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California on 'verge of system failure' Add to ...

Billionaire Warren Buffett, who advised U.S. President Barack Obama during his White House run, suggested recently that a Washington bailout of California and other troubled states is inevitable. How, he wondered, can Washington deny California after saying yes to General Motors, AIG and dozens of banks.

"I don't know how you would tell a state you're going to stiff-arm them with all the bailouts of corporations," Mr. Buffett said.

The alternative for many state and local governments may be default. Mr. Buffett said many state and municipal bonds are only triple-A rated because investors assume there's a federal backstop. "If the federal government won't step in to help them, who knows what [the bonds]are," he said.



An Investor's Guide to Understanding the Economy by Gary Rabbior:

  • Part 1: How the money in the economy is managed
  • Part 2: How inflation works
  • Part 3: Avoiding the deflationary spiral
  • Part 4: How much money is too much money?
  • Part 5: How markets and currencies work
  • Part 6: How interest rates affect your investments




California's credit rating is already the lowest of all 50 states.

How California, the largest and once most-prosperous state, got in this mess is a story decades in the making. It began with middle-class angst and a property tax revolt in the sprawling suburbs of Los Angeles. The movement would eventually sweep the country in the inflation-ravaged economy of the late 1970s, leaving government unable to pay for many of the services and entitlements people now take for granted.

John Serrano Jr., a social worker, was frustrated that he had to move his family out of East L.A. to find decent public schools for his children. He would eventually lend his name to a class-action lawsuit that would go all the way to the California Supreme Court. In a series of decisions, the court found the state's school finance system to be unconstitutional for relying too heavily on local property taxes, which vary widely in poor and wealthy neighbourhoods. For example, a school in tony Beverly Hills would often get more than twice the funds per student than one in poor East L.A.

The landmark case would forever change the fiscal landscape of California, and many other states, shifting the financial burden of kindergarten to Grade 12 education from local to state governments, but not the tax base. K-12 education is now the State of California's single largest expense, soaking up roughly a third of its budget.

A tax revolt would further tilt the tax burden to the state and deprive local governments of their most stable funding source - property taxes.

In the mid-1970s, California property taxes were soaring, along with real estate values, and incomes couldn't keep pace. The result was a campaign, financed by L.A.-area apartment landlords, that culminated in the now-infamous Proposition 13 ballot initiative in 1978.

Prop. 13 rolled back and capped both residential and commercial property tax rates at 1975 levels. And it virtually guaranteed that only a revolution would reverse the measure. Proposition 13 imposed a two-thirds majority requirement for all tax bills and required local voters to approve all municipal tax increases.

"California put itself in a straitjacket that it hasn't been able to get out of," Occidental College's Prof. Dreier explained.

In the years since Prop. 13, California has come to the rescue of local governments, taking on ever-greater responsibility for schools, low-income health care and welfare. And it has paid for all that with volatile sales and income tax revenue, making it tough to balance its budget when the economy stalls.

"A lot of people predicted doom and gloom in 1978. It just took a long time," said John Tanner, executive director of Local 721 of the Service Employees International Union, which represents 85,000 government workers in Los Angeles and throughout Southern California.

Prop. 13, according to Mr. Tanner, has put schools, courts, parks and a raft of other government services in a downward spiral. "We are at an unacceptable place right now," he said.

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