Banana Republic of California

"'California may have to go into bankruptcy,' Rep. Brad Sherman told me at a brunch in Washington this past Sunday. The California Democrat, who represents the wealthy Los Angeles suburbs, is no hysteric -- he's a certified public accountant and former chair of the State Board of Equalization, which administers California's sales tax system. 'It would be unprecedented,' he said. 'A judge may have to step in if and when the state can't pay its bonds.'

"The scenario is becoming more likely as tax revenues have declined so sharply that California now faces a budget deficit of some $15 billion by June. If six budget measures on next Tuesday's ballot fail, blocking extension of certain "temporary" tax hikes and preventing the state from selling future lottery revenue, the state's red ink may hit $21 billion. In a last ditch effort to save the ballot measures, which are trailing badly in the polls, Governor Arnold Schwarzenegger has announced he's preparing a 'doomsday' budget with massive spending cuts in case the propositions fail.

"One reason the ballot measures look like losers is that California voters swallowed harsh medicine only three months ago in February when the legislature passed a series of tax hikes to stem the budget shortfall. Those tax hikes in the middle of a recession have only exacerbated the state's unfriendly business climate. So far, California legislators have avoided making fundamental budget reforms. The spending cap they placed on next week's ballot is riddled with loopholes and would only go into effect if voters approve extending the February tax increases. 'It's the equivalent of holding a gun to voters' heads,' says Rep. Tom McClintock, a Republican from Sacramento. 'Voters may not know the details, but they feel the politicians have abdicated their responsibility to clean up the mess.'

"Those same politicians will now look to Washington for a solution rather than address the problems squarely if the ballot measures lose. Rep. Sherman says state officials will ask the federal government to guarantee the state's short-term debt in order to keep checks flowing to creditors. He points out that California faces limits on how deeply it can cut social programs, such as education or health care for the poor, without jeopardizing federal stimulus funding. Just last week, the Obama administration informed Governor Schwarzenegger that his proposed wage cuts for home health-care workers would cost the state billions of dollars in stimulus funds. Governor Schwarzenegger's office complains that the powerful Service Employees International Union, which lobbied the Obama administration to withhold stimulus funds if the state went ahead with pay cuts, was included in a conference call in which state and federal officials discussed Washington's ultimatum.

"Kim Belshe, California's Secretary of Health and Human Services, told the Los Angeles Times she was surprised the union was allowed to participate in government-to-government negotiations. 'The involvement of a stakeholder in this kind of state-federal deliberative process is unusual at best. This was really atypical and outside any norm I am familiar with,' she said.

"Ms. Belshe may have to get used to the new norm. The powerful public sector unions that run California would rather lobby for a federal bailout than tolerate any repeal of the tax hikes that are driving people and businesses from the state. Unless the state's elected leadership finds a way to break this stranglehold, California['s state government] may face a death spiral in which an unelected bankruptcy judge will ultimately control the state's destiny."

-- John Fund, Wall Street Journal