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Tax cut asteroid to hit California budget

by Bob Morris, published

The California budget deficit could now reach $28 billion over the next 18 months due to estate tax cuts proposed by Obama. These cuts will cost California $2.7 billion in expected revenue, as it raises the excluded amount from $8 million to $10 million, and lowers the tax rate from 55% to 35% on estates.

Even more ominously, Build America Bonds (BABS) will not be extended. These securities give state and municipality bond issuers and purchasers, respectively, federal subsidies and tax credits and were signed into law in Feb. 2009 by Obama. In November, former hedge fund manager Bruce Krastling said BABS were supposed to be revenue neutral at the federal level but instead proved mightily profitable for investors with taxpayers footing the bill. Who could have imagined such a thing could happen?

He also said if BABS were not renewed there would be slaughter in tax-exempt Munis, the economic recovery would stall, and California would have a new fiscal crisis, "If BABs is not extended the Muni market will get smoked. The epicenter of the fire will be California, followed very quickly by New York." Writing in November, he assumed the government would extend BABS, but what a difference a few weeks make. The plan proposed by Obama and Republicans specifically does not extend BABS.

Without BABS, California will pay more for issuing new bonds, and those bonds will be more difficult to sell. It is in effect a subsidy for California (and other states) allowing them to borrow more cheaply. However, the cost gets dumped on taxpayers and increases the deficit. But without BABS, if Krastling is only half right, the effects will be catastrophic.

California's huge deficit does not include over $200 billion in loans and unfunded liabilities, including projected pension expenses it has little chance of paying. At some point, the deficit spending has to stop.  If not voluntarily, events will force the issue. The probability of California defaulting on debt, sooner rather than later, increases evermore on a daily basis.

If the tax bill passes as is, then California will take a big double hit, with $2.7 billion less in revenue at a time it desperately needs more, along with the unpalatable reality of increased borrowing costs. 

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