This is a new political environment. This is the first time California has had an Austrian-born Mr. Universe as governor.
-- Arnold Schwarzenegger, November 17, 2003
When Arnold Schwarzenegger came calling on Halloween night -- appropriately, my kids were out trick-or-treating in Terminator costumes -- to ask if I would serve on his budget-audit committee, I already knew that California's budget situation was a horrible mess. But I had no idea just how gloomy the fiscal outlook really was.
After countless hours combing through the budget with star budget director Donna Arduin, we realized that the state faces roughly $15 billion annual deficits, twice as high as expected, from here to eternity. California's budget deficit is now larger than those of the other 49 states combined -- and this state is already the most indebted in the nation.
So how is Arnold doing so far in filling this enormous fiscal black hole? He has already scored some impressive victories: He has -- much to the indignation of the liberal intelligentsia -- unilaterally slashed $150 million from the budget, including money for left-wing groups such as a taxpayer-funded pro-union think tank run out of the University of California.
But the state's immediate problem is not the long-term deficit but a cash-flow crisis: The state could easily run out of money to pay the bills around June. Gray Davis's parting gift to taxpayers was a set of accounting books that disguised Sacramento's money woes in a scandalous manner: Correcting for all the accounting gimmicks, the real deficit balloons to at least $62 billion through 2007.
In meetings I have had with Arnold, it has become reassuringly clear to me that this governor, like his predecessor of three decades ago, Ronald Reagan, thinks and talks like a supply-sider. He fundamentally understands that restoring growth is the key to restoring budget balance. It will take 6 percent growth of the economy in California to cut the state deficit in half; the rest will have to come from budget cuts -- and that is where the governor may be a bit wobbly.
But Arnold is right to focus on igniting growth as the first step toward ending California's miseries. Between June 2000, the height of the boom, and the end of 2003, the state has had a negative growth rate in overall revenues after inflation. Why? Because, for the first time in the state's history, more taxpayers have left California than have entered it over a given three-year period. According to data from the State Board of Equalization, about 80 percent of the state's revenue losses were a result of disappearing millionaires. Some of this was a result of the dot bomb in Silicon Valley. But a lot of it was policy-driven. The leftists in the state legislature have made it clear through high taxes and anti-business regulations that they despise rich people, so the rich people have retaliated by leaving. The number of reported millionaires in California plunged from 44,000 in 2000 to 29,000 in 2002.
In 2000, those 44,000 millionaires contributed $15 billion to the state treasury. This remarkable statistic means that the richest 0.3 percent of Californians contributed roughly 20 percent of the state's income-tax revenues. California has a steeply progressive tax structure, highly dependent on rising incomes at the top to generate revenues; the state's income tax is, at 9.3 percent, the third highest in the nation. This needs to be changed, and the best way to do it is to enact a flat-rate tax, as California resident Arthur Laffer has been advocating for years. The flat tax would have two very desirable effects: It would even out revenue streams in good times and bad, rather than create mountains and valleys in revenue collections from year to year, and -- most important -- it would bring back the rich folk on whom the state is so dependent for job creation and tax revenues.
Another crucial economic issue in California is the governor's $15 billion bond initiative -- and this fight isn't going well for conservatives. Arnold had promised conservatives during the recall campaign that he would support the bond initiative only if it were combined with an ironclad spending-limit measure; the spending-cap measure is essential to ensure that deficit spending never gets out of control again. Lew Uhler of the National Tax Limitation Committee has drafted a new spending-limit plan that would hold the growth of the state budget to the rate of population growth and inflation. If taxes and outlays had risen only as fast as inflation and population growth since 1988, the average California family would be paying some $2,000 less per year in state and local taxes today -- and the budget would be balanced.
The Democrats in Sacramento, who control roughly 65 percent of the legislature, were immovable when it came to expenditure limits; Arnold caved and agreed to the bonds without the spending discipline. This was not just bad economics but bad strategy on his part: It will only make the Democrats even less cooperative on budget issues.
In early December, the governor stumbled again. He was asked the media's favorite question: Could you ever raise taxes? Arnold swallowed the bait. "Right now people despise the idea of new taxes," he replied. "We don't know what the situation is a year or two from now." Gulp. Arnold immediately "clarified" his statement, but the damage was done. On the bright side, I think the gaffe was the result more of political inexperience than of pro-tax sympathies on his part. I once warned Arnold that he has never faced a more tenacious adversary than the Democrats in the state legislature; but I think he still has the well-intentioned but naive belief that he can get everyone in a room together, regardless of ideology, and charm them into endorsing sensible policies.
It is difficult to describe for people outside California just how extreme the left-wing tilt of the Sacramento Democrats really is; some of them make Charlie Rangel and Barney Frank look moderate. Assemblyman Ray Haynes has assembled a Bad Business Bill Watch List, and it includes such absurdities as "living-wage requirements," anti-global-warming tax hikes, mandatory employer health coverage, paid parental-leave requirements, domestic-partnership employee-benefit laws, and even anti-discrimination laws that cover cross-dressers. This last bill is sadly symptomatic of Sacramento's loony-left culture: It would impose fines of up to $150,000 on employers (including, for example, religious businesses and Boy Scout Councils) if they "refuse to hire individuals on the basis of gender or perceived gender . . . which could include cross-dressers, and transsexuals." This bill actually passed the senate.
So far, the left-wing interest groups promoting kook legislation like this have been making more demands on the governor than have the conservatives who voted him into office. "If we want Arnold to succeed," advises Lew Uhler, "fiscal conservatives better start holding the governor to his budget promises." The key is for the governor to recognize that the members of the Democratic leadership are his adversaries, not his allies. He has to be willing to neutralize them by going over their heads and directly to the voters who put him in office -- just as Reagan did so effectively. And no one would be better at it: Arnold is the best GOP communicator since the Great Communicator himself.
Given the leftward tilt of California politics, Arnold has only two real assets: the bully pulpit and the veto pen. If he uses both, this Austrian-born Mr. Universe has a unique chance to break the Left's vise grip on Sacramento -- and put the bloom back on the state that was once, and not so long ago, golden.