KEATING: A ‘Pretzel Palace’ of Benefits

June 20, 2012

by Maryann O. Keating, Ph.D.

Gov. Jerry Brown refers to the California state budget, riddled with earmarks and creative accounting, as a “pretzel palace of incredible complexity.” If a governor is challenged by the complexity, what hope does the ordinary resident have in getting a handle on state revenue? There will be a cost, however, if Hoosiers ignore what went wrong in the Sunshine State. California’s state deficit is projected to grow from $3.4 billion in 2009 to over $15 billion next year unless significant changes are made prior to the new fiscal year beginning July 1. The state will not be able make certain payments to school districts and vendors or pay salaries of elected officials and staff. The Legislature hopes to work out a deal with the governor in the coming days. To assist in balancing the state budget, elected officials are counting on voters to agree in November to increased sales and income taxes. In February alone, 10,300 California state and local government jobs were cut. Since the beginning of the recession, government jobs in California have declined by five percent. The four dominant sources of revenue coming into a state’s budget are intergovernmental revenue (mainly from the federal government), taxes, charges and miscellaneous income.* California and Indiana state revenue by source divided by the respective number of residents is provided below for 2010:


Source: Calculations are based on U.S. Census Bureau data. 
 
In 2010, the federal government channeled slightly more per capita in Medicaid, unemployment benefits, etc., through the California state budget than through the Indiana budget. The most striking difference, however, is the fact that California collects more than twice as much per capita in individual and corporate income taxes than Indiana. No doubt, the heavier reliance on income taxes (as compared with sales taxes) makes California’s revenue stream highly volatile. Half of California’s revenue from income taxes is derived from the top 1 percent of the population, who experience dramatic income collapses during recessions and stock-market declines.

California is the state with the largest amount of cash and investment holdings for state and locally-administered pensions. Nongovernmental securities consist of corporate stocks and bonds, foreign and international securities, mortgages, funds held in trust, and other instruments, including mutual funds. The value and income earned on these assets contributes further to increased revenue volatility.

Now, let’s consider how California and Indiana spend dollars collected mainly from taxes and intergovernmental revenue. The division of responsibilities between local municipalities and state government weaken our cross-state comparisons but the facts about state spending remain. Although Table 2 below lists state expenditures per resident by function, there is no way to determine what percentage actually filters down to the client in the clinic, in the classroom or on the highway. Listed amounts include compensation for state employees providing services.

For each man, women and child resident, the state of California in 2010 spent $817 in wages and salaries to public employees. The comparable amount for Indiana was $654.


Source: Calculations are based on U.S. Census Bureau data.
 
The state of Indiana spends considerably more per capita on education and highways than California, which spends significantly more on welfare, health services, police and corrections. The California prison system spends in excess of $45,000 per year per inmate, about equal to the median take-home pay of American families.

Unlike Indiana, California has not been able to pass pension-proposal reform for public employees. Active California government employees, however, contribute (and receive) more dollars on average in state and local pension funds than do those in Indiana. There are 1.66 active state and local employee participants for each defined benefit recipient in California, and 1.99 in Indiana.

In 2010 in California, 6.2 percent of all residents were members of a state or local public-employee “defined benefit” retirement plan, and 2.8 percent of all Californians received a yearly state-local pension averaging $31,629. California state and local tax revenue contributed $417 per resident to these plans.

In Indiana, 4.5 percent of residents are members of state or local public “defined benefit” plans and 1.8 percent receive a pension averaging $15,115. Indiana state and local taxpayers contributed $229 per resident to these retirement systems.

All states deal with “pretzel palaces,” but some state budgets are easier to digest than others. Increased tax rates and uncontrolled spending are causing the Golden State to forfeit its global leadership in technology, agriculture and entertainment. The lesson for Indiana is that state finances don’t go wrong, they grow wrong.

Maryann O. Keating, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation living in South Bend, is co-author of Microeconomics for Public Managers, Wiley/Blackwell, 2009.

* The population of California is over five times that of Indiana; therefore, dollar values presented above are given on a per-resident basis, which includes estimates for illegal aliens. Per-capita figures include every man, women and child, and as such underestimate household tax burdens. For the U.S. as a whole, there are about 2.5 persons per household.



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