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Wednesday, February 18, 2009

A brief economics lesson on the California budget

[Warning: this is a bit longer and more of a rant than my usual posts but there's also quite a bit of real economics here]

For the last several days, I have been reading about California's budget mess with increasing horror. I honestly cannot understand what is going on with the Senate Republicans (Note: my frustration is really aimed at Senate Republicans because they are the ones holding up the budget process. From what I've heard, Assembly Republicans are ready to sign off if the Senate does). I have quipped on both Facebook and Twitter that my Econ 102 students understand California's budget situation better than the Senate Republicans and while I was partly sarcastically expressing my frustration, the more I've thought about it, the more I'm wondering if it's true. Last week, my class learned about Production Possibility Frontiers and I used the state budget as my example. Specifically, the 2008-09 budget started out, at some distant point last summer, at a projected $103.4 billion in the general fund. It was actually surprisingly difficult to find good numbers but I pulled this chart from a report from the Legislative Analyst:

So the numbers I used in the example for my class were $103.4b for the total budget, roughly $52b for education (K-12 and higher ed), leaving roughly $51.4b for 'everything else'. My students then drew the following budget constraint:

Then I told them that the projected shortfall in revenue for this fiscal year is $15B (which was the best estimate I could find; from what I can tell, the $40B shortfall that people keep talking about is the expected problem by the end of the 09-10 fiscal year. The specific numbers don't actually matter for this exercise, since the main point is we do NOT have $103.4B anymore). They then drew the new budget constraint:

Note that the old allocation point ($52b for education and $51.4b for everything else) is now OUTSIDE the frontier. In economic parlance, this point is not feasible. We then had a lively class discussion about how to deal with this problem. The most common suggestions involved increasing revenue, which students correctly identified as having the effect of moving the PPF back out (some clown of course had to suggest 'we should tax weed'. Sigh.). When I asked them for suggestions that did NOT involve new revenue, most understood that you could move directly down to the new PPF by taking the full $15 billion out of everything else and leaving $52b for education, or move directly left by taking the full $15 billion out of education and leaving $51.4b for everything else, but most students felt it should be some combination (which then led nicely into a comparison of the positive and normative issues here).

The situation facing Sacramento is certainly more complicated (and the situation now involves the full $40b drop in revenues) but in some ways, it isn't. The drop in revenue means that we can no longer afford our old allocation and we have three basic options: raise enough revenue to get back to our original constaint (never gonna happen), cut spending by the same amount as the drop in revenue, or some combination of new revenue and spending cuts. Within the 'some combination' option, there are endless combinations and that's what the Governor and Legislative leaders have been hammering out for several months now. The Senate Republicans seem to be saying they won't support anything but the second option, all spending cuts. Remember we are now talking about $40b, or roughly 40% of the original allocation. That is the entire budget for higher ed, social services, criminal justice, transportation and environmental protection combined.

I get that Republican ideology is against taxes and for smaller government. But they talk as if this problem was created because we were spending "too much" before. The reality is that the problem was created because revenues fell and the budget constraint shifted in. One can certainly argue that we should not have been on the constraint before, that we should have stayed inside the constraint and saved for the inevitable downturn in revenue, but that really doesn't help us now. What I really don't understand is why these people expect sacrifice from everyone else in the state (and if we are going to cut spending by $40 billion, you can be sure that there isn't a single person in the state who wouldn't feel that somehow) when they are not willing to compromise AT ALL. And at what point will Californians realize that this group of ideologues are the ones sending the state into bankruptcy?


  1. "they talk as if this problem was created because we were spending "too much" before"

    That is EXACTLY the problem.
    The size of Government has DOUBLED in 10 years. The amount of pork spending is huge.

    How about economics 101:

    spending <= income


  2. "One can certainly argue that we should not have been on the constraint before, that we should have stayed inside the constraint and saved for the inevitable downturn in revenue, but that really doesn't help us now."

    You think? That is the source of the problem. I think that helps us a lot now because now we know who to kick out of office and who to watch more closely.

    Maybe we could borrow some money from the 30 million dollars from the federal stimulus package allocated for the endangered field mouse in Nancy Pelosi's district...



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