California State’s Bankruptcy and its Economic Future: A report from a conference

California State’s Bankruptcy and its Economic Future: A report from a conference

Liberty on the Mind (an offshoot of Liberty on the Rocks for conferences) organized a conference on the subject of the fiscal crisis of the state of California at Santa Clara University on 27th April 2009. As a grassroots organization, LOTR attracts members who are capable of animated public policy discussions in bars, the background noise notwithstanding. They agitate for a freer and more prosperous world and they like to be well-informed citizens rather than partisans.

The topic of the conference generated some controversy. A member of one of the think-tanks, close to the state’s establishment, felt that bankruptcy does not accurately describe the current state of finances in the state. According to him, the current crisis is an administrative issue created by the two-thirds majority rule for passing a budget which an unnecessarily high bar. He added that there has never been a bankruptcy in any of the Union’s states anytime in history. We checked with an economic historian and confirmed that some states did experience bankruptcy in the early nineteenth century. A deficit of $40 billion clearly reflects a deep-rooted economic malaise especially when consider the fact that the credit rating of California is the lowest of any state, the tax rates are the highest and cost of doing business in the state is 20% higher than the average cost of doing business in USA. Also, there has been an out-migration of 1.2 million from California over the last four years. We concluded that his comments about the two-thirds majority rule are a not-well-disguised rationale for an unhindered spending binge.

We, therefore, sought speakers who had done research on the state’s expenditure policies as well as the business environment for growth. Seven speakers from think tanks and universities around California agreed to come and speak. Michael Shires of Pepperdine Public Policy Institute was eventually called for jury duty and could not make it.

Professor Fred Foldvary, Director of Civic Society Institute, displayed data on persistent deficits in the state which are accounted largely by soaring expenditures on education, health and prisons. One striking slide showed that expenditures on prisons are rising at the same rate as education. Liberalization of drug sales and their regulated use is one way of relieving the pressure on prisons and for increasing the revenue base for the state.

Expenditures keep rising despite the constitutional provisions for citizens to vote against them on the ballot. A wide variety of checks and balances exist in the state, such as the use of two-thirds majority rule for raising taxes, Proposition 13 which caps property taxes, provisions for recalls of elected representatives, term limits on legislators and voter approvals for major initiatives, to guard against political intransigence. The voices of ordinary citizens, nevertheless, are overwhelmed by sophisticated advertising campaigns by organized groups such as teachers unions, firefighters and law enforcement officers unions. Vallejo had to recently go into bankruptcy because it was unable to honor its pension liabilities to 17 of its firefighters. Professor Foldvary recommends a cellular democracy, widely discussed by public economics expert and Noble Prize winner James M. Buchanan, where politicians are elected at the micro-local level. At this level, the actions of politicians to be visible to each citizen and they can be easily recalled when voters don’t approve of them. A constitutional convention will clear the way for a new set of rules to govern the state.

Lisa Snell, an expert in school reform at the Reason Foundation, pointed out that nearly 20% of expenditures on education are incurred on retirement and health liabilities of teachers. Teacher layoffs are usually a chimera. Typically, teacher layoffs are widely reported in the press. However, the reversals of layoff decisions are ignored by the press. Altogether, only 31 teachers have been laid-off mostly for cause. Other egregious wasteful use of resources is the $20 billion bonds on new schools building while enrollment in older schools drops.

Innovative school education methods account for only about one-percent of the students but they have been able to provide better quality education at lower costs. Charter schools are initiated at the local level and are spared a backlash from teachers’ unions. The state has refused to call even a meeting to consider school vouchers but a small program, sponsored by private foundations, has been successful. She was particularly enthusiastic about virtual academies similar to the free learning materials provided by MIT. These are internet based learning options that aggregate teaching materials from a wide range of sources.

Health spending accounts is the next highest budget item. John R Graham, Director of Health Care Studies at the Pacific Research Institute spoke on the built-in incentives to increase health expenditures regardless of the outcomes. Between 1997-1998 and 2006-2007, Medi-Cal (the state version of Medicaid) spending nearly doubled. The 2009-10 budgets of $135 billion for the California state allocates $38 billion of state funds for health & human services. In addition, the U.S. government throws in $40 billion for Medicaid & SCHIP: almost three quarters of the total budget. At the end of the day, physicians have to be prepared to serve patients if any of this spending is to help at all. One survey, quoted by Dr. Graham, found that there are only 46 primary care physicians per 100,000 Medi-Cal beneficiaries, versus 75 per 100,000 for users of other health insurance plans in California. This is not hard to explain given that Medi-Cal pays less; in 2003, Medi-Cal paid physicians only 59 percent of what Medicare paid. According to a study by Professor Daniel Kessler, the premiums paid by private individuals would fall by 11 percentage points if Medicare and Medi-Cal were to pay the full costs of their patients’ hospital care. Next time anyone buys insurance, remember you are subsidizing someone else.

Health Savings Accounts (HSA) have already proved to be a means to lower costs. In 2007, CIGNA HealthCare conducted a two-year study to compare cost management by consumer-directed and more traditional HMO/PPO plans among its membership of 430,000. It found that the costs of subscribers of consumer plans were lower by 12% even though they spent more on preventive care and maintenance medications. Despite the proven benefits of HSAs, the California Government chooses not to provide tax benefits for money invested in these funds. Consequently, only 4% of Californians have invested in HSAs compared to 8% nationwide.

David Zetland, a Wantrup Fellow at UC@Berkeley spoke on the mismanagement of natural resources, especially water, in California. The state still treats water as a free good and farmers don’t have to pay for it. The state’s investments in water infrastructure are hard to recoup. Farmers resist paying prices by drawing on underground water. The effects are especially devastating in times of drought when crops are left to wither.

Dr. Robert W Fairlie, Professor of Economics at the University of California, Santa Cruz, spoke about trends in entrepreneurship and its effects on California’s economy. New businesses rely a great deal on their personal savings, such as second mortgages on their homes, financial investments and savings, to bootstrap their businesses before financiers are willing to risk their money. The decline in personal wealth, as a result of fall in home and stock prices, has affected financing of new businesses. Immigrants, especially Asian entrepreneurs, are important sources of human and start-up capital. They are able to raise capital from additional sources such as their ethnic networks. A slowdown in immigration will have an affect on growth.

Jim Atkins from the law offices of James E. Atkins P.C. is a specialist in bankruptcy law and provided a window into the experience of businesses in recent months. While business cycles are a common experience and most owners learn to rough it out till growth starts again, this time the mood is less optimistic and entrepreneurs dread a worse turn of events.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.