Haas Newsroom

September 24, 2003

New Berkeley Report Debunks Myths about California Fiscal Crisis, Proposes Rainy Day Fund from Excess Revenues

Berkeley, California-A new report on the causes of California's fiscal crisis and the myths about its jobs and tax environment was released today by the Fisher Center for Real Estate and Urban Economics at UC Berkeley's Haas School of Business.

The report, entitled "Anatomy of the California Fiscal Crisis: Facts and Figures Do Matter," attributes the current crisis to the unsustainable tax revenue increases related to the boom in the NASDAQ, IPO, and venture capital markets in the late 1990s. By treating this revenue surge as permanent and locking in higher spending, the report says, the state General Fund spending grew by 15% in 2000 and another 13% in 2001.

The report was written by Kenneth T. Rosen, California State Professor of Real Estate and Urban Economics at Haas and chairman of the Fisher Center; Daniel T. Van Dyke, principal at RCG, Berkeley; and Elisa T. Beller, analyst at RCG.

"Wrongly blaming the economy, high tax rates, or too large a government sector will not solve the real budget issues facing California," says Rosen. "Those criticisms of California simply do not stand up under close scrutiny of the facts and figures. It will take some imagination for elected officials to correctly diagnose the problems, and then to design measures to deal with those issues."

California's job loss is often credited with the problems in the state's budget. However, the authors point out, during the period in which the fiscal crisis developed, California's employment situation was actually marginally better than the nation's.

California also has the reputation of having a large number of state government employees, according to the report. But, says Rosen, "This is simply not true, if we normalize by population. In fact, among the ten largest states, California has the third smallest number of state employees per capita, after Florida and Pennsylvania. We just don't have a big state government."

Another myth concerns California's tax rate. When the burden of all state and local tax sources are pooled, says the report, California's tax rate does not particularly stand out. Among the ten largest states, California's total tax rate relative to gross state product is about in the middle, according to the authors.

To remedy the crisis, the authors suggest that temporary revenue ought to be treated as such, so that expenditures are not geared upward to reflect those temporary revenues. They suggest a $5 billion baseline for capital gains revenue, with excesses above that amount being considered temporary revenues and siphoned off into a "rainy day fund" to allow for a stable expenditure stream when capital gains revenues fall below that baseline.

For the current situation, they say, there is no choice but to decrease expenditure growth or raise taxes until the budget situation is again stable. Then, the budgeting process should take place on a "normalized" revenue base that corrects for large swings in capital gains revenue.

The authors also consider a reform of Proposition 13, passed by California voters in 1978 to keep property taxes aligned with a property's purchase price. Proposition 13 caused the state to rely more on sales, income, and corporation taxes as sources of state and local funding, leaving those more cyclical taxes to shoulder 70% of the tax burden.

This proportion is the highest among the large states, making California's tax revenue base among the most cyclical, making California's revenue base more vulnerable to economic downturns. At the same time, large parts of the expenditure stream are locked in by voter mandate or statute. If California voters do not want to change Proposition 13, then the "rainy day fund" is all the more urgent.

The report is available through the Fisher Center for Real Estate and Urban Economics at 510-643-6105 or from Ute Frey at 510-642-0342.


For more information, please contact Ute S. Frey at the Haas School of Business at 510-642-0342 or at frey@haas.berkeley.edu.