by John M. Curtis
(310) 204-8700

Copyright January 15, 2003
All Rights Reserved.

eeking to close a catastrophic $34.8 billion budget deficit, California Gov. Gray Davis proposed a staggering $11.8 billion in spending cuts, $8 billion in tax increases and $4.6 billion in funds shifts, loans and other revenues, facing the ugly reality that the tax gravy train left the station. Spreading the pain, Davis' plan slashes $5.4 billion from public schools and a blistering $4.2 billion from local governments. "This budget will not pass the Legislature as presented, not with $8 billion worth of job-killing tax increases," said Assemblyman John Campbell (R-Irvine), vice chairman of the Assembly Budget Committee. "That will not happen. Republicans will not vote for that." Supply-siders like Campbell believe that tax-increases stifle growth and hurt an already weak economy. While Davis bears some blame, he's not responsible for the stock market meltdown that began in March 2000.

     When Reagan cut taxes in 1981, his projections promised a balanced budget by 1983, based, according to supply-siders like his budget director Dave Stockton, on the stimulus created by tax reductions and fiscal discipline. When Reagan left office in 1989, he handed his successor George H.W. Bush a $160 billion deficit, nearly tripling Jimmy Carter's original $63 billion shortfall in 1981. When Clinton took over in 1993, he faced a nearly $300 billion deficit, though its fraction of the Gross Domestic Product continued to shrink. When Clinton finally balanced the budget in 1997, Republican's attributed it to the promises of Reaganomics—supply-siders finally proved their point. Taking the credit, Democrats attributed the balanced budget to Clinton's sound economic policies. By 1996, stock market averages began to advance, generating unprecedented capital gains revenue in both federal and state coffers.

     From 1997 through March 2000 the DOW jumped 65% or 18% per year, while the tech-rich Nasdaq skyrocketed 350% or 85% per year, generating hefty capital gains, income tax revenue and whopping surpluses in both federal and state government. With the Internet frenzy and dot.com bubble generating copious market capitalization, businesses went on a four-year splurge, lavishly spending on payroll and new infrastructure. Supply-siders continue to credit low tax rates with the record run-up in share prices, but in reality, marginal tax rates were obscenely high during the Clinton years, attesting to the unexpected surpluses. With the economy booming, neither Republicans nor Democrats pushed tax cuts or fiscal discipline, growing government programs without much restraint. Those same Republicans now blame Davis for his run-a-way spending binge, putting the state into its current fiscal mess.

     Most economists now realize that Internet frenzy and dot.com bubble was a one-time anomaly, loading government coffers with cash from income tax and capital gains revenue. "It has been very tough forecasting the unknowable, which is the stock market and what would arise out of the stock market," said outgoing California Director of Finance Timothy Gage, anticipating continued shortfalls in the state budget. Few experts predict the kind of rapid stock market growth seen during the tech-bubble of the late '90s. In the early '60s, the state derived only 18% of revenues from income or capital gains taxes. Today, the state gets 48% of its revenue from income taxes, leaving the treasury hopelessly dependent on income and capital gains taxes. With economists forecasting anemic growth in 2003, Davis is going after sales tax and vehicle registration fees to make up the difference.

     Income tax from stock options and capital gains dropped from its peak of $16.9 billion in 2000 to $4.7 billion in 2002, leaving the state a $12.2 billion shortfall derived directly from the stock market. When you add in job losses and rising unemployment, ordinary income taxes also expect to take a hit, lowering revenue estimates from $40.5 billion to 33.6, billion, well below the 2000 peak of $45 billion. "The economy took a turn for the worse over the summer," said Gage, though the stock market has showed some signs of life after bottoming out in early October. Depending on future capital gains taxes is risky business for a state still reeling from spiraling power prices in 2000 and 2001. It's difficult to pinpoint the amount of red ink directly attributable to energy, though Davis claims the state is owed $9 billion, just under 25% of the current deficit. One thing's for sure, the state can no longer count on the stock market.

     Diehard supply-siders must get with the program and stop fantasizing about tax cuts producing balanced budgets. During the late '90s, California grew dangerously dependent on one-time capital gains taxes connected to the booming stock market. With the market now deflated, the state must look for new sources of revenue, other than income taxes. Working with Davis, elected officials must stop pointing fingers and decide which combination of tax-hikes and program cuts make sense. "These are hard choices," Davis told reporters at a Capitol press conference after unveiling his budget. "I did not like making them. But the buck stops with me, and I had to make them," echoing the misery of slashing $24.4 billion from the $34.8 billion deficit. Unlike the U.S. treasury, Davis can't print more money to solve the current fiscal crisis. Though the choices seem bleak, they're far better than waiting for the market to come back.

About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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