David R. Henderson  

California's Phony Budget Surplus

Superfreakonomics on Geo-Engin... Does liberty require polymaths...

My personal finances are doing great. I have a "surplus." I saved $1,000 last month after paying all my expenses. Well, not all my expenses. I didn't pay my $1,500 monthly mortgage. But, hey, don't be picky.

The above is something I made up. Actually, my personal finances are great and this is after never having missed a mortgage payment in 27 years. (OK, I was a few days late once but the stiff 5% penalty on that payment caused me never to be late again.)

But here's what's not made up:

And California, which faced a $26 billion deficit two years ago, expects a surplus of between $1.2 billion and $4.4 billion this year, thanks to a combination of tax increases, budget cuts and an improving economy. But it could be erased if the state were to adequately finance its teachers' pension fund, which says it will need an additional $4.5 billion a year, much of it from the state, to pay the benefits it promised.

In other words, California's state government has committed to a pension fund for teachers and has ginned up a surplus by underpaying into that fund. And notice the number: $4.5 billion. That puts it at the top end of the optimistic estimate of the surplus. And, according to this New York Times article, other state governments are playing similar games.

A couple of weeks ago, when California's state budget was released, a local TV station, KION, which has interviewed me on national economic issues, called me to ask if they could interview me on the state budget. I told them that I would need to spend at least 40 minutes to do my homework and have anything interesting and important to say and that I didn't have 40 minutes that day. In light of the above, I'm glad I declined.

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CATEGORIES: Fiscal Policy

COMMENTS (11 to date)
Daublin writes:

Good point.

Of course, a mere 1 billion deficit is way better than the feds.

Becky Hargrove writes:

Thanks for posting - I wondered what was really going on! Luckily you didn't do that local interview. Even though there's so many local issues like this, it's lousy to be the one who's the bearer of bad news, especially when you're basically in the middle of it. I rain on too many local "parades" myself, but prefer to do it from a reasonable distance just for this reason.

David R. Henderson writes:

@Becky Hargrove,
You're welcome. I think you missed my point about the local interview. I don't mind being the bearer of any news--good, bad, or indifferent--if it's correct. What I was saying in my post is that I'm glad I wasn't the bearer because I wouldn't have known the facts until this came out. I had suspected they underpaid because I remember that issue coming up in April or May, but I didn't have time to research. So there was a good chance that I would have missed that fact and then be speaking from false premises.

Mark writes:

Not to rub salt in the wounds, but worse than the inadequate contributions to state employee pensions is the inadequate contribution to state employee health care obligations.

David R. Henderson writes:

I just checked your link. Wow! Thanks.

Steve Z writes:

The analogy to a household budget doesn't really hold though, does it? If you don't pay your mortgage, your bank will charge you higher fees. If you continue to refuse to pay, they can foreclose on your house, and you'll be personally liable for the balance. They'll reduce their claim to judgment, and take out a lien on your assets and/or future earnings.

If the government fails to pay obligations it created, the obligees have little recourse. They can't walk into city hall and auction off the furniture.

Mark writes:

@Steve Z says:

If you don't pay your mortgage, your bank will charge you higher fees. If you continue to refuse to pay, they can foreclose on your house, and you'll be personally liable for the balance. They'll reduce their claim to judgment, and take out a lien on your assets and/or future earnings.

It depends on the state. A non-recourse state gives the bank no recourse other than foreclosing on the home and reporting the default to credit agencies. Only in a recourse state can a lender go after the defaulting borrower's personal assets.

Tim writes:

@Steve Z

The consequences may be different, but the ridiculousness of the claim is the same.

Steve Z writes:

Mark: Right, I was describing mortgages with recourse.

Tim: I don't see why. The different consequences make a difference in the analogy. If my household budget includes a large expenditure that I can cut out with no consequences, and I do so, then couldn't I credibly claim I've handled my budget problem? Of course, the analogy Prof. Henderson makes is probably still valid, in the end, because it is so hard to get rid of entitlements. Imagine ZMP government workers rotting in the fields on merely above-average pensions, rather than cadillac pensions!

Norman Pfyster writes:

Municipalities and other sub-state units can be subject to bankruptcy (there's a bankruptcy section specifically devoted to it). Whether states can appeal to it simply hasn't been tested. Municipalities, as units of the states, also enjoy sovereign immunity, but it has been held that they are subject to breaches of contract, which is what a default on a bond is.

The larger issue raised by the post is what constitutes surplus for states. The liability for the pension reserves is an accounting fiction; the only pension liability that really matters is the current payment. While I support the recording of pension reserves for purposes of inter-generational fairness and financial transparency, it has no real meaning for annual budgets.

Bette Cessna writes:

Ok, so let's use the low end of the surplus estimate (1.2B) and factor in the 4.5B teacher's pension fund. That still represents a MINIMUM 87% reduction in our budget deficit! If we use the high end of the surplus estimate (4.4B), we basically break even and have no deficit. So how about we celebrate the amazing (and quick) feat of turning a 26B deficit into a maximum 3.3B deficit before you start slamming a job well done?

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