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From Athens to Sacramento: Austerity Coming to America

As the Greek people have painfully experienced, you cannot “austere” yourself out of a budget crisis. It only makes the crisis worse: higher taxes destroy the tax base and spending cuts increase government’s net drain of resources out of the economy. The result is that fewer people work, more people qualify for welfare programs – and government spending ends up growing while tax revenues go down.

The only way to solve the budget crisis created by a welfare state is – surprise – to do away with the welfare state. This can be done; it takes hard work and dedication on behalf of us and our elected officials, but it can be done. So far, though, not a single welfare state in Europe, and not a single U.S. state, has been willing to step up to the plate and be the first to reform away the welfare state. Instead, Europe’s political leadership is going deeper and deeper into panic mode, relying as they are on budget cuts and tax increases to save their morbidly obese, fiscally unsustainable welfare states.

So far America has been saved from the austerity flu. But don’t bet your job on us being able to keep it that way. Some states are already resorting to policies reminiscent of austerity, and one of them has already entered the downward spiral that hurled Greece into full-fledged fiscal and political turmoil.

That state is California. The Golden State has wrestled with budget problems for many years, and Governor Brown was elected on promises to finally solve the problems. However, his strategy was the same old, same old: modest spending cuts and modest increases in some taxes. (He even accepted microscopic tax “cuts” by allowing a minor, temporary sales tax increase to expire.) Predictably, his strategy has not worked. As shown by an article in The Washington Post, The Golden State is now in even deeper budget trouble than it was before Jerry Brown got (back) into the gubernatorial mansion:

California’s budget deficit has swelled to a projected $16 billion — much larger than had been predicted just months ago — and will force severe cuts to schools and public safety if voters fail to approve tax increases in November, Gov. Jerry Brown said Saturday. The Democratic governor said the shortfall grew from $9.2 billion in January in part because tax collections have not come in as high as expected and the economy isn’t growing as fast as hoped for.

Part of the reason for this problem is of course that the governor and his staff joined the Democrats in the state legislature in an overly joyous forecast of how the Obama administration’s policies – including the nonsensical and totally wasteful stimulus bill – would put the economy back on a growth path. But part of the problem is also that the Democrats in California will try to save the welfare state at any and all cost. Thereby they allow themselves to completely ignore the very problem that caused the crisis in the first place: the welfare state.

But even worse is the fact that the solution they are applying – a very mild version of austerity – is now driving the state budget deeper into the deficit ditch.

In short: the medicine is killing the patient.

The austerity policies applied in California are supposed to increase tax revenues through higher taxes and cut government spending through – yes – spending cuts. But what austerity-minded politicians like Governor Brown do not understand is that the economy responds to austerity policies just like it responds to all kinds of economic policies. Tax increases discourage productive, private-sector economic activity; in combination with spending cuts, the tax hikes actually increase the government’s drainage of resources from the economy.

As a result, private-sector business activity is reduced or its growth rate is significantly reduced. Fewer people pay taxes and more people apply for the entitlements that the welfare state provides. Predictably, this is exactly what is happening in California. As shown by data provided by state controller John Chiang, tax revenues are lower while welfare-state spending is considerably higher this year than California’s politicians foresaw last year when they enacted the first round of Governor Brown’s austerity policies.

An analysis of the controller report for the period July 2011 to April 2012 shows a rise in two of the best short-term indicators of welfare-state spending:

  • Medical Assistance Programs spending has increased almost a quarter of a billion dollars more than even the Brown administration predicted it would under the recession; and
  • Social Services spending was hit hard by spending cuts and predicted to fall by $346 million; in reality, spending is almost $200 million above the budget target.

At the same time, tax revenues are coming in below target. During the period July 2011-April 2012 the state of California took in $73.5 billion in tax revenues. The forecast for the same period this year was $69.1 billion; the actual number is $65.6 billion. In other words, the state’s tax revenues are more than five percent below what the governor and his Democrat fellows in the state legislature needed in order to protect their welfare state from further cuts.

As is evident from these numbers and from the article in the Washington Post, the Sacramento statists have failed. The reason is not that they did not cut spending and raise taxes enough – the reason is that they combined spending cuts with tax increases. With this combination government takes more from the economy each year and gives less and less back. It is like government is trying to sell a new 2011 car at 2013 prices one year and a new 2010 car at 2014 prices the next year.

One of the most obvious reasons why austerity won’t work in California is that the state has a small and, relatively speaking, shrinking tax base. From the peak of the business cycle in 2007 to the 2011 California lost 1,028,000 private sector jobs. This was partly due to the national recession, partly due to California’s business-unfriendly policies. As of March 2012 The Golden State had fewer private sector jobs than it had in March of 2003, when the state was still suffering from the Millennium Recession.

During the same period, the state has increased its spending paid for with in-state tax revenues by 40 percent. In other words, the state is expecting each privately employed Californian to be able to pay $140 in 2012 for every $100 he paid in taxes in 2003. Yet his income has increased by far less: for every $100 a private-sector employee earned in 2003 he earns approximately $120 in 2012.

Where does the state government expect to get the remaining $20 from?

Looking again at California’s employment numbers, we find that there are fewer people working in Californa’s private sector in March of ’12 than even in March of 2000. Yet the state legislature has not downsized its government to 2000 levels. The state has 12 percent more employees now than it had in 2000; in fact, the state government had as many employees in March 2012 as it had in March of 2007.

It is unlikely that Governor Brown will realize what he is doing to his state in time to save it. To do so, he would have to abandon his policies of combining spending cuts with tax increases. Instead, he would have to:

  • Combine spending cuts with tax cuts;
  • Make the spending cuts structural so that they phase out, and eventually eliminate, entitlement programs; and
  • Cut taxes in such a way that people can take care of themselves instead of relying on government.

It is very unlikely that he will do this. More likely, Governor Brown will press on with his austerity policies: higher taxes and less spending. The result will be a continued erosion of the tax base. Not only will businesses refrain from expanding, but there will be close-downs and an escalating migration of productive citizens and businesses out of the state.

In 2009 California had a net migration loss to the other states of 87,000 people. The largest destinations for outbound Californians were states with notably lower taxes. Among the most attractive were no-income-tax states like Texas, Washington and Nevada. These numbers, which are the latest available, are likely to be significantly higher for more recent years.

California still has the chance to get out of the austerity spiral. But time is running out. If Governor Brown does not take the right steps and put his state on the right track, his austerity policies will put the entire nation’s economy in jeopardy. The consequences for all of us would be devastating.

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