December 3, 2012 5:09 pm

California predicts $1bn budget surplus

Surfers ride waves at a beach in Cardiff ,California where parking is no longer free as local communities and the state look for ways to solve their budget shortfal©Reuters

After a decade marred by ballooning budget deficits, rising unemployment and swingeing cuts in public services, California’s economy may have finally turned a corner.

The state was hit hard by the financial crisis, with the rate of mortgage foreclosures and unemployment much higher than the national average. Regular budget deficits forced the state to slash public services and two years ago it even had to offer IOUs to its creditors in lieu of cash.

But jobs growth in the Golden State, an economy larger than those of India or Russia, has outpaced the national trend in the US in recent months. California’s Legislative Analyst’s Office is projecting a $1bn budget surplus by the 2014-2015 fiscal year, as $6bn of new tax revenue is due to flood into state coffers after voters passed a staggered tax increase on individuals and families earning more than $250,000 and $500,000 a year.

The LAO said years of spending cuts, the new taxes and an economic recovery had “combined to bring California to a promising moment: the possible end of a decade of acute state budget challenges”.

The passage of Proposition 30, which increases the top rates of tax with new money ringfenced for the state’s ailing education system, was a big victory for Jerry Brown, California’s governor. Mr Brown has urged Barack Obama, president, to consider the state’s election result – and the willingness of California voters to sanction new taxes on the wealthy – in his negotiations with Republican congressional leaders over the so-called fiscal cliff.

But critics of Proposition 30 say it could prove harmful to California and should not be replicated at the national level.

“Dramatically increasing taxes on entrepreneurs and small business owners, as Prop 30 does, is going to hasten the exodus of employers from California to other states, and the jobs and tax revenue will go with them,” said Darrell Issa, a Republican congressman in the state, in an emailed statement.

“Repeating that mistake on a national scale will force those jobs overseas to countries where the business climate is more favourable.”

A spokesman for Mr Brown responded that Republicans liked to “drone on” with complaints about California. “We’re leading the nation in job growth and Mitt Romney just spent Thanksgiving at his home near San Diego,” he said. “There is only one Golden State, and it will continue to be a magnet for people all over the world – including former Republican presidential candidates.”

California has lost jobs to nearby states in recent years as companies moved out, lured by more business-friendly tax regimes.

Russell Goldsmith, the chairman and chief executive of City National bank, which has a big presence in California, said more job losses could be ahead. “We will see some migration out of California to states like Nevada and Texas,” he said.

“California creates a lot of jobs and has huge markets so there is still going to be a vibrant and dynamic economy here driven by world-class industries. But politicians have to stop taking the economy for granted and need to foster stronger economic growth.”

Mr Brown’s office denied that new taxes would spur migration out of the state and pointed to a 2011 report from the Center on Budget and Policy Priorities, which says “compelling evidence” shows that claims about a link between tax policies and migration are untrue.

“The effects of tax policies on migration are, at most, small – so small that states that raise income taxes on the most affluent households can be assured of a substantial gain in net revenue,” the report says.

But in increasing taxes on the top 1 per cent of residents the state has made itself more susceptible to downturns and economic shocks, according to Ross DeVol, chief research officer at the non-partisan Milken Institute.

“The top 1 per cent of earners in California accounts for 20 per cent of income but pays 41 per cent of income taxes,” he said. “After Prop 30 the top 1 per cent would pay something north of 50 per cent of income taxes. What we have done is accelerate the volatility of the tax base in California. What if there’s a downturn?”

He suggests a tax on services to accompany state sales taxes and wants to reopen the debate about property taxes in the state, which have been capped at 2 per cent of a property’s value since the passage of Proposition 13 in 1978. Prop 13, the proposal of anti-tax campaigner Howard Jarvis, is blamed by many in California for causing the state’s dysfunctional finances.

“California has a band-aid approach to budgeting and public policy,” said Mr DeVol. “It’s not good for the long term.”

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