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Last week in my Public Financial Management class, I was explaining the time value of money and why lenders charge borrowers interest. A student asked “Isn’t the state of California increasing the amount of money they withhold from people’s paychecks, and isn’t that like an interest-free loan from taxpayers?” Ah, yes, it would seem that once again my home state had provided a case study in budget dysfunction.
And yet, this may be one of those examples where the real world deviates from the textbook for good reason. Perhaps the only thing worse than California’s balancing its books on the backs of taxpayers would be NOT balancing its books on the backs of taxpayers.
Here’s what happened: Last July, the California legislature was scrambling to close yet another budget gap. Just five months before, it had cut spending and raised revenues by $36 billion. However, a new revenue shortfall opened up only weeks later. Adding insult to injury, voters rejected $6 billion worth of budget solutions in a May special election. So lawmakers confronted a $24 billion gap. As they wrangled over a new budget (the third in eleven months), the state entered a cash flow crisis. It began paying bills with IOUs, shuttered government offices on Fridays, and watched its bond rating drop.
So, in July the Legislature cut spending by another $15 billion, mainly from education (although some of this would be replaced by federal stimulus funds). And it decided to accelerate tax collections starting in November to the tune of $2.3 billion by increasing personal income tax withholding and changing how individuals and corporations calculate tax payments throughout the year.
Just to be clear: this was not a tax increase – the legislature had already been there and done that in February. As my student surmised, this was an interest-free loan from the Bank of Taxpayers. Indeed, taxpayers were not the only involuntary creditors to the state – the legislature borrowed $2 billion in local property taxes and diverted another $2 billion from local redevelopment agencies (who are suing). State employees will kick in their share by taking June 2010 paychecks in July (a new fiscal year).
Sure, the state could have done something about the deep structural problems with its tax code, including an income tax that relies too much the volatile incomes of high earners, a sales tax with high rates and a narrow base, and a property tax eviscerated by Proposition 13. And, as Milton Friedman used to say about federal income tax withholding, “temporary” changes to expedite revenues have a way of sticking around. Moreover, taking an additional $20 or $30 per month out of workers’ pockets could counteract the Making Work Pay Tax Credit in the federal stimulus package.
On the other hand, the state needed some money fast and voters had shown little appetite for tax hikes or deep cuts to popular programs. In any case, California may get another bite at the apple soon. The state Controller recently announced that revenues are already coming in $1 billion below projections and the governor says he expects to face at least a $12 billion gap come January.
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