Generally speaking, a federal bailout creates bad incentives for elected officials in California and elsewhere. State legislators may propose even larger spending increases in the future, knowing that if deficits occur, Congress will force taxpayers in other states to pick up the tab. And it would be unfair in that it would penalize taxpayers in states that have exercised fiscal discipline.
However, incentives created by the bailout do not necessarily have to be bad. Indeed, if the bailout is designed correctly, it might even exert a beneficial influence. One way would be to require that states enact tight constitutional limits on either expenditures or revenues before receiving federal bailout funds.
California’s experience is instructive. In 1979, California residents approved the Gann limit, which placed a low constitutional limit on the annual growth of appropriations of tax revenue. During the 1980s, the Gann Amendment proved to be effective at keeping state spending in check. From 1980 to 1991, California’s rank in per capita state expenditures fell from 7th to 16th. Furthermore, when tax receipts exceeded the Gann limit in 1987, the state refunded $1.1 billion in surplus revenues to the taxpayers.
However, in 1990 Proposition 111 substantially raised the Gann limit. Since then the Gann limit has ceased to be a meaningful constraint. The sharp growth in government spending during the late 1990s and the large budget shortfalls the state consistently endures during economic downturns demonstrate that Californians are still paying the price for weakening the Gann limit. A well‐designed fiscal limit could prevent these boom‐and‐bust cycles and help restore fiscal health to California.