A Cautionary Tale

Europe has Greece and Spain.   The United States has California and Illinois.

Fiscal wrecks.  Budget nightmares. Ticking debt bombs.

Each is a testimonial to why the tax and spend, welfare state, public union, red tape regulation form of government does not work.

Both of these states are on track towards a debt cliff that is on the horizon.  They do not seem to think of using the brakes.  It has been full speed ahead.  Their only thought seems to be to continue to feed the Democrat voting constituencies in these states of the liberal elites, labor unions, envionmental extremists and welfare state advocates.

The only good that might come out of it is the cautionary tale it should be to other states and the federal government.  This is not the way to run a railroad...or a government.  You cannot tax and spend your way to prosperity.  You cannot continually serve special interests at the expense of the public interest.  You can only get so many golden eggs out of the golden goose.

The Wall Street Journal's Allysia Finley recently interviewed Joel Kotkin, one of the nation's premier demographers and a long-time California resident, about the problems in the Golden State that are driving the middle class out of the state in "Joel Kotkin:The Great California Exodus."

Nearly four million more people have left the Golden State in the last two decades than have come from other states. This is a sharp reversal from the 1980s, when 100,000 more Americans were settling in California each year than were leaving. According to Mr. Kotkin, most of those leaving are between the ages of 5 and 14 or 34 to 45. In other words, young families.

The scruffy-looking urban studies professor at Chapman University in Orange, Calif., has been studying and writing on demographic and geographic trends for 30 years. Part of California's dysfunction, he says, stems from state and local government restrictions on development. These policies have artificially limited housing supply and put a premium on real estate in coastal regions.

"Basically, if you don't own a piece of Facebook or Google and you haven't robbed a bank and don't have rich parents, then your chances of being able to buy a house or raise a family in the Bay Area or in most of coastal California is pretty weak," says Mr. Kotkin.

While many middle-class families have moved inland, those regions don't have the same allure or amenities as the coast. People might as well move to Nevada or Texas, where housing and everything else is cheaper and there's no income tax.

In other words, the liberal elite have their place in the sun so no one else needs to be anywhere near the beach.

"The new regime"—his name for progressive apparatchiks who run California's government—"wants to destroy the essential reason why people move to California in order to protect their own lifestyles."

Kotkin also speaks about California's cap and trade law (AB 32) which will further increase energy costs while making almost no difference in carbon emissions as another middle class killer.  California's energy costs are already 50% higher than the national average and it is certain to get a lot worse.  These high energy costs will drive more middle class manufacturing jobs out of the state over the next decade.

There is also the $100 billion bullet train.  Right now a train to nowhere.

Mr. Kotkin calls the runaway-cost train "classic California." "Where [Brown] with the state going bankrupt is even thinking about an expenditure like this is beyond comprehension. When the schools are falling apart, when the roads are falling apart, the bridges are unsafe, the state economy is in free fall. We're still doing much worse than the rest of the country, we've got this growing permanent welfare class, and high-speed rail is going to solve this?"

Of course, we can't forget about taxes.  You always can use more tax revenues to feed the budget beast in California.

Meanwhile, taxes are harming the private economy. According to the Tax Foundation, California has the 48th-worst business tax climate. Its income tax is steeply progressive. Millionaires pay a top rate of 10.3%, the third-highest in the country. But middle-class workers—those who earn more than $48,000—pay a top rate of 9.3%, which is higher than what millionaires pay in 47 states.

And Democrats want to raise taxes even more. Mind you, the November ballot initiative that Mr. Brown is spearheading would primarily hit those whom Democrats call "millionaires" (i.e., people who make more than $250,000 a year). Some Republicans have warned that it will cause a millionaire march out of the state, but Mr. Kotkin says that "people who are at the very high end of the food chain, they're still going to be in Napa. They're still going to be in Silicon Valley. They're still going to be in West L.A."

However, the middle class has been (and will continue) to leave in droves.

As a result, California is turning into a two-and-a-half-class society. On top are the "entrenched incumbents" who inherited their wealth or came to California early and made their money. Then there's a shrunken middle class of public employees and, miles below, a permanent welfare class. As it stands today, about 40% of Californians don't pay any income tax and a quarter are on Medicaid.

It's "a very scary political dynamic," he says. "One day somebody's going to put on the ballot, let's take every penny over $100,000 a year, and you'll get it through because there's no real restraint. What you've done by exempting people from paying taxes is that they feel no responsibility. That's certainly a big part of it.

And the welfare recipients, he emphasizes, "aren't leaving. Why would they? They get much better benefits in California or New York than if they go to Texas. In Texas the expectation is that people work."

It is not much better in Illinois.  It actually might be worse.

Illinois raised corporate taxes 30% and individual income tax rates 67% in January, 2011 to supposedly solve a $4.6 billion deficit.  Where do things stand today?  The projected budget deficit for this year is $5 billion.  In addition, the unemployment rate increased faster in Illinois than in any other state in 2011.  This feels a lot like quicksand.

A big reason that Illinois is not making any progress on its fiscal challenges is that its public pension and retiree health program is an economic black hole.  The public sector employees have completely taken over the state.  For example, consider that the unfunded retiree health obligations for public employees averages $3,399 per person if you live in Illinois.  In neighboring Indiana, it is a mere $81 according to Steve Malanga of the Manhattan Institute.   That raises the question of who would want to move to Illinois and assume that obligation?  And if you live in Illinois, why would you not be making plans to move to Indiana if you could?

Even Rahm Emanuel, President Obama's former Chief of Staff is seeing the writing on the wall.

Chicago Mayor Rahm Emanuel recently offered a stark assessment of the threat to his state's future that is posed by mounting pension and retiree health-care bills for government workers. Unless Illinois enacts reform quickly, he said, the costs of these programs will force taxes so high that, "You won't recruit a business, you won't recruit a family to live here."

George Will writes in The Washington Post that "Illinois is running out of time and money" and cites the depth of the problems that Illinois has brought upon itself with its public employees.

The Illinois Policy Institute, a limited-government think tank, in a report cheekily titled “Another $54 Billion!?” argues that in addition to the $83 billion in pension underfunding the state acknowledges, there is $54 billion in unfunded retiree health liabilities over the next 30 years. Illinois, a stronghold of public-employees unions, “is on pace to spend nearly $1 billion on retiree health care benefits in fiscal year 2013, more than double what it spent in 2003. Worse yet, these liabilities are growing more than twice as fast as tax revenues.”

A day of reckoning is on the horizon.  The cliff draws closer.  The big question is what happens when they go over the cliff?  We have seen Wall Street bailouts.  We have seen European bailouts.  We are sure to hear calls for a California and Illinois bailout.  This may be the biggest unspoken issue that will be before us in the next four years.  Who is sitting in The White House and in Congress will make an enormous difference when the time comes.  A cautionary tale, indeed.