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When political dysfunction threatens the economy

By David Ignatius
Sunday, January 3, 2010; A17

The U.S. economy survived the traumas of 2009, thanks to good policy and good luck. What worries me, looking ahead, is what might be called the "Californiazation" of America -- the growing tendency of our political system to make promises in social spending programs that it isn't prepared to pay for with tax increases.

America's other economic problems seem solvable: The economy is returning to normal growth, even though consumers are sensibly saving a greater proportion of their incomes; the global economy is becoming more balanced, with China contemplating an upward adjustment in the value of its currency; and the Federal Reserve is managing the transition from a crisis policy of free money to a tightening that's likely to begin later this year.

Unemployment remains stubbornly high at 10 percent as of November -- which is roughly 1.5 percentage points above what government economists expected -- but the White House hopes this is a temporary deviation. To encourage quicker job growth, the Obama administration is likely to ask Congress for another dose of stimulus, perhaps $50 billion more in spending for infrastructure. After the huge bank bailouts, who's going to quibble over that?

What's worrisome this year isn't economic decline but political dysfunction. And nowhere is that clearer than in California, where politicians -- despite some serious bipartisan efforts -- haven't been able to make the decisions that would put the state on a sound financial footing.

The political forces that generate deficits are just too strong: a Democratic Party in hock to public-employee unions and a Republican Party in love with tax cuts. Gov. Arnold Schwarzenegger labored mightily in 2009 to close a $60 billion budget deficit, hammering out a plan that included $32 billion in spending cuts and $12.5 billion in temporary tax increases.

But at year's end, Schwarzenegger was still looking at a combined $21 billion deficit for the current and coming fiscal years, and he was pleading for an $8 billion federal bailout. A Bay Area news site last week featured this telling headline: "Schwarzenegger's New Action Role: Beggar."

"The problem is that there are no easy solutions left," lamented Jean Ross, director of the California Budget Project, in a comment to Bloomberg News. Schwarzenegger is talking about a new round of budget cuts, but what he really wants is a federal rescue. I can't help thinking of California as the new AIG -- spending money extravagantly on the way up and then extending the tin cup to Washington when the bubble bursts.

California is hardly alone in its fiscal difficulties. Most states are still recovering from the effects of the recession. But even more, they suffer from a chronic inability to resist the impulse to spend big and tax small.

There's Wisconsin, for example, which finished 2009 with a $2.7 billion deficit despite a technical requirement that the state balance its budget. Wisconsin's budget shortfalls have grown every year but one since 1999, and its deficit per capita is four times that of California, according to an article last week by Todd Berry, a budget expert based in Madison.

What many state governments want is a federal bailout, which would free them of the consequences of overspending. It's a classic case of what economists call "moral hazard" -- in that the bailouts would allow the irresponsible behavior to continue, rather than force a halt. One prominent economist argues that if the states were countries, the International Monetary Fund would grant relief only if it came with conditions that imposed fiscal discipline.

So will Washington become like California? Some would argue that has already happened, with the fiscal disaster masked by the federal government's ability to sell its massive debt cheaply and print money to pay its bills. And you see in Washington the same dysfunctional political process that's at work at the state level -- Democrats who get elected by delivering services and Republicans who get elected by delivering tax cuts.

The test case this year for Californiazation will be the health-care bill. Democrats' desire to provide universal access to care is right, but the country has to pay for it. Indeed, we have to lower the cost of delivering health care so that paying this bill won't be a crushing economic burden.

We should judge President Obama and Congress this year on whether they're paying for the promises they make -- and providing real reform that cuts costs, rather than another political goody bag.

davidignatius@washpost.com

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