The voices of Tax Policy Center's researchers and staff
A recent blog post at TheEconomist.com nicely summarizes California’s fiscal mess. It’s an exaggeration to say the state suffers from “extraordinarily low levels of taxation”—its revenues rank 10th in the nation on a per capita basis, 18th as a share of personal income. But California has been captive to a “something for nothing mentality” since at least the recession of 2001 and probably back to 1978, when voters slashed property taxes in half without relenting in their demands for schools, parks, roads, etc. (See also the Washington Post.)
Of course, as I’ve written before, neither living in denial nor running up deficits are uniquely Californian. And TheEconomist.com, among others, is right to point out that tax hikes and spending cuts in California and other states could counteract the federal stimulus.
But is California really “too big to fail”? Should the federal government put aside concerns about moral hazard and bail the state out as it did AIG, the auto industry, and many other concerns perhaps less deserving than school kids and poor families?
As the world’s 8th largest economy, California almost certainly generates spillovers. Still, it’s hard to imagine the state defaulting on its debts. More likely, it will be forced to borrow at higher cost. This too-familiar risk premium has not really been passed on to California’s local governments before, and probably won’t be this time either. If the state is too small to move the rest of the California municipal debt market, it’s unlikely to trigger a global financial catastrophe.
Recall too that California didn’t get into this mess through exotic investments or off balance sheet accounting. Like most American households, it simply lived beyond its means (or what voters agreed to pay).
Although it might be nice for the feds to provide political cover for unpalatable choices like repealing Prop 13 and the constitutional requirement that 2/3 of the legislature must approve new budgets, the price in terms of foregone state autonomy may be too high. (Just ask the banks who want to return their federal bailout money.)
More generally, it may be a great idea to enact a new system of federal aid or general revenue sharing to avoid this predicament in the future. But it’s not clear that a new, more rational system will emerge out now.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.