Commercial Surety Bond Agency President and SCCA member Dan Huckabay wrote a stellar article for the November/December 2018 SCCA Magazine on how contractors can prepare for the next recession. He referenced an analyst who had said 2019 looks economically solid but the picture gets a lot murkier after that. The analyst ultimately predicted a mild recession in 2020 or 2021.
Throughout the article, Huckabay explained that reducing debt, deferring large business purchases, and preparing businesses to operate with reduced earnings and less gross profit are ways to prepare for the inevitable recession. Valuable and wise advice.
Similarly, a Public Policy Institute of California report published in May 2019 entitled “Preparing for California’s Next Recession” examines California government’s revenue sources and why they are so volatile. It explores three potential recession scenarios with the worst showing a $173 billion revenue loss to the state over a five-year period. For comparison’s sake, the 2019-2020 budget anticipates nearly $215 billion in spending. Most importantly, it discusses options for the state when the recession ultimately hits.
Only a select few people in Sacramento have thought about an economic downturn. Why should they? The current economic expansion is approaching its 120th month. Job growth alone has seen an increase for the last 102 months.
Despite the extraordinarily long economic expansion, some economic prudence has risen in Sacramento. During Governor Brown’s final budget presentation in 2018, he provided the following advice to his successor: “What’s out there is darkness, uncertainty, decline and recessions, so good luck baby.” The governor’s pessimistic attitude toward future economic conditions is a blunt reminder that the Golden State can, and will, experience future recessions.
The intensity and duration of those future recessions are unclear. However, after reviewing and analyzing them, the PPIC report produced Table 1, which estimates the duration and lost revenue of mild, moderate and severe recessions.
Note that even a moderate recession, as Huckabay referenced as a strong possibility, will result in a 12 percent revenue loss equaling $23 billion less in state spending per year.
That’s a steep decrease for a moderate recession. The reason why it’s so significant is directly related to California’s progressive tax system, resulting in strong revenue volatility. Surprisingly, the top 1 percent of California income earners reported about 23 percent of all the adjusted gross income reported in California personal income tax (PIT) returns, accounting for 46 percent of the total personal income tax paid – that’s the top 1 percent contributing about half of all PIT revenue.
Considering that the personal income tax accounts for 70 percent of California’s General Fund revenues, the significance becomes rather apparent – California heavily depends upon the top income earners for its revenue. When recessions hit, the top income earners see significantly less revenue as their investments generate lower returns. And California revenues spike downwards because of it.
A quick sidebar discussion – California’s revenue volatility is no surprise to policymakers. Senator Hertzberg (D-Van Nuys) has long talked about it. The legislature has considered reducing this volatility several ways, usually by expanding the base number of taxpayers in order to more evenly distribute a recession’s impact. But the political challenges always squash the proposals. There’s no solution to the volatility without reducing the burden on high-income earners and, most troubling to California policymakers, increasing income taxes on the middle- and low-wage earners. Viable solutions can’t circumvent that challenge.
So, what has the state been doing and what can it do to prepare for the next recession? Not surprisingly, a lot of the advice given by Huckabay is similar at the state level.
The state has been paying down previous debt and depositing considerable revenue into so-called rainy-day funds. These funds are provisions in statute, such as Proposition 2, that are triggered when revenues exceed a certain amount.
Governor Brown was diligent in depositing more revenue into the rainy-day funds than he was mandated to. To date, the state has at least $21 billion set aside for reserves. It won’t completely save the state in a recession, but it will significantly ease the pain.
Another sidebar – many policymakers from the conservative persuasion tend to believe these higher-than-expected revenues should be returned to the taxpayers, not added to reserve funds. Their argument is that the state government is receiving more than it needs and therefore should be returning it to taxpayers.
However, the volatility in revenues creates a feast or famine, rollercoaster-type fiscal scenario for state government. So, rather than return the funds during strong economic times, policymakers have socked them away to be used during a recession.
It’s also true that utilization of the reserves will potentially reduce tax increases on the top earners during economic downturns. Knowing this, policymakers should be cautious not to raise taxes with such a massive reserve or else they may experience a revisit of the 1970s when similar political dynamics occurred. Proposition 13, which limits the growth and caps the amount of assessed property tax, passed in 1978 as a reaction to Sacramento’s desire to tax while it held significant revenues.
Other ways the state can plan for the next recession were foreshadowed by Huckabay’s article as well. Policymakers and their staffs are already looking to prioritize state programs in advance. These decisions will begin the process for choosing the “least” bad options that align most closely with their values.
Of course, the “worst” options are increasing taxes or cutting programs during the recession. Increasing taxes only removes dollars from the economy when they’re needed most. And cutting spending in social programs and education, the two biggest recipients of the state’s General Fund, are equally “bad” because many Californians will need the economic support they provide. Shrinking that net will be unpopular with policymakers.
The state should expect the federal government to assist in a recession, as well. Unlike the state, except for the state-issued general obligation and revenue bonds the feds can utilize deficit spending through borrowing.
But the days of robust federal assistance may be a thing of the past. U.S. debt has traditionally stayed in the 40 percent to 65 percent range of the country’s gross domestic product. It spiked to 100 percent after the Great Recession in 2009. That tool will likely be limited in future recessions.
Despite the debt-to-GDP ratio concerns, there were two significant tools California used to help ease the impact of the Great Recession. It’s likely those tools will be used again in the next recession. Voters approved nearly $20 billion in infrastructure bonds in 2008 and part of the federal government’s stimulus plan included more infrastructure funding through the American Recovery and Reinvestment Act of 2009. That program spent $878 billion at the national level, although, as noted, federal assistance might not be as strong for the next recession. Regardless, infrastructure investment was used heavily during the last recession, something of a time-honored tradition in the United States.
California truly suffered during the Great Recession, losing approximately $125 billion in revenues. But we learned some valuable lessons during the recession and, while there isn’t a golden bullet to solve budget deficits in a recession, policymakers have begun to prepare for the next one. Todd Bloomstine is a California registered lobbyist. He is the owner of Bloomstine & Bloomstine LLC and has represented SCCA in Sacramento since 2001.
Todd Bloomstine is a California registered lobbyist. He is the owner of Bloomstine & Bloomstine LLC and has represented SCCA in Sacramento since 2001.
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