Thursday, October 8th, 2009

What’s Killing California?

California has a case of the same disease that felled the Rust Belt. Will the patient survive?

California Failin’

The troubles of California, and their causes, are a widely discussed topic these days. America’s most populated state by far, its successes and failures always loom large in the national consciousness. In the last year we’ve seen the state face a massive $42 billion budget deficit and the humiliation of having to issue IOU’s as payments. Its pensions are radically underfunded and there are other long term structural budgetary problems. Parts of the state were ground zero for the housing collapse and among the highest foreclosure zones in the country. Unemployment, high everywhere, is particularly so in parts of California. California, the place people once moved to, is now the place the move from, as the state is experiencing net domestic out-migration, leading to the prospect of losing a representative in Congress for the first time in its history. A complicated political system has led to decision making paralysis. Even disasters like wildfires have been played up.

There are no end to explanations for this which, unsurprisingly, tend to follow people’s political beliefs. To those on the right, California is the ultimate blue state, with high taxes, an anti-business mindset, and environmental and other regulations designed to send people and businesses fleeing for the exits. To those on the left, California’s problems are the comeuppance for decades of unchecked sprawl, the ultimate car culture, and unchecked exploitation of resources. Whatever your particular policy pet peeve, California must be it.

But is this really the case?

The real problem could be much more simple and yet much more terrifying in its implications. California has simply now outgrown its youth and is now well into its middle age. Like the Rust Belt before it, California is now old. As with people as they age, “chronic lifestyle diseases” hit places too. These are: unfunded liabilities, the end of growth economics, and institutional rigidity, each of which builds on the one before it.

Unfunded Liabilities

I’ve long noted that places have an incredible tendency to accumulate unfunded liabilities, most of them of the “off balance sheet” variety. The temptation to defer problems into the future is simply too great for most governments to resist, hence structural imbalances build up over time. The sources of these liabilities are many, but here are some key ones:

  • Deferred Infrastructure Investment. As populations and development grow, infrastructure is built with a lag and generally there is a lack of funds for completion. As a result, cities and states end up with deficient infrastructure for their size, leading to all sorts of problems such as traffic and transit congestion. Clearly, California is suffering here.
  • Infrastructure Maintenance. Similarly, cities build some infrastructure, then “sweat the assets” as long as possible. Infrastructure is often not well-maintained, and the periodic capital refresh unbudgeted. Condo associations do reserve studies and set aside funds to meet future capital needs such as roof replacements to avoid painfully huge special assessments, but government do not. I have yet to see any city or state that even has a schedule of major assets and infrastructure with needed maintenance and replacement timeframes, much less funding for any it. California’s Golden Age infrastructure is now aging, and it is facing repair bills merely to maintain what it has.
  • Underfunded Pensions. Politicians love to sweeten public sector pensions. This buys both labor peace and a powerful political constituency. These are seldom funded at adequate levels – and with the rapid growth in life extending technology, it’s questionable whether any level of funding is sufficient – leading to major problems downstream. California’s pensions are unfunded by upwards of $300 billion.
  • Other Redevelopment Costs. When ever homes and buildings are shiny and new, things are great. But what happens when your building stock gets old like in Rust Belt inner cities, and often no longer meet the functional and technical demands of the modern day, such as sizes, layouts, energy efficiency, etc.?

Add this all up, and it’s a huge bill that eventually comes due. The most important thing to understand about this is that the bill attaches to the territory, not to the people. So residents and businesses can avoid paying up simply by leaving for another jurisdiction. It’s like being able to run up a huge credit card bill in someone else’s name, then skip town.

This ability to run up massive deferred and unfunded liabilities, then leave, sticking other people with the bill, is one of the most powerful forces driving greenfield development. Even if there weren’t a drop of subsidies to, say, suburban expansion, the financial incentive to escape the huge liabilities of central cities and older suburbs is a key incentive on its own.

This why I’ve said it is critical to find ways to prevent governments from accumulating these liabilities in the first place.

The End of Growth Economics

Look at companies and industries. There is a standard growth curve to them. They start out in incubation and infancy, then, if successful, on to growth, then finally to maturity and decline. Why would we think that what is true for firms would be different for places? Why would we think that cities or states are immune from the forces of creative destruction? The answer is, they aren’t.

Having done consulting in the retail industry for some years, I often observed the growth curves played out in companies. Category killers came along and grew and grew and grew, seemingly as unstoppable juggernauts. But eventually, they hit the end of their growth phase, and had to endure a period of wandering in the wilderness. The reasons for this are varied – market saturation and consequent over expansion, changes in the marketplace, insufficient infrastructure and operational disciplines, more nimble competitors – but we’ve seen it played out before our eyes in America. Think McDonald’s, Home Depot, and the Gap.

The logic and economics of high growth are fundamentally different from that of operating a more or less steady state or low growth business. In the growth phase, everything is oriented towards expansion, mostly building more infrastructure to keep up with it. Also, scale economics are in your favor. With more people, for example, you are spreading fixed costs across more bodies and more buildings, so you can spend more money and tax less per capita all the same time. Your brand value is expanding with size, etc. That’s all great if you can pull it off.

But when something causes growth to take a hit – maybe accumulated liabilities, resource exhaustion, jurisdictional limits, etc – the equation changes radically. You can no longer rely on growth to provide unit cost efficiency. You have to start thinking like an operator. That is an extremely difficult mindset shift and requires a totally different set of skills. From what I’ve seen, companies have an extremely difficult time doing this. They generally have to struggle for some time, usually bring in new leadership, and undergo painful structuring. Many of them never really recover. But some do. I think of McDonald’s, which stopped relying on store growth to fuel its engine, but now relies on product innovation (Angus burgers, coffee, salads, etc) and operational effectiveness.

California, for whatever reason, stopped growing. The trends in domestic out migration make this very clear. The fact that total population has not declined doesn’t matter. Most Rust Belt states never actually physically lost population. Their growth simply slowed to a crawl. And it was the most entrepreneurial and high skill classes that fled. In California that his been somewhat masked by outsized productivity in the technology sector and international immigration, but the overall trend is clear. California now has to think like an operator. Welcome to the world of legacy. California is now a gigantic “brownfield”.

As California struggles with this transition, the scale economics start to go in reverse. As people and businesses leave, the unit cost of all those unfunded liabilities looms large. Just as growth begets growth, decline begets decline. If you are young and ambitious, why stay in California and pay off all those pensions? All things being equal, it is much better to leave for a more greenfield location, where you can benefit from running up the credit card, not paying off someone else’s bill. If not arrested, decline eventually reaches a tipping point, as we’ve seen in so many Rust Belt cities.

Institutional Rigidity

The third symptom of civic aging is a creeping institutional rigidity that makes change difficult. In established, mature places, there many, many powerful institutions and interest groups. These can often be forces for good, but too often become barriers to change or getting things done. What’s more, these institutions were typically created in the past to meet the perceived challenges of that time and age, but survive today in a world that is very different. As most institutions are never sunset, and new ones form over time, there is a gradual accumulation of friction over time. Eventually, the gears and seize up.

These institutions can take many forms. Constitutions and political structures, non-profits, clubs and social networks, various trade-offs and political accommodations and deals from over the years, power structures, corruption, local business practices, unions, recipients of government funding, taxpayer or other advocacy groups, political party organizations, business groups, etc. Much is made of California’s many times amended constitution as a barrier to change, but that is only the tip of the iceberg.

As decline sets in, a toxic dynamic takes hold. In a growth mode, it is very easy for everyone to hold hands and sing kum-bah-ya. It’s comparatively easy to cut deals to divide the fruits of prosperity. In decline, those deals come back to haunt. The status quo is failing, but people are still profiting from it. Even in Detroit, America’s ultimate failed city, so many people and groups benefit from the current system that there is complete paralysis. No one wants to give up an inch of hard won gains, especially since in a dismal region there’s little hope of replicating that privileged position or income. Hard times promote solidarity, some say. But the reality is that hard times also often produce selfishness and civic dysfunction as well as people cling desperately to what they have instead of looking boldly forward to the future.

I’ve seen this shift happen in a few cities. Where once civic boosters dreamed of glory and invested their own money into the city, now they focus on what they can get out of it. So too in California. Everyone knows the Titanic has hit the iceberg, but they are determined to loot as many state rooms as they can before shoving the women and children out of the way and commandeering the life boats.

This institutional rigidity is another force driving people to greenfield locations. It’s a global phenomenon. Consider this Newsweek coverage of a study of Chinese industry that notes much lower levels of corruption and better governance in new cities than old.

An intriguing pattern is that governance is best in coastal cities that had very little industry when reform began in 1978. Shenzhen now has the highest per capita GDP in China. The same holds in Jiangmen, Dongguan, Suzhou–all were industrial backwaters in 1978, and responded to China’s opening by creating good environments for private investment and learning from outsiders. Cities that already had industry tended to protect what they had and reform less aggressively.

Jim Russell hypothesizes that this effect of frontier geography explains a lot of the success of the Sunbelt, which industrialized late.

Cities such as Austin, TX and Charlotte, NC have offered a frontier opportunity akin to the one observed in the boomtowns of China. On the other hand, Pittsburgh stagnates. Governmental reform is key for attracting investment and stimulating growth. This is unlikely to happen in Western Pennsylvania, leaving this region at the rear of economic globalization.

For Pittsburgh, substitute California and you’ve got a pretty good picture.

Writers like Joel Kotkin like to reminisce about the Golden Age of California, and the leadership of that age from enlightened members of both parties like Pat Brown and Ronald Reagan. But you can never go home again. That letter jacket from your high school glory days might still fit, but you’re never going back to the state finals. Brown and Reagan were products of their era – an era that no longer exists. While they might be better executives than Gray Davis and Arnold Schwarzenegger, even if you assume they could get elected today – unlikely – I doubt they’d prove much more effective.

It’s been said that China will get old before it gets rich. Well, California got rich first – but it still got old. Not old demographically, but old civically. The polity of California is now well into middle age. As with people, places that reach that point experience a mid-life crisis as they look back longingly at the optimism, energy, flexibility, dynamism, and endless capacity for reinvention of youth. That’s often a bitter pill to swallow.

Can California Recover?

Can California pull out of this? It’s hard to point to a lot of examples that offer hope. But California has a lot going for it. It’s got the stunning climate and physical geography. Cities like San Francisco and Los Angeles remain powerful. In addition to the technology and film industries, California also has a robust agricultural sector, legal and illegal, an entrepreneurial immigrant base, as well as an American hub for contemporary art and other creative fields besides the movie business. So there’s a lot of assets to build on.

The challenge is that these existing strengths are part of the institutional rigidity. Another way to say “build on assets” is “defend the past”. Other than the its physical setting, the assets of California only exist because previous generations didn’t build on assets. If they did, Silicon Valley would still be orchards, not the powerhouse of the global technology industry. If a city or state is failing to create new industries, it has economically stagnated, no matter how prosperous it might be or appear for a time.

Looking at the Rust Belt, we do see that tier one global cities have managed to renew their cores. Chicago, New York, and Boston have glittering city centers and a migration back to the city of upscale residents. This is a far cry from the sour days of the 70’s. But if you look beyond those zones, you see places with surprisingly unimpressive metro area statistics in many regards. And the states they are in look at lot like, well, California. A handful of metro thriving cores can’t energize an entire state or even metro area. Places like New York and Illinois have major structural challenges of their own. And California has already followed this program, with booming regions that are among globalization’s winners, with many larger areas of losers. Of course the alternative is worse – look at Michigan, with the same failures and no global city to even partially make up for it.

The global city phenomenon perhaps illustrates the way. Cities that have experienced that boom like to pat themselves on the back. Indeed, there has been some good leadership along the way. But when something happens in most similarly situated cities, you have to look first to a common force acting on them. Chicago, New York, London, etc. all had their own Rust Belt eras and suffered in the 70’s and 80’s. Starting in the 90’s a large number of what we now call global cities had urban core booms. As Saskia Sassen noted, the new networked global economy requires new financial and producer services, that tend to be concentrated in global cities. In effect, the global city is an emergent property of the globalized economy, just like the company town was in a previous era. I noted previously with regards to Chicago that it was the artifact, not the architect.

To me that shows that a state like California needs to look at and understand the macrotrends affecting it and the world, and figure out how to position itself to profit from them. One area it is trying to do so is in the “green economy”. I’ve got a few problems with “green jobs”. The first is that the entire concept of a green economy is a transitory one. Likely in a decade or so it will be gone. There will no longer be green industry, but only industry – it will all be green. This immediately prompts the question of whether, since we’re not going a very good job of competing in traditional industry, we’ll do any better in green industry. Indeed, China and others are already making a move here.

The other aspect of this is the huge gamble California is placing on the environmental trend. That is, it has imposed the strictest environmental controls in the world. There is no doubt this is one factor causing a lot of short term pain. But the state hopes that in the long term this will attract talent and, what’s more, position it for future success because other states will be forced into the same painful restructuring for environmental issues in the future and California will be ahead of the game. California’s ultimate goal here is clearly to push to federalize its policies to prevent any other states from not following its lead and producing a differentiated product. Because international migration is so much more difficult than domestic, this would, in theory, eventually help staunch the flow of people out of the state. Other states no doubt realize this and will resist the push at the federal level. It remains to be seen how this turns out on many fronts.

Other than that, it is difficult to identify a strategy California has other than more of the same. While the green realm might be a good place for California to put some chips, I don’t think piling everything on one square is a good idea, so new ideas are clearly needed.

And these economic strategies will only be ultimately a success to the extent that they enable California to reach an equilibrium and either successfully make the transition to an operator, or somehow reignite growth.

I would suggest that California and other maturing jurisdictions should look to partner with academics in our economics departments, and especially our schools of business, who have studied industry growth and maturity curves, and how to manage that transition over time, strategically and operationally.

Has the United States Reached Maturity?

Given the problems of California and the current Great Recession and associated talk of American decline, it’s worth asking the question: has the United States matured? That is, are the life cycle forces that are hurting California now affecting America as a whole?

Let’s consider our three harbingers: unfunded liabilities, the end of growth, and institutional rigidity. Clearly, we’ve racked up huge unfunded liabilities, just like every industrialized nation. I believe we are projecting a deficit of $1.8 trillion this year alone and that doesn’t even count off balance sheet problems like social security and medicare. So a definite check mark in that box.

As far as institutional rigidity, clearly we observe some. There is no doubt that it has gotten harder to do things in America and that one of the key advantages of China is its greenfield location and lack of this cruft, not just its low labor costs. Regulatory arbitrage, for example, can be a powerful motivator. Still, I haven’t observed a ridiculous amount of change here in my lifetime. At the federal level, it has always been hard to do things in America, by design. I do argue that in some areas we’ve turned the dial too far. In a country that desperately needs to make transportation investments, it shouldn’t take a decade to get approval to build a new transit line, for example. But on the whole the United States still feels like a fairly dynamic society to me.

Which brings us to growth. Clearly we have been in a major recession. The question is whether our best days are behind us. I say clearly No here. America is demographically healthy. Compared to Europe we have comparatively high birth rates, more or less replacement rate, in our native born population. This shows a society with confidence in the future. Also, people from around the world are still voting with their feet to come here. And I believe we’ll get back on economic track eventually.

But this is where the warnings signs should be looked for. If growth dries up, I believe the institutional rigidity will enter that toxic cycle and we could be in trouble. Keep an eye on immigration. When people stop wanting to come here – because they don’t want to pay taxes merely to pay off yesterday’s unfunded liabilities, because they think there are better opportunities elsewhere, or whatever – and especially if Americans start leaving in any material numbers, we’ll know we have a major problem on our hands.

Obviously no one can predict the future, but I remain bullish on America.

38 Comments
Topics: Demographic Analysis, Economic Development, Public Policy, Strategic Planning
Cities: Los Angeles, San Francisco

38 Responses to “What’s Killing California?”

  1. Harmon says:

    "As decline sets in, a toxic dynamic taxes hold." Freudian typo?

  2. Anonymous says:

    Great post… some very interesting thoughts.

    China presents a compelling challenge—the ultimate "peoples paradise" that's transformed itself into the world's largest capitalist sweatshop in a generation. It's efficiencies are admirable if you like the idea of the mafia running a nuclear world power.

    Regardless of what you say about California, the marketplace seems to still work in its favor. It has been projected, by far, to have largest increase in state population by the year 2050. Despite its legacy costs, it's still attracting new residents.

    The reality is that whether or not you believe in government (and I do, personally), governments at almost all levels enjoy a monopoly on the services they provide. Even Reagan, for all his bluster, could not stop the expansion of the Federal government.

    It's both a curse and blessing. Yes, the costs of government make geographies with fewer legacy cost cheaper and more profitable to develop. On the other hand, those with government jobs are the last to enjoy the security and benefits that private sector employees have been forced to give up over the past two decades by the global forces that fuel our economy's race to the bottom.

    The American "brand" may have suffered globally during the Bush years, but its geographic isolation, stable politics and opportunities for personal economic advancement allow it to maintain an attractive, if somewhat diminished, position in the global marketplace.

  3. Alon Levy says:

    Liberals don't blame California's problems on sprawl; they blame them on Prop 13. And both sides blame many problems on the initiative process, which makes it easy to spend money but hard to raise taxes for it.

    Both problems – initiatives in general and Prop 13 in particular – relate to the legacy issue. The spending initiatives mandate expenditures that can't be rolled back later, except with a referendum, which may not pass. This mandatory spending piles on top of past mandatory spending; I've read that right now three quarters of California's state-level spending is mandated by initiative.

    And Prop 13 is the ultimate giveaway to longstanding residents. It limits property taxes on continuously inhabited houses, regardless of how much they're worth. New houses or houses that change hands are not so protected. This discourages moving, and encourages overtaxing newcomers. It also makes it harder to raise money for schools, and unsurprisingly both California's living cost-adjusted per capita spending on education and its test scores are among the country's lowest.

  4. Anonymous says:

    Michigan's Prop A does the same. Has anyone ever analyzed state's with property tax cap systems like CA and MI against others and see if there's any connection?

  5. pete says:

    California Unemployment Trends – August 2009

    California Unemployment Trends in Heat Map form:
    here is a map of California Unemployment in August 2009 (BLS data)
    http://www.localetrends.com/st/ca_california_unemployment.php?MAP_TYPE=curr_ue

    versus California Unemployment Levels 1 year ago
    http://www.localetrends.com/st/ca_california_unemployment.php?MAP_TYPE=m12_ue

  6. Anonymous says:

    Do we think at some time all local, state, and federal governments, and the big legacy corporations are going to have to go through a bankruptcy process to massively cut the pension costs?

    Before I was born, my grandparents promised your parents that I would pay them a salary from age 62 until death. If I actually have to do that, I'll take home $1,000 a month. If I can find a job.

    I do think we have an obligation to care for elders, but if we do it at the levels promised, there will be nothing resembling an American dream for post-Boomer generations.

  7. Alon Levy says:

    Anon: think of it this way – 62 in the 1930s isn't the same as 62 today; it's more like 67.

    There's no reason entire countries have to be burdened with legacy costs. The US isn't – its social security costs are very low by first-world average, due to its high birth and immigration rates. The only countries that are actually worn down by this issue are countries with very low birth rates and little immigration, such as Japan, Poland, and Italy.

  8. The Urbanophile says:

    Harmon – hah! You got me – fixed.

    Thanks for all the comments.

    anon 7:56, states can't declare bankruptcy. The states with the biggest pension problems are the ones where dealing with it is most difficult.

    I don't think elimination of pensions is required. We do need to expect public sector workers to spend more years working to earn that pension, eliminate "double dips" and other shenanigans, and we need to properly fund them. Also, I'd suggest that we probably need to maintain pensions at the state level, not the municipal so that people who try the "skip town" approach by moving to a new suburb can't as easily escape the pension mess they created while they lived in the city.

  9. Anonymous says:

    What does fully funded mean? As the last year has shown us, there is nothing you can invest in that can hold value and appreciate fast enough to cover a growing pension liability. Equaties can decline. Commodities can decline. Real Estate can decline. Currencies can be inflated. And it can all happen at once.

    That's the argument for not privatizing social security, but keeping it pay-as-you-go.

    The Chinese save a lot. That puts too much money out there for anything and everything, so your pension investment isn't going to return anything. We've had four or five big bubble pops this decade. Why should we fully fund unless there's reason to believe something has changed.

  10. Alon Levy says:

    What does fully funded mean? As the last year has shown us, there is nothing you can invest in that can hold value and appreciate fast enough to cover a growing pension liability.

    Social security is invested in the national debt in most countries. For developed countries, this is a very safe investment; for the US, it's considered the safest investment in the world, in the sense that if the feds default, no other asset can be expected to hold any value.

  11. Mark Arsenal says:

    Bullish gets harder when you realize how many of these type of books are out there:

    http://amzn.com/0313345066

  12. Anonymous says:

    A fascinating analysis of California's present economic troubles and how it may affect our economic future.

    I am a California resident and closely follow what is going on with the state government.

    There's no one single policy remedy that will fix our current financial troubles.

    Reforming Proposition 13 is a non-starter. It has to go before the public, and with more than 70 percent of the citizens of California protected by it, there's no chance they'll allow for any reforms that opens them up to pay more.

    Also, the state is the custodian of Prop. 13, so it isn't affected as much by Prop. 13 as local cities. They are the ones who are more impacted by it.

    However, Prop. 13 is indirectly responsible for California having such an unfavorable climate for small businesses.

    Local governments could not count on property taxes to bolster their services, and residents did not want to see services cut in proportion to taxes. And Prop. 13 did not provide a mandate for any agency to put a limit on government services.

    So enterprising local governments instead farmed sales taxes, or what has been called the fiscalization of land use.

    This sales tax farming has every local government playing the game of attracting nonresidents to spend money in order to put the receipts into the services that residents consume.

    So cities tend to favor businesses that have a better chance of attracting a broad consumer base and higher tax receipts. Cities prefer new car dealerships, big-box stores and shopping centers.

    This arrangement is two strikes against small business owners. The cities are more likely to help out car dealers and large-scale developers over small business owners because the former would provide more tax revenues. Even if small business can clear that hurdle, they must then contend with being at a competitive disadvantage to big businesses.

    This is just one of a slew of issues that can be tackled but won't right our waterlogged ship.

    We have a Gordian knot of problems.

    California has high taxes, but lowering taxes does not reduce the costs of business or living. There's still a very high demand of in-migrations of human, social and monetary capital.

    California has political paralysis in the Capitol, but in theory direct democracy can be used as a check on gridlock. It's hard to get a read on how Californians would vote based on an issue. Social conservatives see success on things like gay marriage bans and tough-on-crime laws, but Californians are very generous with the purse strings.

    Voters have approved billions in bonds for high-speed rail, water infrastructure, open space preservation, schools construction, environmental improvements … I could go on for days about this. Yes, bonded debt and taxation are also voted upon directly by the electorate.

  13. david vartanoff says:

    Some words from a Californian who voted for 13. When, almost 33 years back, I signed the deal to buy the house I live in the price was about 1/20th what it is worth even now. If the real estate taxes had escalated at the same rate, I would be in a cardboard box somewhere because my earning power has NOT gone up by a factor of 20.
    We used the referendum process because the State Legislature sat on its hands doing nothing as people watched their parents taxed out of their homes. Mind you, I am NOT part of the 'starve the beast' right wing at all, but the absurd rises in housing costs have made otherwise legitimate policies untenable. The ongoing stalemate in the Legislature which prevented for instance taxing oil companies on the oil they extract(CA is unique in NOT doing so) is based not only on Republican 'discipline' but essentially permanent gerrymandering guaranteeing just enough Republicans to obstruct but never pass anything of their own.
    Every time I hear 'anti-business' about our state, I think about how by and large this is an assault on worker protections that usually only came into effect after many worker casualties. Sure, it costs more to provide ear plugs for a worker using a roto-hammer. Can anyone justify not doing so?
    Is this a tired old economy? I thimk not. I look to greening this state to a point where we will never be vulnerable to another Enron raid. Already in the bottom 3-4 states in per capita energy use, we will go lower and if we build enough distributed electrical generation, we can escape from building grid 2.0 because more usage will be closer to point of use.
    Next, if we can escape the stupid drug laws, we can close much of the prison system to spend that money on something productive. Okay, too much optimism and idealiam even for me.

  14. […] More: Carter Wood/ShopFloor, Jon Fleischman/Flash Report. And Aaron Renn at Urbanophile has a broader look at California’s decline. […]

  15. […] the left vs. right arguments about why California is collapsing says Urbanophile. California has simply now outgrown its youth and is now well into its middle age. Like the Rust […]

  16. Mike K says:

    It didn’t take long for Prop 13 to come up. If the left were able to reverse that law, property values would fall about another 30%. They never seem to understand, probably because they don’t believe in free markets, that home owners and home buyers factor in taxes when deciding what they can afford. When Prop 13 was passed, the taxes on a home that would sell for $250,000 were $7500/year. After the law changed, that house was worth more to the next buyer. The taxes went up because the new selling price reset the basis. The left is annoyed that somebody figured out a way to limit taxes.

    I grew up in Chicago’s South Side and have watched its decline. My daughter was assigned to a federal office in Detroit for seven years. California is dying of the blue disease. That is a combination of high taxes, lax law enforcement and bad public education. The illegal alien influx has wrecked much of the medical system of California, especially the wonderful public hospitals that once took good care of the poor. My wife taught school in the Hispanic neighborhoods of east Los Angeles in the 1960s. That was before the teachers’ union. She briefly went back to teaching about 10 years ago and was appalled at the changes. I don’t know if there is a solution.

  17. Alon Levy says:

    The left isn’t annoyed that someone figured out a way to limit taxes. It’s annoyed that upper-class homeowners sitting on million-dollar homes pay $3,000 a year in property taxes whereas an immigrant who’s just bought a heavily mortgaged house for $500,000 (anything less is unavailable due to 13, which the NIMBYs of rich towns like just fine) pays $10,000.

    Everything else you say is factually incorrect. Taxes in California are progressive, but they’re not very high by US state standards (link) – nor is there any correlation to begin with between state taxes and unemployment. Law enforcement in Los Angeles is brutal – whites in SoCal almost cheer when blacks and Hispanics get beaten up. And education spending in California plummeted after Prop 13, forcing teacher salaries down so much that nowadays California doesn’t require high school math teachers to have majored in math in college.

    But please, keep bashing immigrants. Racism will save us from all social problems.

  18. Mike K says:

    Excellent comment. You and Jerry Brown may well be the last two residents of California. I guess those people are moving to Texas to escape the low taxes. Hilarious. I especially enjoyed the knee jerk response of “racism.”

  19. DavidN says:

    This is one of those fun discussions that never seems to end. So you’re a schoolteacher in the ’50s, and you bought a small ranch house. You could afford it, you made the payments on it, you paid the taxes and insurance on it, added a room in back, put on a new roof, etc. But it turns out you made a mistake. You’re still a schoolteacher, not getting paid much, but you bought a house in Santa Monica, or Westwood, or some other region of town to which wealthy people moved in large numbers. Now you’re retired, living on Social Security and a small pension, and some idiot wants you to pay property taxes based on what the property’s worth if you sell it. Hmmm…what do you want to bet that for a lot of people, that would mean you *would* be selling the property, because you couldn’t afford the taxes?

    Meanwhile, the state has powerful public employee unions milking the state’s financial coffers dry. They’re among the loudest voices whining about Prop. 13, because if we could just raise property taxes, sales taxes, income taxes, and everything else, we could probably almost fund the state’s pension system. The state currently has (really, I looked it up) over 9200 retirees from state and local government who collect pensions in excess of $100,000 each. The winner is a former official of the city of Vernon who gets just short of half a million a year in state pension money.

    I have often said that the best solution to California’s revenue problem would be if we could tax those businesses and individuals who’ve moved to other states. We could send them a bill: you’ve left California, but you still owe us money for the things we provided you (a bad education, poor roads, etc.) and so here’s the taxes you owe us. It wouldn’t work, but it’s the only thing that can save the state from insolvency.

  20. Alon Levy says:

    Mike, should I take your comment to mean you agree that California’s tax and spending levels aren’t very high?

    David, the most unionized states in the US are in the Northeast, where they don’t have California’s financial problems. New York, which is by a large margin the most unionized state, manages to fund its government just fine.

    If the teacher who bought the ranch can’t afford to pay those taxes, he’s free to petition his town to shift the tax burden from property to income. But no; it’s more beneficial for him to limit his own property taxes, while forcing people who moved in 20 years later to pay much higher property taxes. It’s especially beneficial for him to promote severe restrictions on housing growth, reducing supply and driving housing prices through the roof.

  21. […] Alon Levy: "Mike, should I take your comment to mean you agree that…" on What’s Killing California? […]

  22. JG says:

    I am not sure if any state does this, but a progressive property tax system would not be a bad idea to limit the burden on the middle class and poor who own homes. The arguements against raising property taxes always includes (rightfully) those with fixed incomes who’s property values rise (normally a positive) but have not desire to move, and are strapped by the tax burden. Some people love their neighborhood and home more than a big pay day from flipping their property. Additionally some tax burden could be shifted to the sale or purchase, especially when speculation is clearly involved to even out bubbles in the market.

    Indiana has adopted limits on the rate of INCREASE per year for property taxes. It has yet to be seen what the effects will be, though it gives homeowners predictability of the upper limit of tax they may owe when purchasing a home or considering retirement.

  23. Mike K says:

    JG, that is what Prop 13 actually does. The home is assessed based on the last sale and then the assessment is limited on its annual increase. Since the vast majority of homes change hands every five years, the effect is far less than the political left asserts.

    There is a valid complaint about the shift of cities from property tax to sales tax but that was not Prop 13; it was state law that raided the property tax revenue for its own spending. I have served in city government and know a little bit about the problems in California. The killer will be the public employee unions and the nexus between them and local officials they elect. Those officials then hire more employees and increase their pensions. We have the same problem in my own small city. Eventually, the cities and counties will go bankrupt and the retired employees will lose their pensions and medical benefits.

    I’m still chuckling about the fellow who complained that poor immigrants had to pay $500,000 for a home in California. There is this thing called renting.

  24. Alon Levy says:

    The teacher who complains about being priced out of his own home can rent, too. Why should immigrants rent while long-timers get to own?

  25. JG says:

    Thanks Mike K. I don’t know the “ins and outs” of Prop 13, however protection for middle class and poorer homeowners, so they do not get priced out of their homes, is very important. I will have to read more on it.

    Imposing property taxes is not a terrible idea as I have heard argued. They meant more in the 18th and 19th century when property ownership was a better sign of wealth, and therefore today should and do play a smaller role in the current tax system. They are part of a diversified tax system. I am always stunned when I hear proposals for ONLY a consumer sales tax, or ONLY a flat income tax, etc. Diversifying taxation and making rates progressive protects us all from disproportionate tax burdens based on our employment, social economic status, family size, land ownership, potential for inheritance, etc.

    Furthermore, property taxes should be more directed toward real estate speculation. It’s potentially difficult to assess when someone is speculating or not, but efforts would shift the burden from “school teachers,” “immigrants” or any other group who tends to be disproportionately affected by tax. I am though warying in my arguement not to crush real estate markets with excessive tax on investors, and realize some speculation in older cities and neighborhoods is helping drive improvements and attract folks back – something I care a great deal about. I think we can differentiate that in a tax code from speculating on new vacation condos in Naples, FL or Orange County, CA.

    Still property taxes and sales taxes continue to affect middle income and lower income persons more than those in higher tax brackets. Something to think about when making adjustments.

  26. Mike K says:

    Well, I might suggest that saving for a long time is a good way to start. You ask why should immigrants rent ? Maybe because they can’t afford to buy ? The last time I read the Constitution there was something about “pursuit of happiness” but happiness itself was not guaranteed except by Barney Frank and Maxine Waters. I really don’t mean to offend but it is possible you are kidding me by appearing to be a clueless liberal ?

    To JG, the property tax is rightly a source of revenue for local concerns like roads and schools. The state, in an arbitrary and dangerous move a decade ago, took the property tax revenue and replaced it with a share of sales tax. This has led to cities competing to lure certain businesses, like shopping malls and car dealers, by offering incentives, like a share of the sales tax revenue. This has been the source of angry community action when local politicians, just as affected by cupidity and stupidity as the national variety, squander city funds on some of these ill advised adventures. Both car dealers and mall operators are in trouble now and the city tax sharing investments look pretty bad.

    I lived a while in New Hampshire which has high property taxes but they have no sales or income tax (although that may not last as Democrats take over state offices). The property tax funds great schools. Hanover, where I lived for a year, has a wonderful high school and smaller cities pay the city tuition to send their kids to Hanover High School. I would have no objection to those taxes because you can see the benefit. On the other hand, Asbury Park, New Jersey has school spending of over $35,000 per student per year. And the students are below grade level in every year.

    California politicians have not shown themselves to be trustworthy with public funds. It’s a shame because I can remember it when I first came here over 50 years ago.

  27. Alon Levy says:

    Mike, the problem with the Prop 13-induced property value appreciation is that it increases both prices and rents. Rents in towns like Palo Alto and Menlo Park, with their strict zoning and their property tax limits, are higher than in Manhattan.

    Yes, people should totally rent instead of buy. The problem is that the government gives financial incentives to buy, including Fannie/Freddie, Prop 13-style laws, federal mortgage tax deductions, and property taxes that are higher for renters than for buyers. People who buy real estate to rent it to others are often so vilified that the government hikes their taxes, which they then pass on to renters. Prop 13 supports this regime, since homeowners tend to hold on to property for much longer than landlords, because of their emotional attachment to it.

    You don’t have to have high property taxes to fund government. New York City doesn’t – it has income taxes. One of the reasons the upper middle class is starting to move back in from the suburbs is that the suburbs have high property taxes to support their top-rate, $25,000/student public schools; in the city, they could just pay the $25,000 directly to a private school of similar quality.

  28. Mike K says:

    Alon, you are right but don’t know it. You say:

    “Rents in towns like Palo Alto and Menlo Park, with their strict zoning and their property tax limits, are higher than in Manhattan. Yes, the property tax limit raises prices. Why is that a bad thing ? The zoning limits make building smaller, cheaper houses less economical. WHy is zoning good but tax limits are bad ?

    Because you like government spending and you like zoning limits. I grew up in Chicago, on the South Side when it was a middle class white area. Some of the homes were quite nice; I would like to have one of them now. Interspersed with the homes were apartment buildings, many that were two and three flats. It allowed a mixture of families with different income levels. Those apartments were plenty big enough for families.

    We learned one lesson from that experience. Apartments tend to deteriorate with age and are not maintained as well as single family homes. There is a saying, “In the history of the world, no one has ever washed a rental car.” Home ownership has been perceived as a virtue by many, including Margaret Thatcher who sold off a lot of council housing to the tenants. The problem is that interest rates got too low and it created a housing bubble. Prices became astronomical. That had nothing to do with tax limits but tax limits protected a lot of people until the crash came.

    If you think that New York City doesn’t have high property taxes you are reading other literature than I do. What I see is an exodus of higher income people from NYC who are being replaced by lower income residents. Taxes drive behavior. That is why Texas is thriving relative to California and California is dying. I will be gone in a couple of years.

    Take a look:

    http://www.nypost.com/p/news/local/tax_refugees_staging_escape_from_qb4pItQ71UXIc0i6cd3UpK

  29. Alon Levy says:

    I don’t think strict zoning laws are good; I never have. I especially don’t think zoning laws whose sole justification is propping up property values are a good idea. (And before you mention Houston to me, you should know that Houston has plenty of zoning, by other names: parking minimums, setbacks, prohibitions on street grids, rules encouraging developers to deed-restrict properties to single-family.)

    What you say about New York is just wrong. Yes, some people leave – and some people move in. Overall the city has gained residents since 2000; based on metrics like education spending and crime rates, it doesn’t seem to have had net tax base loss.

    What you say about apartment buildings being undermaintained is wrong, too. There are plenty of places where owner-occupied homes deteriorate – for example, Detroit. And there are plenty of places where low home ownership coexists with well-maintained buildings, such as Manhattan’s Upper West Side, or any public housing project in Hong Kong and Singapore.

    What happened on the South Side isn’t about renting. It’s about incentives for racial discrimination. As blacks started to move in, developers whipped up scares, encouraging white flight. White owners sold their houses at a discount, and white renters left as well. The landlords and house flippers then invited blacks in, overcharging them for rents and mortgages and keeping the down payments whenever they defaulted. The government looked the other way, since at the time whites still considered blacks beneath contempt. At times, the government even encouraged this, by razing intact neighborhoods and building housing projects on the land. This describes Newark and East New York every bit as well as the South Side.

  30. Alon Levy says:

    As for why Texas is thriving relative to California: I’m not sure why, but it can’t be taxes or spending. Here’s a list of states by per capita spending. On this list, Nevada ranks last in per capita state spending, and Florida ranks 10th last. California, ranks 26th, spending two thirds as much per capita as Vermont, Alabama, and New Mexico.

    Similarly, here’s a list of states by per capita state taxes. Florida ranks 12th last, Arizona 13th last, Nevada 21st last. Among the epicenters of the housing crash, only California has above-median state taxes.

  31. Mike K says:

    “What you say about New York is just wrong. Yes, some people leave – and some people move in. Overall the city has gained residents since 2000″

    So you know more about it than the NY Post. I will let you two fight that one out.

    I still think you are kidding me and eventually you will tell me that you really don’t believe these left wing chestnuts you are putting out here. If not, I’m embarrassed for you.

  32. Mike K says:

    ” It’s about incentives for racial discrimination. As blacks started to move in, developers whipped up scares, encouraging white flight. White owners sold their houses at a discount, and white renters left as well. ”

    I missed this the first pass. Yes, there was white flight. Crime will do that. My father was attacked on his front porch. Kids walking down the alley pulled down the branches on two cherry trees we had in our back yard. The neighborhood had been safe as only 1950s cities were safe. Left wing theories about crime destroyed them. Giuliani brought NYC back but the Daleys have not done as well with Chicago.

    I think you see racism in normal human behavior. People don’t want to live with crime. Black don’t want to live with it either but they have got to get away from racist preachers like Wright and race pimps like Jackson and Sharpton who convince them not to cooperate with police. My sister lives in Beverly, on Chicago’s far south side. Those are beautiful homes near her but there are still murders in the next block and kids are robbed walking home. People avoid that pathology and that is a lot of the story about the dying of cities.

  33. I think this is becoming unproductive. Everyone has given an opinion and it sounds like no one will be convinced.

    I don’t personally think that any reductivist theory every explains the whole truth. That is, there isn’t one or two simple explanatory variables that explain everything, everywhere. The world is complex, multi-variate, and dynamic.

    I will say this, Mike, clearly unscrupulous practices played a role in the rapid racial turnover in various Chicago neighborhoods. I suggest, among other things, looking up “block busting”: http://en.wikipedia.org/wiki/Blockbusting

  34. Alon Levy says:

    Sorry for the comment barrage, but here’s one thing I just checked: I ran correlations between unemployment and per capita state taxes. If you take unemployment figures from September 2009, the last month for which figures are available, the correlation is -0.11; this means that higher taxes are associated with lower unemployment, but that the correlation is statistically insignificant. If you take figures from September 2008, the correlation is positive, but even more insignificant, at 0.03.

    Higher state taxes and spending are both correlated, but insignificantly, with better performance on the following three stress tests used by the same data set: increase in unemployment from 9/08 to 9/09, foreclosure rate, and increase in food stamp participation.

    So no, taxes and spending don’t hurt states economically. They don’t significantly help, either, but they definitely don’t hurt.

  35. Alon Levy says:

    Mike, white flight began before the crime wave. For example, in Newark, the white population peaked in 1950, and the city had become majority-black by 1967, when the crime wave was just starting and before the first race riot. In fact, the riot was based on the fact that the city was (barely) majority black whereas the police force was overwhelmingly white.

    And yes, I know more than the NY Post, which is a tabloid. See Wikipedia for New York’s recent population trend.

  36. Anonymous says:

    MIKE: I think Texas has a luxury of maintaining lower taxes due to the amount of revenue generated from the oil business. It seems to have as heavy a burden of illegal immigrants as California making that appear as less a factor (though still contributing to drag on local and state resource usage.) Unfortunately apartments have too often been viewed as a drag on neighborhoods. I find this trend troubling, for having a mixture of housing styles creates the possibility of more diversity in a neighborhood by mixing singles, the elderly, and young adults among families and couples. In the suburbs, apartment complex construction continue to violate every law of humanity, but in older neighborhoods like southside Chicago and much of old Indianapolis, the apartments are smartly intermixed with single family housing on tight lots meeting the streets. Condo conversions of many of these older apartments has offered some solution, though, as you mentioned earlier some people just need to rent. Being single and needing to move for work in a few years, I find renting slightly more economical.

  37. Mike K says:

    I agree that the comments are becoming repetitive. I agree that white flight was stimulated by block buster real estate agents but the crime came first. I lived there at the time and left for college in 1956. I came home summers and watched it happen. The problem was not racism per se but that fact that the vast majority of urban crime is committed by blacks. Of course, the black non-criminals are the primary victims but the emptying of white neighborhoods was driven by crime, not racism.

    There was no more desirable place to live than South Shore where I grew up. If it was safe, I would live there today but it’s not. My mother lived in 7447 South Shore Drive, a 33 story apartment building in South Shore, until just before her 100th birthday in 1998. Toward the end, she was one of three remaining white residents. I spent a few days with her every quarter until she died three years after leaving South Shore. The last few years, her nieces could not visit because they feared crime. I rented a parking space for her even though she didn’t own a car. When someone came to visit, it was always filled by another car. In the 1996 election, she was not allowed to vote although the polling place was in the lobby of the building where she had lived in for 30 years. A Democratic poll watcher challenged her and she was turned away. These are not huge matters but examples of why the whites eventually all left, even those determined to stay.

    My point about the apartments was that they were allowed to deteriorate and weakened the neighborhood as less desirable elements moved into apartments first and the crime came with them. One issue about apartments that was not an issue then is the parking. I have served on a planning commission and small cities are constantly dealing with parking issues around apartment complexes because the codes are too lax. It’s not unusual to have four car owners in a two bedroom apartment near a college. Single family home neighborhoods nearby then find there is no street parking.

    I’m amused that someone cites Wikipedia over the NY Post but such is political debate these days. I will leave the argument about taxes, spending and the viability of states to the remaining residents of California as I will be leaving for Arizona soon. I already have a home there and was quick to get Arizona plates for my truck there as California plates are police magnets for minor traffic violations. Fleeing Californians are not popular anywhere as it is feared they will bring their voting preferences with them.

    Thanks for a great post.

  38. Alon Levy says:

    The Wikipedia link comes from the Census Bureau – it’s just easier to find. You can follow the references there, unlike with the NY Post, which makes things up all the time. It’s a fact that New York City’s population is increasing, in fact faster than at any time since the 1920s.

    The parking issue is moot. It’s not the government’s job to provide you with free parking – it’s your job to have a garage, or pay for metered parking. In neighborhoods that are dense enough for parking to be a problem, density is usually high enough for transit to allow low car ownership. In Uptown Manhattan there are entire neighborhoods of mid- and high-rise buildings with no off-street parking, where you can easily find free parking spots – people just take the subway and don’t buy cars.

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