Arnold Schwarzenegger is taking the lead in a more gripping drama in Sacramento than he ever managed in Hollywood. As governor of California, he now faces grim choices. The state’s political system is being overwhelmed by the depth of the crisis facing it. The result is that the richest state in the US is currently unable to pass a budget and is forced into fiscal tightening in a severe recession. The federal government must help.

California’s sheer size makes its local politics fraught. The state has had to find room for both the disciples of Richard Nixon and the denizens of Haight-Ashbury; the free marketeering of Ronald Reagan and the dirigisme of its powerful public sector trade unions. Meanwhile the political system exacerbates the state’s tensions. Gerrymandered electoral districts are uncompetitive so the floating voter matters remarkably little. For assembly members and senators, there is little to be gained from compromise. Moderates can seek reform through plebiscites, but even these contests are distorted by the large budgets of the trade unions.

Mr Schwarzenegger campaigned for referendum measures on fiscal consolidation and political reform in his first term, only to be knocked back by a campaign funded by organised labour. The governor settled on his current “post-partisan” moderate position only after being beaten by a political machine that he was unable to change. Elected as a reformer who attacked his predecessor’s profligacy, the governor has presided over a worsening of the state’s finances.

This political system allowed a complete lack of discipline in the good years. The unusual heavy reliance on its progressive income tax means that the state is peculiarly sensitive to the fate of its high-earners. The state enjoyed a fleeting surge in capital gains income – but did not put aside this gain in case of a rainy day in the Golden State.

That bad weather has arrived. House prices have fallen by a third since 2007. Unemployment has risen by 49 per cent – to 1.6m – in the past year. California’s unusual degree of exposure to the international economy, which was such a benefit in the good times, now makes matters worse.

After months of deadlock the state’s legislators have still not agreed a budget for the coming year. With a shortfall of $42bn and a legislature gripped by intransigence, California now has the lowest credit rating of any US state. Legislators have little choice but to calm investors – pushing through a sudden fiscal tightening. But this is calamitously bad policy. As private demand has collapsed, public spending should seek to offset it.

The federal stimulus package, signed this week by President Barack Obama, included only $34bn of explicit fiscal relief for all 50 states this year. This component should have been larger. It would create moral hazard problems: the profligate would be bailed out. But the alternative is that states – particularly those with balanced budget amendments – will find themselves cutting budgets into a downturn. No one wins if local governments across the US apply a range of fiscal sedatives.

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