The Red Ink State

This article was published in The Weekly Standard, Oct. 6, 2003.

In the campaign to save California governor Gray Davis's job, no one bothers to defend the Davis record, not even Davis. Instead, in the September 24 gubernatorial debate, the lone Democrat Cruz Bustamante conspicuously distanced himself from Davis's policies, treating the governor like a political leper. California Democrats, by their silence, appear to concede that the prosecution has an ironclad case against him.

Does it ever. The total of high-paying manufacturing jobs lost on Davis's watch now exceeds a quarter million. These jobs and the businesses that created them weren't all victims of a business-cycle recession. No, Davis and the legislature have been energetically elbowing employers out of the state. In the last five years Davis has signed into law roughly two dozen business-hostile regulations and mandates -- from anti-global warming measures, to paid family leave requirements, to smoking bans in restaurants and bars. Even now -- in an economic crisis labeled California's worst since the Great Depression, with an unemployment rate above the national average -- Davis and the Democratic legislature still treat businesses like ATM machines to pay for do-good social welfare.

Take the new bill passed by the legislature requiring small businesses with 50 employees to pay for health insurance for their workers. Davis is expected to sign this into law any day now. The Wall Street Journal estimates this will push $5.7 billion in new costs onto the backs of employers.

The question is: What employers? The joke on the left coast is that only three businesses will have to pay up -- the last three businesses still operating in the state. Davis's high tax, obese-welfare, anti-business, pro-trial lawyer policies (California has the highest workers' compensation insurance premiums in the nation) have led to the first significant exodus of businesses and high-wealth individuals from the Pacific Coast in the state's history.

Californians are also paying a hefty price for Davis's bungling of the infamous electricity blackout fiasco of 2000 and 2001. Davis could have solved the crisis in short order through the free market pricing system. Instead, he used government intervention to lock the state into long-term energy contracts. These contracts will require homeowners to pay an estimated $24 billion in utility bills above market rates over the next decade. Enron didn't do this; Gray Davis did.

But, of course, nothing can compare with Davis's ineptitude in handling the budget crisis. In five years, he has somehow converted a $12 billion budget surplus into a $38 billion deficit. In 1998 California had the largest surplus of any state in the nation. Today, California's deficit is larger than the deficits of the other 49 states combined. As the state's chief financial officer, Davis has allowed the debt rating of the state to be downgraded three times in three years; its status is now just marginally above that of junk bonds.

All of this grim news has been fairly well documented. But what is not well known is the hideous depth of this fiscal swamp. I have just returned from Sacramento, where I spent several days combing through the financial numbers, and I am convinced that, as angry and nervous as Californians are, they don't know the half of it. The Democratic line is that the worst of the budget disaster is behind California. Hardly. This state is a lot closer to an Argentina-style financial meltdown than a balanced budget. Every day that the Gray Davis-Cruz Bustamante administration stays in power, the state plunges another $20 million in debt.

In this year's budget process, Davis resorted to bookkeeping chicanery so fanciful it would have made a WorldCom accountant blush. Instead of balancing the budget, as is conventionally defined and required by the state constitution, Davis borrowed $10.7 billion and then declared the cash inflow "revenues" to put the budget in balance. This loan came on top of the $50 billion in outstanding state and local bonds California is already carrying on its books. John Cogan of the Hoover Institution, a leading expert on the California state budget, grimly notes that "Davis is the first governor in California history to eviscerate the balanced budget requirement by issuing billions of dollars of debt without a vote of the people." Then he adds: "This may also be the first time a state has ever balanced its budget by borrowing."

These billions of dollars in five-year bonds make balancing the budget in 2004 and 2005 an even more Herculean task. Even if the general fund budget were held constant for the next three years (an improbable scenario given that it grew 28 percent in Davis's first three years), expenditures and receipts would likely remain out of balance because of the massive payments the state now has to make to service its debt. The next governor, whether Republican or Democrat, will almost certainly have to beg for more dollars from the credit markets (that is, issue more debt) to pay off the existing debt. Joel Fox of the Howard Jarvis Foundation warns that this gambit means Californians could be paying for Gray Davis's "overspending for not years, but decades to come." It's not unlikely: Tax-weary New Yorkers are still paying off bonds from the infamous debt crisis that erupted in the mid-'70s under Mayor Lindsey.

What is most unsettling about the dismal state of California's finances is that no one in charge seems to have any clue how to stem the tide of red ink. Lieutenant Governor Bustamante has declared that, if elected governor, he will immediately raise taxes on the rich and on corporations to balance the budget. Even many liberals in the state groaned in response to this economic delusion. With a 9 percent income tax on the rich, California already has the third highest such tax rate in the country, with about one-third of all the taxes paid by the wealthiest 1 percent of Californians. Another reason Bustamante's plan stinks is that the last time income tax rates were raised -- under Republican governor Pete Wilson -- the state actually lost revenue because the rich fled to places like Nevada, Texas, and Washington that impose no income tax at all.

An even bigger fantasy is the Democrats' latest party line that the recall is causing the budget debacle, not the other way around. State treasurer Phil Angelides recently fumed that: "I don't think there's any doubt that the recall has been part of the mix that brought down the state's credit rating." Angelides continued: "These credit ratings aren't a reflection of our economy but rather of the political paralysis, and the recall is another manifestation of the political paralysis."

Credit ratings aren't a reflection of the economy? How perfect. In the Davis administration, not even the treasurer seems to understand the basic rules of fiscal accountability -- or to realize that gross mismanagement is the reason California is now burdened with an astronomical deficit.