For cash-strapped California, bankruptcy may be best option (Feature)

By Andy Goldberg Apr 20, 2010, 6:07 GMT

Sacramento, California - When Arnold Schwarzenegger rode into the state capital in 2003 after victory in a snap recall election, he pledged to fix the state's finances, which had run up a 38-billion-dollar deficit in the wake of the dotcom bust.

Seven years later, as the Governator prepares to leave office, California continues to limp along, shackled by a budget and debt crisis that makes a mockery of its reputation as the richest state in America. The situation reached its nadir last year when the state was so close to running out of money it was forced to issue IOU's to its suppliers, slash funding on welfare and education, and force workers to take unpaid furloughs to save on the wage bill.

Even with those measures, California still had to deal with a 26.3-billion-dollar budget crisis last year, and is facing a 14- billion-dollar deficit this year. With figures like that, it's not surprising that California has the lowest credit rating of any state in the US, making it more expensive to borrow money that's needed to make much-needed infrastructure repairs.

Much of the crisis can be attributed to California's dysfunctional political system, which allows voter initiatives to set policies and requires a two-thirds majority in the legislature to raise taxes or pass a budget.

The most damaging initiative, called Proposition 13, was passed in 1978. It reduced property taxes by 57 per cent and pegged any annual increase for property owners to 2 per cent. Ever since, income from property taxes has failed spectacularly to keep pace with inflation.

Further complicating California's fiscal challenges are the especially close links between politicians and the large public sector unions. Their jaw-dropping wage and benefit deals for state workers - from policemen to teachers and from firefighters to beach life guards - are the envy of all Californians and a huge drain on government resources.

The budget crisis will dominate the race to replace Schwarzenegger in the November elections. One prominent Republican candidate, former Hewlett Packard chairwoman Carly Fiorina, has even proposed a novel solution to the problem: simply declaring itself bankrupt and starting afresh, just as many of its citizens have done for their personal debt.