The California Bankruptcy Experiment

Nevada Development Authority

The Golden State hasn’t been that golden in a long while. Year after year the state seems to move from one budget crisis to the next. From one massive budget shortfall to another just as big or bigger. If political speeches promising a better future had any worth, the state would be platinum by now.

The experience that California is going through can be very helpful to the rest of the nation.

If we were to look at what the state has done to avoid technical default, it would be an amazingly long list, just to name a few:

1. Defer payments to its creditors;
2. Front-load tax payment obligations from its residents;
3. Short term furloughs;
4. Pile on more debt;
5. Reduce services; and
6. Increase already high taxes on its residents.

To someone who has not followed the events more closely these maneuverings might give the impression that the state is addressing its budget problems. However the reality remains that if it were not a state it would have been in actual bankruptcy years ago.

One might conclude that California has done all it can, and that all the state needs to do is weather the current economic storm so that it can look forward to a bright future again.

But such a conclusion would be wrong on two accounts.

First, the state has bit by bit destroyed the business environment that made it the birthplace of many high technology industry giants, and the laboratory in which many of the things we take for granted today were invented. A few such examples are the mouse (Stanford), the graphical user interface (Xerox), the modern hard drive (IBM), and Ethernet (Xerox).¹

Second, California continues to avoid doing the one thing it should have done years ago: cut its programs that are bankrupting it. After adjusting for inflation and population California has increased its state spending per capita by 38% in the past 10 years.²

Even though the answer is staring every Californian right in the face, the state imposed yet another round of gimmicks, short term accounting adjustments and more debt to make it through the 2009-2010 budget year that was almost $25 billion short (about 22%). Now as the 2010-2011 budget year is getting closer, it seems that another $14 billion deficit needs lipstick.³

It’s not difficult to figure out where to look for real solutions to these problems. To start, here are a few good ideas by Craig Westover at the Minnesota Free Market Institute. While Mr. Westover makes the proposals for Minnesota, they apply equally to California:⁴

1. Reform the state tax system;
2. Cut state spending;
3. Limit state regulatory activity;
4. Reform tort law; and
5. Reform the relationship of state and local government.

Should California fail to address the root of its budget problems, then the rest of the country will get to observe the Great California Bankruptcy Experiment and hopefully learn what not to do.