Brown Confronts California Intractability as Gap Widens

California Governor Jerry Brown took office last year on a promise to deploy political skills honed over three decades to break the most populous U.S. state out of its annual fiscal crisis.

After 16 months, the 74-year-old Democrat is having as little success as his Republican predecessor, Arnold Schwarzenegger, in governing the state with the world’s ninth- biggest economy as it slips into a $15.7 billion deficit, up 70 percent since January.

Brown’s attempts to deal with political gridlock and a vulnerable fiscal structure since voters passed tax-limiting Proposition 13 in 1978 may mean real pain. Income taxes on top earners may be increased to the highest in the U.S. Severe cuts loom for universities, school children, the elderly and the poor. And California’s credit, rated lowest of any state by Standard & Poor’s, may be reduced further, risking higher borrowing costs.

“I’m not sure California’s budget system responds much anymore to political acumen,” said Raphael Sonenshein, executive director of the Edmund G. “Pat” Brown Institute of Public Affairs, named for the governor’s father, at California State University, Los Angeles.

“Every governor since the passage of Prop. 13 has faced these budget catastrophes and have said their goal was to get rid of the problem,” Sonenshein said in an interview. “I think most Californians would be happy if it just became a manageable problem so we could think about something else.”

Political control of California’s budget by either party has been eroded by ballot measures spelling out how the state must spend its money.

Constitutional Amendment

A 1988 constitutional amendment, for example, locks in a minimum level of spending for public schools and community colleges. In 2004, voters guaranteed funding for local governments and prohibited the state from reducing property-tax proceeds to cities and counties. The landmark Proposition 13 reined in property taxes and required a two-thirds vote by lawmakers in order to raise taxes.

“The budget is a pretzel palace of complexity,” Brown, who was governor for two terms in the 1970s and 1980, told reporters in presenting his revised spending plan May 14.

Since he took office in January 2011, the linchpin of Brown’s attack on deficits has been higher taxes.

His first budget rested on a plan to ask voters to extend $9 billion of expiring taxes and fees that Schwarzenegger raised in 2009. Republican lawmakers, whose votes were needed to reach a two-thirds majority, refused to permit voters to decide.

Finding Republicans

“Finding Republicans to cross over I think has been frustrating for him and probably more so than he anticipated,” said Bill Whalen, a fellow at the Hoover Institution at Stanford University near Palo Alto.

“Schwarzenegger was able to get Republicans to cross over,” Whalen said. “Pete Wilson was able to get Republicans to cross over. Ronald Reagan was able to get Republicans to cross over, back in the day.”

“It worked for previous governors, so why not believe that he could do it too?” said Whalen. “But it’s been elusive.”

Without the tax money, Brown had to negotiate spending reductions with fellow Democrats who control the Legislature. They proved unwilling to wipe out what was then a $26 billion deficit with cuts alone.

Instead, they passed a budget that counted on an improving economy to produce $4 billion more in revenue than what fiscal analysts predicted. That money never materialized.

This year, Brown and his allies decided to take his plea for more taxes directly to voters through a ballot initiative. He turned in more than 1.5 million signatures last week to qualify for the November election.

Sales, Income Taxes

Brown’s plan would temporarily raise the statewide sales tax, already the highest in the U.S., to 7.5 percent from 7.25 percent. It would also boost rates on incomes starting at $250,000. Those making $1 million or more, now taxed at 10.3 percent, would pay 13.3 percent, the most of any state.

That push has been complicated by other groups who want to put their own tax increases on the ballot. The governor’s measure will compete with one championed by the California State PTA and Molly Munger, the daughter of Berkshire Hathaway Inc. (BRK/A)’s vice chairman, Charles Munger.

Munger’s plan would increase taxes on income of $7,316 or more, from 0.4 percent for the lowest earners to 2.2 percent for individuals making more than $2.5 million a year. It would raise $10 billion annually for 12 years.

In March, Brown was able to convince the California Federation of Teachers to merge their tax-increase plan with his. That may help the governor’s plan pass, as surveys showed voters favored the group’s measure.

Poll on Plan

A poll on the governor’s tax plan in April by the Public Policy Institute of California found 54 percent of likely voters expressed support when read the ballot title and a brief summary. Thirty-nine percent said they’d vote against it.

Brown’s bid to raise income taxes on the wealthiest Californians drew support from 65 percent of likely voters, while his proposal to raise sales taxes was opposed by 52 percent, the poll showed.

“Money is not in a piggy bank,” Brown told reporters May 14. “It comes from the people and the people are sometimes more successful than at other times in terms of their businesses and their income.

‘‘So when the money isn’t there, government has to cut back,’’ Brown said, ‘‘or you have to borrow or kick the can down the road.’’

1 Million Jobs

California, with an economy bigger than Russia’s, lost more than 1 million jobs in the recession that started in 2007, reducing the most-indebted state’s revenue by 24 percent. For the past four years, California lawmakers have trimmed spending and temporarily raised taxes to combat deficits of more than $100 billion combined.

California is one of nine states where revenue has trailed expenditures since July 1, according to a report by the National Conference of State Legislatures. California had the third- largest gap relative to its general fund, 4.8 percent, trailing Alabama and Washington, the report said. The figures predated Brown’s deficit revision May 14.

The Golden State is among 33 states that haven’t seen tax revenue rebound to levels prior to the global recession that began in December 2007, according to a study by the Nelson A. Rockefeller Institute of Government in Albany, New York. Tax receipts in California are down 0.6 percent from their peak in 2008, compared with a national average of 2.9 percent, the report showed.

California has the lowest credit rating of any state from Standard & Poor’s and Fitch Ratings, at A-, six levels below AAA.

S&P Outlook

While S&P raised its outlook to positive in February, the credit rating company said yesterday that the larger deficit may threaten to undermine the state’s potential for credit improvement. Balancing the budget even with higher taxes, Gabriel Petek, a San Francisco-based analyst said in a report, will require ‘‘significant policy choices in a short time frame on the part of the legislature.”

Unlike some other states, California hasn’t stockpiled enough money in growth years to compensate during downturns, said Doug Offerman, Fitch’s senior director for U.S. public finance. Expenditures increased during boom years, making it more difficult to adjust to revenue losses, he said.

“This has combined over the past decade to give the state a repetition of fiscal crises every time the economy goes down,” Offerman said in a telephone interview from New York. The state’s reliance on income taxes from higher earners also leaves it vulnerable to downturns.

“California faces a revenue structure that’s very cyclical,” Offerman said. “This is an economy that’s prone to swings.”

To contact the reporters on this story: Michael B. Marois in Sacramento at mmarois@bloomberg.net; James Nash in Los Angeles at jnash24@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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