Ailing California could prolong U.S. recession

SACRAMENTO, Calif. - California faces a $24 billion budget shortfall, an eye-popping amount that dwarfs many states' entire annual spending plans.

Beyond California's borders, why should anyone care that the home of Google and the Walt Disney Co. might stop paying its bills this week?

Virtually all states are suffering in the recession, some worse than California. But none has the economic horsepower of the world's eighth-largest economy, home to one in eight Americans.

California accounts for 12 percent of the nation's gross domestic product and the largest share of retail sales of any state. It also sends far more in tax revenue to the federal government than it receives — giving a dollar for every 80 cents it gets back — which means Californians are keeping social programs afloat across the U.S.

While the deficit only affects the state, California's deepening economic malaise could make it harder for the entire nation's economy to recover.

When the state stumbles, its sheer size — 38.3 million people — creates fallout for businesses from Texas to Michigan.

"California is the key catalyst for U.S. retail sales, and if California falls further you will see the U.S. economy suffer significantly," said retail consultant Burt P. Flickinger, managing director of Strategic Resource Group. He warned of more bankruptcies of national retail chains and brand suppliers.

Even if California lawmakers solve the deficit quickly, there will likely be more government furloughs and layoffs and tens of billions of dollars in spending cuts. That will ripple through the state economy, sowing fear of even more job losses.

Seeking federal help
Californians have already been scaling back for months as the state's unemployment rate has climbed to a record 11.5 percent in May. Increases to the income, sales and vehicle license taxes approved by lawmakers and Gov. Arnold Schwarzenegger in February acted as a further drag on spending.

Personal income declined in California in 2008 for the first time since the Great Depression, and income tax revenue fell by 34 percent during the first five months of this year.

The decrease in spending is especially evident in automobiles. California is the largest U.S. single auto market, and sales are down 40 percent from last year. Auto dealers see little hope of a quick turnaround, especially after a 1 percentage point increase in the state sales tax and hike of the vehicle license fee.

State agencies also canceled contracts for hundreds of new vehicles, retroactive to March, said Brian Maas, director of government affairs for the California New Car Dealers Association.

Because California's $1.7 trillion annual economy is so important, the state's treasurer has asked for federal help — in the form of a guarantee that would allow California and other states to take out short-term loans at lower interest rates.

A federal guarantee would cut the interest rate on the state's borrowing by as much as half, saving California taxpayers hundreds of millions of dollars.

"It's not that California got itself into trouble and wants the federal government to bail it out," said state Rep. Brad Sherman. "California wants the federal government to do for a fee that which Wall Street would do for a fee if Wall Street wasn't broken."

No bailout
But some members of Congress worry about setting a precedent for bailing out local governments.

"You've got many states throughout this country, you've got many cities that are in tough financial problems, so they will all come for help," explained Rep. Kevin McCarthy.

Any extra federal assistance is sure to be a hard sell in Washington and elsewhere because of California's free-spending image.

That may have been true before the recession, but the state cut $15 billion in government spending in February and plans to solve most of the $24 billion deficit through even more cuts.

Government workers face the possibility of three-day-a-month furloughs, teachers are being laid off, lower-income college students stand to lose their grants and hundreds of thousands of poor children could go without health care.

The recession is behind this fiscal turmoil. Some 1 million jobs are expected to be lost in California in two years and unemployment is estimated to peak at 12.3 percent in early 2010, said Jeff Michael, director of the Business Forecasting Center at the University of the Pacific in Stockton.

Schwarzenegger has repeatedly stressed that he hasn't asked for a bailout and doesn't want any special treatment for California — though he likely wouldn't reject more stimulus funding if it came his way.

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