How to Fix California’s Fiscal Problems: A Guide for Schwarzenegger

Now that the recall election has ended, Governor-elect Arnold Schwarzenegger needs to turn his attention to California’s deteriorating fiscal condition. Resolving California’s $8 billion deficit should definitely be his top priority. However, the governor-elect and his aides also need to give serious consideration to long-term strategies for keeping California fiscally solvent.

One idea that has received broad support is a constitutional spending limit. Indeed, a tight expenditure limit would have gone a long way in preventing California’s current fiscal crisis. If spending had increased by the inflation rate plus population growth, since Gray Davis’ inauguration, the budget would have been $14 billion lower in fiscal 2003. Furthermore, the accumulated surpluses would have totaled $40 billion. This could pay down the state’s debt and leave a tidy sum for tax relief.

However, it should be noted that enacting a tight limit offers no guarantee of success. Indeed, California’s constitution includes a number of spending mandates, most notably for education. This might spell trouble because during fiscal shortfalls courts often suspend fiscal limits in favor of budgetary mandates. This is especially likely in California because state courts have often issued rulings hostile to the local government limitations included in the tax-relief measure Proposition 13.

As a result, if a spending limit is to enjoy long-term success, it has to be self-enforcing. There are two provisions that would help accomplish this. The first would be to require immediate taxpayer rebates of surplus revenues. As a result, any proposal to spend over the limit would reduce the size of each taxpayer’s rebate check. This would make voters more hostile to attempts by the legislature or the judiciary to tamper with the limit.

The second provision would be to couple the limit with a reserve fund. Now, in the short term, this would reduce the amount of tax relief issued to California taxpayers. However, during economic slowdowns, the reserve fund would increase the pool of funds available for constitutionally mandated programs. Because there would be fewer conflicts between budgetary mandates and the spending limit, judges would have less opportunity to invalidate the spending cap.

California’s previous history is instructive. In 1979, California voters enacted a spending limit known as the Gann Limit, which limited appropriations of tax revenues. During the 1980s the Gann Limit effectively kept budgetary growth in check. In fact, in 1987, California taxpayers received $1.1 billion in tax rebates when revenue exceeded the limit.

Unfortunately, the Gann Limit was not designed to provide direct relief to California taxpayers on an annual basis. As a result, the benefits of the Gann Limit were largely invisible. This is part of the reason why teachers unions were able to enact Proposition 111 in 1990. Proposition 111 raised the Gann Limit to increase education spending. Ever since the passage of Proposition 111, the Gann Limit has ceased to be a meaningful constraint on the size of state government in California.

Indeed, if Schwarzenegger is looking for a better model, he should look no further than Colorado’s Taxpayer Bill of Rights (TABOR). After its enactment in 1992, state spending has been kept in check. Furthermore, between 1997 and 2002, taxpayers received annual tax rebates from surplus revenues totaling over $3.2 billion. During this time, Colorado easily led the nation in tax relief.

More importantly, these annual tax rebates have contributed to TABOR’s durability. Between 1993 and 2001, seven proposals have appeared on the state ballot to spend over and above the limit. However, knowing these increases would reduce the size of their rebates, voters rejected six of the seven, keeping the limit intact.

Now, a constitutional spending limit has been gaining a great deal of currency in California in recent months. In fact, both of the Republican candidates for governor, Arnold Schwarzenegger and Tom McClintock, came out in support of a constitutional limitation on expenditures. That is a good start.

However, more needs to be done. When Governor-elect Scharwarzenegger introduces a fiscal reform plan, he needs to detail how a spending limit can provide tax relief, prevent future fiscal crises, and revive the California economy. Indeed, if the recall election results in the enactment of a constitutional spending limit, the recall effort could pay dividends for years to come.

Michael New is an adjunct scholar with the Cato Institute and a post-doctoral fellow at the Harvard-MIT Data Center.