Commentary

California Needs a Spending Limit

California’s budget is once again in the red. The governor signed a balanced budget in August of last year, but before the ink was dry, a slowing economy, the real estate bust and a spate of unplanned spending resulted in a significant budget crunch. The Legislative Analyst’s Office now projects a deficit of about $10 billion over the next 18 months, and Gov. Schwarzenegger says the shortfall may be as high as $14 billion. To be sure, the slowing economy has reduced revenues, but excessive spending remains the root cause of California’s persistent financial troubles.

The governor plans to declare a “fiscal emergency,” requiring legislators in Sacramento to correct the deficit. The resulting legislation will likely include spending cuts, fee increases and borrowing. Details aside, Schwarzenegger must insist that any legislation contain an enforceable framework to help prevent future fiscal crises and allow for a voter referendum on a constitutional spending limit.

The time is right. California’s taxes are already high, so the solution is to control spending with a constitutional constraint limiting expenditure growth to inflation plus population growth. Schwarzenegger proposed a spending limit in 2005, but it was poorly designed, and voters had little incentive to support it. Now, the fiscal crunch is much worse. A new proposal should require legislators to get voter approval for any expenditures above the limit, and include a component allowing taxpayers to decide for themselves whether they want higher spending or a tax refund.

Such a law would lessen the severity of budget shortfalls in economic downturns. Recent experience provides an example of how this would work. The state’s revenues began to rise in the 2004-05 fiscal year. Since that time, pegging spending increases to inflation and population growth would have allowed spending to grow by 15 percent. Instead, expenditures increased by more than twice that much. If spending growth had been limited to 15 percent since 2004-05, we’d be facing a $7 billion surplus rather than a $2 billion deficit for the current fiscal year.

Thirty states already have some form of a tax or government spending limit. Most of the limits link the growth of state expenditures to growth in personal income. California overwhelmingly passed a population growth plus inflation spending constraint in 1979, but it was amended by voters in 1990 to limit expenditure growth to increases in population plus growth in personal income. This more generous limit has never effectively constrained state spending. Linking spending growth to increases in population plus inflation is a more effective way to establish fiscal discipline in Sacramento.

We know from other states that tax and spending limits can constrain the expansion of government. Research shows that the most effective limits are constitutional, written by voters and limit increases in spending rather than revenues. As an added bonus, financial markets reward states with expenditure limits by demanding lower interest rates on state borrowing. This offers significant savings over time.

During economic booms, if revenues increase more than inflation plus population growth, the surplus should be refunded to taxpayers or used to shore up California’s rainy-day fund. If state leaders wanted to spend some of the additional revenues, they should put their proposals up for a vote.

California has little choice but to get its spending under control. Higher taxes are not an economically viable option. The Tax Foundation in Washington, D.C., ranks California 46th in its 2007 State Business Climate Rankings. Our neighboring states – Arizona, Nevada and Oregon – rank considerably better.

Despite healthy revenue growth over the last few years, the California budget has been mismanaged. Schwarzenegger has been unable to make good on his pledge to reform Sacramento and get state lawmakers off of what he called “autopilot” spending. In the 2003 recall election, he ran as a budget reformer, promising he would “tear up the credit cards” and rein in runaway spending. He has failed to live up to his promises.

A spending limit would give California some much-needed budget stability, and allow the governor to salvage his legacy. With a new fiscal mess brewing, it’s time for him to try again.

Robert Krol is a professor of economics at California State University Northridge and author of a forthcoming Cato Journal paper on state budget institutions.