California’s economy still has some cracks, but its strengths — including its diversity of industries — are starting to overshadow weaknesses such as the high cost of doing business in the state, according to speakers at the Milken Institute State of the State Conference 2011.
But if the state wants to reduce the revenue volatility for which it has become known, it has to take long-needed steps like enacting the kind of broad tax reform that was defeated during the legislative session, said Susan Kennedy, senior policy advisor for law firm Alston & Bird LLP and chief of staff to former Gov. Arnold Schwarzenegger.
Kennedy, who spoke on Thursday at the event in Beverly Hills, focused on the changes needed to deal with decades-long problems that have resulted in a structural deficit.
But Scott Minerd, the chief investment officer for Guggenheim Partners, who spoke earlier in the day and prefaced his comments by saying that he often takes the contrarian view, described why he still thinks the state of California is still a good bet.
Last year, as Meredith Whitney Advisory Group was predicting financial doom for California, Minerd was recommending that people buy California municipal bonds.
“While Meredith Whitney was talking about the demise of California, we published a research piece that talked about the opportunity in California,” Minerd said. “We did a research piece at the same time recommending that people buy California municipal bonds.”
Part of the reason for Minerd’s faith in California bonds is that the state’s tax base is highly correlated to capital gains.
When the stock market begins to show improvements, the state experiences growth in tax revenue, he said.
According to Minerd, the condition of the state’s pension system also is not as dire as what has been reported. Currently, the state only has 20% in unfunded liability as compared to Illinois, which has 45%, and New Jersey, which has 65%, he said.
“The idea that the state will not be able to pay its employees is nonsensical,” Minerd said. “We have seen California’s willingness to reform.”
California, unlike states like Michigan, does not have overexposure to one industry. Its diversity means it is not as vulnerable to protracted problems like those faced by the auto industry.
The state also tops many lists that indicate economic strength, according to Minerd.
California ranks second in exports, second in foreign direct investment, first in capital, and first in tourism and business travel.
However, Kennedy disagreed with Minerd’s comment about the state’s willingness to reform.
In addition to her criticism of the Legislature’s failure to pass tax reform that would lessen the burden on businesses, she criticized Gov. Jerry Brown’s budget “trigger cuts,” saying they just add to the state’s volatility.
Under the trigger cuts, the state can make cuts to this year’s spending plan in response to shortfalls in revenue.
The first shortfall and subsequent cut came this week when revenue came in $301 million below projections, according to a release from state Controller John Chiang.
Even Minerd’s optimistic tone was tempered. He said the state has the opportunity to broaden the tax base and lower taxes, which would encourage more businesses to relocate.
“The 10% rate on capital gains is very punitive, but the equivalent tax burden on personal income would be 3%,” Minerd said. “This tells us that there is an opportunity to broaden the tax base and lower taxes on small businesses, which would encourage more to locate here.”
A frequent theme of the conference was the idea that California is losing businesses to Texas, because of that state’s lower tax rates and lighter regulatory structure.
The two reforms that Minerd has recommended to attract investors were changes to the tax system to attract companies with high wage earners, and streamlining regulations to make it easier for businesses to get licensed in California.
Brown, who also participated in the conference, cited eliminating regulations as one of his priorities.
“If you want to kill regulations, it is like killing a vampire — you have to put a stake right in the heart of the regulation,” Brown said.
International companies that manufacture renewable energy products want to locate their operations in California because it has a reputation for encouraging the development of such technologies. However, the same companies find the state’s tax structure and regulations burdensome.
“We are attracting bio-med and technology companies,” said Brown, a Democrat. “We need to eliminate regulations that make it difficult to start a business here.”