Strategy

California's crushing debt

The Golden State's crushing debt problem is a warning to governments everywhere: real austerity is agonizing.

Greek politicians, take note: this is what austerity looks like. Lawmakers in Greece, as well as Spain and Portugal, struggled over the past two months to slash government budgets and avoid economic ruin. But their efforts look meagre compared to the hacking proposed by California Gov. Arnold Schwarzenegger, who is working to overcome his own $19.1-billion budget shortfall.

In a plan unveiled in mid-May, Schwarzenegger called for the elimination of the state’s welfare program, a 60% reduction in community mental-health programs, a 5% pay cut for government workers, and the near elimination of drug and child care subsidies. In addition, the state previously announced plans to lay off 22,000 teachers. “California no longer has low-hanging fruits,” the governor said when announcing his plan. “As a matter of fact, we don’t have any medium-hanging fruits. We also don’t have any high-hanging fruits. We literally have to take the ladder away from the tree and shake the whole tree.”

California’s situation is gloomy. It was ranked in early May among the Top 10 governments worldwide likely to default on their debt, according to CMA, a London-based credit information company. Placing seventh on the list, California was considered safer than Greece and Ukraine but riskier than Latvia and Iraq.

The state has since been bumped from the list by the Dominican Republic and Portugal, but still grapples with double-digit unemployment, the after-effects of the housing bubble and a US$1.3-billion drop in income tax revenue in the first four months of this year. Following the oil spill in the Gulf of Mexico, Schwarzenegger abandoned plans for new drilling off the California coast that could have raised $118 million in the coming year. Given this, the governor said he had no choice but to propose cutting key programs.

“You see what’s happening in Greece, you see what’s happening in Ireland, you see what’s happening in Spain now,” he said. “And everyone has to…come to the realization that we can’t continue spending money and promise people things that we can’t keep.”

Comparisons between California and Greece are not entirely apt. In 2009, Greece’s budget deficit was 13.6% of its GDP; California’s US$20-billion deficit was just 1.1% of its GDP. Furthermore, the spending requirements placed on a national government are far more extensive than those faced by a state legislature. “People are always saying California is the size of a country, but we’re not a country. We don’t have our own military. Our social security net is nowhere near the size of a country like Greece’s,” says Daniel Mitchell, a professor emeritus at the Anderson Graduate School of Management and the School of Public Affairs. “California’s debt is big in terms of the public sector, but it is not big in terms of the whole state economy.”

Observers also caution that while Schwarzenegger’s proposals look severe, they’re only a bargaining position. Any budget must receive two-thirds support from the Democrat-controlled state legislature, meaning the Republican governor has plenty of negotiating to do before July 1, when the new fiscal year begins. “How he gets to balanced budget is open to debate,” says Philip Romero, dean of the College of Business and Economics at California State in Los Angeles. “In this case, he’s proposed substantial cuts that have no chance of passage by the Democrats.”

A compromise will likely still involve severe cuts to services, along with possible cuts to the state worker’s pension program, which costs $6 billion annually. Schwarzenegger favours these cuts, noting pensions cost more than all of his proposed cuts combined.