The California Syndrome

STANFORD – California has long been a harbinger of national and global trends (both wonderful and overindulgent), a birthplace of innovation in everything from technology and entertainment to lifestyles. The world’s most important technology companies still make their start – and their headquarters – in California: Apple, Intel, Cisco, Oracle, Google, and Facebook, to name a few in the neighborhood where I teach and live.

California once was a source of widely shared rising standards of living and tremendous upward economic mobility. The state had America’s best public schools and state universities. Its citizens were less socially and economically stratified than in many other US states. After World War II, Americans migrated steadily to California, a land of opportunity, great natural beauty, and some of the world’s most fertile agricultural land.

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But then something went radically wrong, and understanding why offers lessons for national and subnational governments everywhere. California’s economy, which used to outperform the rest of the country, now substantially underperforms. The unemployment rate, at 12.4%, is higher than in every other state except Nevada.

In recent years, net migration has reversed, with hundreds of thousands of workers and their families leaving the state in search of better job opportunities elsewhere. California’s public schools, from kindergarten to high school, rank poorly on standardized tests. The state is an epicenter of the housing bust and the foreclosure crisis.

Silicon Valley CEOs say they will not expand in California because of high taxes and burdensome regulation, which make the state uncompetitive. With 12% of America’s population, California accounts for more than 31% of its public-assistance recipients. It has a vast and growing prison population, with annual spending on each incarcerated inmate equivalent to a middle-income California household’s after-tax income.

Meanwhile, the state lurches from fiscal tragedy to fiscal farce. Governor Jerry Brown (who was also Governor in the 1970’s) inherits a budget deficit of $26 billion. And that’s before the coming deluge from generous public employee pensions and health costs. At the heart of California’s problem is its deranged progressive tax system, which includes among the highest personal-income, sales, corporate, and gas rates of any state. Only property taxes are below the US average.

California’s government collects about one-half of its income-tax revenue from the top 1% of the state’s taxpayers. But the system’s extreme progressivity makes proceeds so volatile that the state continually experiences boom-bust cycles of rapidly rising revenue, inevitably followed by collapse. The revenue is all spent on the upswing, forcing disruptive emergency cutbacks on the way down.

Attempts to build a serious “rainy day fund” have failed badly. The political economy of California’s budget has taken the progressive tax-and-spend experiment to the breaking point, threatening the state’s ability to fund basic services, from prisons and parks to education and health care, even those aimed at helping its most vulnerable citizens.

California’s government rarely manages to satisfy the balanced-budget requirement in the state constitution. It winds up borrowing “temporarily” with short-term debt; then, as borrowing accumulates, it is refinanced with longer-term securities. Spending is temporarily reduced and taxes raised, but the long-run structural deficit remains, a pattern now repeated in many state capitals and the primary reason for the current political turmoil over budgets and public sector unions.

Many other strains are also self-inflicted. From federal water shutoffs, in the name of protecting a tiny fish, which have decimated agriculture and left tens of thousands unemployed, to severe local zoning restrictions that drive home prices higher, California now has a wide array of problems begging for solutions.

Illegal immigrants perform a substantial share of the state economy’s menial and physically demanding work. Absent a sensible guest-worker program, they remain in the shadows, and they and their children crowd public services. (In one school in Los Angeles, a teacher reported 70 kids who came and went during the year in a class of 25, and more than a dozen languages are spoken in some school districts). The state’s extensive environmental and energy regulation, including micromanaging carbon emissions, in combination with globalization, has driven away much of California’s manufacturing and many of its middle-class jobs.

Among US states, California still ranks first in technology, agriculture, and entertainment. But it also stands at or near the top in deficits, tax rates, prison inmates, and, by a wide margin, welfare recipients relative to population. It ranks last or near the bottom in business climate, housing affordability, and state bond rating (below even the US territory of Puerto Rico). It’s a complex picture, but at its core is a high-tax welfare state run amok.

No one should write off California; it still has great strengths. And it can turn some of its short-term problems, such as the pressures arising from ethnic and linguistic diversity (the state is now 37% Hispanic and 13% Asian) into long-term strengths in the global economy. But its political class will have to confront some hard realities and face up to the fact that Californians who pay no income tax (almost half the workforce) will have to start paying for services, and that services will have to be more carefully targeted.

A healthy democracy cannot have half the population paying taxes and the other half collecting benefits. Relying on ever-higher taxes to fund payments to an outsized population of benefit recipients is a recipe for exporting prosperity elsewhere. That is one California trend that others emulate at their peril.