California's Budget Crisis: Is There a Way Out?

With budget negotiations stalled, a cash crisis looming and its fiscal crisis deepening, California today will begin issuing IOUs — formally called registered warrants — to tens of thousands of businesses and individuals to whom the state owes money. Gov. Arnold Schwarzenegger on Wednesday declared a fiscal emergency and ordered a third unpaid furlough day each month for 235,000 state employees. California's fiscal crisis has been years in the making and will not be easy to fix. But is there a solution?

In Sacramento, which rises like the city of Oz on the flat plains of the California's Central Valley, Schwarzenegger has not underplayed the gory details. "Our wallet is empty, our bank is closed. Our credit is dried up," he says. But the crisis has not helped bind up the gaping political divisions over what to do about it. Democratic lawmakers have proposed cutting billions of dollars from the state's safety net and educational system to balance the budget. Governor Schwarzenegger says the cuts must go even deeper and joins legislative Republicans in refusing to raise taxes. On Wednesday, Schwarzenegger said, "Haven't we promised too much the last couple of decades?"

Conservatives view the budget crisis as an opportunity to slash California's spending back to the level it had reached 10 years ago. "Gross overspending and fiscal irresponsibility will not be tolerated by the people of California," says Senate Republican Leader Dennis Hollingsworth. Liberals, however, see this as an attack by the right on the public infrastructure that helped make California an economic giant, and an act of war against the poor and minority populations in particular.

Conservatives claim California is a high tax state. In fact, California's taxes are similar to other high-tech, industrial states. According to the non-partisan Legislative Analyst Office and the Tax Foundation, California has comparatively high sales taxes and rates for corporate income, but very low property taxes. State income taxes are very progressive, with a large proportion of revenue comes from households earning more than $100,000, as well as from taxes on stock options and capital gains. Low-income households, meanwhile, face lower tax rates that in most other states. This tax system, says Steve Peace, director of finance under Gov. Gray Davis, "worked in a highly leveraged, supercharged economy. Those days are gone."

The state's finances could be made more stable by raising income taxes on middle and low-income families — which would reduce the state's dependency on volatile stock and capital gains income — a big reason for the current catastrophic deficits. But that is all but politically impossible in California.

Is there a solution to California's dilemma? A number of reforms are receiving attention. On the tax and budget side, these include eliminating the need for a two-thirds majority vote on budget and tax matters and instituting a split-roll for property taxes that would allow homeowners to continue to pay according to the low rates mandated by Proposition 13, but require commercial property to be assessed at market value. To relieve the logjam in California politics, momentum is growing for an open primary system, in which the two top vote getters in the primary, regardless of party, would face each other in the general election. Proponents believe it would loosen the grip of partisan ideologies and make it easier of moderates to win elections. In addition, a redistricting reform won narrow approval last November and proponents of good government keep trying to lengthen the state's term limits on legislators.