California: Falling Off the Political Cliff

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San Bernardino, California

While Democrats celebrated Barack Obama's re-election on Tuesday, a more portentous election took place in California. If state voting trends carry to the rest of the country, we can look forward to continued class warfare, higher taxes, higher spending and a worsening of the general business climate across the nation.

Often touted as a leader in political and social trends, progressive California swung even further to the left during last week's election. Voters in the once golden state tightened their vice-like grip on businesses and job-creators. Voters approved a series of propositions that make the state a more difficult place to run a business and provide jobs.

The biggest headlines go to the passage of Proposition 30 which raises the sales tax by ¼ percent for four years and retroactively increases state income taxes for seven years on the three percent of California taxpayers who make more than $250,000 annually. California's top tax rate now goes to 13.3%, by far the highest in the country. Interestingly, Proposition 30 was competing for passage with another measure, Proposition 38, which would have raised all state income tax rates. By rejecting the broader measure and choosing to soak only those earning more than 250,000, California voters have shown that class warfare is alive and well as a winning electoral strategy.

In addition to the income tax increase for the wealthy, voters also agreed to protect unions' ability to use payroll-deducted funds for political purposes (Prop 32) and to raise taxes on multi-state businesses by approximately $1 billion annually, spending a large portion of this money on "energy efficiency and alternative energy projects" (Prop 39). This is despite the fact that coal remains by far the cheapest source of energy in the world. Combined with higher taxes, higher energy prices, a higher corporate tax bill, and a continued ability for labor unions to influence policy, this will likely act as a deterrent for businesses to create jobs in the state.

But perhaps the most ominous election development was within the California State Legislature. After the votes were counted, Democrats now control two thirds "super majorities" in both the Assembly and the State Senate. Combined with the power of famously left wing governor Jerry Brown, the Democrats can now completely set the agenda in the state. The small Republican minority will not be able to prevent Democrats from unilaterally raising taxes or increasing spending.  Progressives are chomping at the bit to raise more revenue through the destruction of the decades old Proposition 13, which limited rates by which local governments could assess property taxes. 

In California, more than in just about every other state, many people have come to believe that the Democratic Party is firmly in the pocket of gargantuan public sector unions including the teachers, prison guards, police, and municipal workers. These interests have never shown the slightest regard for the needs of business or for fiscal sanity. It seems their only agenda is to secure higher pay and fewer work requirements for their members.

The last time any party in California held the governor's chair and a supermajority in both houses was in 1933. But Democrats have for decades controlled the legislature, albeit without a supermajority. In addition they have had to deal with a series of Republican governors, including the most recent "Governator", Arnold Schwarzenegger. Despite these obstacles, Sacramento has managed to make California one of the least competitive states in the nation. They now have the ability to approve spending and tax increases without any Republican support. 

In Washington, Democrats have not enjoyed that kind of power since 1978. In fact, the last time any party was so firmly in control was during the Johnson Administration in the 1960's (and to a lesser, and briefer, extent during the first half of the Carter Administration).The ruinous policies of Johnson's "Great Society," which many believe laid the foundation for today's fiscal disaster, would not have been possible if Republicans could have mustered 40 filibuster votes in the U.S. Senate. Republicans finally got that 40th vote in 1978 and have not lost it since. The lack of a clear supermajority on the Federal level prevents Democrats from simply raising taxes to avoid the fiscal cliff. For more on our take of the impending fiscal crisis, check out our special election edition of our Global Investor Newsletter.

For those of you who may have missed the news: California is in serious trouble. According to Forbes magazine, pensions for the state and local government employees are underfunded to the tune of $650 billion. That comes to roughly $17,000 per Californian. The state's yearly operating budgets over the last decade have featured deficits larger than the budgets of twenty states. California now boasts the third highest unemployment rate in the nation (10.2%) and some of the highest rates of home foreclosures in the nation. The Wall Street Journal reports that the state has also borrowed $10 billion from the Federal Government to pay for jobless benefits. In the last year, five major California municipalities have either filed bankruptcy or took steps to do so. Forbes also reports that since 1998, 4.4 million taxpayers have left the state in search of better economic climates.

Sacramento politicians seem completely unaware that their state is fast becoming an economic basket case. At present their biggest priorities seem to be going into deeper debt to fund a high speed rail line that no one wants and to saddle businesses with even more restrictive environmental regulations. As a result, the trend of California employers pulling up stakes for more hospitable markets has increased markedly in recent years. Last week Los Angeles voters even had the poor sense to saddle one of its stalwart industries, the adult film business, with unneeded condom regulations. Many speculate that the industry may just decide to decamp to Las Vegas.   

It's hard to underestimate the power that this unilateral political control offers, especially when it's wedded so firmly to the re-distributive impulses of public sector labor unions. As a result, we can expect the business defections from California to pick up speed. With tax paying job creators increasingly taking their businesses to more hospitable environments, look for California's already bleak fiscal picture to get even worse. At some point, our nation's biggest state may become a national albatross.   

In depth analysis of this and past election's 'day after' market trends can be found in our current election edition of the Global Investor Newsletter. Worse than the much-ballyhooed fiscal cliff, it appears that California is headed off the political cliff. The only silver lining is that we may now have a clear test case that will illustrate the destructive nature of big government solutions. When California finally runs out of steam, the left will have to take all the blame. But given the size of the Californian economy, and its importance to the rest of the country, we may not survive the experiment.  

This article is taken from a special Election Edition of the Euro Pacific Capital Global Investor Newsletter. Click here to read additional articles from the newsletter.

Neeraj Chaudhary is an Investment Consultant with Euro Pacific Capital. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

This article is contributed by Euro Pacific Capital and does not represent the views or opinions of International Business Times.

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