The New York Times has made it official: California is not Greece. The state is showing the first signs of a rebound, reported the Timess Adam Nagourney this week. The housing market has stabilized. The jobless rate is down. Spirits are rising. All true. The numbers show that the state is finally pulling out of its worst slump since the Great Depression. And as someone who has lived in California all his life, I welcome the news.
But I know enough of the states history to worry about how this promising story might end. This is a state that, at least over the past few decades, has had trouble handling success. Its politicians have much in common with Lindsay Lohan: they have some good years, come into big money, behave badly, and end up on probation. The Great California Exodus, a Manhattan Institute study I coauthored with New York demographer Bob Scardamalia, points to the states fiscal instability as one factor that could be discouraging employers from setting up shop or expanding in California. When the state goes broke and scrambles for money, it casts hungry looks at profitable businesses. Who wants to be Sacramentos next lunch?
To point out this toxic-state syndrome, as one might call it, is not to predict utter ruin for California. This is a curable condition, though the cure requires discipline that the state legislature rarely displays. So the Times, in its otherwise accurate story, is off the mark when it mentions the Exodus study as if it were part of some conservative doom-saying chorus. The point of our analysis was not to suggest that California would become another Detroit. Rather, it was to argue that with the right policies, California can regain its role as the nations most economically dynamic state.
Our study takes a long view of the states migration patterns. The exodus of the title refers to a trend of domestic out-migration that began two decades ago, long before the latest recession. Around 1990, California, once a strong magnet for migration from other states, became a sender state, losing more residents than it gained. Foreign immigration masked this trend for a time, but immigration (legal and otherwise) is now on the decline as well.
In itself, slowing population growth is neither good nor bad. What counts is a states wealth. And here, the Golden State has been sending out warning signs. Over the past decade, the state has lost ground in employment and taxable income to economic rivals, especially Texas. Internal Revenue Service data show that California lost more than $4 billion in personal income to Texas from 2000 to 2010. Nevada netted more than $5.6 billion at Californias expense. Arizona gained nearly $5 billion.
For a state that depends heavily on the personal income tax, these losses are significant. They also point to broader problems in the states business climate. People tend to move mainly for economic reasons, such as jobs or cost of living. California is expensive for businesses and individuals; not only taxes, but also land, office rents, and the cost of housing and electricity are well above national averages. California also has a reputation for onerous state and local regulation of businesses. The onset of new rules aimed at cutting greenhouse gases (which began phasing in last year) only adds to the sense that California takes its business community, and the wealth it produces, for granted.
The state performs remarkably well, considering the failings of its political class. And it really has had a good run lately, as one statistic Nagourney doesnt mention makes clear: for the 12-month period ending on September 30, Californias nonfarm payrolls, as measured by the Bureau of Labor Statistics, were up 1.9 percent, or nearly 300,000. Except for the Texas job juggernaut (plus 2.5 percent), no other big state—New York, Illinois, Ohio, Pennsylvania, Florida, Michigan, North Carolina, Georgia, New Jersey—showed better payroll growth over this period than California. (Even this good news, though, needs to be kept in perspective: the Golden State has long been a pacesetter in losing jobs to other states.)
The jobs comeback has brightened the states fiscal outlook. Unfortunately, well never know whether sustained job growth, on its own, would have been enough to close the states budget gap. Voters on November 6 approved tax hikes expected to add some $7 billion in new revenue each year. The states Legislative Analysts Office says this new money should reduce the deficit over the next 18 months to $1.9 billion and produce surpluses thereafter.
Thats if everything goes right. The LAOs scenario depends on a growing national economy—no fiscal cliffgenerated recession, for instance—and tight control over spending. Of course, should the top federal income-tax rate go up as part of a budget deal, more of Californias money will be drained from its local economy and sent to Washington. As it is, the nature of the states tax base requires a steadily rising stock market. With the top income-tax rate now at 13.3 percent and capital gains taxed at the same rate as ordinary income, the state is hooked on a highly volatile revenue stream, subject to the whims of Wall Street.
California has been here before. Twice in recent history, in the late 1990s and the mid-2000s, the state saw a spike in revenues from rising stock prices and tech-sector IPOs. Both times, government spending ramped up with the windfall revenue; when the party ended, the state plunged deep into the red. In 2000, net capital gains peaked at $120 billion after soaring from just $22 billion five years earlier. Spending in the states general fund followed apace. In the fiscal year beginning in mid-2000, spending was up 72 percent from just five years earlier. Then the tech-stock bubble burst. A budget surplus of $5.4 billion in the 19992000 fiscal year became a deficit of $6.6 billion in 200001. A similar story unfolded after the 2008 market collapse. A small deficit ($412 million) in 200708 exploded into a huge one ($12 billion) the next year—despite $8 billion in spending cuts.
These spikes occurred when the states top income-tax rate was 10.3 percent. The top-rate increase to 13.3 percent can only make such volatility worse. So the need for iron spending discipline will be even greater. But after several years of cuts in health and welfare spending, the legislature has some hungry constituencies to feed. And with Republicans sidelined by Democrat supermajorities, there is currently no viable party of fiscal conservatism to play bad cop.
Californias newly approved tax hikes have already been earmarked, mainly for schools, as the Los Angeles Times recently explained: The election wasnt even over Tuesday when state Treasurer Bill Lockyers phone started ringing. Activists of all stripes had the same message for him: With voters apparently poised to approve billions of dollars in tax hikes, it was time to spend more money. They had to be reminded the money has already been spent, Lockyer said.
Its safe to bet that those phones wont stop ringing. If Democratic lawmakers buckle under the pressure, they can do one of two things: raise taxes or spend money that the state has no right to expect. In the past, legislators have mainly chosen the spending option. Their new supermajorities now empower them to take the tax route. Either way, they will send a discouraging message to the states job producers: stay here, and youll face more fiscal chaos or higher costs—or both.
The one man who might be able to prevent the toxic-state syndrome from taking hold is Governor Jerry Brown. Having successfully campaigned for a tax increase, he owes his allies in the public-employee unions no further favors. Facing no compelling opposition from Republicans, he looks like a shoo-in for another term. This is Browns moment. He has the clout and the freedom to do the right thing and rein in his free-spending party. If he doesnt, Californias nascent recovery may be short-lived.