EDITORIAL FROM TOMORROW’S PRINT EDITION OF THE WALL STREET JOURNAL

The Decline of California

They still think they can tax their way out of this one.

If you thought Washington’s stimulus debate was depressing, take a look at the long-running budget spectacle in California. The Golden State’s deficit has reached $42 billion, Governor Arnold Schwarzenegger is threatening to furlough 20,000 state workers (go ahead, make our day), and as we went to press yesterday Democrats who control the legislature had blocked lawmakers from leaving until they finally get a deal.

It’s sad to watch. The Golden State — which a decade ago was the booming technology capital of the world — has been done in by two decades of chronic overspending, overregulating and a hyperprogressive tax code that exaggerates the impact on state revenues of economic boom and bust. Total state expenditures have grown to $145 billion in 2008 from $104 billion in 2003 and California now has the worst credit rating in the nation — worse even than Louisiana’s. It also has the nation’s fourth highest unemployment rate of 9.3% (after Michigan, Rhode Island and South Carolina) and the second highest home foreclosure rate (after Nevada).

Roughly 1.4 million more nonimmigrant Americans have left California than entered over the last decade, according to the American Legislative Exchange Council. California is suffering more than most states from the housing bust, but its politicians also showed less spending restraint during the boom.

To close the current deficit, the pols in Sacramento are nearing a deal that cuts spending by $15 billion and raises $14.2 billion in higher taxes on income, sales, gasoline and cars. Six years ago Mr. Schwarzenegger helped depose Governor Gray Davis by calling him "Car-taxula." Now he’s agreed to double the same tax.

Mr. Schwarzenegger has won at least some concessions from Democrats, who run the most liberal legislature this side of Trenton. The budget deal contains a handful of useful tax breaks for job creation and the first public union workplace reforms in a decade; it also creates a new rainy day fund. These taxpayer victories wouldn’t have been possible if Republicans in the legislature hadn’t held out for them.

But the plan is still far short of the radical tax and spending surgery the state needs. It’s loaded with short-term gimmicks — such as $5 billion of borrowing from future lottery receipts and nearly $10 billion in one-time federal stimulus cash. Even proponents concede the plan doesn’t balance spending and revenues 18 months from now.

The tax increases will continue to chase even more productive people out of the state. For at least two years, the sales tax would rise by one percentage point to 8.25% and the income tax by 0.3% to a top marginal rate of 10.56%. These will both be the highest statewide rates in the nation (see chart).

Do these taxes hurt business? Ask Hollywood. Film makers are threatening to flee to avoid the state’s high costs, so to keep them in Southern California the deal offers $500 million in tax breaks for producers. Rich liberals like Rob Reiner, who love higher taxes on other people, get a sweetheart tax break and everyone else pays more.

Mr. Schwarzenegger is finally getting a constitutional state spending cap that will be on the ballot in the next election, but even that is flawed. This cap would limit spending hikes in any year to a rolling average of the percentage increase of the past 10 years. Nice idea, except that if Californians vote yes, the higher income and sales taxes automatically kick in for three more years. So to get a modicum of spending restraint, the voters have to agree to tax themselves by $25 billion more for three additional years. Californians can be forgiven if they say "no deal."

The tragedy of this gamesmanship is that the political class still won’t address the root cause of its financial problems, which is that the state is becoming less economically competitive. California businesses and high-income families already pay a surtax for locating inside the state. The new budget deal raises that tax toll higher still.

It’s no surprise that most CEOs we talk to, many of whom live in California, say they’d be foolish to build another plant in the state. California’s budget crisis is the inevitable result of runaway liberal governance, and the state’s voters will keep paying for it until they reduce their tax burden and adopt more radical spending controls.

This entry was posted on Tuesday, February 17th, 2009 at 12:00 am and is filed under Blog Posts.