leveling off.

Debt, Unfunded Pension Liabilities, Neglected Infrastructure

When considering how weakening tax revenues in California will impact the ability of the state and local governments to cope with existing debt, it’s hard to know where to begin. To get an idea of the scope of this problem, the California Policy Center just released an analysis of California’s total state and local government debt. As shown on the table, California’s total state and local government debt as of 6/30/2017 is over $1.5 trillion. More than half of it, $846 billion, is in the form of unfunded pension liabilities.

Calculating pension liabilities is a complex process, with controversy surrounding what assumptions are valid. In basic terms, a pension liability is the amount of money that must be on hand today, in order for withdrawals on that amount – plus investment earnings on that amount as it declines – to eventually pay all future pensions earned to-date for all active and retired participants in the fund. Put another way, a pension liability is the present value of all pension benefits – earned so far – that must be paid out in the future. The amount by which the total pension liability exceeds the actual amount of assets invested in a fund is referred to as the unfunded liability.

The controversy over what is an accurate estimate of a pension liability arises due to the extreme sensitivity that number has to how much the fund managers think they can earn. Using the official projection which is typically around 7.0 percent per year, the official pension liability for all of California’s government pension funds is “only” $316 billion. But Moody’s, the credit rating agency, discounts pension liabilities with the Citigroup Pension Liability Index (CPLI), which is based on high grade corporate bond yields. In June 2017, it was 3.87 percent, and using that rate, CPC analysts estimated the unfunded liability for California’s state and local employee pension systems at $846 billion. Using the methodology offered by the prestigious Stanford Institute for Economic Policy Research, California’s unfunded pension debt is even higher, at $1.26 trillion.

Where pension liabilities move from controversial theories to decidedly non-academic real world consequences, however, is in the budget busting realm of how much California’s government agencies have to pay these funds each year. California’s public sector employers contributed an estimated $31 billion to the pension systems in 2018. Extrapolating from officially announced pension rate hikes from CalPERS, California’s largest pension system, by 2024 those payments are projected to increase to $59 billion. And these aggressive increases the pension systems are requiring are a reflection more of their crackdown on the terms of the “catch up” payments employers must make to reduce the unfunded liability than on a reduction to their expected real rate of return.

Huge unfunded pension liabilities are another reason, equally significant, as to why California’s state budget is extraordinarily vulnerable to economic downturns. If assets stop appreciating, not only will income tax revenue plummet. At the same time, expenses will go up, because pension funds will demand far higher annual contributions to make up the shortfall in investment earnings.

A cautionary overview of the economic challenges facing California’s state government would not be complete without mentioning the neglected infrastructure in the state. For decades, this vast state, with nearly 40 million residents, has been falling behind in infrastructure maintenance. The American Society of Civil Engineers assigns poor grades to California’s infrastructure. They rate over 1,300 bridges in California as “structurally deficient,” and 678 of California’s dams are “high hazard.” They estimate $44 billion needs to be spent to bring drinking water infrastructure up to modern standards, and $26 billion on wastewater infrastructure. They estimate over 50 percent of California’s roads are in “poor condition.” In every category – aviation, bridges, dams, drinking water, wastewater, hazardous waste, the energy grid, inland waterways, levees, ports, public parks, roads, rail, transit, and schools, California is behind. The fix? Literally hundreds of additional billions.

What Governor Newsom might consider is refocusing California’s state budget priorities on areas where the state already faces daunting financial challenges, rather than acquiescing to the utopian fever dreams of his constituency and his colleagues.

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Government Created Energy Blackouts Coming to a City Near You

Most countries around the world think that it’s a good thing to have cheap energy. But in California, we have plenty of cheap energy available, just not the political will to access it.

California depends on natural gas-driven turbines and hydroelectric generators to provide just 38 percent of its oil needs. The state imports 12 percent of its oil from Alaska, and another 50 percent from foreign nations, relying heavily on Canada.

So why are California’s utilities warning of potential rolling blackouts again?

It’s political. And it’s corrupt.

Highest Electricity Rates = Less Power in CA

California’s natural gas shale formation is one of the largest in the world. And, California has been a pioneer in renewable energy, albeit still unreliable and unproven. Yet warnings are already coming that Californians may have rolling blackouts this summer. While California sits on one of the largest known deposits of recoverable oil and gas, production is falling steadily, as the state ignores its vast onshore and offshore deposits, which are fully accessible through conventional and hydraulic fracturing technologies.

This is one reason California electricity costs more than twice the national median –  thanks to a government-created shortage.

Another reason is that the California Public Utilities Commission, the state’s energy “regulator,” has an historic dubious relationship with Wall Street, making promises to keep the profits higher of the state’s publicly held utilities, than utility profits elsewhere. Those profits come out of ratepayers’ pockets. “You’re ego is writing checks you’re body can’t cash,” the famous quote from the movie Top Gun says.

$5 Billion Cover-Up at San Onofre

Another of the problem areas is the California Public Utilities Commission $5 billion cover up and scandal over the 2012 closure of the San Onofre Nuclear Generating Station, due to the failure of the steam generators. San Diego attorneys Mike Aguirre and Mia Severson exposed the attempt to make the public pay big for utility and regulatory executives’ mistakes at the failed San Onofre nuclear power plant.

20160613-CPC-GrimesSan Onofre could have operated for additional decades
if it weren’t for corruption and mismanagement.

Southern California Edison executives purchased new steam generators from Mitsubishi, but were warned that they were bigger and run hotter, and could fail. SCE executives purchased and installed the generators anyway, knowing of a flaw in the generator design, according to records. Built to last 40 years, the generators at San Onofre failed after 2 years. And, the generators’ cost had not yet been included in rates. So SCE was faced with broken generators they could not charge ratepayers for.

then-PUC President Michael Peevey, and executives of Southern California Edison colluded in secret to saddle ratepayers with $3.3 billion of the $5 billion shutdown cost. The $5 billion recovery settlement was negotiated in secret in Poland, away from prying eyes and open records laws in California.

Blackouts coming…

The state is awash in ultra cheap natural gas, yet in California, our corrupt government finds a way to create an energy shortage, and charge rate payers the highest rates in the country.

“State officials warn that Southern California could face as many as 14 days of scheduled blackouts this summer because of depleted reserves of natural gas caused by the massive leak in Aliso Canyon,” the Los Angeles Times warned in April. The LA Times neglected to mention that California ratepayers do have options, but its politicians have no will. The state sits on one of the largest known deposits of recoverable oil and gas — the Monterey Shale, a 1,700 square mile oil-bearing shale formation primarily in the San Joaquin Valley, which contains an estimated 15 billion barrels of oil. The Times article quoted Bill Powers, of Powers Engineering in San Diego, who said the utility’s pipeline system has not exceeded its capacity of 3.8 billion cubic feet per day during summer in the last 10 years, thus the concern of blackouts is without merit. “It is crying wolf for state agencies to be implying blackouts from a lack of gas, especially from a lack of gas in the summer time,” Powers said.

The Monterey Shale formation is estimated to be several times bigger than the Bakken Shale formation, currently delivering a record economic boom to North Dakota. But even as the fourth-largest oil producing state in the country, oil and gas production has been steadily declining here. Instead, California lawmakers turned their attention to wind and solar, and other types of alternative energy. The state has been only focused on implementing the Renewable Portfolio Standard, passed in 2011, which requires the state to be using 33 percent renewable energy by 2020.

A University of Southern California study, “Powering California: The Monterey Shale & California’s Economic Future,” looked at the development of the vast energy resource beneath the San Joaquin Valley known as the Monterey Shale. It found that hydraulic fracturing could create 512,000 to 2.8 million new jobs, personal income growth of $40.6 billion to $222.3 billion, additional local and state government revenues from $4.5 billion to $24.6 billion, and an increase in state GDP by 2.6 percent to 14.3 percent on a per-person basis.

It’s Not Easy Being Green

California politicians have gloated over being the first state to enact such aggressive green energy and greenhouse gas busting policy, but have yet to produce any proof that these oppressive and business-killing laws have had any “green” results.

All while they ignore that natural gas is clean, less expensive to extract, natural and abundant. It wasn’t that long ago that natural gas used to be the left’s preferred alternative to all other “dirty fuels.” But as the oil and gas industry found better, more affordable ways to access natural gas, it fell out of favor with emotional, whimsical environmentalists.

The last California Governor blamed for rolling energy blackouts was recalled by voters… hold that thought.

Katy Grimes is senior correspondent for The Flash Report, and a contributor to the Canada Free Press and Legal Insurrection. She is a senior media fellow with the Energy & Environmental Legal Institute, and she serves as president of the Sacramento Taxpayers Association.

Budget Primer for California Citizen Taxpayers

Average taxpayers in California are probably aware that the state budget was in the news again over the weekend. But even folks who follow both Presidential politics and local issues probably couldn’t be blamed if they tune out stories about the California budget. It’s not that they don’t care. It’s just that public finance issues can be horribly confusing and difficult to follow.

In terms of timing, the process itself is easy to grasp. The annual budget year runs from July 1st to June 30th of the following year. That’s why people refer to a single budget using two years. For example, the budget currently being discussed is the 2016-2017 budget. The Constitution requires that the Governor present a budget in January and that the Legislature enact the budget by June 15th. Because state bean counters and analysts don’t have a full grasp of the economy or revenue projections in January, the Governor’s budget goes through an update, or “revision,” in May. It was this May “revise” that the Governor presented on Friday that has been in the latest news cycle.

But perhaps the most confusing aspect of the state budget is the fact that many of the numbers that are bandied about are inconsistent. Thus, an average citizen might hear on the radio that the state budget is $122 billion dollars. And yet, when they get home, they read that spending is actually $173 billion. At this point they are more apt to turn on the Giants v. Dodgers game rather than make sense of the huge disparity.

The inconsistency in these budget numbers usually is attributable to the fact that there is a big difference between “general fund” spending and total state spending which includes “special funds.” General fund revenue comes from the state income tax, sales tax, corporate tax and a handful of other sources. “Special funds” come from the gas tax and fees from regulatory programs like cap and trade funds. For average taxpayers, the worst example of “special fund” revenue consists of the illegal CalFire “fee” which slams property owners with hundreds of dollars of additional property taxes. The legality of the CalFire fee is currently being challenged in court.

When it comes to the state budget, citizen taxpayers are justified in being both confused and angry. Not a day goes by without some scandal surfacing about those who spend our tax dollars. Whether it is the Bay Bridge, which exceeded the original cost estimate by a factor of six, or California’s feckless policies that have driven up state debt so high that, were the state a private company, it would be immediately eligible for bankruptcy.

As should be expected, California has the largest state budget in the United States. But what should not be expected or tolerated is the hostility of our political leaders toward those of us who pay the bills. California has the highest income tax rate in America as well as the highest state sales tax. Our fuel costs are also the highest due to both the current gas tax and environment regulations. The result of these policies has been an accelerated exodus from the state by both businesses and individuals. It should be painfully obvious even to the Governor and left-leaning legislators that you can’t have a vibrant state budget unless you have a vibrant economy.

Finally, Governor Brown, while not officially endorsing a proposal to retain California’s sky-high income tax rates, implicitly endorsed it by noting that the state would be in a deficit situation if the measure didn’t pass in California. But this deficit projection is only attributable to higher state costs due to the foolish policies of elected leaders, not state revenues which are actually increasing faster than population and inflation.

The real cure for California’s budget woes is a combination of policies that would make California competitive in the global economy, not higher taxes and more burdensome regulations.

Jon Coupal is president of the Howard Jarvis Taxpayers Association — California’s largest grass-roots taxpayer organization dedicated to the protection of Proposition 13 and the advancement of taxpayers’ rights.