California offers budgetary lessons for U.S. government, Stanford professor says

Stanford law Professor Joseph Bankman argues that California's budgetary actions offer a blueprint for resolving the federal budget stalemate. The success of Proposition 30, passed in 2012, shows that people may be willing to support higher tax rates to maintain government services.

Reed Saxon/Associated Press Supporters of Proposition 30 attend a Los Angeles rally in 2012 shortly before the election. Proposition 30 won, raising taxes to fund education and maintain government services. Proposition 32, which lost, would have banned union and corporate contributions to state and local candidates.

Once the fodder of late-night comedians, California's budgetary strategy is actually one that national lawmakers might emulate, a Stanford tax scholar says.

Just two years ago, California's budget situation was among the worst in the nation, wrote Joseph Bankman, a law professor at Stanford University, in a new journal article. The Golden State's annual budget deficits soared past $20 billion, its net asset deficit was more than $127 billion, and the state legislature seemed dysfunctional.

Then, pushed to the brink with very real fears of cutbacks in state services, schools and escalating college tuition, California voters approved Proposition 30 in November 2012.

"California voters defied the conventional political wisdom in resoundingly embracing Prop. 30 by an over-10 percent point margin, 55.4 percent to 44.6 percent," wrote Bankman and his co-author Paul Caron, a law professor at Pepperdine University.

Proposition 30 stabilized California's school funding for the first time since the Great Recession began, allowing school districts to avoid thousands of teacher layoffs, Bankman said. And it gave the state a way to balance its budget for the first time in years, without cutting deeply into social programs.

The big fear about Proposition 30 was that the higher tax rates would induce wealthy individuals and companies to move out of state or create a new business somewhere other than California. But, Bankman said, previous studies have shown that tax increases of this magnitude are not a major driver of interstate moves.

California's tech economy is also different, he said. "It may be that tech jobs are more easily exported. On the other hand, there seem to be huge economies of scale to locate tech jobs in one place, and right now at least, the Bay Area is the place."

So far, California has rebounded after Proposition 30. The state's unemployment rate dropped from a peak of 12.4 percent in 2010 to 7.4 percent in July 2014, according to the researchers. California's GDP increased, up to 2 percent in 2013 compared to a 4.1 percent decline in 2009.

Still, the state of California is not out of the woods by any stretch, Bankman warned. "Unfunded liabilities exceed $300 billion, with $80 billion for teachers' pensions," he wrote, noting that these liabilities continue to accrue each year "off budget," which has the effect of hiding overall costs to citizens.



Public choices, costs

Proposition 30 called for an overall .25 percent sales tax increase, with the bulk of the law's estimated $6 billion annual revenue increases coming from income tax hikes at the highest levels, including a 13.3 percent rate at the top.

Why did the public embrace Proposition 30?

Bankman said, "We believe the public weighed these costs (higher taxes, possible out-migration) against the economic and social costs of bankruptcy, including sudden disruptions in services. Voters accepted the former costs to avoid the latter costs, and at this point appear happy with that decision."

With the largest economy of any U.S. state, California has often been called a harbinger of sorts for the nation, he added. In 1978, California voters approved Proposition 13, which reduced taxes and spurred a nationwide tax revolt. Today, it may be the opposite dynamic at play that receives attention.

"Thirty-six years later, California Prop. 30 might represent a similar watershed moment, in which federal and state politicians who are willing to realistically acknowledge the need for greater tax revenues are rewarded by voters," wrote Bankman, the Ralph M. Parsons Professor of Law and Business at Stanford University.

Federal budget dysfunction

Bankman said he believes that the failure of both political parties in Washington, D.C., to remedy the federal budget imbalance threatens the future of the nation. There is no easy, one-way solution.

He noted that over the past 40 years, federal spending has averaged 20.5 percent of GDP while federal revenues have averaged 17.4 percent of GDP. The 3.1 percent gap between revenues and spending has produced a $17.7 trillion federal debt held by the public. This constitutes 74 percent of the nation's gross domestic product, the highest in U.S. history and double the percentage as recently as 2008.

"As sobering as these numbers are, they pale in comparison to future projections," he wrote.

Virtually all economists agree, Bankman said, that an ever-increasing debt-to-GDP ratio threatens the prosperity of future American generations. And simply making spending cuts alone will not reduce the debt.

"The need for more revenue is therefore inescapable," he said.

As a next step, he urged tax scholars to focus their energies on the "existential financial threat facing the nation in the coming years."

Media Contact

Joseph Bankman, Stanford Law School: (650) 725-3825, [email protected]

Clifton B. Parker, Stanford News Service: (650) 725-0224, [email protected]