Sunday, June 19, 2011

Jerry Brown's challenge.

On the streets of Greece and in the legislative chambers of Sacramento, people are grappling with the same issues: Are we willing to pay for those things that we want. And what are the consequences if we don’t.

This week, Governor Jerry Brown vetoed the budget sent to him by the Democrat majority of the California legislature. In his incoming State of the State speech five months ago, Brown suggested that it was time to address the State’s long-standing fiscal problems and produce a balanced budget. Brown proposed a Solomonic solution of sorts to close the $25 billion gap in the State’s budget: Half the budget gap would be closed by budget cuts, the other half through revenue actions which would be submitted to the public for a vote. Specifically, he proposed to ask voters to approve the extension of existing taxes that are set to expire.

The Golden State has now endured literally decades of budgetary trials and gimmickry, and seen its credit rating decline along with its fiscal resources. But for all the rhetoric about decline and bankruptcy, California’s problems are political, not economic. Yes, its economy has suffered as high costs have pushed industry inland and off-shore, but it remains a vibrant economy that is home to several of the nation’s strongest economic drivers and export industries: entertainment, technology, aerospace and agriculture.

The chart below illustrates the budget situation in California. Interestingly, the data suggest that California’s history is not a story of government spending run amok. The General Fund budget, which funds core services—including public safety, transportation, support for public and higher education, transfers to local governments and bond debt service—has declined relative to State personal income and GDP growth. As this graph shows, the steady growth of the State economy has not been matched by growth in the budget, and General Fund spending has dropped significantly in recent years. The dotted lines across the top indicate the impact on taxpayers, as General Fund expenditures per $100 of personal income declined 32% over the past three decades, from $7.43 per $100 of personal income in 1980 to approximately $5.05 this coming year.

Jerry Brown is providing a test case to see if our political establishment is—just this once—capable of setting aside party interest in favor of a broader and essential urgency. While the Democrat majority agreed to significant budget cuts, thus far, Republicans in Sacramento have declined to meet him halfway. Brown’s effort to find partners willing to seize the opportunity to chart a course toward real fiscal solvency and responsibility have been stymied by Grover Norquist, the anti-tax Jeremiah of the Republic establishment, who flew to California early on to pronounce that even a vote to put the revenue measures on the ballot would constitute a violation of the Republican anti-tax shibboleth.

Our political challenge, in California and nationally, is that too many people see more opportunity in exacerbating our problems than in solving them. It is too easy to rail against the debt and decry raising the debt ceiling, all the while conveniently ignoring one’s own complicity in the problem.

Over the past 30 years, Americans have become used to not having to pay for the government services we expect and desire—like the Greeks whose profligacy we so easily disdain. And this is a universal affliction, indifferent to political party. As illustrated below, federal personal income taxes paid—the purple line—have not kept pace with the growth of national income and GDP since 1980, while federal outlays have grown steadily. Like Californians, Americans have seen personal income taxes decline modestly as a share of national income. From 2009-2011, personal income taxes have ranged from 9-10% of personal income, slightly below the average level since 1980.

Of course, the difference between California and the nation is that national spending is not constrained by actual tax collections, but only by the political will to borrow and investors’ willingness to lend. Accordingly, as this graph illustrates by the divergence and convergence of the green and purple lines, instead of constraining spending, declines in tax receipts (the purple line) have simply led to increasing levels of public debt (the green line) and conversely, increases in tax receipts have led to moderating debt levels. Over the past twenty-five years, we have not had to weigh priorities, but instead have chosen as a matter of course to borrow rather than pay out of pocket for those things that we want. Year after year, we choose not to raise taxes to fund growing military, healthcare and other program costs, or to reduce spending to offset the impact of tax cuts.

It is in the proclivity to borrow rather face up to the limited nature of financial resources that America is more like Greece than California. And it is the ready availability of capital from foreign investors that makes our national problem differ from both.

Imported capital—that funds the "current account" deficit that comprises our budget and trade deficits—has supported economic activity in much the same way borrowing on credit cards allows households to live beyond their means. And like households that allowed increasing debt to mask the reality of their economic condition, U.S. economic growth has become dependent upon borrowed funds. As illustrated in the graph below, U.S. GDP growth has been 4% or greater for much of the past three decades, however, the share of that growth that has been supported by borrowed resources has grown.

While our economic growth has become more tenuous and entitlement costs have accelerated, Americans have abdicated their personal responsibility for our predicament. We will willingly vote for those who promise to cut our taxes or to expand our entitlements, but have shown no serious interest in addressing the the imbalances that have built up in our name. And lest one be fooled by the rhetoric, the Tea Party caucus of House Republicans have proven themselves no different, as they imposed pay-go rules on spending increases but not on tax cuts.

In California, Jerry Brown has proposed putting the question of the funding and size of state government to the voters. Voting for pain is simply not part of the democratic bargain. Yet that is what Jerry Brown is demanding. Let the voters choose. Treat us like grownups, and insist that we bear the consequences.

On the other side of the pond, as they seek to resolve the Greece situation, European leaders have come to believe that the Greek polity will never willingly take the steps to reduce spending and increase taxes that European bankers are demanding. What remains to be seen is what the consequences of that unwillingness will be, for Greece and for the concept of European union.

And for us. Because in our unwillingness to accept collective responsibility for the economic situation of our own making, we may have more in common with Greece than the grownups of Jerry Brown's imagination.

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