In a Tale of Three States, California Is Loser

SAN FRANCISCO — California, Oregon, and Nevada have taken a harsh battering in the Great Recession, but lawmakers in the three Far West states have reacted very differently.

Oregon and Nevada not only have cut spending but also raised taxes to balance budgets and wait out bad times. California has made massive spending cuts but has relied heavily on short-term budget fixes and never quite balanced its budget.

The result is that the richest state in the Far West has fallen to last place in state credit quality, while neighboring Oregon and Nevada, which plan to bring general obligation bonds to market next week, both carry double-A level ratings.

“You can raise taxes, you can cut spending, but you have to do something,” said Moody’s Investors Service analyst Emily Raimes. “The difficulty that California has faced is that those decisions have been extraordinarily difficult for them.”

Democratic Oregon Gov. Ted Kulongoski relied more on tax hikes to balance its budget for the 2009-11 biennium and has maintained its ratings. Oregon, which is selling $51 million of GOs next week, is rated Aa2 by Moody’s and AA by Standard & Poor’s and Fitch Ratings.

In Nevada, lawmakers overrode a veto by Republican Gov. Jim Gibbons to pass a combination of big spending cuts and tax increases that balanced the 2010-11 biennial budget. Gibbons wanted to solve the state’s budget woes with cuts alone.

After downgrades, the state, which is selling $131 million of GOs this week, is rated Aa2 by Moody’s and AA by Fitch. Standard & Poor’s affirmed its AA-plus.

But the comparison with California is instructive. In the face of economic woes, Nevada suffered single-notch downgrades rather than the multi-notch drops that have slammed its big neighbor.

California, which dwarfs its neighbors in population and spending, most recently closed a $24.2 billion general fund gap in July by cutting spending and changing the timing of payments and borrowing. The general fund budget has shrunk to less than $85 billion in the current fiscal year from more than $100 billion in 2007-08.

But its budget solutions have only come after the state fell into a deep cash-flow crises, and they have been short-lived.

The current fix is already looking inadequate. California’s general fund revenue was more than $1 billion below projections in the first quarter of fiscal 2010, Controller John Chiang said earlier this month, and the California Redevelopment Association last week filed suit to stop a $2.05 billion shift of redevelopment funds from local agencies to the general fund.

California’s GO ratings have fallen to BBB from Fitch, Baa1 from Moody’s, and A from Standard & Poor’s. Those are the lowest ratings for any state in the nation.

“The cause for California’s multiple-notch downgrades can be boiled down to two things: the liquidity crises and the political stagnation that has come up around the budget gaps that have opened up,” said Moody’s Raimes.

“While the magnitude of the downturn might be different from state to state, generally what we’ve seen in states that have higher ratings than California is that revenues have declined and they’ve dealt with that” through spending cuts, revenue raising measures and less than perfect one-time fixes, she said.

Lawmakers in other states have generally found the political will to fix budget gaps as they appeared. The difference between the states seems to have more to do with governance than economics.

California is the wealthiest of the Far West states with per capita personal income equal to 109% of the national average in 2008, according to the Bureau of Economic Analysis. Nevada incomes are 102% of the national level and Oregon’s are just 90%. All three have faced massive job losses and steep drops in revenue.

Nevada’s jobless rate is the highest in the region at 13.3% in September, according to the Bureau of Labor Statistics. That’s up 6 percentage points from a year ago. Oregon’s jobless rate has risen 4.7 percentage points in the past year to 11.5%, and California’s jobless rate has surged 4.4 percentage points to 12.2%. The result has been deep budget gaps in all three states.

Oregon faced a projected $3.8 billion gap in its $13 billion general fund budget for 2009-11. Lawmakers raised taxes by about $750 million, cut spending by $1.8 billion, and used reserves and federal stimulus dollars to fill the balance of the gap.

Californians often blame their budget woes on the two-thirds supermajority requirement for legislative approval of budgets and tax increases. They’ve also split power between Republican Gov. Arnold Schwarzenegger and Democrats who control majorities in both chambers.

Oregon requires a three-fifths supermajority to pass revenue bills, but doesn’t face the challenge of divided government. Democrats have large enough majorities to pass their tax proposals over GOP opposition, and the governor is a Democrat.

That’s not to say they can pass higher taxes without any checks. Tax hikes this year face an electoral challenge in January, when voters will get to decide whether to accept or reject higher taxes.

“Their financial managers have taken measures and indicated that they’ll take additional measures to maintain balance,” Fitch’s Kenneth Weinstein said in an interview.

Oregon also came into the recession with a cushion that California lacked: ample reserves. Oregon created a new rainy-day fund during the last economic expansion, and by the time the recession hit, it had put almost $800 million in that fund and an education stability fund. Lawmakers say they plan to spend the remaining $415 million of their reserves to cover expected shortfalls in the current biennial budget.

Nevada balanced its budget despite both divided government and deep economic decline. Revenue fell 10.3% in fiscal 2010, as even typically resilient gaming revenues tumbled 13%.

The state expects revenue to fall 0.2% in the current biennium. The result has been two downgrades so far, but both ratings agencies emphasized that the state has managed the downturn well.

“The economic downturn has had a severe impact on the state’s financial operations, with economically sensitive revenues falling dramatically,” Fitch said in a report announcing a rating downgrade from AA-plus to AA yesterday. “The state has responded rapidly to the financial stress with a significant increase in taxes and made legislative changes to shore up its now depleted rainy-day fund.”

Gibbons used executive powers to make mid-year cuts to reduce spending to match lower-than-expected revenues last year, and Democrats who control the Legislature wrangled a two-thirds bipartisan majority to pass a budget that closed a $2 billion gap in the current biennial budget before the current fiscal year began.

Moody’s analyst Raimes said: “What has kept their rating from falling further and what distinguishes them from some lower-rated states is the fact that they have been very proactive in dealing with those” deficits.

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