The Intelligence Pool
State of Dysfunction: California Lurches Closer to Fiscal Anarchy
Part Four
Structural Problem # 4 – Fiscal Insanity. State Funding for Counties, School Districts, and Cities.
Proposition 13 limited property taxes to 1% of valuation, and increases in valuation to 2% per year as a percentage of the previous valuation. It thus forebade the meaningful market-driven reassessment of property until the property was sold to a new owner, at which point the property could be valued at its sales price. Prop 13 applied to both residential and commercial property. Almost immediately Proposition 13 reduced county and school district revenues by 60%.
The California Legislature decided to aid counties, school districts, and cities after 1978 by raising sales and income tax rates and sharing some of this revenue with these local entities. Most U.S. counties, school districts, and cities raise their own revenues directly through property taxes; they have to be self-sufficient and manage their own spending and taxes. They cannot go begging to state governments for handouts. In California, all school districts and counties have become heavily dependent on state revenues. The cities collect sales tax as well as property taxes (along with many other taxes, including business taxes), and for the most part they are less dependent on Sacramento, though still impacted by state budget cuts.
This means that some of the most critical functions of local government – K through 12 education and county social workers and hospitals, for example –have came to depend on state taxation. This has resulted in an unstable situation in which state officials are responsible for funding critical local functions. No local entity has a strong incentive to control costs. It is easier to appeal to Sacramento for the funds needed to expand services. If Sacramento agrees, the counties and school districts can, in effect, spend tax dollars collected elsewhere –or so they imagine. This gives each local entity an incentive to ask Sacramento for as much money as possible. Each of these local entities is in effect competing with the others for state revenues. As a result, their appetite for more money is voracious and insatiable. None of them is forced to take full responsibility for their own tax and spending decisions.
And this is a big part of the problem. As time went by the state government became more and more dependent on income taxes. While sales taxes tend to be relatively stable year–to-year, income taxes are extremely volatile. Most of the state income tax is paid by wage earners in the top 10% of incomes, and these incomes are prone to sharp declines during economic downturns. Proposition 13, therefore, forced the state legislature to rely on the most unsteady source of income to fund the most critical local functions.
This arrangement is insane. Yet Proposition 13 is often referred to as the “third rail of California politics” – touch it and die. No significant attempt to modify Prop 13 has been attempted in 31 years, even as California’s per capita school spending has plunged from first to 47th in the nation – in the nation’s 8th richest state!
The “Peace Dividend”
During the 60s and 70s, as the population grew and real estate values skyrocketed in the urban areas, California became a very costly place to live, and a costly place to run a business. Economic growth slowed. Yet growth remained robust enough through the 1980s to postpone most consequences of Proposition 13 until the 90s.
In the 1990s, after the end of the cold war, when the rest of nation enjoyed a “peace dividend” through lower expenditures on the military, Southern California fell into a deep recession. Average unemployment in California grew from 5.1% in 1989, before the fall of the Berlin Wall, to 9.5% in 1993, and it was worse in Southern Cal. Among many other projects that were canceled, the U.S. stopped building B-1 bombers and space shuttles, which had provided tens of thousands of jobs in Los Angeles County. Other projects were curtailed. Work on the enormous C-17 cargo plane in Long Beach, for example, slowed down. The number of planes produced was cut back. All these decisions turned “peace dividend” into an ironic phrase in Southern California.
As thousands of jobs were lost in the aerospace and defense-related industries, mostly in Southern California, thousands of new jobs in the booming microcomputer industry were created, mostly in Northern California. But it was not an equal trade at first. Not until the year 2000 did unemployment in the California as a whole fall back to where it had been in 1989 – about 5%. (It is currently at 11.2%, one of the highest levels since the Great Depression.)
As a result of rising unemployment, property values in Southern California actually declined by as much as 30% in the first half of the 1990s. High Unemployment also slashed state income tax receipts, along with sales tax and business tax receipts as well.
The five counties of Southern California – Los Angeles, Riverside, Orange, San Diego, and San Bernardino – are home to more than 20,000,000 people. These five counties would be the second most populous state in the Union – just behind Texas – if they were a separate state. As the “peace dividend” hammered the enormous population of Southern California, it also produced the first of California’s intractable budget crises during Pete Wilson’s first term.
Ironically, it was peace – not size or diversity – that finally detonated the supermajority time bomb, first set in 1933.