PERSPECTIVE - Once again, California is facing a budget crisis.
No surprise. What did you expect when the state government cannot accept the existence of volatility?
Governor Brown is still living in the past. He, as most of us, has witnessed national recoveries from oil price shocks, the tech bubble and 9/11 – including the wars spawned by that act of terrorism.
Up until the collapse of the financial markets in 2007, the American economy was driven as much by exuberance than substance, and for good reason – productivity gains in the 1990s seemed to assure stability and provided a false sense of security that the United States could weather any financial crisis.
According to Alan Greenspan in a speech he made at a Federal Reserve Bank symposium in August 2002, “…accumulating signs of greater economic stability over the decade of the 1990s fostered an increased willingness on the part of business managers and investors to take risks with both positive and negative consequences. Stock prices rose in response to the greater propensity for risk-taking and to improved prospects for earnings growth that reflected emerging evidence of an increased pace of innovation.”
Greenspan also recognized the downside: “productivity acceleration does not ensure that equity prices are not overextended …The danger is that in these circumstances, an unwarranted, perhaps euphoric, extension of recent developments can drive equity prices to levels that are unsupportable even if risks in the future become relatively small. Such straying above fundamentals could create problems for our economy when the inevitable adjustment occurs.”
Too bad Greenspan did not heed his own advice and address the housing bubble that was inflating under his nose.
And too bad Governor Brown believes a robust recovery is on the horizon. I can surmise as much from his belief that tax increases will eliminate the state budget deficit in five years.
At least Greenspan recognized the potential of volatility risk even if he did not act on it. Brown’s assumptions for a turnaround amount to nothing more than exuberance and ignores the risks of volatility still very much with us.
No one can say with any degree of confidence that the economy will recover at a pace capable of sustained, steady growth of the type that will fill the state’s treasury. The housing market alone will be a drag for years to come as we work through foreclosures and equity is rebuilt for those homeowners still current on their loans but underwater. The future for the commercial market is not bright either.
Brown is banking on the 1% who generate 40% of the overall personal income tax. According to an article in the Los Angeles Times, H.D Palmer of the state’s Department of Finance recognizes the volatile leverage of that ratio. He was quoted as saying, “So small swings can swing your assumptions.”
The governor is in an unenviable position, but why does he want to make it worse by not facing up to the risks of his tax plan? A ballot measure in November would increase rates on those earning more than $250,000 from 1 to 2 points. [link]
Brown would be better off taking whatever cash the state has left and betting it on red or black at a roulette table.
High earners depend much more on capital gains from real estate, stocks and business investments. Even in the unlikely event that all of these markets had better than average turnarounds, there will be carryforward losses offsetting some of the gains.
You don’t want to bet the house on high-end taxpayers, assuming you have a house with sufficient equity, but that is what Brown wants to do.
How many of the high-end taxpayers would leave the state if their rates are increased is often debated. However, given the leverage the 1% have on state revenue, it would not take too many departures to offset the estimated increase in taxes from higher rates.
Short of broadening the tax base by introducing a system resembling a flat tax structure, there is little choice but to cut.
It will be impossible not to slash education, as Brown is threatening to do, in the absence of concessions from powerful public employee unions. There are no negotiations of any substance along those lines and Brown is not seeking any.
The LAUSD is considering a parcel tax to partially cover its deficit. [link] Sticking it to the homeowners has been tried before and failed.
The outlook is grim and there will be pain.
Now, more than ever, we must demand that state and local governments are tasked to perform with less, just as the private sector has these last several years.
Ultimately, there will be a recovery, but things may never be the same. The past is over; let’s prepare for a more competitive future.
(Paul Hatfield is a CPA and serves as Treasurer for the Neighborhood Council Valley Village. He blogs at Village to Village, contributes to CityWatch and can be reached at: [email protected]) –cw
Tags: Paul Hatfield, California, Governor Brown, Alan Greenspan, Federal Reserve, housing bubble, foreclosures, economic recovery, economy, high-end taxpayers
CityWatch
Vol 10 Issue 4
Pub: Jan 13, 2012