May 14, 2008

Schwarzenegger can't -- or won't -- balance the budget

The governor's revised budget would give more to schools and less to health and welfare than he proposed in January, but the real story is his proposal to use lottery revenues to bridge the stubborn gap between spending and tax collections. Schwarzenegger's press staff is furiously trying to portray the lottery deal as something other than borrowing, but borrowing it is. The state would change the game's rules in ways designed to attract more business, then lean on private investors for $15 billion in up-front payments. That advance on lottery revenues would be repaid over 30 years from the new proceeds generated by the changes. But the up-front money runs out after three years, and guess what happens then: Yup: the budget deficit reappears, unless there's an economic miracle between now and then. Ironically, if there were an economic surge and the governor's revenue-averaging proposal were in place, the state couldn't spend the new money and would still be left with a shortfall to cover. That persistent shortfall, at least according to the governor's numbers, is in the range of about $5 billion to $6 billion a year. Fixing that would be the next governor's problem.

UPDATE: OK, I think David Crane from the governor's office might have persuaded me that legally, the lottery transaction would not be "borrowing." He says the state would have no obligation to repay the $15 billion if the lottery changes didn't generate the proceeds to do the job. If that were the case, then the investors would be taking the risk, and the state would be off the hook. I do find it hard to believe that anyone would make such a deal without a really, really, high expected rate of return, or what you might call an interest rate if this were a loan, to compensate for the risk.

Fiscally, however, the effect of the transaction is still the same as borrowing. The state has a potential revenue stream, and instead of letting it roll in naturally, it captures it all up front, then in exchange gives up the revenue stream for an extended period, with interest (or a rate of return). If the upfront money is used to plug a gap between spending and tax revenue, as Schwarzenegger has proposed, then it's just another form of deficit spending, and when the lottery money runs out, you're screwed.

UPDATE 2: Two more arguments for calling this borrowing. First, the fact that the new proceeds from the expanded lottery are not the only thing pledged to repay the investors. If that money is not sufficient to make the scheduled payment, the current lottery revenue stream, the part now going to the schools, would be used. So the state does have its money at risk. Second, the due dillegence papers the state commissioned on this deal and distributed to reporters refer to the annual payments as "debt service." It's hard to pay debt service when you don't have a debt.

Posted by dweintraub on May 14, 2008 2:03 PM