Nuveen Urges Brown to Shun Gimmicks Closing $28 Billion California Deficit
California Governor Jerry Brown will be judged on how he avoids gimmicks, cuts spending and raises more money when he presents a budget to close a $28 billion deficit for the biggest U.S. state borrower, according to bondholders such as Nuveen Asset Management.
The plan unveiled today will be “an honest budget,” Brown has said, without accounting ploys such as moving the last state payday from one fiscal year to the next, an $800 million device that helped Arnold Schwarzenegger balance the books in 2009.
“Investors look at those gimmicks as not permanent solutions,” said Paul Brennan of Chicago-based Nuveen, which holds $73 billion of municipal securities including California debt. “They are just one-time things, a shot in the arm that only medicates the patient but doesn’t solve the illness.”
Brown, a 72-year-old Democrat who was governor from 1975 to 1983, has already warned that his budget will cut deep, a move likely to face opposition from unions that helped elect him. He’s said he won’t raise taxes without voter approval and is widely expected to call for a special election to extend $8 billion in expiring levies.
Schwarzenegger, who faced similar pushback as he grappled with $100 billion of combined shortfalls in the last three years, relied on several bookkeeping maneuvers to erase deficits that left the state that produces 13 percent of U.S. gross domestic product tied for the worst credit rating in the U.S.
Gimmicks
In October, Schwarzenegger and lawmakers helped close a $19 billion gap by simply declaring that they would get more tax revenue than was officially projected. They booked another $2.3 billion by approving the sale and lease-back of 11 state buildings, a move now facing a court challenge.
California shares with Illinois the lowest credit rating of any state from Moody’s Investors Service. The A1 grade is Moody’s fifth-highest. Standard & Poor’s rates California A-, its fourth-lowest level for investment-quality securities.
The extra yield that buyers want for 10-year California bonds compared with top-rated municipal bonds fell to 115 basis points Dec. 30, from 150 on March 11, the 2010 peak. A basis point is 0.01 percentage point. The so-called spread rose to 124 points Jan. 7.
“Investors are looking for evidence that he’s going to make progress on the structural deficit,” said Josh Gonze, who helps manage $7 billion of municipal bonds at Thornburg Investment Management in Santa Fe, New Mexico. “They want to see that he is genuinely bringing expenses and revenue closer together on an operating or structural basis, and not through one-time gimmicks.”
Isn’t Alone
Brown isn’t alone. U.S. states will contend with about $140 billion in deficits in the next fiscal year after closing $160 billion in gaps this year, the Center on Budget and Policy Priorities, a Washington research group, estimated Dec. 16.
The difference from other states is that Brown’s budget will help guide a $1.89 trillion economy that’s bigger than Russia’s. California is home to 14 percent of the companies in the Standard & Poor’s 500 Index including Apple Inc., Google Inc., Chevron Corp. and Wells Fargo & Co.
The longest recession since World War II left California with the nation’s third-highest unemployment rate at 12.4 percent, $88.3 billion of bond debt and as much as $500 billion of pension liabilities.
Brown’s budget may eliminate local redevelopment agencies, shrink social-service benefits, slash aid to state universities, close parks and end some tax breaks for business, the Sacramento Bee reported, citing sources familiar with the plan. Voters would be asked to retain three temporary tax increases approved two years ago to help fix a $42 billion gap.
Temporary Taxes
Schwarzenegger and lawmakers in 2009 agreed to add 0.25 percentage point to all personal income-tax rates, increase the state sales-tax levy to 8.25 percent from 7.25 percent, and boost vehicle license fees to 1.15 percent from 0.65 percent of the automobile’s value.
Voters have already once refused to extend the taxes that are to expire July 1. Retaining them would keep $8 billion of revenue flowing, according to figures from the nonpartisan Legislative Analyst’s Office.
While Democrats control both the Senate and the Assembly, they lack the two-thirds supermajority required to raise taxes or fees. An alternative, a ballot measure on the issue, would need the assent of two-thirds of lawmakers or a citizen initiative drive.
Pocketbooks
“Republicans understand that we are the last line of defense for California taxpayers’ pocketbooks,” said Assembly Republican minority leader Connie Conway. “Republicans and Democrats must respect the will of the voters.”
“The last thing we should do in a recession is raise taxes, especially to fund a bigger government,” she said.
Brown can’t count on economic growth to lift the state out of its deficit. Controller John Chiang said last week that cash receipts were running 5.8 percent below estimates used in the budget for the fiscal year that began July 1.
Brown’s father, Pat Brown, who served as governor from 1959 to 1967, presided over dramatic growth in the state’s university systems and infrastructure, according to “California Dreaming: The Political Odyssey of Pat & Jerry Brown,” a 1982 biography.
Under the senior Brown, lawmakers approved gasoline tax increases in 1959 and 1963 that helped pay for an expansion of the state’s iconic freeway system, according to the website cahighways.org. The Master Plan for Higher Education and related legislation passed in 1960 created the California State University System, according to a history produced by the University of California, Berkeley.
Waterways
The California Water Resources Development Bond Act of 1960 expanded the network of reservoirs and pumping plants that catch runoff from the mountains of the Sierra Nevada and distribute it to 25 million Californians for drinking water, according to the Department of Water Resources.
State worker unions worry that the new governor will dismantle some of that work.
“The broad set of budget cuts that Governor Jerry Brown will propose in the coming days are destined to touch nearly all Californians,” the California State University Employees Union, representing 16,000 worker, said in a Jan. 5 statement. “It seems clear at this point that he plans to cut deeply into California State University and the University of California budgets.”
Labor Unions
Teacher unions have already pledged to campaign for a ballot measure to extend the tax increases, saying public schools have already been devastated by $18 billion cut from education in the last three years.
“A lot of people are going to portray this as a tax increase, and it’s not. It’s asking the voters and the taxpayers to leave in place the tax structure that they’re working with right now,” said Bob Wells of the Association of California School Administrators. “If you have been paying those taxes the last few years and if school funding is important to you, then vote yes on the measure. It won’t improve school funding, but it will keep things from getting worse.”
Brown has said his budget will include plans to shift the responsibility of running many state education, health, welfare and public safety programs to cities and counties. That could free up as much as $8.7 billion from the state’s general fund according to figures from the Legislative Analyst’s Office.
Requiring counties, for instance, to run child-care programs for families on welfare would eliminate a $2 billion drain on the state’s general fund. The state could shave $400 million from its budget by requiring counties to run jail programs to treat drug addicts, and cut $827 million by increasing the local share of costs for the main family welfare program to 25 percent from 2.5 percent.
Governor Pete Wilson, a Republican who served from 1991 to 1999, did something similar when he raised the sales tax and carved out a portion of the vehicle license fee for cities and counties while handing them $2 billion in welfare and health programs.
Proposition 13
Funding of those programs has been in the state’s hands since 1978 -- during Jerry Brown’s first term as governor --when voters approved Proposition 13. The ballot initiative rolled back and restricted the growth of property taxes. But it also put the state in charge of gathering local tax revenue and distributing it back to counties.
Brown hasn’t said how he would help local government pay for shifted services. Mike Coleman, fiscal policy analyst for the League of California Cities, said he believes Brown’s budget will help local governments at first, possibly with the extended tax increases. Then local governments would be allowed to decide whether to seek to raise their own taxes to keep the programs running.
Cost, Revenue
“Fundamentally they are talking about pushing down costs, not revenues,” he said.
Lawmakers in October approved an $86.6 billion general-fund budget, down from a record $103 billion in 2007. Combined with bond proceeds and other revenue such as dedicated taxes, the current budget spends a total of $125.3 billion, down from $138.1 billion three years ago.
California gets 53 percent of its general-fund revenue from personal income taxes, according to the Legislative Analyst’s Office. Another 30.4 percent comes from retail and use taxes, 10.2 percent from corporate taxes and the remaining 6.4 percent from various other fees and taxes.
“The notion that California is not a high-grade credit needs to be solved and needs to be solved politically,” said Bud Byrnes, chief executive officer at Encino, California-based RH Investment Corp., which specializes in the state’s debt. “If Brown and the state Legislature manages to close the structural budget gap at all significantly, we will fall back closer into line to what a high-grade credit should be.”
To contact the reporter on this story: Michael Marois in Sacramento at mmarois@bloomberg.net
To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net
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