Lessons Not Learned: California’s $35 Billion in Red Ink Calls for Fearless Leaders

The San Jose Mercury News, January 12, 2003
By Leon E. Panetta
As California confronts a record $35 billion deficit and the federal government faces $200 billion annual deficits, citizens would be right to ask, “Why do we keep getting into the same mess, and how can we get out of it?”

The simplest answer to the first part of the question is that the political leadership of both the state and the nation continually fail to address budget problems quickly and decisively. Then, even after a crisis forces tough actions, they don’t keep their eyes on the ball, often letting go of budget controls and spending more when a healthy economy pulls in more taxes.

As for how to get out of budget messes, history makes clear that there is no magic formula for dealing with deficits. You have to either raise taxes or cut spending, or do both. And yet, each time these difficult decisions must be made, both political parties fear for their survival and inevitably try to postpone the day of reckoning. That failure of leadership is what leads to crisis, and ultimately it is crisis that forces action. That is what is happening now in Washington and Sacramento.

A look at the actions – and inaction – of the last two decades at the national level provides some telling lessons for California’s painful budget crisis.

During the 1980s, the nation was looking at what Office of Management and Budget Director David Stockman had predicted would be “deficits as far as the eye could see.” As a result of the Reagan tax cut, dramatic defense-spending increases, growing entitlement and discretionary spending and a slowing economy, deficits were projected to reach $200 billion by the end of the 1980s and escalate to $300 billion by the early 1990s, and skyrocket to $600 billion by the beginning of the new century.

The national debt was well on the way to quadrupling from less than $1 trillion to more than $4 trillion by 1992. The economy was being affected by high long-term interest rates, increased government borrowing, reduced capital for investment and ever-larger interest payments on the debt.

In a word, the deficit was out of control, and both political parties knew it. But neither had the political will or courage to directly confront the problem.

Republicans argued that taxes could not be raised and defense spending could not be reduced. Democrats argued that entitlements and domestic spending could not be cut. The result was budget gridlock and a political blame game as to which party was responsible for the deteriorating fiscal situation.

Quick fixes

Rather than making the tough budget decisions that had to be made, Congress passed budgets based on a combination of “smoke and mirrors” accounting, “rosy scenario” economic projections, funding shifts from one fiscal year to another to hide spending, and exaggerated savings from program reductions that few believed would be realized.

In the midst of the frustration over exploding deficits, members of Congress began to search for quick-fix formulas. Sens. Phil Gramm, Warren Rudman and Ernest Hollings put forth a successful 1985 legislative mandate that if certain deficit-reduction targets were not met, spending automatically would be cut across the board. Congress, however, out of fear for what such arbitrary cuts would do, kept changing the deficit reduction targets. (Gramm-Rudman-Hollings was eventually scrapped.)

Others proposed a presidential “line-item veto” as the solution. Still others supported a constitutional amendment to balance the budget, arguing that only the Constitution could force members to do what they otherwise did not have the courage to do. That effort failed as well.

In the end, it was recognized that the key to the budget process was not procedural gimmicky or artificial legislative or constitutional mandates of one kind or another. Nor could one resolve conflicting priorities by putting the budget process on automatic pilot. Political leaders are elected to make choices, exercise leadership and take risks.

As the 1980s deficit crisis grew worse and eventually became a campaign issue, both parties began to recognize that the challenge could no longer be postponed.

In 1990, former President George Bush agreed to a budget compromise that raised taxes and cut spending. He did so even though it violated his campaign pledge that he would not raise taxes. The agreement achieved significant debt reduction, established caps on spending and implemented a “pay as you go” discipline that required any new proposal for tax cuts or new spending to be fully paid for. The budget agreement was the first major step in slowing the growth of what was then an approximately $250 billion deficit. It was the right thing to do.

In 1993, President Bill Clinton pushed through his economic plan of $500 billion in deficit reduction over five years – about $250 billion in tax increases and about $250 billion in spending cuts. It passed by a single vote in the Senate. At one point during the development of the plan, the president wondered out loud what political price he would have to pay before the economy would respond to his plan.

The Democrats lost control of Congress in 1994 and some believe that the vote for tax increases was partly why. But the plan helped contribute to the largest economic growth streak in the history of the nation, resulting in not only a balanced budget but a huge projected 10-year $5.6 trillion surplus by the time the next President Bush took office in 2001.

And yet today, the economy has slumped and it’s time to make hard choices again. The surplus has been wiped out. The nation is back to deficit spending. But the lessons of the past seem lost. Neither the president nor Congress seems that concerned. Instead of working toward a balanced budget, President Bush is proposing to add $674 billion in tax cuts to the deficit over the next 10 years, and Congress has allowed key budget disciplines, such as spending caps and the requirement to pay for tax cuts and new spending, to expire.

The reasoning seems to be that it is OK to borrow your way out of trouble. The question is:  Who will ultimately have to pay that bill? The estimate is that the national debt will grow by at least $1.7 trillion — possibly as much as $2 trillion — over five years.

California’s dilemma

Here in California, the constitution requires a balanced budget to be passed by the Legislature. The problem is the state is facing the largest deficit in its history. California is not alone. Budget deficits now looming over state governments will probably reach $60 billion to $85 billion collectively.

But here, too, the lessons are clear. For too many years, California has ignored the financial dilemma that resulted from an array of state initiatives that have reduced governmental discretion and moved decision making from the Legislature to the populace. One example is Proposition 98, passed in November of 1988, that locked up a little more than 40 percent of the state’s general fund for schools through the community college level. Other mandates have set aside funds for such areas as road projects and after-school child care.

However well-intentioned these initiatives may be, they, along with super-majority requirements to fund some local projects, make it that much more difficult to write budgets, respond to the changing needs and set reasonable priorities. Government is being set up to fail in its basic responsibilities.

As more and more areas of the budget are spared cuts because of mandates, the remaining areas of education, health, social services, transportation and criminal justice become more vulnerable. They are also vulnerable because they are so costly: Education, health and social services alone now account for 71 percent of total state spending. Add to this the fact that term limits have deprived the Legislature of experience, familiarity with issues and institutional memory, and the result is both structural and political barriers to resolution.

Combine this situation with falling revenues due to a slow economy, increased spending over the past four years, the cost of the energy crisis, and the failure to address the deficit in an election year when it probably would have been easier to fix. The result is the worst budget crisis in the state’s history.

Because a two-thirds majority of the Legislature is required to pass a budget, there is no alternative but for the governor and the Legislature to negotiate compromises. Every governor in recent history has had to bargain with his political opposition. That will be no different this time. But the huge size of the deficit makes the process that much more daunting.

The bitter reality is that there is no answer to this crisis that does not involve pain. Layoffs, tax increases and deep cuts in spending will be necessary.

Familiar refrain
And yet, the same old arguments will be heard. Republicans will oppose raising taxes. Democrats will oppose any budget that cuts only programs for human services. Most of the “smoke and mirrors” options like fund shifts, borrowing from the tobacco fund, and transfers have largely been used up.

The issue is whether, after several decades of deteriorating financial controls, the political leadership of the state and Davis in particular will finally rise to the challenge. Allowing crisis to drive the budget could risk the state’s financial credibility and jeopardize its bond ratings and ability to borrow. There simply is no other alternative but for both sides to confront this crisis and learn the lessons of the past.

Like former presidents Bush and Clinton, the governor has the opportunity to take the kind of bold action on the budget that could make the difference between strong economic recovery or chaos. He must use his bully pulpit to build support from the residents of California.

He must be willing to negotiate a multiyear approach to restoring the fiscal integrity of the state – an approach that is fair, balanced and enforceable. And for the sake of the future, he must be willing to propose broad reforms in the financial structure of this state that stabilize its revenue base and returns greater discretion over the budget to elected officials.

Davis, in the budget recommendations presented late last week took the first step in the right direction. His proposals include a stiff dose of pain – controversial tax increases and difficult reductions in spending. But pain is not the only measure of a credible budget. What really matters is his ability to convince the people of California that the sacrifices called for in his budget are in the best interest of themselves and their children.

Budgets are not just about numbers. They are about setting the fundamental priorities of the state and nation. Throughout history, the executive and the legislative branches have struggled to find budget agreements to restrain spending and establish priorities. They have to be fashioned in the caldron of politics.

But history has also shown us that politics alone cannot work unless leaders are willing to lead. That is the essence of any budget process. It is the essence of our democracy.


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