State of dependence as debts mount

LOS ANGELES // California, a state with a larger economy than those of Russia, India and Brazil, is going broke. Facing a budget shortfall of US$26 billion (Dh96bn) and with revenues plummeting because of tax cuts and the recession, the California governor, Arnold Schwarzenegger, has declared a fiscal emergency. His cash-strapped state government last week started handing out IOUs to state vendors in place of regular cash payments. Economists say the state will run out of money to pay its core functions in mid-September. With the state legislature locked in a bipartisan battle over how to close the yawning deficit, the California government is expected to issue nearly $3bn worth of the interest-bearing IOUs in the month of July alone.

Some major banks, including Citibank and Bank of the West, have agreed to accept the IOUs for another week, but other major financial institutions, including Wells Fargo, JP Morgan Chase and Bank of America announced on Friday that they would no further longer bear the state's burden. "California - just like any household or business - must be responsible for living within its means," said Wells Fargo in a statement. "Banks are not and cannot be the solution to California's budget problems." In addition to the IOUs, the government has furloughed state employees for three days a month, cancelled summer school programmes, slashed budgets at the state college system and temporarily shut some state services. "We are facing institutional paralysis," said Gabriel Aguilera, who teaches political science at California State University in Chico. "The Republicans are unwilling to contemplate any form of tax increase and the Democrats are unwilling to cut spending."

Mr Schwarzenegger, a Republican, outraged liberals when he proposed eliminating welfare and child health care programmes and reducing state care for elderly and disabled people. After his approval ratings plunged to 33 per cent, the Hollywood star-turned-politician backed off those plans, instead turning his attention to weeding out what he called "fraud and abuse" in the state's social services programmes. For all that Mr Schwarzenegger's star has fallen, California legislators are even less popular, according to a recent Field Poll, which found that only 14 per cent of state residents approve of the job the legislature is doing, the lowest rate since the organisation began polling three decades ago. In recent weeks, California lawmakers have taken up a raft of seemingly trivial food regulatory measures: scripting a legal definition of honey and determining what qualifies as pure pomegranate juice, among others. They also debated a bill that would bar cattle farmers from lopping off the tails of their cows, prompting the enraged Terminator-turned-governor to pounce.

"I think that this is inexcusable," Mr Schwarzenegger said in a July 1 press conference. "How do they explain this to the people of California? That in the midst of the biggest budget crisis, we're having a debate about cow tails. Stop debating about cow tails and let's do this budget." But lawmakers in California are stuck in an impossible situation. Since the late 1970s, successive legislatures have slashed property, capital gains, inheritance and vehicle taxes, while state spending has soared. California was able to make ends meet during the dot-com bubble and through years of economic boom, but the fiscal situation headed south quickly when the housing crisis struck and later when the financial meltdown occurred. Polls have found that a majority of Californians are not willing to finance the state's recovery through tax hikes, but neither do they want to see cuts on health care, public schools or higher education.

"Voters seem to want an unsustainable combination of increased services and lower taxes," wrote John Vasconcellos, a former state senator, in a column in the Los Angeles Times on Saturday. "That, in a nutshell, is how we got into this mess." Unfortunately for the US economy, California is far from alone. In Illinois, the governor, Pat Quinn, vetoed a new state budget on Wednesday, saying it did not guarantee how state services would be funded, while Ohio lawmakers were locked in debate over whether to raise funds by legalising gambling. States from Florida to Oregon are closing down summer school programmes and bracing for tough education cuts in the fall. The Washington-based National Association of State Budget Officers said 42 states are contending with severe budget deficits, the highest number since the group began tracking state budgets three decades ago. The organisation blamed an across-the-board drop in tax collection, along with falling home prices, the poor economy and declining wages. Nowhere is the problem as severe as California, where economists and political analysts agree that a 30-year span of overspending and undertaking will have to end. "The political and institutional setbacks are reminiscent of many of the developing economies that I study in Latin America," Mr Aguilera said. "Through a combination of greed and negligence, we are destroying a very important engine in the US economy." [e-mail]