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Unsustainable California: The Top 10 Issues Facing the Golden State – Wall of Debt

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In Brief

California’s actual “Wall of Debt” is an estimated $443 billion, much larger than the $26.2 billion frequently cited by officials and the media.

Introduction

Over the last decade, California amassed extensive debt that it will have to repay over the coming decades. More recently, the state government and media began referring to the state’s billions of dollars of mounting debts as a “Wall of Debt.” Generally, state officials and the media depict that “wall” as $26.2 billion, far smaller than it actually is. California’s actual wall of debt is $443 billion.

The state’s complete and growing Wall of Debt reflects unsustainable budgeting practices. As its repayment costs rise and shift to later generations, the Wall will redirect spending away from critical public services. Significantly reducing its size is crucial to securing the state’s fiscal health and eliminating year-to-year budgeting gimmicks that mask deeper underlying challenges.

Furthermore, aggressively excluding long-term liabilities (such as those for public employee pensions) from debt discussions is dangerous to citizens and policymakers, alike. While the state does acknowledge its long-term liabilities, it generally fails to treat them as “debt.” Governor Jerry Brown argues that “it is critical that the state develop a plan to address these liabilities which will crowd out the state’s ability to take on new ongoing commitments.” However, refusing to include these critical liabilities in the official Wall of Debt can greatly diminish its significance in the mind of many voters and policymakers.

Reassessing the “Wall of Debt”

According to Governor Brown’s 2014-15 proposed budget, California’s Wall of Debt amounts to $26.2 billion and largely includes short-term debts incurred since 2007-08. These debts include postponed payments to schools, community colleges, and California’s Medicaid program (Medi-Cal).

Among these debts are the “deferral of state payroll costs from June to July,” an accounting gimmick that appears to reduce the year’s overall payroll costs by delaying and pushing those payments into the next fiscal year. Another opaque budget approach included temporarily shifting money from dedicated funding pools called Special Funds to pay for other areas of the budget.

Ultimately, such accounting gimmicks obscure a government’s true financial condition and undermine fiscal transparency by limiting the public’s ability to fairly and accurately evaluate the state’s budgetary and fiscal health. For example, the state has repeatedly resorted to borrowing from internal pools of money to “balance the budget.” On paper and in reality, this type of gimmick misrepresents actual costs to citizens, the media, departments, and policymakers.

“Ultimately, such accounting gimmicks obscure a government’s true financial condition and undermine fiscal transparency by limiting the public’s ability to fairly and accurately evaluate the state’s budgetary and fiscal health.”

The official Wall of Debt vastly understates the actual magnitude of the state’s debt. The actual wall is $443 billion. The complete wall builds upon the smaller official one and includes the following: retirement benefit debt, bond debt, deferred infrastructure maintenance, deferred payments, federal unemployment funds, and interfund borrowing.

The state has largely foregone infrastructure maintenance over the last half-decade, and as a result, California now requires an estimated $64.6 billion in maintenance costs to restore the quality of its infrastructure. Officially, the state’s unfunded public pension and retiree healthcare liabilities total $218.6 billion. Additionally, the state’s outstanding general obligation bonds ($81.1 billion), unissued bonds ($30 billion) and lease revenue bonds ($11.3 billion) total $122.4 billion.

Finally, California borrowed $10 billion from the federal government to fund the state’s unemployment insurance fund. Of that $10 billion, the state currently owes the federal government an outstanding $8.8 billion.

Figure 3a: California’s Official vs Actual “Wall of Debt” Figure 3a: California's Official vs Actual "Wall of Debt"

At eighteen times the size of the Governor’s official figure, $443 billion is a far more accurate and comprehensive estimate of the state’s debt. If the Governor’s outlined $26.2 billion debt is a wall, then the full $443 billion the state owes is a skyscraper.

The Impact of a Growing Wall

The Wall of Debt’s impact will become increasingly apparent as it continues to crowd out often essential services throughout the state. Between 2007-08 and 2013-14, the state’s budget breakdown changed significantly. During the period, the state’s bond interest payments increased 24% and annual retirement payments increased 25%. Conversely, transportation, social services, the University of California, and the California State University’s portions of the state budget all shrank, illustrating the crowd-out effect on some of the state’s key services.

The costs associated with maintaining debt grow as it grows and remains unpaid. They may further harm the state’s fiscal sustainability by limiting its credit worthiness and ability to borrow. Furthermore, delaying massive debt repayment inherently weakens the state’s long-term financial sustainability because it poses the risk that those debt costs will become prohibitively expensive for future generations to repay.

“Furthermore, delaying massive debt repayment inherently weakens the state’s long-term financial sustainability because it poses the risk that those debt costs will become prohibitively expensive for future generations to repay.”

Without significant reform, citizens will continue financing rising debt interest, annual retirement benefit, and higher retiree health cost payments. In the long-term, chronically underfunded systems will hit critically low levels (as is currently occurring with the California State Teachers’ Retirement System, or CalSTRS), meaning they will require ever larger bailouts going forward. Inaction will result in even greater tax burdens on citizens and/or additional cuts to key public services.

In his January proposed budget, Governor Brown outlined a plan to pay down $26.2 billion of the state’s actual debt, but he has failed to address the state’s full $443 billion in outstanding debts. Publicly emphasizing only 6% of the state’s debts – and arguably the least pressing among them – deepens the impact of long-term fiscal obligations on both current and future citizens, jeopardizing the health of their communities.

Accrual-Basis vs. Cash-Basis Budgeting

The accounting gimmicks the state has used to balance its budget are only possible under “cash-basis budgeting.” The practices, such as deferred payments and internal borrowing, have prompted some calls for state and local governments to use “accrual-basis budgeting” in place of cash-basis budgeting.

Under cash-basis budgeting, borrowed funds are considered revenue and expenditures are only recognized when cash actually changes hands. For this reason, governments using cash-basis budgeting may actually be misrepresenting their true fiscal conditions to the public. As stated by the State Budget Task Force, “The practice of cash-based budgeting facilitates gimmicks and short-term measures that obscure actual financial conditions.”

“The practice of cash-based budgeting facilitates gimmicks and short-term measures that obscure actual financial conditions.”
– State Budget Task Force

For example, in the current budget year, California is able to report a budget surplus because it is ignoring billions of dollars in retirement costs earned, but not paid, during the fiscal year. These payments will instead be deferred to future budgets at higher costs. If the state adopted accrual-basis budgeting, it would acknowledge all of the costs accrued in the fiscal year. Doing so now would prevent the state from reporting a surplus, but it would help it better represent the costs facing citizens.

Conclusion

A growing Wall of Debt threatens the state’s ability to provide sufficient public services, which are a cornerstone for California citizens. The wall’s growth is unsustainable. The cost of maintaining too high of a wall manifests itself as higher taxes and service cuts for citizens, a prospect that is already a reality throughout the Golden State.

Reframing the public’s and policymakers’ understanding of our state’s full debt is critical for California’s future. However, the most substantive actions will be establishing and adhering to funding plans that will allow the state to manage those growing long-term debts, interest payments, and retirement contribution levels.

Effectively managing the state’s debt requires more than just paying down internal borrowing and reducing the state’s use of budget gimmicks to report a balanced budget. It requires slowing the growth of unfunded liabilities and working toward truly sustainable systems overall. For today’s citizens and future generations, the difference between the wall’s misrepresentation and reality may be the defining aspect of their lives as Californians.

Works Cited [+ Expand]

Governor’s Budget 2014-15. “Emergency Drought Response.” May Revision 2014-15. http://www.ebudget.ca.gov/2014-15/pdf/Revised/BudgetSummary/EmergencyDroughtResponse.pdf
“Report of the State Budget Crisis Task Force: California Report.” http://www.statebudgetcrisis.org/wpcms/wp-content/images/California-Report-Complete-Version.pdf.
Schick, Allen. “Sustainable Budget Policy: Concepts and Approaches.” OECD Journal on Budgeting. http://econpapers.repec.org/article/oecgovkaa/5l9n6d3bmtmp.htm.
Arnett, Sarah. “State Fiscal Condition: Ranking the 50 States.” Mercatus Center, George Mason University. http://mercatus.org/publication/state-fiscal-condition-ranking-50-states.
Tatum, Adam. “Case Study: Los Angeles’s Pension Slide, 2003-2013.” California Common Sense. http://cacs.org/research/case-study-los-angeless-pension-slide-2003-2013/.
Tatum, Adam. “Re-Calibrating CalSTRS:Evaluating the California State Teachers’ Retirement System’s Funding Shortfall.” http://cacs.org/research/re-calibrating-calstrs/

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