May 4, 2004 - From the August, 2003 issue

A Lopsided Imbalance Exists Today Between Federal Taxes Paid & Recieved But California

In light of the current state deficit, there is likely to be an increased focus on California's tax burden relative to its share of federal expenditures. In order to shed some light on this subject, MIR is pleased to present this excerpt of the California Institute Special Report: California's Balance of Payments with the Federal Treasury, Fiscal Years 1981-2002. The report reveals that in recent years California subsidized the nation at unprecedented levels, sending tens of billions more to Washington in taxes than the state received in federal expenditures.

In 2002, Californians sent $58 billion more to Washington in federal taxes than the state received back in federal spending. Fueled largely by a sharp increase in its federal tax burden compared to other states, the Golden State's imbalance set new record for any state, surpassing the previous mark (set also by California, in 2001) of $47 billion.

To some extent, the shortfall is understandable. Two California characteristics make it likely that the state would pay more federal taxes than the state receives back in spending. First, state residents' income levels are above the national average, yielding above-average income tax receipts - an effect amplified by the progressive nature of the federal income tax scheme. Second, California's population is significantly younger than average, so the state has fewer recipients of Social Security and Medicare payments - the fastest growing budget sector that now accounts for nearly half of all federal spending.

It has been many years since California's federal spending relationship was in surplus. The defense buildup during Ronald Reagan's first presidential term in the early 1980s kept California's federal balance of payments in the black for six straight years. From 1981 to 1986, federal expenditures in California exceeded federal taxes paid by $26.9 billion, with a single-year high-water mark of $6.8 billion surplus in 1984. As defense procurement began to wane in the mid 1980s, however, California's federal funding advantage declined, and the state's balance shifted into the red in 1987 and has remained there ever since. By 1990, California had erased the inflows of the early 1980s, and the 16-year combined tally since 1987 has now grown to $280 billion. (In the early 1990s, the balance figure dipped from a nearly $15 billion loss in 1991 to just a $5 billion shortfall in 1994. But the retreat was short-lived, and deficits since then have risen at a steady clip, by an average of $4 billion each year through 2000 and by far more since then.)

The taxing-versus-spending imbalance means that every California man, woman, and child paid $1,660 more in federal taxes in 2002 than he or she received in federal funds and services. Put differently, California received 77 cents in federal payments and services for every dollar sent to Washington - a decline from 88 cents in 2000 and a record low return for the state. Yet California is not the worst off among the states. According to the nonpartisan, Washington D.C.- based Tax Foundation, California ranks 45th among states in balance of payments. The biggest receiver, New Mexico, ranked first with a balance of $2.37 in return for every dollar paid to the federal government (at $6.44, the District of Columbia was higher still), while New Jersey ranked lowest, receiving just 62 cents for each dollar paid in. (Other states with a very negative balance include Connecticut, New Hampshire and Nevada and Massachusetts.) The balance of payments figure is calculated by comparing federal spending attributable to each state (excluding spending in territories and non-allocable costs such as overseas operations and interest on the national debt) against federal tax and fee revenue dollars collected by states. The tax burden figure is then adjusted to provide an "apples-to-apples" comparison between the two numbers.

Two primary factors comprise the balance of payments: taxes and expenditures. To further explore equitableness, we also include the state's share of the U.S. population as an illustrative benchmark. In 2002, California housed 12.2 percent of the nation's residents, paid 14.1 percent of federal taxes and received back 11.0 percent of federal payments and expenditures.

Population

California is home to nearly one in eight Americans. In sharp contrast to steep population increases during the 1980s - when California's share of the national population rose from 10.5 percent in 1981 to 12.0 percent in 1990 - throughout the 1990s the state's share remained relatively stable. In recent years, California's share of the nation's population has been rising slowly, from 11.9 percent in 1996 to 12.2 percent in 2002. A number of federal grant programs distribute funds to state and local governments based in whole or in part on population data. Some argue that the methodology for collecting census population data, avoiding statistical methods for estimating totals, advantages some states over California and other rapidly-growing urban states.

Federal Taxes

California's share of the nation's $1.8 trillion tax burden climbed sharply to 14.1 percent in fiscal year 2002 from 13.5 percent in 2001 and 12.8 percent in 2000. The state's increasing share of the nation's federal tax burden may in part be due to a strong economy in California relative to other states. The recession of the early 1990s hurt California's economy more than that of most other states, and the state's relative share of federal tax contributions declined from 1991 through 1995. (Despite the hardship, however, California remained a donor state with respect to the rest of the country throughout the period.) Since then, California's share of federal taxes paid has risen steadily. As has been true for more than half a century, California's $256 billion contribution to the federal treasury in 2002 was by far the largest federal tax-dollar total of any state, according to the Tax Foundation, well above both New York's $145 billion and Texas's $126 billion. Whereas most states and the nation as a whole experienced a substantial reduction in federal taxes between 2000 and 2002, from nearly $2.0 trillion to $1.8 trillion, California's tax burden actually increased slightly, from $253 billion to $256 billion.

Federal Spending

According to the U.S. Census Bureau's Consolidated Federal Funds Report for fiscal year 2002, total federal expenditures in California rose to $206 billion, a 9 percent increase from 2001. Calculated as a percentage of the $1.9 trillion total that the U.S. government spent in all states, California's share of federal expenditures rose to 11.0 percent in 2002 from 10.8 percent in 2001, a rise largely due to a faster-than-average increase in procurement expenditures and to a relatively small increase in the state's share of the huge direct payments category.

Total federal spending in California had climbed from 12 percent in 1981 to 13 percent in 1984, propelled largely by military procurement contracts won by California's aerospace industry. Expenditures returned to the 12 percent level by 1988, remaining there until 1994, after which it began a gradual decline to the current 11 percent mark.

Federal Taxation and Spending Per Capita

In fiscal year 2002, the federal government spent a total of $5,878 per capita in California, compared to $6,527 per capita nationwide, a spending shortfall for the state of 11 percent. On the taxation side of the ledger, Californians paid $7,286 per capita to the federal treasury, compared to a national average of $6,309 per capita, or a discrepancy of -13 percent. The 2002 spending discrepancy was larger than any recorded year except 2001, and the federal tax discrepancy was the largest since data collection began.

Categories of Federal Spending

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The Census Bureau divides federal spending into four components - procurement, direct payments, salaries and wages, and formula and other grants to states and local governments. California's share of federal procurement spending rebounded sharply, from 12.8 percent in 2001 to 13.7 percent in 2002, reversing a multi-year decline. Direct payments in California edged upward slightly to 10.2 percent of the nation's total, remaining near the proportion that the state has maintained for several years, though the long-term trend has been downward for a decade. The state's share of federal salaries and wages remained flat at 9.8 percent, holding below the 10 percent threshold for the third year in a row. And California's share of federal formula program expenditures and other grants dropped sharply, from 12.2 percent to 11.8 percent, falling below the state's share of total U.S. population for the first time in a decade. (Formula Grant expenditures are discussed in greater detail below)

Formula Grants

For grant payments to states - comprised primarily of federal formula grant expenditures for such programs as Medicaid, highways and transit, welfare, education assistance, and nutrition programs - California's total receipts rose from $44 billion to $48 billion, but the state's share of the nation's total declined from 12.2 percent in 2001 to 11.8 percent in 2002. Grant expenditures in all states rose sharply, from $364 billion in 2001 to $407 billion in 2002. Formula grant program spending represents roughly 85 percent of the grants category, with the remainder spent on competitive or project grants.

After holding steady in the 1980s at 10.5 percent of the nation, California's share of federal grants to state and local governments rose sharply to nearly 13 percent in 1994. The share of grant spending then fluctuated for several years between 12 and 13 percent, before settling to 12.2 percent for 2000 and 2001. The reduction to 11.8 percent brings grant spending below the state's population share for the first time since 1992.

The bulk of grant spending is distributed to states by congressionally designed formulas, often based on population, income, poverty, and similar data. More than 60 percent of the nation's $407 billion in 2002 grants funding was distributed pursuant to four programs: Medicaid, highway planning and construction, welfare, and Title I education grants.

With regard to transportation funding, for many years, California has received fewer highway planning and construction funds than the state's motorists have paid into the highway trust fund in gasoline taxes, and the states' share of highway money remains relatively low. In 2002, California received $2.7 billion in highway planning and construction funds out of the $29.5 billion distributed nationwide, or approximately 9 percent of the U.S. total. However, the state's low highway funding share appears considerably less problematic when the state's large transit fund share is considered in tandem; California received $1 billion of the $4 billion distributed nationally under federal urbanized area transit formula grants.

In fiscal year 2002, California received $1.2 billion (or 14.5 percent) of the $8.2 billion distributed nationwide from the Title I Education for the Disadvantaged program, the federal government's largest K-12 education grant. This percentage reflects the continued growth in the state's share of Title I from an 11 percent average during the 1990s.

Factors Contributing to the State's Shortfall

Several factors contribute to the state's taxes-versus-spending disparity. First, California remains a relatively prosperous state. Despite economic downturns in the early 1990s and this decade, incomes of California's residents remain above the national average. Thus, the state's residents pay relatively more in federal income taxes under the progressive tax system.

Second, California is a relatively young state and thus has fewer residents receiving payments under Social Security and Medicare, an increasingly large slice of the federal budget pie. In 2000, 10.6 percent of Californians were age 65 or older, compared to 12.4 percent of all U.S. residents.

A third key factor in California's ongoing funding disparity is the state's slippage in federal procurement spending. The nation's total defense contract spending had fallen from $123 billion in 1991 to $108 billion in 1998, a drastic drop-off even before accounting for inflation, before expenditures rebounded to $155 billion in 2002. California's defense procurement funding, on the other hand, experienced a faster fall and a slower recovery - dropping from $23.6 billion in 1991 to $17.3 billion in 1998, and climbing back only as far as $17.9 billion in 2000. Whereas the early 1980s saw nearly one-fourth of defense contract dollars spent in California, the state's share fell as low as 14.6 percent (in 2000) before recovering to 15.5 percent in 2002.

Despite the state's taxes-versus-spending disparity, some opportunistic legislators from other states may continue to view California as a drain on the federal treasury and as a competitor for the federal dollars they covet. If that perception were ever valid, it certainly is no longer.

As has been the case for more than a decade, California subsidizes the rest of the nation at unrivaled levels.

For further California-focused information regarding formula grant programs, including in-depth analyses of the highway and welfare programs, consult Federal Formula Grants and California, a joint project of the Public Policy Institute of California and the California Institute for Federal Policy Research, at http://www.calinst.org/formulas.htm

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