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California is going bankrupt

California isn’t bust. Not yet. But it’s carrying on in the way that will drive it so. The base problem is that the progressives running the state – and California politics is nothing if not progressive – have not worked out the most basic thing about taxation systems. You cannot run progressive expenditure on a progressive taxation system.

The current problem is significant. The projected deficit for the coming year is $68 billion dollars. Most of us have no measure of the size of that – but it’s 30 per cent of everything they’re going to spend. This is also a reversal from the predicted surplus of $100 billion only two years ago.

How did that happen?

The little tactical problem that led to this reversal is not unique, it’s a feature of allowing politicians a chequebook anywhere. When the money rolls in then every interest group and political constituency gets allocated yet more taxpayer money in spending. That’s just the way it works – asking politicians to save is like insisting kiddies keep the sweeties for next week. So, every time the California treasury does receive some money there are multitudes of plans to spend all that and more. Those plans are always rises in annual spending which will have to be sustained into the future. So, as and when revenue falls the deficit becomes an ogre – as now. Cutting spending is extremely difficult as it now means disappointing – and fighting against – every interest group and political constituency previously favoured.

The larger, structural, problem is that the California taxation system is highly progressive. Fully 50 per cent of state income tax (which itself can run to 13.3 per cent, on top of the top Federal rate of 37 per cent) comes from the top 1 per cent of taxpayers. Most of that, 33 per cent, comes from just the top 0.1 per cent. Dunning the rich is terribly progressive, of course it is. But it’s also wholly unreliable. For those top incomes are not salaries, they’re reflections of business earnings. The economy takes a tumble and those top end earnings plummet. Stock markets fall and capital gains turn to losses. Interest rates rise and housing transactions fall, killing transactions tax revenues. Exactly what is happening right now, significantly reducing cash flowing in to pay for all those political promises.

But, as above, spending is largely made up of permanent funding streams. Which aren’t things that will be usefully funded over time by an entirely unreliable tax source, those hugely variable earnings of the 1 and 0.1 per cents. Californian politicians have looked at European social democracy and found that it is good. But they’ve failed to learn the tax lesson. You cannot buy tax funded presents for all by only taxing the rich. You have to tax everyone, European style – eyewatering VAT rates, payroll taxes, substantial middle class income taxes. European taxation systems are less progressive than that of the US for this very reason – that’s how you fund social democracy. For the incomes of the rich, therefore the revenues to be got from taxing them, are highly variable. As they’re also finding out, raising the rates to make up for it just means those rich, and their businesses, depart for Texas.

We might think this is illuminating, possibly that it’s sad, but you cannot be progressive only using the wallets of the rich. Something that all politicians, not just those of California, could usefully learn.

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