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Tuesday, January 25, 2011

Jerry Brown's California Budget Proposal

"It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own self interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages." — Adam Smith

In November of 2010 the people of California chose Jerry Brown to be the person to lead the State out of its fiscal demise. Now that Brown is governor of the Golden State he has stated addressing the state's massive $25.4 billion 18-month budget deficit ($8.2 billion for the remainder of the current fiscal year and $17.2 billion in FY 2011-12). Thus, his first governor's budget proposal has plenty for everyone to hate. Below I will attempt to outline the good, the bad, and the ugly of the proposed budget.

The Good

First, the good. The governor's budget contains $12.5 billion in necessary cuts. These include significant cuts to health, welfare, and higher education, as well as pay cuts of 8% to 10% for state employees not covered by collective bargaining agreements. Curiously, Democrats legislators and labor unions are showing begrudging support for the cuts from the new Democratic governor, despite the fact that they vehemently opposed such cuts, including many of the very same reductions, when they were proposed merely a year or two ago by Republican Governor Arnold Schwarzenegger. According to a Los Angeles Times article, Senate President Pro Tem Darrell Steinberg (D-Sacramento) admitted, "I hate the cuts, but I am not going to reject the cuts." Added Barbara Blake, a registered nurse and state secretary of the United Nurses Association of California, "We're feeling a little better about this budget." The end of redevelopment funds would also be a good thing, as government should not be engaged in such subsidies.

The proposal would also rely on shifting some services currently provided by the state to local governments via block grants. Counties would be responsible for things such as foster care, adoptions, child abuse prevention programs, outpatient mental health treatment, psychiatric hospitals, and some firefighting duties. In addition, a number of prison inmates (defined as those convicted of "nonviolent, non-serious, non-sex offenses" who had no previous criminal records) would be housed in county jails instead of the more expensive state prisons. As Brown explains, "My proposed restructuring will return decisions and authority—as much as possible—to cities and counties and schools. And, in that way, there will be greater accountability, transparency, and hopefully citizen participation because government will be closer to the people." This is a welcome development for all the reasons the governor stated. To the extent that government is necessary at all, decision-making authority should be provided at the most local level possible (and, ideally, the individual level).

Gov. Brown was absolutely correct when he asserted during his press conference Monday on the budget proposal, "For 10 years, this state has put together its budget with gimmicks and tricks and unrealistic expectations that have pushed this state deeper and deeper into debt." Anticipating arguments that the state might try to address its fiscal crisis through borrowing or "kicking the can down the road," Brown said, "The problem is, next year, there's not that much more money, but then we'll have debt service and a much bigger burden to pay back. It's better to take our medicine now and get this state on a balanced footing." These are important acknowledgments, especially for a state that has been addicted to spending, for the first step in breaking an addiction is to admit the problem.

The Bad

That admission must be qualified, however. Gov. Brown relies on $12 billion in tax measures to plug the remainder of the budget gap. This comes primarily from extending the "temporary" tax hikes imposed as part of the 2009 budget measure for an additional five years (assuming, of course, that the state is not still spending everything it can and more, requiring yet another extension of these "temporary" tax increases!). In addition to acknowledging that borrowing and gimmicks will not solve the state's budget problems, the governor and the Legislature must admit that spending, not revenue, is the real culprit.

California has experienced fiscal straits for many years, including long before the latest recession. The problem was that even when revenues were growing strongly the state's appetite for spending was insatiable and surpassed revenues even when its coffers were flush. And, even after suffering a significant decline of nearly $20 billion in General Fund revenues from FY 2007-08 to FY 2008-09 during the depths of the recession, revenues have actually grown $11.5 billion (14%) in the two years since.

California is already one of the highest-taxed states in the nation and consistently ranks at or near the bottom of states in terms of business climate. This is why we have seen an exodus of individuals, businesses, and jobs to more tax- and business-friendly states like Texas, Arizona, Nevada, and Utah in recent years. The state must focus on encouraging economic growth by simply removing the shackles it has placed on economic activity by reducing taxes and burdensome regulations.

The proposed budget also falls short by failing to incorporate a number of other reforms that could help plug the budget gap and get the state back on the road to fiscal responsibility. I have written about a number of these before but. A good place to start would be the 1,200+ recommendations, estimated to save $32 billion over five years, made by the California Performance Review Commission in 2004 (and largely ignored since then). The state should also aggressively pursue privatization and employ a "Yellow Pages test" of state services. Basically, if the state is performing a function that can be found in the phone book, either the state should not be in that business in the first place or it should at least put those services up for competitive bid. Implementing priority-based and performance-based budgeting and spending/revenue and debt limits are also necessary to improve transparency, control spending, and result in a more rational budget-making process.

The Ugly

While Gov. Brown's proposed budget addresses many of the state's fiscal issues, it completely ignores the 800-pound gorilla in the room: state employee pay and benefits. Unionized state workers were conspicuously spared from the budget pain, despite the fact that U.S. government statistics consistently show that government workers typically earn higher salaries and significantly higher benefits than their private-sector counterparts, and that non-unionized workers are facing 8-10% pay cuts. Cuts to unionized state employees would require collective bargaining, but why isn't this being proposed, especially considering how state employees have largely been shielded from the effects of the recession while the private sector has been forced to adjust? And then there are the retirement benefits. According to several academic studies, California's unfunded pension liabilities lie somewhere in the neighborhood of $400 billion to $500 billion. That's several tens of thousands of dollars per California household—and that does not even include an additional $50+ billion in unfunded retiree health care obligations.

I realize that the governor is focused primarily on filling the budget gap in the immediate term, and that savings from pension reforms would take a few years before they really started to accumulate, but any serious effort to address the state's serious fiscal problems must incorporate state employee compensation reforms. Chief among these are: (1) switching new state employees from the existing defined-benefit pensions to 401(k)-style defined-contribution retirement plans in line with compensation levels received in the private sector and (2) implementing a constitutional amendment that would require voter approval of future state employee benefit increases.

Governor Brown, while attacking some of the State’s fiscal problems is ignoring (no doubt for political reasons to serve his SEIU backers) is skirting the one that 800 pound gorilla. In 2003, amidst another budget crunch that was almost as dire as the one faced today the Reason Foundation carried out a comprehensive review of the state budget. The culmination of this effort was an analysis and set of recommendations that they called the Citizens' Budget. The study contained a 10-point plan to putting the state government back on the right path. The recommendations included the following:
  1. Avoid accounting gimmicks
  2. Acknowledge that spending--not revenue--is the problem (California is already one of the highest-taxed states in the nation and revenues have grown significantly until very recently due to the recession)
  3. Adopt a performance-based budgeting process so that funding decisions can better be tied to program results and priorities
  4. Consolidate duplicative governmental functions and eliminate some of the hundreds of unnecessary boards and commissions
  5. Adopt personnel reforms such as reducing the number of state employees, reducing pension obligations for future employees to get workers' benefits back in line with compensation in the private sector, and provide incentive bonuses to state employees for innovative ideas that lead to cost savings
  6. Increase the use of competitive sourcing (The state could achieve significant cost savings and/or service improvements by contracting out numerous services to the private sector.  Moreover, it should implement a "Yellow Pages" test: if the state is performing services that private companies listed in the phone book are already performing, then the state probably shouldn't be in those businesses in the first place.)
  7. Implement education reform by cutting red tape, and adopt funding reforms such as merit pay for teachers and weighted student funding
  8. Reform health and social service programs by eliminating optional Medicaid services and reducing the waste from fraud through the use of recovery auditing
  9. Switch to a biennial budget and impose a real spending and revenue cap
  10. Improve the state's business climate by reducing regulations and taxes that drive people and businesses out of the state.
These ideas are not new, but they are at least as relevant today as they were back in 2003.  It is time for the governor and the Legislature to dust off the reports and utilize them to make real changes to the way California's state government operates, rather than merely trying to tinker a bit at the edges and kick the can a little further down the road.

In 1996 I was a member of an eight person peer review panel, mandated by the California Legislature, to review the project management policies and performance of CALTRANS, the state’s transportation agency. The panel consisted of private sector and public sector leaders.

Our review found that CALTRANS could not bring any project to fruition on time or on budget. There are a myriad of reasons for this, but the number one culprit was that the CALTRANS mangers did not have the ability to choose their team members and outsource for services they could obtain quicker and cheaper in the private sector. This caused using staff members who were under-utilized so they could justify their continued employment. This featherbedding obviously increased the labor costs for the project. They also had to use staff members that were not really qualified to perform the task required of them.

When we completed our report we presented it to the director of CALTRANS along with some of his senior staff. After an hour’s discussion the director accepted the report thanked us for our good work and then told us he believed the problem was that CALTRANS did not have adequate project management software. The report was given to the legislative analyst and the director purchased $500 thousand dollars in new project management software. No changes were made in the staffing or outsourcing polices as this would run counter to the dictates of the Professional Engineers in California Government (PECG), the union representing the 25,000 CALTRANS employees. This is just one small example of the power and influence of the civil service unions in Sacramento. It is also why I am doubtful that Governor Brown, a person dedicated to the public service unions, will be able to make the changes that will bring California to fiscal health.

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