Brown's Taxing Headace

California Governor Jerry Brown is dealing with a "taxing" headache these days. Within the last week, Brown has taken a jarring one-two punch.

[1] The state is projected to run budget deficits for years to come. Despite rosy economic assumptions, Brown's 2012-13 budget was expected to result in a $9.2 billion deficit. A report issued today by the nonpartisan Legislative Analyst's Office concludes that Brown's forecast is overstated by approximately $6.5 billion.

Brown was looking at roughly a $9 billion budget gap. Now he's looking at $15 billion. To quote another governor wunderkind: "Oops"!

Silicon Valley is experiencing a "mini-bubble," and Facebook's pending IPO is expected to create hundreds of new millionaires. Brown's revenue estimate assumes that "social networking" entrepreneurs and investors will pay billions in state taxes on capital gain income. The LAO report emphasizes that capital gain income is highly variable and notoriously difficult to project. California has been down this road before. Those who cannot remember the past are doomed to repeat it.

California is lurching down a path towards Greek-style insolvency. Here's the basic formula. Politicians create an expansive state bureaucracy. The state employees organize into dues-paying members of public employee unions. The unions funnel dues into political elections to support candidates who promise to keep the gravy train running. The politicians become pawns of union bosses. They borrow money to cover budget deficits as state employees become increasingly detached from the public sector.

In the long run, the cycle is unsustainable and doomed to implode. California cannot afford to pay its recurring bills and satisfy its health and pension commitments to retired state employees. However, that's a problem for the next generation. Brown is a political careerist, and he has no interest in disrupting the cozy relationship between Democratic politicians and public employee unions in California.

[2] Brown wants to solve the $9.2 billion budget gap with a two-pronged tax increase. He wants state voters to approve an initiative to raise tax revenue. The "Brown Tax Initiative" would raise the sales tax by half a cent and raise tax rates on families who earn more than $250,000. In a savvy -- but disgusting -- political move, Brown would link a failure of his initiative to automatic cuts in the K-12 education budget.

Does the income threshold sound familiar? Yes, another Democratic politician defines a working family with $250,000 in income as nouveau riche. To give Brown some credit, his initiative would at least "spread the pain around." Everybody pays sales taxes; a vote to increase the sales tax is a vote to tax me and the "man behind the tree." I'm more disgusted by Brown's decision to hold K-12 teachers and students ransom for his tax increase proposal. (Full disclosure: my wife is an elementary-school teacher.)

The LAO report complicates Brown's overall strategy. The Brown Tax Initiative will not cover the LAO's projected revenue shortfall. Brown will have to go back to the drawing board. Or play games with the numbers, which is usually the "solution" to problems in Sacramento.

[3] Meanwhile, recent poll data suggests that the Brown Tax Initiative may be caught in the crossfire among competing initiatives. Someone pass the Tylenol!

Brown is not the only advocate for higher taxes on the "wealthy." Public employee unions are pushing a "Millionaire Tax Initiative." They want to increase tax rates by 3% for incomes over $1 million, and by 5% for incomes over $2 million.

A wealthy lawyer (Molly Munger) and the state PTA is pushing the "Munger Tax Initiative." The Munger Tax Initiative would progressively raise taxes on all taxpayers, and would funnel the revenue into education.

According to the recent poll, likely voters express support for the Millionaire Tax Initiative (63%) and the Brown Tax Initiative (58%). More likely voters oppose (48%) than support (45%) the Munger Tax Initiative. No big surprise. The first initiative provides a "free lunch" courtesy of the highest-income taxpayers. The second initiative echoes Team Obama's drumbeat to raise taxes on the top 3%. The third initiative would require increased taxes for everybody, which triggers some soul-searching among voters.

If you need to guard the entrance to Hades, I'd recommend a three-headed monster named Cerberus. However, a three-headed tax initiative may confuse and fatigue California voters. Team Brown conducted an unofficial poll suggesting that voters will play "knock out" and select one plan while rejecting the others. If so, voters may fragment their support for the initiatives and tank the entire process. (Team Munger disputes Brown's logic.)

A final remark on the California initiative process. Why exactly do we elect state politicians, when they put any tough decision on the ballot?

Solar Fizzles; Green Jobs "Pipe Dream"

This week, I'm going to focus on the U.S. energy sector. I'll be discussing the landscape broadly, and then specifically discussing the tax policies intended to subsidize the development of renewable energy.

Before I get into the tax policy angle, a couple recent developments:

[1] Governments Lose Bets on Solar Manufacturing

Two U.S. solar manufacturers have recently filed for bankruptcy (Evergreen Solar and Intel spin-off SpectraWatt). The price of solar panels has fallen dramatically as China ramps low-cost manufacturing. That's good news for U.S. energy consumers and the environment, because the cost differential between solar power and power generation from fossil fuels is narrowing. If the trend continues, solar power will become a competitive alternative energy source without government subsidies.

However, the good news for consumers and the environment is bad news for U.S. solar manufacturers and their stakeholders (investors, employees, government benefactors). Despite federal and state subsidies directed at the solar industry, the cost of manufacturing in the United States far exceeds the cost of manufacturing in China and other emerging markets. Evergreen Solar made a losing bet on the wrong technology. SpectraWatt crumbled under market pricing conditions. Industry analysts predict more consolidation in the industry (i.e., more bankruptcies for U.S. and foreign manufacturers).

Along with investors and employees, taxpayers joined in the pain from the bankruptcy filings. Massachusetts directed $21 million in cash grants to Evergreen (along with tax incentives that are now moot). SpectraWatt's bankruptcy filing reported $6 million in "state economic inducements" as assets.

Talk about skewed incentives. Our politicians get to "bet" on business deals with other people's money. If the "bet" is successful, the politician takes the credit. If the "bet" is a bust, the politician blames China and suffers no consequences (because he or she has no skin in the game). Unlike a private enterprise, the "investment" process is so opaque that it's difficult to identify anyone to hold accountable.

[2] Green Jobs "Pipe Dream"

The collapse of the U.S. solar manufacturing industry is the latest bad news for advocates of a transformative "green" economy. On August 18, the New York Times published an interesting article discussing the dismal growth in the "green jobs" sector. (The article focused on the San Francisco Bay Area and California with some general observations about the sector nationally.)

In a development that will take few of us by surprise:

[T]he green economy is not proving to be the job-creation engine that many politicians envisioned. President Obama once pledged to create five million green jobs over 10 years. Gov. Jerry Brown promised 500,000 clean-technology jobs statewide by the end of the decade. But the results so far suggest such numbers are a pipe dream.... A study released in July by the non-partisan Brookings Institution found clean-technology jobs accounted for just 2 percent of employment nationwide [2.7 million jobs].

I suppose that we get the politicians that we deserve. If voters took these types of "pledges" at face value, they were bound to be disappointed. I have no problem with either politician's attempt to set "lofty" aspirations. However, at some point, a "lofty" aspiration starts to resemble the empty promise of a snake oil salesman. Let's see if anyone in the next election cycle tries to hold President Obama accountable for overpromising and underdelivering on his green jobs "pipe dream."

[3] Your Bus Driver Has A "Green Job"

One note on methodology. I skimmed the Brookings Institution report; the allocation of "green jobs" among industries is surprising. The largest two categories of "green jobs" are Waste Management/Treatment (386,000 jobs) and Public Mass Transit (351,000 jobs), followed by Energy-Saving Building Materials (162,000 jobs), Regulation and Compliance (142,000 jobs), Professional Environmental Services (141,000 jobs), Organic Food/Farming (130,000 jobs), and Recyling/Refuse (129,000 jobs).

I'm sure that many of the individuals working in these industries would be surprised that their position qualifies as a "green job." I understand the methodology, but most of these job "categories" have existed for decades -- long before politicians became obsessed with "sustainability." When you start looking at the numbers, it makes you wonder how President Obama kept a straight face when he pledged to create five million new green jobs over the next decade.

Adult Supervision

California taxpayers are enjoying a day of schadenfreude (which goes nicely with a fresh Hefeweizen, as I'll explain below).

If you have access to the Internet, you've heard that California is a fiscal basket case lurching towards Greek-style insolvency. The latest chapter in California budgetary chaos pits a Democratic Governor (Jerry Brown) and Democratic Controller (John Chiang) against Democratic legislators.

Since his election in 2010, Brown has been negotiating a budget with Democrats and Republicans. The state continues to project large fiscal deficits and an unsustainable "wall of debt" in the next decade. Compounding the impact of the Great Recession, businesses are fleeing the state's oppressive regulatory and tax regime in droves.

To his credit, Brown has rolled up his sleeves and attempted to exercise some adult supervision of the legislators in the sandbox. He has proposed a mix of temporary tax extensions and spending cuts to balance the state budget and improve the overall trajectory of state finances. Brown hoped to bring the temporary tax extensions to a statewide vote through the ballot initiative process. However, he was unable to persuade Republicans to support a ballot initiative. (Republicans claim that Brown was unwilling to consider necessary reforms to the state's unsustainable pension system. We don't know what transpired behind closed doors.)

Unable to sway Republicans to support Brown's proposal, Democratic legislators enacted "Plan B" on Wednesday, June 15. Plan B was basically a variation of "kick the can down the road." After approving the plan, Democrats broke out a case of Hefeweizen to celebrate another year of accounting gimmicks.

The next day, Brown added insult to (hangover) injury by vetoing the Democratic budget. After taking an obligatory swipe at state Republicans, Brown described the Democratic budget as containing "legally questionable maneuvers, costly borrowing and unrealistic savings."

And now for the taxpayer schadenfreude. California voters approved a law last fall that permitted legislators to pass a budget with a simple majority vote but stripped them of pay for every day the budget is late. Today, Controller Chiang announced that the Democratic budget was defective, and, consequently, legislators would be working for free until they passed a balanced budget. Despite his party affiliation, Chiang did not give the Democratic legislators a free pass: "My office's careful review of the recently passed budget found components that were miscalculated, miscounted or unfinished."

Ballot initiatives are a big part of California's political and budgetary quagmire. However, in this case, the voters deserve a celebratory case of Hefeweizen for trying to impose some accountability on their state "political leaders."