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California—shining again, but not necessarily golden

Boom but long-term gloom.

“California has once again confounded our critics,” Governor Jerry Brown proclaimed triumphantly in his State of the State speech back in January. The Golden State, goes the gubernatorial rhetoric, is back on track. Gone are the days when California was the butt of jokes across the country, when the government would try to appease debtors it couldn’t pay with IOUs and the housing market seemed like it would never hit bottom. The economy is finally growing once again—faster than the national average—and churning out jobs at higher rates than most other places. Revenues from social media and mobile ads have lifted the average Silicon Valley salary to $100,000, and tech money, in turn, helped kickstart a real estate recovery that is now expanding to commercial property and the state’s poorer inland as well. Oil is also a new potential source of riches, as California, it turns out, sits on large shale-oil reserves that new drilling techniques have now likely brought within reach. And, wonder of wonders, this year the state proposed its first balanced budget since 2007.

None of this, though, should have confounded the critics. For one, the roaring comeback, which is certainly welcome, was to be expected: California is notoriously prone to boom-bust cycles, so it tends to plunge faster and deeper than most other states during recessions and outperform the nation in the good times. Second, erasing the deficit this year—assuming it really happens—doesn’t come close to tackling the true fiscal nightmare threatening the state’s finances, and, ultimately, the entire economy in the not-so-distant future: California faces $500 to $800 billion in long-term liabilities, mostly tied to public employees’ pensions and health benefits. By comparison, the state had a deficit of $9 billion last year.

Brown’s 2013 budget deserves praise for finding matching short-term expenses with revenues and eschewing the accounting gimmicks that California bean-counters have become renowned for — such as predicting that Facebook’s IPO would bring a $2 billion tax windfall (the stock, though, sunk and revenues turned out to be less than half as much). For once, independent budget analysts validated the government’s math this year. The dirty little secret, though, is that California’s state budget projections don’t include any long-term fiscal liabilities.

But ignoring the fiscal black hole on paper, doesn’t make it go away. In fact, it has already started sucking in resources that were never meant to pay for teachers’ pensions and public administrators’ medical bills. Just a few weeks ago, the state’s Legislative Analyst’s Office quietly announced that the California State Teachers’ Retirement System will need an extra $4.5 billion a year for the next three decades in order to keep pension and health benefits promises based on absurdly high investment return expectations (one such absurd expectation, according to Bloomberg‘s David Crane, who used to work for Brown’s predecessor, Governor Arnold Schwarzenegger, is that the stock market would double every 10 years). It’s hard to see where that money might come from, if not from $50 billion in temporary tax hikes that were originally meant to avoid further cuts to schools and universities.

As in many other states, California’s structural liabilities are higher and growing much more rapidly than revenues, reflecting the costs of ever-pricier health care and aging populations, on one side, and weaker economic growth on the other. California politicians’ instincts has been to increase tax, mostly income taxes, and preferably on the rich. That approach, though, is exacerbating state coffers’ vulnerability to the business cycle, as income taxes across U.S. states have become increasingly sensitive to the economy’s ups and downs and are particularly volatile in the top-end of the income spectrum. That seems like a particularly bad idea in an economy known for its wild swings.

So far, nothing leads us to believe that California’s current adrenaline rush won’t end with another disastrous crash.

Erica Alini is a California-based reporter and a regular contributor to CanadianBusiness.com, where she covers the U.S. economy. Follow her on Twitter: @ealini.

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