California Must Reinvent Its Ties to Washington

President Bill Clinton’s visit to California last week to stump for Democratic candidates inadvertently highlighted one of the most important, but least discussed, economic challenges facing the state: restruc turing its dysfunctional relations with Washington. Nothing comes close to the federal government as the primary cause of California’s recent recession. Yet, rather than fundamentally alter the increasingly ill-informed federal tax, regulatory and technology policies that are punishing the state’s economy, most politicians are seduced by the notion that they can improve the state simply by getting a bigger piece of the federal pie for their constituents.

This is a dangerous, if appealing, strategy. Bidding for Beltway baubles returns far less to California than the billions of tax dollars it contributes to Washington, erodes the fiscal foundations of the state’s healthier industries and obscures the true sources of its industrial vitality.

The dimensions of the problem are staggering. Clinton’s brief visit served to mark the nearly two years during which Washington’s adverse effect on California’s high-wage industries has gone from bad to immeasurably worse. Typical was the Administration’s 1993 tax plan, which a secret government report, released the day after Congress approved the new levies, estimated will cost the state $37 billion over the next five years, by far the largest increase in the country.

Since then, with growing frequency, Clinton-appointed regulators have tried to impose air, water and other resource restrictions that threaten California’s economy, while the Justice Department supports legal challenges to community improvement measures, such as controlling panhandling. The Administration has conducted, or plans, punitive tax and labor audits of such growing California sectors as textiles and entertainment. Its disproportionate defense cuts--California was stripped of defense jobs at four times the rate of other regions--account for at least 50% of the state’s total recessionary job losses in the 1990s.

With such an economic backdrop, pledges to “fight for California” and bring home more federal bacon as an antidote to Washington’s anti-industrial policies seem illusory, if not foolish. Even the most spendthrift federal programs will cost California more than their “face” value, because for each new dollar of federal spending, Californians contribute an increasingly disproportionate share of the underlying tax base. Politicians celebrated the millions of dollars they “won” for the state in the recent federal crime bill, for example, but were strangely silent about the price. Californians, in fact, will pay $250 million more than they will receive under the program.

But even if the funds flowing to the state equaled the taxes going to Washington--and, today, California pays billions more to the federal government than it receives--the state’s economy would still be shortchanged. Pre-tax dollars in the hands of California consumers, which can be spent in any way they choose, are worth more in real terms than dollars sent back, encumbered by federal mandates and used to buy goods and services from Washington bureaucracies.

When consumers spend their money on what they prefer to buy, workers and businesses in California that meet their needs learn to develop the skills and products required to compete in global markets. By contrast, no matter how well-justified by promises of technology “spin-offs” or magical new industrial development, spending by federal bureaucrats, in the vast majority of cases, diverts what would otherwise be more productive uses of labor and materials into esoteric, non-market areas.

Contrary to what many may believe, for example, sending $1 billion of taxes to Washington in exchange for a $1-billion defense contract is a terrible deal for California. In such a transaction, the state has to move resources from competitive, growing sectors--engineers who might otherwise be designing biomedical instruments, writers who could develop the next box-office smash, or electronic components that could be used in novel auto sensors--to meet federal contract demands. It also has to pay for the goods and services used to assemble the final products, expenditures that inevitably leak to and benefit vendors and workers in other regions. These and other offsetting expenses can reduce the real value of federal contracts to just pennies on each dollar the taxpayers send to Washington.

Such remarkably one-sided exchanges, moreover, strip resources from the smaller-scale, growing companies that are actively building California’s economy, and blind the state’s leadership to the needs of the industries that will generate their constituents’ future prosperity.

A study of more than 18,000 firms employing 370,000 people in the software, environmental, entertainment, mechanical engineering, biomedical and textiles areas in Los Angeles County, for example, showed that 96% were privately held firms of fewer than 100 employees. The huge majority reported absolutely no reliance on federal funding, training, technology or procurement schemes so avidly pursued by their congressional representatives. Rather, they grew by using family and personal resources to start their firms, reinvested the proceeds, and developed new products and technologies in collaboration with other self-financed companies in the region. Most expanded throughout the recession.

Until quite recently, California’s leadership had no inkling of their state’s true vitality. Having lost faith in the private sector, they begged for help from federal bureaucracies. But to the embarrassment of the high-profile economic “forecasting” outfits and special interests who exploited preliminary, wildly inaccurate employment data to help justify federal bailouts, California’s official recessionary job-loss figures are being lowered to about 50% below the 870,000 level once repeated as gospel just a few months ago.

Driven by previously unmeasured gains in non-defense sectors and by privately held, smaller firms, the new data show that California came out of its recession nearly a year earlier than previously believed, and its job growth during that period was five times the rate earlier reported. Major companies like BankAmerica are now increasing their estimates of California’s job expansion by threefold over the next year.

California can thus ill afford the lost opportunities and diverted development produced by the economic fantasies contained in pork-barrel politics. Rather than continue to play a game that the state can only lose, every candidate should be debating proposals for restructuring the federal tax, various regulatory regimes and other policies to strengthen California’s new economy.

Unfortunately, few of California’s aspiring leaders have exhibited the willingness to discuss, let alone accomplish, such changes. Yet, no issue is more crucial to the state’s economic future. If Californians cannot find leaders to effectively represent the interests of their real economy in Washington, the state’s newly rediscovered burgeoning sectors and growing firms could well become the next casualty of misguided federal policies.*