State Budget Crisis Candidly Examined By State's Budget Director Steve Peace

How did the State of California, reportedly the fifth largest economy in the world, descend so rapidly, like the nation, into the depths of our current budget deficit? Give us your read of state's fiscal balance sheet and the depth of the budgetary shortfall.

The depth of the situation is pretty deep and the components of it are pretty easily described. About $6 billion can be divided into three different categories. Republicans and Democrats both significantly increased spending on education. Republicans pushed for a series of tax decreases and Democrats pushed for a series of increases in eligibility in health care programs. That adds up to about $6 billion.

About $10 billion of the problem can be attributed to the slowdown in the economy. That is money that will return to the system when economic performance improves. The most troubling component of the problem is the $15-18 billion that is directly attributable to what is now known as a false economy-a stock market driven pace of expansion. What is troubling about this $15-18 billion is that, even when economic performance improves, we are not going to get that revenue back. That is why the governor has focused on the need to address this shortfall structurally. We have to adjust to the fact that that $15-18 billion is not coming back.

Elaborate on that structural deficit and how a state budget director constructively and pragmatically approaches dealing with it.

There are two different components to the issue. In the short term, as with any enterprise that finds that its revenues are not aligned with its expenditure applications, the first thing you have to do is move your expenditure obligations into a smaller box. As you do that, you are trying to make sure that you are not being pennywise and pound foolish-you don't want to cut things that maintain your efficiency when the economy is performing better. The first step has been to identify where we can be more efficient, where we can reduce expenditures programmatically, and where we can stop growth.

The second element is more complicated and goes well beyond the boundaries of the capitol-the imbalance of the portfolio on an ongoing basis. And, this goes back to the big picture discussion we have been having around the Sacramento for over a decade, addressing the disconnect between the revenue portfolio, which the state and local governments depend upon, and the expenditure applications, which are divided amongst the state and local governments.

The governor has proposed addressing some component of that in his realignment by identifying programs currently administered at the local level but technically run by the state. He suggests that if the work is being done at the local level, then the decisions also must be made at the local level and the revenues should go to the locals, rather than have the state operate as a middle man. That's an example of aligning revenue responsibilities with expenditure responsibilities and having the decision making process as close as possible to the delivery system.

We are familiar, of course, with the long-debated problems with land use decisions and the degree to which those decisions are distorted as a consequence of the way in which we try to share revenues. That fiscalization of land use is part and parcel of a long term depressive effect of California trying to grow its economy at a rate that is commensurate with the growth of its population.

In a TPR interview last October you said, " local government budgets are really an illusion because they benefit from massive subsidies from the state. Contrary to the rhetoric of local government folks, the reality is that the post-Prop 13 environment has created circumstances in which the statewide taxpayer dramatically subsidizes the local delivery system." Given such a relationship, is there any sign in the capital that the Legislature is willing to reform our state/local fiscal arrangements?

Assemblymen Steinberg (D-Sacramento) and Campbell (R-Irvine) are currently co-authoring a piece of legislation that I suspect will be the center of the current debate and dialogue on that question. The resolution, if it's to be done both to the benefit of local government and to us as citizens who benefit from the services provided for us by local government, must be drawn from both local government and the business community.

The Steinberg-Campbell bill (AB 1221) proposes local government swapping half of its local sales tax to the state in exchange for an equal dollar value of property tax back from the state. Is that an idea or formula with support in the capital?

I guess we'll find out. More importantly, though, irrespective of what state that proposal is in at this time, it is the repository of the conversation in which local government can really engage in a substantive question about how to realign the sharing of those revenues. It is a complicated process, principally because you have so many different local governments going in so many different ways and would be affected unevenly by the proposed changes. And so you have to have two proposals ultimately: one that says this is what we want the future to look like and that can be supported by a broad coalition of folks, and a second proposal that suggests how we're going to transition from where we are today to where we want to be. That is a very tough task, but obviously Mr. Steinberg and Mr. Campbell have chosen to take it on and it is to their credit that they have.

Elaborate for our readers and other stakeholders outside of the capital on the politics of drafting reform legislation or reaching consensus on this year's budget deficit. How will the sausage be made? On what factual basis?

Fortunately, politics is more of a job these days for the elected folks than it is for me. These days, I'm more concerned with making sure that the people who ultimately have to grapple with those politics and who have to make those decisions have reliable information. I try to make sure that the elected folks understand the consequences of the decisions they make. So what I have spent most of my time doing in the past few months is sharing information, the same information with elected officials as I share with the local folks. I share information with the business community or other groups that may either come into the capital or into Sacramento and I am open to make presentations to similar groups around the state.

The most constructive thing that the Department of Finance can do in this environment is to make sure everybody is operating on the same page with respect to budget information. From a clearly identified starting point, they can start to go through what options they want to look at. You have a political dynamic that involves some folks that are mostly focused on the here and the now and how do you reconcile the immediate crisis. You have others who see that crisis as an opportunity to perhaps make some changes that have long term value to the state. And, there's a whole gradation of viewpoints in between those two.

I suspect that the most difficult issue for the Legislature will be judging just how far they must go with structural change in order to not simply be revisiting this kind of budget problem every single year. Similarly, how far can they go from a practical perspective, given the inherent controversy of any sort of substantive change? How far can they go and not find the structural reform conversation simply weighing down their ability to find some compromise on resolving the budget crisis?

To emphasize your points, even as we do this interview today, Senator, the press reports in Los Angeles are that both Republicans and Democrats in the capital are reluctant to follow the governor's lead on cutting programs and raising taxes. Is the Legislature's present paralysis merely a sign of how difficult it will be to reach consensus on a budgetary fix. Is there, in your opinion, a fiscal light at the end of the tunnel this year?

Well sure. They should be reluctant. These cuts are difficult-they are not choices that either Republicans or Democrats would make if they didn't have to. And, they're not choices the governor would have made either. Similarly, nobody likes to raise taxes or propose to raise taxes. One only gets to that point when you believe that the benefit associated with the programs-whether it be education, health care, or roads and highways-are necessary to be able to keep the economy going. And it's a judgment call as to when you hit that juncture in which you need additional revenue.

People are going to have differences in opinion about what the need is based upon their view of what government ought to provide. I don't think it should surprise anybody that Republicans and Democrats are having a difficult time making the kinds of difficult decisions that the governor has made. That's not unusual. In my 20 years in the Legislature, I don't know of any time in which the Legislature didn't have a difficult time grappling with those kinds of decisions. This is without a doubt the most difficult budget that the Legislature has had to deal with in the 20 years I've been in Sacramento-it is to be expected that they would struggle with it.

How does one sucessfully communicate to the public, without cynicism, the challenging tasks at hand for their representatives in the Capitol? How do officials like yourself avoid the either-or rhetoric that so clearly dominates the public debates about this bugetary crisis?

Most often in life, when we find ourselves in circumstances where we, as individuals or as a group, are grousing excessively about the circumstances we're in, we ultimately find the mirror to show us why we are where we are. We spent at least 20 or 30 years in this country, in my view, undervaluing the role of compromise in democratic institutions. It is the heart of what makes a democracy work. Seemingly, we have suspended the ability and the willingness to accept the fundamental reality that we sometimes see things differently. Being a democratic society, we provide a forum to help understand why we see things differently and reconcile some sort of compromise within which we're each willing to live with temporary agreements. That's a value that is fundamental to democracy-it is democracy.

It's easy to just look at the Legislature and say, "Why are they struggling with it?" But we also have to look at ourselves, in the general public and the media and everybody, and recognize that all of us have to have a unity of purpose. The Legislature is no more than a reflection of what the public asks for. And, if the public and the media reward behavior that does not produce compromise, then you won't get compromise. There's a sobering recognition of the seriousness of the current budget crisis and the need to compromise, and I think we will get there. But, it requires cooperation among the public, the media, and elected officials to get there.

How, by the way, do you explain to your children the importance of the work that you're doing on the state's budget?

I have two children that will graduate from college this year, and one is finishing up his freshman year at UCLA. It's pretty easy to explain the seriousness and the consequence to them-are there going to be jobs for them as they come out of their educational experience? And, if there are going to be jobs, what kind of quality of jobs are they going to be? Are there going to be housing opportunities for them to raise a family? Are they going to have options about where they're going to want to live? Will their lifestyle choices be so narrow that the job will dictate where they must live?

I expect that my conversations with my kids are similar to those of parents with kids of a similar age anywhere in the state. One part of the conversation that may be a bit different in our household is sharing with them the degree to which decisions made here in Sacramento ultimately can influence their lives. It is so important that each and every citizen pay attention and have a higher level of understanding of what's going on. It's easy to dismiss whatever goes on in our decision making process as just a bunch of politics. But, the reality is that our lives are affected every single day by decisions that were made and are being made in Washington and in Sacramento. Once those decisions are made and the process launches itself, you have little recourse.

Last question, Senator. We do this interview in the midst of the war in Iraq. A good part of our state budget is impacted directly by the amount of dollars flowing to and from the federal government. Elaborate on our current state/ federal fiscal relationship, and the significance of the national deficit on California's budget crisis and on possible solutions.

It's devastating. California has a long-term relationship with the federal government in which, at its root, Californians send money to Washington and it is in turn distributed around to the rest of the country. We lose more than $30 billion a year to the federal government, meaning that our taxpayers send in excess of $30 billion more to the feds than the feds send back to California. We're all familiar with the constant battles that we have, whether it's the current concern over the federal government not fully funding its commitments with respect to Homeland Security or the historical, high profile issues associated with the impact of a failed federal immigration policy. The way in which the federal government spends and allocates funds directly impacts our state's fiscal health.