Triple threat to California’s budget

There is near unanimity among economists that the United States will experience a recession in 2023. Last month, the Conference Board predicted a 96 percent likelihood of a recession in the U.S. within the next 12 months due primarily to the Federal Reserve’s interest rate hikes.

Relative to other states, California is ill-prepared to weather a recession, especially a severe one. But even without a recession, California’s Legislative Analyst predicts a $25 billion shortfall for fiscal 2023-24. The deficit, which the LAO calls a budget “problem,” is mainly attributable to revenue estimates that are $41 billion lower than previous budget projections.

Moreover, the LAO acknowledges that programs which include inflation adjustments will make the problem worse: “Our estimate of a $25 billion budget problem understates the actual budget problem in inflation-adjusted terms.”

Particularly surprising is that all this bad news from the LAO doesn’t even assume that a recession is imminent. “While our lower revenue estimates incorporate the risk of a recession, they do not reflect a recession scenario.” If a recession does occur in 2023, the LAO says that revenues could be $30 billion to $50 billion below its initial revenue outlook.

If the legislature took seriously the report from the LAO, it would take immediate action to blunt the damage from the economic downturn predicted for 2023. But that is unlikely because California’s political leadership lacks the will to reduce spending as well as the high tax burden which drives that spending. Government spending is California’s growth industry, exploding 600% since 1989-90. ($49.1 billion to $303 billion).

California’s out of control spending leads to the second reason why an economic downturn will hurt California more than other states: A reduced tax base due to outmigration of businesses and productive taxpaying individuals.

This column has reported numerous times on how California’s high taxes, heavy regulations and lack of affordable housing have led to an exodus out of California. The well-known satire site, Babylon Bee, recently featured an image of a high speed train emblazoned with a U-Haul logo with the caption: “U-Haul Builds Bullet Train from California to Texas.” Humorous, but capital flight out of California is no laughing matter.

A recent report from the Hoover Institute is downright frightening: “In 2021, California business headquarters left the state at twice their rate in both 2020 and 2019, and at three times their rate in 2018. In the last three years, California lost eleven Fortune 1000 companies, whose exits negatively affect California’s economy today. But California also is risking its economic future as much smaller but rapidly growing unique businesses are leaving, taking their innovative ideas with them.”

Because California is overly reliant on high-wealth individuals paying the lion’s share of income tax revenue, their departure inflicts a disproportionate level of harm to the state budget. As California experienced in the last recession, the drop in revenue from stock options and capital gains exposes California to a vulnerability not shared by other states. But that’s not all.

Governor Gavin Newsom touts California’s status as the leader in high tech and venture capital. But other states are cashing in on California’s reputation as an anti-business state. According to a Bloomberg report on initial public offerings (IPOs), only nine companies headquartered in California went public during the first three quarters of 2022. More troubling was that California’s share of U.S. IPO proceeds fell to 2% through Sept. 30, compared with 39% for 2021.

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The final concern for California is the fact that the U.S. House of Representatives, the house of origin for all appropriations, is now under the control of Republicans. For two years, right-leaning states have watched California receive favorable treatment from Washington from everything from High Speed Rail funds and other special projects. (Remember Nancy Pelosi’s securing $200 million for a park within walking distance from her home?) The extent to which California received more than its “fair share” of federal assistance is a matter of debate. But the odds of Congress going out of its way to help California with its budget “problem” are now zero.

The only silver lining to this very dark cloud is that a recession may finally force the tax-and-spend politicians in Sacramento to do something they haven’t done in decades: Reduce waste and prioritize spending.

Jon Coupal is president of the Howard Jarvis Taxpayers Association.