Bankrupt government in California

Thomas Lifson
The city council of Vallejo, California voted last night to declare bankruptcy. Will the state of California follow? It may be far-fetched now, but thinking the unthinkable occasionally has value.

The problems facing Vallejo bear some comparison to those of the state in which it is located. Vallejo spends about 80% of its budget on personnel costs, more than the state's share. But California is locked into extremely generous labor contracts which not only offer high salaries and benefits to groups such as prison guards (many of whom earn six figures with overtime -- not bad for a job which does not require college) and bureaucrats, but which promise generous retirement benefits, including gold plated health care for life. Years ago, a study concluded that state employees were paid about 30% more than their private sector counterparts for jobs of comparable skill level and responsibility. And California state employees are not widely renowned for the competence or hard work. To say the least.

Vallejo's budget deficit is $16 million dollars, not an extreme sum for a city of 116,000. California's budget deficit estimates for the coming year are 10 or 20 billion dollars, a sum that would require crippling tax increases to fund. Already a high tax state driving a flood of businesses and affluent residents to Nevada, Arizona, and elsewhere, California would cripple its future if taxes were raised that much. The migrants fleeing California mostly are being replaced with low income, service-consuming immigrants, some of whom have papers.

Nobody has even whispered about the possibility of the state going bankrupt. But the power of state employee unions, and the lock that Democrats have on the state legislature, make it extremely unlikely that the unions can be confronted and pay and benefits go in any direction but up. There is no political will to impose cuts. So self-defeating drastic tax increases, driving the state further into a vicious cycle, may be the only alternative the political process offers.

So how to solve the problem of excessive spending, when the political process will not yield any cuts of a magnitude capable of making a difference?

Of course no politician, least of all Arnold Schwarzenegger, wants to go down in history as the many who led his state into bankruptcy. G. Mennen "Soapy" Williams, who took Michigan into bankruptcy, will forever be remembered for that act. But how will the Governator cope with the looming fiscal crisis, facing a legislature which only knows how to raise taxes? Will he be willing to raise taxes that much?

It would be rash to predict a bankruptcy. That would be an extreme solution. And its effect on national credit markets could be extremely bad. But I see no other possibility for reducing state employee compensation to reasonable levels, consistent with external labor market realities. If fingers could be pointed at greedy Wall Street capitalists, perhaps state employees would compare their options on the actual labor market with their compensation minus x percent and less generous retiement, and decide to soldier on.

I was frankly creeped-out recently when the State began offering a new bond issue directly to the California public with radio advertising. It suggested to my cyncial mind that these securities would not be the best investment. No doubt I will be attacked for even raising the thought. But I am not about to buy any California debt.

I will be watching the reaction to Vallejo's bankruptcy. Vallejo's problems, like those of the state, are principally due to mismanagement, not an underlying economic illness. Vallejo is an attractibe and historic place (briefly the capital of California twice) surrounded by growing suburban developments (many of them currently distressed with unsold housing, to be sure). The now-closed Mare Island shipyard is prime real estate being converted to private use. There is probably little that needs to be corrected in Vallejo besides poor political leadership and resulting excessive spending.

Runaway spending is California's problem. I see no solutions to that in the normal political process.
The city council of Vallejo, California voted last night to declare bankruptcy. Will the state of California follow? It may be far-fetched now, but thinking the unthinkable occasionally has value.

The problems facing Vallejo bear some comparison to those of the state in which it is located. Vallejo spends about 80% of its budget on personnel costs, more than the state's share. But California is locked into extremely generous labor contracts which not only offer high salaries and benefits to groups such as prison guards (many of whom earn six figures with overtime -- not bad for a job which does not require college) and bureaucrats, but which promise generous retirement benefits, including gold plated health care for life. Years ago, a study concluded that state employees were paid about 30% more than their private sector counterparts for jobs of comparable skill level and responsibility. And California state employees are not widely renowned for the competence or hard work. To say the least.

Vallejo's budget deficit is $16 million dollars, not an extreme sum for a city of 116,000. California's budget deficit estimates for the coming year are 10 or 20 billion dollars, a sum that would require crippling tax increases to fund. Already a high tax state driving a flood of businesses and affluent residents to Nevada, Arizona, and elsewhere, California would cripple its future if taxes were raised that much. The migrants fleeing California mostly are being replaced with low income, service-consuming immigrants, some of whom have papers.

Nobody has even whispered about the possibility of the state going bankrupt. But the power of state employee unions, and the lock that Democrats have on the state legislature, make it extremely unlikely that the unions can be confronted and pay and benefits go in any direction but up. There is no political will to impose cuts. So self-defeating drastic tax increases, driving the state further into a vicious cycle, may be the only alternative the political process offers.

So how to solve the problem of excessive spending, when the political process will not yield any cuts of a magnitude capable of making a difference?

Of course no politician, least of all Arnold Schwarzenegger, wants to go down in history as the many who led his state into bankruptcy. G. Mennen "Soapy" Williams, who took Michigan into bankruptcy, will forever be remembered for that act. But how will the Governator cope with the looming fiscal crisis, facing a legislature which only knows how to raise taxes? Will he be willing to raise taxes that much?

It would be rash to predict a bankruptcy. That would be an extreme solution. And its effect on national credit markets could be extremely bad. But I see no other possibility for reducing state employee compensation to reasonable levels, consistent with external labor market realities. If fingers could be pointed at greedy Wall Street capitalists, perhaps state employees would compare their options on the actual labor market with their compensation minus x percent and less generous retiement, and decide to soldier on.

I was frankly creeped-out recently when the State began offering a new bond issue directly to the California public with radio advertising. It suggested to my cyncial mind that these securities would not be the best investment. No doubt I will be attacked for even raising the thought. But I am not about to buy any California debt.

I will be watching the reaction to Vallejo's bankruptcy. Vallejo's problems, like those of the state, are principally due to mismanagement, not an underlying economic illness. Vallejo is an attractibe and historic place (briefly the capital of California twice) surrounded by growing suburban developments (many of them currently distressed with unsold housing, to be sure). The now-closed Mare Island shipyard is prime real estate being converted to private use. There is probably little that needs to be corrected in Vallejo besides poor political leadership and resulting excessive spending.

Runaway spending is California's problem. I see no solutions to that in the normal political process.