General Motors, Good Business, Republicans and the State Budget

A couple of big stories this weekend were the continued failure of California’s elected officials to reach a deal on the state’s budget and the emergence of a “new” General Motors from it’s government-forced Chapter 11 reorganization.

Almost everyone is baffled by the inability of California’s legislative leaders to break the state’s budget stalemate, leaving it on the edge of bankruptcy. Concurrently, GM, which a month ago was itself flirting with financial ruin, has been given a second chance exactly because it was forced into bankruptcy.

In each case, layman and analyst alike were bewildered by a culture that had grown so completely isolated from how things work in the “real world.” California’s Governor and Legislature are like GM managment of six months ago, flying hat in hand to Washington in corporate jets when they should have traveled in hybrids.

Unfortunately, there is little chance that the federal government will take over California, force it to reorganize it’s outdated business model and shed billions of dollars of debt by selling off underperforming assets as it did with GM. However, California’s leaders could learn a great deal from the GM experience.

For years, decades even, there have been warnings that the state, like GM, has been operating under an outmoded and untenable business model. Top management in both cases isolated itself in a cocoon of illusion hung from a framework of false assumptions.

GM executives assumed consumers would buy pick-up trucks and SUV’s forever. Management refused to support policies that would have helped contain the cost of production. They made concessions to workers that were unsustainable in lean times. The company ignored market trends while holding out false hope that the market would somehow turn around and bail them out, even as they hemorrhaged billions of dollars.

Operating under it’s outdated business model, the erstwhile automobile giant suffered a four-decade decline in market share. Over just the last decade, GM lost more than 75% of its market value. A few months ago, it reached the point at which it consumed more money than it brought in by making and selling cars.

As with GM, the state of California has become cash-flow-negative. The business model by which the state once operated is no longer sustainable. Costs must be brought under control and the books need to be balanced. In business, cost control is necessary in good times in order to survive in hard times. State leaders must do the same.

To the Democrats credit, they have moved in the direction of cost cutting, but they need to do more. What they need to do is project expenses into the future and determine a reasonable and fixed baseline amount as the basis for programmatic decision making. The Democratic leadership must then show political courage by making the tough decisions by making deep cuts and show leadership by bucking special interests.

GM was forced by a bankruptcy judge and the Obama administration to shed brands, models, factories, workers and a bloated management. It has also been made clear by the bankruptcy court and the administration that GM needs to undertake a radical restructuring of it’s entrenched management system to survive.

California needs the political will to reduce programs, cut costs and adopt a sound financial structure that will allow the state to live within it’s means. However, such an approach is predetermined to fail unless the Republic minority will consider revenue enhancements.

In business, one cannot simply look at one side of a balance sheet. The other, equal side of expenses is income. Balancing income and expenses is a basic principal of business. Taking income increases entirely off the table makes no sense from a business perspective. Sacramento Republicans cannot expect to solve the state’s financial problems while ignoring half of the equation that is the basis for any successful enterprise.

An example of Republican intransigence is opposition to an oil extraction tax. California may be the only state in the union, perhaps the world, which literally gives away resources to oil companies. Other oil producing states and nations charge handsomely for the permission to drill for liquid gold. Not one oil company has walked away from an oil field because it’s owner charged it for the opportunity to make money.

A modest oil extraction fee would enrich state coffers by about $1.2 billion dollars a year. California’s Republican legislators argue that such a fee would raise consumer costs. But, their argument falls flat because petroleum product prices are set internationally. Market forces much greater that any fee the state may impose governs oil and gas prices. One would think that members of the political party that prides itself for being “businesses friendly” would understand such a fundamental economic reality.

No credible economist in the world would endorse the Sacramento Republican’s approach to addressing the state’s budget stalemate. Members of the political party that has always argued that government ought to be run more like a business have taken what is essentially an anti-business position concerning the state’s budget.

With a sound financial structure in place, a management approach that includes flattening out the company’s multiple layers of executives and another $50 billion in federal loans available to make it through the year, GM has no excuses left if it continues to struggle in the marketplace.

Meanwhile, in Sacramento, Republicans have placed their anti-tax dogma above sound business practices. They have abdicated not only their leadership responsibilities, but also one of their most popular and successful political positions to satisfy right wing zealots. It is almost unheard of. California Republicans have ceded their “run government like a business” message to anyone willing to be reasonable about taxes.

This is where GM and the Sacramento Republican leadership face the same paradox. How do they go about changing the way they do things when they have not changed the group of people that got them in this mess to start with?

Don’t Let the State Shut Down On Me

Now that voters resoundingly said "no" to Governor Schwarzenegger's plan to fix California, he has decided to get back at us by slashing $24 billion in program cuts, including the elimination of healthcare for poor children, the elimination of scholarships for poor students to the state's public universities, shutting down 80% of our parks and much more.  If the Legislature does not give him what he wants by June 30, he claims that he will simply shut down the state. Perhaps he will also hold his breath until he turns blue.

The Legislature has been reduced to hearing desperate appeals from deserving individuals, groups and organizations.  We need healthcare, scholarships, parks and dozens of other vital programs. We realize that there will be cuts, but we should demand that these programs we want be cut less.

Here are a few things the legislature should do immediately to lessen the pain. The Governor will not like them. The out-of-touch, “anti-tax,” Neanderthal Republicans in the Legislature will hate them.  Finally, conservative Democrats or, to modify a term from the Republicans, DINOs (Democrats In Name Only), will worry that they may not get re-elected in their right leaning Districts next year.

If most politicians oppose it or are afraid it, it must be a good start on substantive change.

In September 2008 and again in February 2009, the Democratic leadership bought off Republican support for their budget package by offering up tax breaks for certain Republican friendly businesses.  These tax breaks allow corporations to share credits with affiliated companies.  Next, the corporations were permitted to use losses incurred this year in exchange for rebates on previous year taxes. Finally, multi-state and multinational corporations were allowed to choose which tax formula was applied to them, with the obvious result of reducing most of the taxes the corporations owe in California.

We have near unanimity among the populace and the politicians that we do not want to drill for oil off California’s coast.  What some forget is that California has more than a dozen of the United States' largest oil fields, including the Midway-Sunset Oil Field, the second largest oil field in the contiguous United States.  However, unlike other oil-producing states, California does not impose an oil extraction fee or tax. Almost all other oil producing states impose some sort of fee or tax on oil extraction, which is then spent on a variety of public services. With oil prices rising rapidly, the state is giving away literally billions of dollars that could pay for any number of public services that other states are using to help weather the economic storm.

The administrative rules that govern the assessment of commercial property in California are archaic. These rules were written for situations that existed before Proposition 13 passed in 1978. They allow companies that own commercial real estate to get around updating property values except under certain, unusual circumstances. Commercial property undervaluation has shifted the burden of property taxes from businesses to homeowners — certainly not what voters had in mind when the voted to enact Proposition 13.

California voters made medicinal marijuana legal in 1996.  Today, with a doctor's prescription, Californians are purchasing hundreds of millions of dollars of marijuana for medical purposes.  Unfortunately, the state has never gotten around to requiring that sales tax be charged in transactions involving medical marijuana. Other medicines are taxed when sold.  Regardless of how one feels about the legality of medicinal marijuana, we should all agree that it is sold and when sold, it should be taxed.

As I have argued previously, the state has a “rainy day” fund of $4.5 billion to be used in an emergency.  The Governor and the legislature should agree that the current budget crisis is an emergency and access those reserve funds to help resolve the emergency, save lives and preserve services until the economy gets better or state government begins to get a handle on the crippled budget crisis.

 

It’s a Downpour!

When Governor Arnold Schwarzenegger argued in favor of multiple statewide ballot propositions on the ballot in May, he often referred to the creation of a “rainy day” fund for times the state needed money due to some unforeseen crisis. 

Governor, it’s raining cats and dogs.  And, there is a “rainy day” fund. 

The ballot argument for Proposition 58 in March 2004 concluded with “… join Governor Arnold Schwarzenegger, State Controller Steve Westly, Superintendent of Public Instruction Jack O'Connell, the California Chamber of Commerce, the California Taxpayers' Association, and all 80 members of the California State Assembly—both Republicans and Democrats—and support Proposition 58.”  

Proposition 58, dubbed the “California Balanced Budget Act," was approved overwhelmingly by 71% of California voters.

The Governor, every member of the state Assembly – both Democrats and Republicans, the state’s Taxpayer Association, other elected officials and voters mandated the creation and implementation of both a mandatory balanced budget as well as a “$8 billion reserve” that “could be used to smooth state spending over the course of an economic cycle” in early 2004.

The state’s independent legislative budget analyst determined that the fiscal impact of the approval and implementation of Proposition 58 could have “a variety of fiscal effects, depending on future budget circumstances and future actions taken by Governors and Legislatures.” For about five years, there has existed a requirement that Governor Schwarzenegger and the legislature – both Democrats and Republicans – balance the budget and maintain an $8 billion “rainy day” fund.

Again, according to the ballot argument that the Governor signed, the mandated balanced budget would restrict borrowing money to assure that the state’s credit rating remained strong. However, in March 2009, voters were asked to approve borrowing, among other fiscal tricks, and create a “rainy day” fund that would tide us over in difficult economic times.

It appears that what was supposed to happen in 2004 was recycled by the Governor and the legislature in 2009 to balance a budget that was already required to be balanced.  Further, the Governor and the Legislature argued that a “rainy day” reserve fund of about $12 billion be created while an $8 billion reserve was already supposed to be in place. 

Of course, it’s no surprise that politicians in Sacramento didn’t do what they were told.  However, because the politicians could not agree on a budget for last year and placed the burden of raising taxes and shifting resources onto voters in May, the state is back in the red by more than $24 billion. That means we are back to where we started almost two years ago.

The Proposition 58 mandated balanced budget isn’t balanced and it’s unclear, but appears that the $8 billion “rainy day” fund is only about $4.5 billion.  Now, $4.5 billion is nothing to sneeze at, especially when we are looking into the chasm of a $24.3 billion budget gap.

Whether it is $8 billion or $4.5 billion, it’s called a “rainy day” fund for a reason.  Although the Governor and the legislature created the crisis and it certainly was foreseeable, it is a crisis nevertheless. 

Throw the “rainy day” fund into balancing the budget. Starting at $19.8 billion is a great deal better than $24.3 billion.

In fact, the Governor wants to take about $2 billion away from local governments to fix the hole in the state budget.  Allow local governments to keep their $2 billion and state is still $2.5 billion closer to a balanced budget and a budget agreement.