Primer on the California budget drama

Moe has made a good start on explaining the California drama, but the story is quite a bit more complex and contains another case study in the Law of (Predictably) Unanticipated Consequences.

On one key point, though, I think Moe is not quite correct

As near as I can make out, the Republicans will not budge on tax hikes (which would require a special election to ratify) unless the same ballot has measures on spending caps and pension reform.

Actually, it’s much better than that – as I understand it, the Republicans are demanding that caps and pension reform be in the budget (as they only need a majority vote to be passed); they don’t have to go before the voters.

But let me run through the larger story in brief – and I trust our other California readers will chime in with clarifications and corrections

Past History

Prior to this year, passage of a budget required a 2/3rds vote, which meant that all the political drama was over the budget approval itself. Approval for years has required a (shrinking) handful of Republicans to vote for the budget (along with the Democratic majority).

Since the 2/3rds vote for passage itself provided a veto-proof majority, once the legislature approved the budget, the governor would not interfere at this point, and the drama would move to the next year.

Where the fun and games stated, though, was that the California Constitution had several other requirements regarding the budget:

a) The budget has to be balanced

b) The budget is required to be passed by June 15

c) New taxes require a 2/3rds vote of the legislature. (Existing taxes can be extended by majority vote.)

Furthermore, if the budget is not passed before the beginning of the fiscal year (i.e. by June 30th), the state cannot pay any more bills (except for those mandated by the Federal government or the courts).

You can see the public spectacle that this created

When tax revenues were high, then it was easy to balance the budget and the legislature could hand out candy and not build up a reserve.

In low revenue years, the legislature would end up in stalemate – the Democrats trying to raise taxes, the Republicans wanting to lower spending, and a handful of Republicans holding the balance of power. The budget would run late, sometimes spilling over to the next year, and the press would hammer the legislature as each party blamed the other.

In more intractable years, as time went on and the state has to resort to more extreme measures, stop paying bills and event issuing warrants, which did not exactly help its credit ratings or please debtors, pressure from creditors and the public would mount to pass a budget as the legislature took another body blow for not meeting deadlines.

Eventually, the leadership would find various “creative” measures to meet the Constitutional requirement for a balanced budget that they could sell to the caucus while hoping to kick the can down the road until tax revenues would rise again in the next wave. Such would include new taxes under the guise of fees, or small temporary increases in existing taxes.

Bringing us to…

November 2010 Election

We had three events last November that working together set the stage for this year’s change of script.

1) The voters passed Proposition 25, which changed reduced the vote requirement to pass a budget from 2/3rds to simple majority. This of course, dramatically changed the legislative process as it meant that no Republican votes were needed to pass a budget.

As a sweetener, this ballot measure also had the stick that if the budget was late, then starting on June 16 legislators would not receive any pay until they did pass a budget. Prior to then, there were no direct consequences to legislators if the budget was not on time.

2) The voters in the same election also passed Proposition 26, which tightened up the definition of new taxes to tamp down on the evasion tactic of calling new taxes “fees” because the latter only need a majority vote – thereby reducing wiggle room for legislators.

3) We had an election for governor, and the Democrat winner, Governor Brown unequivocally promised in campaign that he would not accept budget-as-usual but wanted a genuine budget – and that any tax increase approved by the legislature would also go before the voters for their vote before being put into effect.

The Script Changes

As a consequence, first of all we see the backfiring aspect (which was why I was quite amused that the Democrats were so eager to pass Prop 25), which is that the Democrats now have ownership of the budget because they no longer require Republican votes to pass the budget. They had pushed this initiative because of the bad press from past failures to pass budgets on time, and wanted to solve that problem, which they did, but at a cost because…

Meanwhile, new taxes still require a 2/3rds vote. This means that the Democrats can pass a budget on their own, but can’t guarantee new tax revenues to fund it without Republican votes. This we still had set up a stalemate between tax increases and spending cuts – except now the Democrats couldn’t argue that they didn’t have the votes to pass a budget.

This left the Democrats in a weaker than usual position, because they either a) had to come to agreement with the Republican caucus so that they share the responsibility (known as the TARP Stratagem), or b) come up with an all-cut budget on their own, which would outrage their voting base, or c) find some way to peel off the needed handful of Republicans to break with their caucus and agree to new taxes (which would be risky to their reelection)…

Or there was d) circumvent the legislative process entirely, which would be very risky because things would end up in court and/or an initiative+/-referendum that would unite Republicans and anti-tax groups. (In the case of a referendum, the tax measures would be suspended in the interim.) And since the California voters like programs but don’t like to vote for taxes to pay for them, these increases would likely go down.

That is, d) was not a credible threat (and an admission of desperation).

So now the vise tightens on the Democrats as two deadlines approach:

1) June 15 these poor legislators would lose their daily allowances (cue the violins). And indeed we are now hearing sob stories of financial ruin from Democrat legislators because of not getting paid, which says something about their household budgeting skills – and we elect these guys for the state budget?

But I digress…

2) On June 30th, two substantial temporary taxes are set to expire, which puts a major hole in the revenues side, meaning even more cuts are needed. This is what’s behind all the efforts to get Republicans to approve a “bridge tax” to continue these taxes, at least until the special election. Not to mention that the state loses its ability to pay new bills.

Coming now to the current situation, the Democrats in the legislature, thinking the script was still essentially the same, put together another smoke and mirrors budget (including new tax increases not-so-disguised as fees or extensions of existing taxes) assuming the governor would not interfere.

Surprise! (except to those listening all along)

First, of course, is that the governor is now relevant for the first time in many years, because he now has the effective power to veto a majority-only budget, unlike past 2/3rds-vote budgets. Which is what he did. Another evident consequence of Prop 25 that the Democrats ignored – it made the governor relevant again to the budget process.

So why did Gov. Brown veto the bill? I see at two basic reasons.

1) His entire credibility as governor rested on passing a real budget, credibility with voters, with legislators, especially with Republican legislators – and with the financial markets . To back down would have exposed him as all talk, not action.

2) Unlike Democrat legislators, Brown understands financial reality. The bond markets have already effectively shut down in California in terms of issuance of new debt (not happening) as warning. If Brown had let this budget go past, that would be an unmistakable signal that California was still not serious about budget/pension reform, which he recognized would be an utterly disastrous message to send to the financial markets.

Finally, to put icing on the cake, the Controller decided that Prop 25 did require him to withhold legislators’ pay and stuck to his guns – a rare example today of operating on principle – and an action that sends another favorable signal to the financial markets that he’s not going to play games.

As we approach June 30 and beyond, the Republicans are definitely holding the stronger cards. Whether they will hold fast or whether the Democrats can recruit enough defectors as the pressure mounts remains to be seen.