Saturday, January 10, 2004

The Kindergarten Governor Meets the New Math

“The governor's proposal does not contain any increase in sales or income taxes, but relies on fund shifts, borrowing and one-time accounting moves to cover more than half of the $14 billion shortfall between spending and projected revenue for the fiscal year beginning July 1. The plan anticipates $3 billion in proceeds from the $15 billion bond on the March ballot. The remainder of the bond proceeds will be used to cover deficits in the current fiscal year.” New York Times 1/10/04

There is an interesting article “Changing Red to Black: Deficit Closing Alchemy” by Professor John B. Petersen in the September issue of the National Tax Journal (56 NTJ #3 page 567). The article is a handy guide to the various tricks that are used to make State budgets appear better than they are. Standard budget magic includes:

1) overestimating revenues
2) booking one-shot asset sales
3) manipulation of transactions between the various “funds” (accounting categories)
4) accelerating revenue and delaying spending
5) capitalizing current costs and borrowing to cover them, and
6) relying on anticipated future savings that may or may not materialize.

State Budget Directors have their own strange lingo. Budgets are constructed out of “smoke and mirrors”. “Scooping” refers to a debt restructuring where all the saving occurs immediately and the costs are deferred to the future. Revenues can be magnified by means of a “spin-up” (accelerating tax collections into an earlier year) and the expenses can be held down by a “slow pay” (delaying payment of bills into the next fiscal year.) The problem, of course, is that reliance on such gimmicks eats away at the margin of safety in public finance to the point where, as Professor Petersen notes, the insulation has now worn very thin.

The extent of California's current desperation is suggested by two of the more convoluted gimmicks that former investment bank groupie and current Budget Director Donna Arduin has contrived in order to squeeze a few million dollars more from the numbers without admitting the necessity for a tax increase. We are told (Budget Summary, p. 103) that Medi-Cal check writes will be delayed one week “to allow additional time to investigate potential fraud”. The projected one-time savings of $143 million does not come from stopping fraud, but from the fact that only 51 weeks worth of checks get written in the year of the change. Similarly, $930 million of the budget shortfall is to be covered by issuing a “pension bond”, to be collateralized by anticipated future reductions in the net paychecks of state employees, who will be ordered to pay more so the State can reduce its contributions to their pension plan (p. 227). The “pension bond” debt service is further “scooped”, being interest-only for the first five years in order to make the cash flow appear positive. How ingenious – taking out a loan using potential future reductions in expenses as security. Our State Budget Director, it seems, has engaged in accounting practices that would subject her to criminal prosecution if used in the private sector. If the charismatic Governor wants to find “fraud and abuse”, he should look at his own budget document.

Arnold's budget is a fake. It is premised on false choice, on the assertion that California’s fiscal problem is due to excessive spending. The claim that taxes went up 25% while spending increased 43% is Kindergarten math. The history of state tax collections at page 45 of the Governor's own budget summary shows General Fund revenues are now 5.79% of total personal income, and as a percentage of income revenues are *lower* now than in 17 of the last 25 years. That table and the one on page 47 also show that the budget problem started with a revenue collapse in fiscal 2001-02, when income tax collections dropped 25% in one year, from $44 billion to $33 billion. Before that, the largest year-on-year decline was only 7% back in 1988.

All the charts in the budget summary compare actual expenditures with a dotted line called “population and inflation growth” over the past six years. (The charts seem designed to fool the news hacks who don’t know how to lie with statistics by selecting the base year.) Presumably this is because comparing expenses with State revenues would reveal that the problem is *tax* instability -- and taxes are the last thing that the big money supporters of Governor Gröper want discussed.

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