California's budget recovery may be wrecked by fiscal cliff tumble

12/28/2012 5:45 AM

12/28/2012 6:49 AM

Gov. Jerry Brown and California lawmakers struck an upbeat tone in recent weeks as they enjoyed their most positive budget outlook since the economic downturn.

Whether that mood survives the winter depends on Washington.

State budget experts say the biggest immediate threat to California finances is a recession triggered by automatic federal cuts and tax hikes, absent a political deal to avoid the so-called "fiscal cliff."

The state's biggest federal program, Medi-Cal, is spared from automatic cuts. But a new recession could threaten the state tax revenue that serves as the lifeblood for California government.

"A lot of it relies on confidence, and I think that one of the things that makes this especially hard to predict is we can't really know how businesses and consumers will respond," said Jason Sisney, the chief forecaster at the Legislative Analyst's Office.

In November, the LAO predicted a relatively small $1.9 billion state budget deficit through June 2014, followed by surpluses in years thereafter.

But in a separate simulation based on a federal impasse, the LAO estimated the state would receive $11 billion less across two years in a recession, nearly a 6 percent drop. A decline that size would force state lawmakers to impose spending cuts, just as many Democrats are eager to restore health and welfare programs, or to look for other ways to raise money.

Sisney said recession predictions assume that consumers and businesses lose confidence in the economy because people have to pay higher taxes and the federal government reduces its spending.

Absent a deal, about 400,000 Californians would stop receiving unemployment checks after this week, representing 43 percent of the state's 923,000 beneficiaries, according to the state Employment Development Department. These are people who have collected unemployment checks beyond the standard 26 weeks. Some have been able to receive up to 99 weeks of assistance.

The federal government would impose across-the-board cuts to most programs, from national parks to regulatory agencies. California has more federal civilian employees than any other state (169,000 as of 2009, according to the Census Bureau), who could face job or pay reductions.

K-12 schools and research universities also stand to lose out. The California Department of Education estimates that K-12 schools will face $346 million in cuts, largely at schools serving low-income and disabled children. In a letter to Congress this month, state Superintendent of Public Instruction Tom Torlakson warned that such reductions could lead to layoffs, school closures and larger class sizes.

"Any funding cuts to education that occur when state funding for education has also been cut would be difficult, but those cuts under sequestration would be truly devastating," Torlakson wrote.

"Sequestration" is the technical term for the method by which cuts would take place.

The University of California system estimates it would lose $335 million in federal research funding this fiscal year, according to Christopher Harrington, spokesman for UC's Washington, D.C., office. That represents roughly 8 to 9 percent of UC's research portfolio from such agencies as the National Institutes of Health, National Science Foundation, U.S. Department of Agriculture and Department of Energy.

"We are urging Congress and the administration to reach agreement so we don't go over the fiscal cliff and we protect research and education," Harrington said.

Sisney noted that California could see delays in tax filing because Congress has yet to adjust for inflation the alternative minimum tax, which is paid by an estimated 3 percent of income tax filers.

The Internal Revenue Service has warned that tens of millions of taxpayers won't be able to file until March or later if the AMT patch isn't approved. That would delay income tax collection in California.

Federal leaders wrote the fiscal cliff triggers last year as a way to force Republicans and Democrats to compromise on a better set of solutions to reduce national deficits. The deal included significant cuts to the defense industry, which has a considerable presence in the San Diego region.

An aerospace industry report by George Mason University economist Stephen Fuller found that California could lose 225,464 jobs by virtue of the defense reductions.

Not all programs would be cut. Besides Medicaid – the national program called Medi-Cal in California – Social Security and veterans' benefits are spared. Medicare would see a smaller 2 percent reduction in payments to providers.

Jerry Nickelsburg, senior economist with the UCLA Anderson Forecast, said he believes the U.S. would experience a "mild recession" absent a fiscal cliff deal, largely because of lower consumption. He also warned that reduced profits in 2013 could mean less tax revenue than Brown expects from his voter-approved tax hike on wealthy earners.

But Nickelsburg said it is difficult to tell exactly how federal cuts would affect the economy, in part because agencies haven't entirely decided how they would cut programs or jobs.

The Congressional Budget Office last month predicted that the fiscal cliff would result in a 0.5 percent drop in gross domestic product in 2013, as well as an uptick in national unemployment.

Federal leaders remain at odds over a fiscal cliff deal, but if they send signals they will avert cuts and taxes, even weeks into the new year, the state and nation may avoid recession, Sisney suggested.

Though the fiscal cliff is described in harrowing terms and many people are advocating for softer, smarter reductions and tax hikes, Sisney said effects in the long term could nonetheless be positive.

"While all of this surely would cause damage to the economy in the short term, the federal government being of sounder fiscal condition has long-term benefits," Sisney said. "In the long term, the federal government may have more resources to put into the economy, more flexibility to lower taxes and more flexibility to invest."

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