Verle Johnston

English

Research Papers in Economics

At that time, one-third of state outlays sup-
ported education, and a quarter, the high-
way system; both were elements ofa social
infrastructure ofsuperior quality that in-
duced in-migration and furthered economic
growth.
Growth a go-go
In the first flush of rapid growth following
World War II, the State budget reached $·1
billion in 1951, while at the local govern-
ment level, expenditures reached almost $2
billion. Local spending was financed in part
by property taxes aggregating $800 million.
Receipt of a $112 property tax bill in this
writer's Bay Area home in 1946 triggered a
On the revenue side, 47 percent ofreceipts
(General and Special Fund) came from the
retail sales tax and taxes on alcoholic bev-
erages, 30 percent from motor vehicle fuel
taxes and Iicense fees, 11 percent from
bank, corporation and insurance taxes, and
only a very modest 7 percent ($20 million,
or $3 per capita) from the personal income
tax. In addition, property taxes at the local
level generated $300 million ($40 per
capita) Statewide and supported public
schools, parks, fire, police and other local
government functions.
In response to these legislative enactments
and the dynamics ofa highly diversified
growth environment, State revenues blos-
somed and reached a record $298 million
by 1941, or $40 per capita. The amount
sufficed (as was the case during most years
ofthe Great Depression) not only to cover
expenditures, butalso toprovideamoderate
surplus of$23 million.
30 percent above the national average. Its
residents prided themselves on having en-
acted progressive legislation that notonly
made the Golden State the True Land of
Hope and Glory, but the hoine ofthe ballot
initiative and referendum as well.
1
A similar combination of circumstances,
including tax cuts in conjunction with con-
tinued rises in spending, relatively high real
interest rates, and the impact ofa protracted
recession on revenues, have made coping
with soaring deficits the nameofthe game at
the state and local as well as national levels.
The past was prologue
In the ninety odd years following the Gold
Rush until the advent of World War II, Cali-
fornia's population swelled to 7 million and
the State boasted a per capita income over
Epluribus unum?
The Golden State is not alone in its fiscal
dilemma. According to the National Gover-
nor's Association, the financial condition of
moststates in the nation deteriorated sharply
overthelast year as aresult ofthe recession.
Ofcourse, finances at the national level
have yielded some unpleasant news too.
The present administration in 1981 fore-
casted a $23 billion deficit forfiscal 1983
and a balanced budget for fiscal 1984, but
these estimates have been superceded by
deficits now forecasted at $208 billion and
$189 billion respectively. The economic
and tax revenue growth that was expected to
result froin large tax cuts in particular,
simply did not materialize as planned.
In presenting his fiscal year 1984 "common
sense" budget to the State Legislature early
in January, California's new governor,
George Deukmejian, proposed a $25.2
billion level ofspending. The new budget
represented about a $450 million (or 2
percent) reduction from the prospective
1983 fiscal year outlays. Notingthat spend-
ing had increased about $6 billion more
than revenues since 1978, wiping outthe
State's $4 billion surplus in the process and
pointing to a potential fiscal 1983 deficitof
$1.5 billion, the Governor commented that
"nowwe are payingthe terrible pricefor this
overindulgence."
The Morning After
February 25,1983IF~(dl~1f@n TI«~~~1fW~
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Opinions expressed in this newsletter do not
necessarily reflect thE' views of the managemellf
of the Federal Reserve Bank of San Francisco,
or of the Board of Covernors of ther Federal
Reserve System.
typical reaction: "Where will itend?" The
question was still being asked in fiscal year
1978 when the State budget reached almost
$14 billion and outlays at the local govern-
ment level reached $31 billion, financed in
part by property taxes that reached a record
$10.3 billion.
The fifteen-fold increase in total State and
local government spending in the interim
since 1951 far outpaced anine-fold increase
in aggregate personal income. As a result,
percapita State and local taxes increased
from $162 to $1,096. The increase not only
contributed to a State surplus ofalmost $4
billion by 1978, but also set the stage for
iratetaxpayers' overwhelming approval of
Proposition 13 (which slashed property
taxes by about one-halO and action ofthe
Legislature (subsequently "permanentized"
by voter approval ofProposition 7 last year)
indexing income tax rates to inflation.
Sending a message
Nevertheless, and in spite ofthe belief of
voters that they were "sending Sacramento
a message," spending (General Fund plus
Special Fund) has almost doubled since
1978 to a projected level just under $26
billion for fiscal year 1983. The jump far
outpaces increases in the price level (up
50 percent), surpasses the net increase in
spending over the previous eighteen years,
and far exceeds a roughly $8 billion rise
in revenues. The principle elements in the
sharp rise in spendingsince 1978 have been
a more than doublingofoutlays for educa-
tion and a 67 percent net increase in outlays
for health and welfare ",hich, together, rep-
resent 70 percent of the total budget.
On the revenue side, proceeds from the
sales, bank and corporation, and personal
income taxes have increased by about 50
percent since 1978 and account for three
quarters of total revenues (the personal
income tax alone, for 31 percent). Still, as a
result ofthe recession and overly optimistic
forecasts of the performance ofthe national
and California economies, revenues this
2
year will probably fall at least $2 billion
short ofearlier estimates. Still other factors
contributing to a revenue loss are the index-
ingofpersonal income tax rates to inflation
(resulting in a $9 billion cumulative loss of
revenues since 1978), and last year's voter-
approved abolition of the State gift and
inheritancetaxes (resulting in a $SOO million
revenue loss during the current fiscal year).
Meanwhile, property tax revenues, which
dropped from $10 to $5 billion following
Proposition 13, have recovered to an esti-
mated $7.5 billion this year in response to
a 50 percent net increase (since 1978) in
assessed valuations. Local government
spending, however, has increased from $32
billion to an estimated $40 billion or more,
financed in part by federal and state transfer
payments that included a $1.4 billion an-
nual state property tax "bailout" (represent-
ing approximately 30 percent ofthe initial
$5 billion loss in property tax revenues).
How to cope
As initially introduced, Governor
Deukmejian's proposed budget for fiscal
year 1984 contemplated a slight reduction
in State spending to slightly more than $25
billion. It also anticipated a $2.2 billion rise
in total revenues in spiteofan expected slow
to moderate recovery in the national and
State economies. The budget called for no
increase in tax rates or any imposition of
newtaxes. The reason was that the rise in
revenues during the next fiscal year (starting
June 30), including an almost 20 percent
increase in revenues from the personal
income tax, was estimated to cover and pay
off the current fiscal year's (1983) deficit.
Compromise
Applauded by Republicans, the Governor's
budget proposals were sharply criticized by
Senate Democrats in particular, who char-
acterized as "fiscally irresponsible" and
incompatible with at least the spirit of the
State's Constitution, his proposal to carry a
large deficit over to fiscal 1984.MONETARY POLICY OBJECTIVES
Federal Reserve Chairman Paul Volcker presented areport to the Congress on "Monetary
Policy Objectives for 1983" on February 16. The report includes a summary of the
Federal Reserve's monetary-policy plans for 1983, along with a review ofeconomic and
financial developments in 1982. Single or multiple copies of the report can be obtained
upon request from the Public Information Section, Federal Reserve Bank of San Fran-
cisco, P.O. Box 7702, San Francisco, CA 94120. Phone-(415) 974-2246.
Some observers also are convinced that
California's economy may lag the national
recovery this time due to the loss oftradi-
tional heavy industriesand the factthat Cali-
fornia has become increasingly dependent
upon "high tech" industries that primarily
are business rather than consumer oriented.
In short, some observers detect in the reve-
nueforecasts at least apotential replay ofthe
overly optimistic forecasts ofthe last five
years. They note that Wishful thinking never
has balanced a budget. I h
Ver e Jo nston
Overly optimistic revenue forecasts?
whi1e some Senate Republicans predictthat
the sales tax "trigger"-the key element in
the "compromise"-neverwill be pulled,
others are far from certain. The Governor
himselfhas urged the State's citizens to start
their Christmas spending 250 days early to
helpbolster State revenues. In the mean-
time, the negotiation of $420 million in
short-term loans from private lenders has
forestalled a massive issuance ofregistered
warrants, or 1.0.U.'s (which have not been
used since the Depression), to State con-
tractors and taxpayers fi Iing for refunds,
although some were printed for distribution
prior to receipt ofthe short-term loans.
It is the accuracy ofthe revenue forecasts,
however, which will largely determine the
final shape and dimensionsofthe fiscal year
1984 State budget.
As partof the "compromise," the Governor
has agreed notto make "significant cuts"
in programs favored by the Democrats, but
barring further changes, families with de-
pendent children will get no increase in aid,
while aid to the aged, blind and disabled
will increase by about2 percent. Outlays for
mass transit also are earmarked for ade-
crease as are most of the State's regulatory
agencies. While an overall reduction of
1,000 in the State's 232,000 workforce is
planned, a 5-percent salary increase also
has been programmed, and increased per-
sonnel and budgetsare contemplated for the
State prison and highway patrol system.
3
As noted previously, the deficit is expected
to be covered by a substantial rise in
revenues generated by a recovering state
economy. However, the compromise stipu-
lates that in the eventthat revenues fall more
than $150 million below their forecast level
by November 1 (the first three months of the
new fiscal year), or ifremainingState
reserves fall below $1 00million by February
1,1984, a "temporary" 1 cent increase in
the State's six cent sales tax will be imposed.
When the "rolled over" deficit is paid off,
the sales tax will then be reduced below its
present level so that over a two-year period
there will be no net tax increase.
The compromise also broadens the Con-
troller's authority to obtain loans from
private lenders to copewith the current cash
flow problem. (The Controllerestimates that
$850 million in borrowings will be neces-
sary in the remainder ofthe current
fiscal yeaL)
Spending increases and cuts
As the budget now stands, spending on
education next year will show a slight in-
crease, financed in part by increased fees at
the University ofCalifornia and the nine
State universities as well as the imposition of
a fee by the State's numerous community
colleges. At the same time, health and wel-
fare payments are slated for a reduction (to
under $7 billion from a peak of$7.5 billion
in fiscal year 1982), largely in response to
the completion ofa phase-out ofmedical
payments for the indigent.
However, after much inter- and intra-party
acrimony, the Legislature on February 16
finally approved acompromise budget.
It calls for acombination of about $638
million in additional spending cuts, tax
speedups, hiring and purchasing freezes,
and internal borrowings from Special Funds
to help cover General Fund expenditures
by June 30. The compromise budget thus
leaves adeficitofbetween $900 millionand
$1 billion to be "rolled over" into fiscal
year 1984.U013u!yseM. yl:'ln .: uo3aJO • l:'peAaN • oyepl
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BANKING DATA-TWElFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
large Commercial Banks
Amount
Outstanding
2/9/83
Change
from
2/2/83
Change from
year ago
Dollar Percent
Loans (gross, adjusted) and investments*" 163,047 -1,136 5,316 3.4
loans (gross, adjusted) - total# 141,843 -1,203 5,627 4.1
Commercial and industrial 44,981 - 435 2,835 6.7
Real estate 57,247 - 32 708 1.3.
Loans to individuals 23,689 - 126 294 1.3
SeCurities loans 2,555 - 276 562 28.2
U.s. Treasury securities"" 7,540 - 95 1,287 20.6
Other securities"" 13,664 162 - 1,598 - 10.5
Demand deposits - total# 38,145 -2,040 - 546 - 1.4
Demand deposits - adjusted 27,652 457 120 0.4
Savingsdeposits - total 61,288 1,436 30,697 100.3
Time deposits - total# 74,083 -1,364 - 17,143 - 18.8
Individuals, part. & corp. 65,424 -1,269 - 16,609 - 20.2
(Large negotiable CO's) 25,189 - 626 - 10,562 - 29.7
WeeJdy Averages
ofDaily Figures
Member Bank Reserve Position
Excess Reserves (+ljDefidency(-)
Borrowings
Net free reserves (+l/Net borrowed(-)
Weekended
2/9/83
40'
o
40
Weekended
2/2/83
83
7
75
Comparable
year~ago period
79
30
49
'" Excludes trading account securities.
# Includes items not shown separately.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of this
and other Federal Reserve publications can beobtained by calling or writing the Public Information Section,
Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 974-2246.

The morning after

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The morning after

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