The Rise and Fall of California
July 01, 2009
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The state of California will offer a lot of important lessons from a historical governance standpoint. it is a state that rose to extraordinary highs and may have some extraordinary lows ahead of it. Today, Reuters reports that California has missed its budget deadline and will issue IOUs to pay its debts. This leads to an important question:
How much would you value an "IOU" from the state of California at?
I know Abitare will probably come by and say $0.01, but look at it realistically. If you are a creditor or contractor, how much is a $1,000 IOU worth?
$600? $450? $300? $200?
The answer probably depends on who you are and what your business might be. An investment bank might be willing to take on some risk and take an IOU with a huge return in the event that California repays its debts. On the other hand, if you're a contractor trying to run a business, how do you pay your employees with IOUs that may or may not come through any time within the next 2-3 years. So in a sense, maybe my predicted answer for Abitare is spot on. Why on Earth would you take on a very risky IOU if you're worried about paying your workers more than all else?
California and The Decay of American Federalism
You might say that Californian politicians will eventually come to their senses and find a way to balance their budget. That might be overestimating the capacity of Californian pols to do good, however. You see, one of my constant critiques of American Federalism is that it's broken at this point. Not completely so, but it's drifted so far from the Founders' original intent that it bears little resemblance to the system established in 1789.
Federalism works alright for New Hampshire. And Vermont. And Maine. And maybe some other small states. It's a complete failure when applied to Goliath states like California, however. The problem is that democracy just doesn't work on a massive scale. It never has and it probably never will. James Madison understood this. He repeatedly brought up this issue in The Federalist Papers. The entire idea behind Madison's American system (i.e. "Federalism") was that political power would be decentralized into managable districts (we call them "states").
The problem is that when you take a massive "district" that is probably larger than France and includes over 10 million people; all of whom are governed by about a hundred legislators and a Governor, then you are asking for corruption.
California's politicians are corrupt. They are not there to serve the interests of the voters. They are there for special interests. Part of pandering to special interests, however, includes pandering to the voters. What I'm suggesting is that California politicians are constantly on a quest to give away more things will promising lesser and lesser taxes.
The Property Tax Cap
I could gush on and on about California's overspending. How the state has recklessly spent money on this and that isn't really necessary, however, because most of that is obvious. What is less obvious is how the state cripled itself to pay its exbortitant debts. Spend more, tax less. But when applied in reality, these conflicting philosophies produce strange results.
In 1978, Californians passed Proposition 13, the "People's Initiative to Limit Property Taxation." It sounds great in theory. Why should you pay higher taxes? Those damned liberals are just out to steal your money!!!!
In reality, that "anti-tax" proposition was nothing more than a giant Ponzi scheme. Since property taxes were capped based on historical cost, it means that the vast bulk of the property taxes are being paid by the newcomers, while the long-time homeowners pay virtually nothing. It's a rather convenient set-up; not that different from Social Security at its inception, which essentially promised to hand out free money at the expense of future generations. Except, Prop 13 was a revenue Ponzi scheme rather than an expenditure Ponzi scheme. It worked so long as newcomers were flooding in and home prices were rising.
The state objective behind the proposition was to prevent people from being taxed out of their homes. A noble objective, but a flawed execution. After all, can you really feel all that sad for someone who bought a home in the Silicon Valley in 1978 and saw their property value rise 500%+?
The result of Prop 13 wasn't lesser taxation. It was simply different taxation skewed towards a different demographic. Instead of property taxes, California was forced to rely on a constantly increasing income tax.
In every way, California's budget displays what happens when you combine reckless and irresponsible Democrats with reckless and irresponsible Republicans. You get idiotic "bi-partisan" compromises like Prop 13. The end result wasn't lesser taxes; it was merely a tax shift that was based on a foundation that was bound to collapse at some point.
How Much Faith Do You Put in the State of California to Repay Its Debts?
So now that I've rambled on a bit, how much faith do you put in California to pay its debt? Will it get its act together? You might think reality forces them to do so and it will ... eventually. But as I said, Californian politicians don't represent people ... they represent interest groups ---very large and polarized interest groups with specific pet causes.
How much do you think they are willing to budge? Their entire foundation is based on enacting policy to suit specific donors. And this is simply inevitable in a state like California, as Madison might have predicted. You see --- elections in New Hampshire are local and run on the ground. Elections in California are run on the airwaves. New Hampshire politicians are unpaid (with the exception of small stipend to cover expenses) and are still citizens of the communities they serve. Californian politicians are compensated well and consider their positions in the Capital as a professional career.
If there's one thing about career politicians, they don't want to be remembered as the ones who both raised taxes and cut expenses. "Tax and spend" and "spend and spend" are alright. "Tax and pay back debt" is not very appealing. So California will probably drag its feet some.
If you are that contractor, how much faith do you have in seeing your money any time soon? Do you think you'll see the money in the next 3 months? How 'bout the next 2 years?
Even despite the headlines, I'm not sure that the reality has quite set in for these California pols yet. Maybe they'll hammer out something this week. Maybe they'll be hanging in a limbo-like state for several years. Eventually, they'll probably come up with some way to make it appear as if they've balanced the budget when in reality, they are just feeding people more bullcrap.
California Is In For the Biggest Bust of All
If there's anything that history seems to tell us, it's that most massive booms were followed by massive busts. the larger the boom, the larger the bust. This is not universally true, but it does seem to hold true most of the time --- large booms are created by unsustainable distortions in the market that will eventually collapse.
Think about that for a moment --- California has basically been in a 60-year boom cycle!!! Do you think things will be glowing in Calfornia in another two years? Another decade?
I don't want to sound like one of the END OF THE WORLD!!! doom-and-gloomers, but let's just recognize the reality: California is in for a world of pain for a very long time. The rest of the US may recover ever so slowly from this disaster. It will take time, but we've emerged from more dismal situations in the past and we can do it again. Don't expect any miracles, but recovery will come eventually. The same holds true for California --- just expect it to take a lot longer than the rest of the nation.
What Does California Have Going For It?
From a business perspective, what does California have going for it now? The tech boom that started in the '90s has fizzled out and California is no longer the capital of technological innovation. The tax burden in the state is probably going to be enormous for the forseeable future. And the mirage of the somewhat Utopian lifestyle that California seemed to offer seems to have been destroyed.
I'm a single male and I'd be willing to move just about anywhere for the right career opportunity. However, I think I'd want about a 50% premium in salary before I even considered living in California. The next question becomes, how does the rest of the nation feel? Will California start losing population or does it still hold enough promise to lure people? I don't know all the answers, but I'm not betting on the latter at this point.
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