10/26/12 – California at the Bleeding Edge Again

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Oct 26, 2012 8:25:45 AM

and tagged Fiscal Cliff, Politics and the Economy, Yesterday's News

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There is a fair bit of news today, which I will deal with in other posts, but I wanted to start with this one because I think it encapsulates a lot of the arguments that are being made at a national level.

The Financial Times has two articles on the decision California is currently making, which is whether to raise taxes to pay for services. The headlines capture the issues very clearly, with “Stark tax choice for California voters” (p. 1) and “California vote set to test U.S. appetite for cuts to services.” There are two initiatives on the ballot, the first of which provides funding for state government, including education, with a surtax on high-income earners—starting at $250,000 per year—and an increase in the sales tax. The threat is that schools will have to close three weeks early if the measure does not pass.

The competing proposal also seeks to raise more funds, but it limits the use of those funds to education. The argument is that education needs the money but that raising taxes without explicitly limiting their use will just “feed the beast” of state government.

So, here we have it. A stark decision: raise taxes or cut services. Whether you choose to limit the use of the money or not, you have to make a decision.

The presidential election is not framed quite as starkly as this, but the choice is essentially the same. The Obama administration plans to continue services as presently provided, which will require a significant tax increase. The Romney campaign plans to cut services, which will still require effective tax collection to at least remain the same. More taxes or fewer services.

The recent move to the center by both parties has made the choice less apparent, but the respite is an illusion—and it will be brief. The fiscal cliff pending at the end of the year means that the president-elect, whoever he is, will have about six weeks to make that decision and start working to make it happen.

The political results remain incredibly uncertain, with both campaigns gearing down for the final push. Obama remains the favorite, but much less so than he was. Economic uncertainty remains high as well. Consumers are apparently ignoring the fiscal cliff, as spending continues to grow strongly, while businesses continue to cut back and postpone spending. See the Wall Street Journal, which has “Goods Orders Show Firms Remain Wary” (p. A2) and “Firms Hit Brakes Before Fiscal Cliff” (p. A6), versus “US Economy Is in the Eye of the Beholder” (p. C1). Third-quarter economic growth came in better than expected on just these two trends, but consumers can’t continue to spend at this rate if businesses don’t start to hire.

The U.S. is on hold until the election at the earliest, and then the clock will start ticking on the fiscal cliff. The fact that a “perfect storm” is heading toward the East Coast at the same time, especially toward Washington, DC, suggests to me that God either has a sense of humor or is trying to make a not very subtle point.

Let’s hope our leaders get it.

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