Deficit Disaster

Around the world we are witnessing a financial disaster looming. From a bull market to a property boom real estate property is spiraling out of control.

From the foreclosures in American states to the top end luxury markets of the once seen as untouchable Group of First Emirates of Dubai, no one is safe.

Budget Deficit

$25 Billion Budget Problem Needs to Be Addressed in Coming Months Our forecast of California’s General Fund revenues and expenditures shows that the state must address a budget problem of $25.4 billion between now and the time the Legislature enacts a 2011–12 state budget plan. The budget problem consists of a $6 billion projected deficit for 2010–11 and a $19 billion gap between projected revenues and spending in 2011–12. 2010–11 Deficit. We assume that the state will be unable to secure around $3.5 billion of budgeted federal funding in 2010–11.

This assumption is a major contributor to the $6 billion year–end deficit we project for 2010–11. We also project higher–than–budgeted costs in prisons and several other programs. In addition, our forecast assumes that passage of Proposition 22 will prevent the state from achieving about $800 million of budgeted solutions in 2010–11. 2011–12 Deficit. The temporary nature of most of the Legislature’s 2010 budget–balancing actions and the painfully slow economic recovery contribute to the $19 billion projected operating deficit in 2011–12. This gap is $2 billion less than we projected one year ago. Actions taken during the 2010–11 budget process to reduce Proposition 98 education spending are a major contributor to the decline.

Ongoing Annual Budget Problems of $20 Billion Persist Similar to our forecast of one year ago, we project annual budget problems of about $20 billion each year through 2015–16. In 2012–13, when the state must repay its 2010 borrowing of local property tax revenues and the full effect of Propositions 22 and 26 hit the state’s bottom line, our forecast shows the operating deficit growing to $22.4 billion.

Because our methodology generally assumes no cost–of–living adjustments, our projections probably understate the magnitude of the state’s fiscal problems during the forecast period. Additional Savings From Proposition 98 Will Be Very Difficult Our forecast indicates that General Fund revenues and transfers will decline by over $8 billion in 2011–12 due to the expiration of the temporary tax increases adopted in 2009.

Because the Proposition 98 minimum school funding guarantee is affected by this drop, our budget forecast already reflects a $2 billion fall in the minimum guarantee between 2010–11 and 2011–12. This reduction would come at the same time that school districts exhaust the billions of dollars of one–time federal money they have received through the stimulus program and other legislation.

For these reasons, it may be very difficult to achieve substantial additional budget reductions in Proposition 98 in 2011–12, compared to the levels already reflected in our forecast. In other words, if the Legislature funds schools at our projected minimum guarantee in 2011–12, it would mean billions of dollars in programmatic cuts to education but not contribute a single dollar to closing the $25 billion budget problem. Key Choice: Painful Decisions Now . . . or Pass Problems to Future Californians Too often, discussions of California’s budget situation are framed in extreme terms: the state about to go “bankrupt,” debt–service payments hypothetically poised to default, the state government on the verge of collapse.

None of these scenarios is remotely likely to occur. History tells us that the state can find ways to temporarily “patch over” its annual budget problems in ways that prove sufficiently palatable to policy makers of both major parties. Periodically, large influxes of capital gains allow for temporary relief, and this too aids in patching over the state’s now–recurrent budget challenges.

The Legislature and the new Governor will be tempted in the next few years to continue patching over the budget problems with temporary fixes. Unless plans are put in place to begin tackling the ongoing budget problem, it will continue to be difficult for the state to address fundamental public sector goals—such as rebuilding aging infrastructure, addressing massive retirement liabilities, maintaining service levels of high–priority government programs, and improving the state’s tax system. Accordingly, the state faces a basic choice: begin to address today’s huge, frustrating budget problems now . . . or defer the state’s budgetary and policy problems to future Californians.

Huge Longer–Term Fiscal Challenges Already Can Be Foreseen One major reason to stop passing the state’s problems to future Californians is that the state’s long–term fiscal liabilities—for infrastructure, retirement, and budgetary borrowing—are already huge. The costs of paying down these liabilities already are reflected, to some extent, in the state’s recurring deficits, but these costs will only grow in the future. By deferring hard decisions on how to finance routine annual budgets of state programs to future years, the state risks increasing further the already immense fiscal challenges facing tomorrow’s Californians.

Time for a Multiyear Approach to Fixing the Budget We continue to recommend that the Legislature initiate a multiyear approach to solving California’s recurring structural budget deficit. In 2011–12, such an approach might involve $10 billion of permanent revenue and expenditure actions and $15 billion of temporary budget solutions. In 2012–13, 2013–14, and 2014–15, another few billion of permanent actions each year could be initiated, along with other temporary budget solutions, and so on until the structural deficit was eliminated. Barring another sharp economic decline, such an approach could fix California’s near–term budget problems by the end of our forecast period in 2015–16 and give the state flexibility to begin (1) building reserves needed to address the next economic downturn and (2) addressing long–term fiscal liabilities.

The solutions needed to balance the budget will mean unavoidably painful sacrifice by today’s Californians. The benefit of this sacrifice would be putting the state on a sound fiscal footing. That sound footing may allow future Californians to live in a place where the annual state budget process is a chance to improve government’s ability to serve its residents. Chapter 1 The Budget Outlook This report provides our projections of the state’s General Fund revenues and expenditures for 2010–11 through 2015–16 under current law, absent any actions to close the state’s budget gap. Our projections primarily reflect current–law spending requirements and tax provisions, while relying on our independent assessment of the outlook for California’s economy, demographics, revenues, and expenditures. The report aims to assist the Legislature with its fiscal planning as it begins to consider revisions to the 2010–11 budget and adoption of the 2011–12 budget. The basis of our estimates is described in the nearby box.