Wednesday, July 15, 2009

Fixing California

We are all aware that the State of California is in a financial mess. What is needed does not require deep intellectual insight…it simply requires common sense.

For almost two centuries, the “golden state” has been the land of opportunity that has drawn people from all over America and elsewhere in the world, seeking a better way of life. Now, even with substantial immigration from Latin America into the state, it is experiencing a net loss in population as its citizens decide to move out. It is not difficult to understand why. As the state with the most unfriendly disposition toward business, jobs are moving out of California to other states. The state’s tax rate is the second highest in America. Its school system, once admired as among the best in the nation has declined to become one of the worst, rivaling Deep South states such a Mississippi. The credit rating of the state has been downgraded to near junk bond status.

All this derives from a totally dysfunctional state government. Our political leaders do not seem to have the wisdom, or the will, to take the actions needed to put the state on a sound financial footing. What is needed is public policy and action that increases tax revenues by making the state, once again, to be an attractive place to live and for businesses to locate and grow…and to reign in its legislature’s excessive spending binge on social programs.

So here is my list of the “tough love” that we need to put our state back in order:

1. Pay cut for all public employees

Firstly, for a very long time the compensation level for public employees has been rising faster than that in the private sector. The Governor’s office has been attempting to deal with these rising cost of labor in public service jobs through a “furlough” system, i.e. employees working less days. This reduces public services without solving the problem. I suggest a pay cut of 10% across the board for all public service employees. That way service levels could be maintained and no one needs to lose their job. They just “tighten their belt” like everyone else. The problem here is that a large number of our public employees are subject to union contracts. Thus, as with the Detroit auto industry, the unions must give back some of the excessive gains that they have obtained over the years.

2. Increase the retirement age

People are living longer and are more productive than decades ago when the retirement age was set. Also, many public service workers become entitled to retirement pay after 20 years of service. They then “retire” (at a young age) and move on to another pubic service job, thus drawing double pay. This is very costly to the public and the under-funded public employees’ retirement funds represent a huge financial liability “time bomb”. California taxpayers will foot the bill for the shortfall in these funds in future years. The retirement age should be increased to 70 for men and 73 for women and indexed to longevity statistics. This would have a huge impact on relieving the financial stress on our public finances.

3. Fix the illegal alien problem

California and, to a lesser extent, other border states (Texas & Arizona) carry a disproportionate economic burden because of the migration of Hispanics across the boarder from Mexico. California taxpayers bear a great deal of this load. There is much debate about this at the Federal level, but no solution is on the horizon. The Federal government should solve this problem and/or compensate California for its disproportionate share of the burden.

I think it is best to create a new class of semi-permanent resident. Do not grant citizenship, but make them legal residents. Currently, these immigrants mostly reside here peacefully, work and contribute in our economy, even vote in our elections (since proof of citizenship is not required). Yet they do not pay taxes and live in a shadow economy. California taxpayers pay for their healthcare, welfare, police & fire protection and the education of their children. They should be permitted to register for this new class of residency, be subject to the payment of taxes (perhaps on a simple flat-rate basis), but not entitled to vote or enjoy other privileges of citizenship. If they do not sign up, they should be fined and deported…and serve jail time if there is a second offence.

4. Break the unions’ stranglehold on public service jobs.

Require that all new public employees be hired as “at will” non-union employees. Continue this until the share of public employees is less than 50% of the workforce. At that point forward make the joining of the union voluntary, truly voluntary and pay less for union workers than non-union employees (because of the additional cost and lack of flexibility of union workers). Also, eliminate the requirement that contracts awarded by the state’s agencies be let to companies with union shops.

5. Make California attractive to employers

California is widely known as one of the most difficult and most costly venues in America to do business. This drives companies, jobs and tax revenues out of the state. There is a mass migration of companies and plants/divisions to friendlier states. We must reverse this aggressively by lowering taxes, severe labor laws and bureaucratic regulations on businesses. By keeping more jobs here and helping companies grow and prosper, the state’s tax revenues will rise.

6. Reduce/restructure taxes on individuals

California has one of the highest tax rates in the nation. Individuals in the highest brackets spend enormous effort avoiding exposure to state taxes (buying California tax exempt bonds, avoiding taxable income, etc.). A large number of them simply move out of the state. The state loses a huge amount of tax revenue that would stay here if rates were more moderate. Also, the Federal capital gains rate is lower than the ordinary income rate, but not so in California. Our tax policy should provide a lower rate of tax on capital invested in California businesses, projects and other state-based activities to encourage investment to stay focused here.

7. Restructure public education

The biggest part of the state’s budget is education. While the K-through-12 system in California is one of the nation’s worst, its higher education system (the University of California, Cal State system and the community colleges) is clearly the best in the nation (and probably the world). However, the higher education system in California is at risk of losing its greatness. This is because the state is cutting its subsidy (with no hope of reversal) while continuing to put a lid on the tuition it can charge students. The “access” part of the institutional mission in education is of high value to the California society and must be preserved. “Access” simply means that every individual with the academic ability, but not the economic means should be able to obtain a top quality university education. However, the economic model is broken now that state subsidies are fading. Currently, the UC system charges a little over $8,000 per year for an in-state resident student. The quality of education delivered by UC Berkeley, UCLA and other campuses is clearly on parity, or superior to leading private universities where tuition is above $35,000. There is no good reason for this disparity in price, except for the “accessibility” issue. This can be easily solved by freeing UC campuses to charge a fair market price for the education they deliver, conditioned on the fact that they carve out a large block of scholarship funds to apply to those that need financial support. If one “runs the numbers” you can see that this works amazingly well.

The K-through-12 challenge is an area that commands our best thinking. The answer is not money, but a new way of doing things. On this matter my thinking is not yet developed.

Over the years, the California legislature has increased spending at an unconscionable rate, doubling outlays in the last decade. At the same time, revenue growth has been weak…and will continue to be weak over the next decade. Fixing this year’s budget deficit is simply an ephemeral solution. We must address the inherent problem of our “business model”. We must increase tax revenues by improving the prosperity of our state (not by increased taxes) and must cut the excessive spending spiral.

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