Editor’s note: See correction at the bottom.

Toto, I have a feeling we’re not in Kansas anymore. We’re in California, where the winter weather is in the 70s and the high taxes are imposed by the Great and Powerful Oz.

Writing in Al Jazerra, David Cay Johnston said Kansas’ tax cuts hurt it, while California was helped by its $7 billion in tax increases, which voters approved with Proposition 30 in 2012. He is an investigative reporter, Pulitzer Prize winner and professor of business, tax and property law of the ancient world at the Syracuse University College of Law.

His headline: “Real world contradicts right-wing tax theories.” Subheadline: “California raised taxes, Kansas cut them. California did better.”

He wrote:

“Ever since economist Arthur Laffer drew his namesake curve on a napkin for two officials in President Richard Nixon’s administration four decades ago, we have been told that cutting tax rates spurs jobs and higher pay, while hiking taxes does the opposite.

“Now, thanks to recent tax cuts in Kansas and tax hikes in California, we have real-world tests of this idea. So far, the results do not support Laffer’s insistence that lower tax rates always result in more and better-paying jobs. In fact, Kansas’ tax cuts produced much slower job and wage growth than in California.

“The empirical evidence that the Laffer curve is not what its promoter insists joins other real-world experience undermining the widely held belief that minimum wage increases reduce employment and income.”

Let’s just deal with that.

First, as I seem to be the only one to have pointed out, California taxes actually have declined in recent years, not risen. I wrote in July:

“California taxes have dropped $6 billion in the last two years. That’s because Gov. Arnold Schwarzenegger’s record, $13 billion tax increase of 2009 expired and was replaced in 2012 by Gov. Jerry Brown’s $7 billion tax increase of Proposition 30.

“Net: a $6 billion tax cut.”

Now, guess what? The entire general-fund budget in 2013 for Kansas was $6.2 billion — roughly equal to the California tax cut.

So anything good Johnston says about tax policy in California has to be assigned to the tax cut here, not to an increase that didn’t happen.

‘Temporary tax’

True, from a Lafferite perspective, things would have been even better had Prop. 30 not passed. But in life, you take what you can get. And Gov. Jerry Brown, who campaigned for voters to pass Prop. 30, reminded us in October, “I said when I campaigned for Prop. 30 that it was a temporary tax, so that’s my belief, and I’m doing everything I can to live within our means.”

That’s highly encouraging to California businesses, which can look to an infusion of investments — Prop. 30 mainly is a tax on the wealthy — in a couple of years when the money is shifted back from the wasteful government sector to the productive private sector. Much more than government, businesses are forward looking.

If that happens, and Prop. 30 expires, taxes will have dropped $13 billion under Brown, the biggest tax cut of any state in history.

And if in 2016, Brown makes a fourth bid for president, all that will make for a compelling part of his “California is back [because of me]” narrative. Indeed, the Kansas governor’s own victory could put him in contention for the GOP nomination. How about a 2016 contest of Brown vs. Brownback?

By the way, it was Laffer who designed Brown’s supply-side, flat-tax proposal, a 13 percent income tax on everyone, during the governor’s 1992 presidential bid. So Brown, hardly the “right wing” partisan Johnston thinks goes for cutting tax rates, is well aware of supply-side economics.

Laffer also helped design California’s Proposition 13 tax cuts in 1978; and Ronald Reagan’s tax cuts that propelled more than two decades of strong American growth, until the unfortunate Bush-Obama policies of recent years. Laffer currently heads the Laffer Center for Supply Side Economics at the Pacific Research Institute, CalWatchDog.com’s parent think tank.

I recently reviewed, “The Pillars of Reaganomics: A Generation of Wisdom from Arthur Laffer and the Supply-Side Revolutionaries,” edited by Brian Domitrovic.

Supply-side

Johnston explained:

“Laffer’s model illustration looks like a bullet pointed to the right. It shows that the government collects no revenue when tax rates are at 0 or 100 percent. As tax rates rise, revenue does until reaching an unspecified rate that Laffer calls “prohibitive.” Above that level, as tax rates rise, government revenues fall off quickly.”

But this seems pretty obvious, doesn’t it? If the income tax were 100 percent, would you work? Of course not, except on the black market. What would be the point? (The Laffer Curve graphic he kindly linked to is from Laffer’s own site, and is reproduced nearby.)

Johnston wrote:

“Laffer qualifies many of his assertions about changes in tax rates, noting that tax cuts may result in less government revenue, for example.”

Right. As you move down the lower part of the Laffer Curve, the white area, both tax rates and revenues drop. Taxes at a 0 percent rate obviously raise 0 dollars. (Unless the good professor volunteers to send the treasury a check.)

Kansas vs. California

Johnston continued:

“But on one issue from the Laffer curve, he is absolute:

“Tax rate cuts will always lead to more growth, employment and income for citizens, which are desirable outcomes leading to greater prosperity and opportunity.”

This is where the Sunflower State vs. Golden State rivalry comes in, an economic version of the Kansas State Wildcats vs. the UCLA Bruins at the Valero Alamo Bowl on Jan. 2.

“Is this absolute rule right?” Johnston asked. “Let’s consider the tax law changes in Kansas and California that took effect at the start of last year [2013; although Prop. 30 actually was retroactive to Jan. 1, 2012].”

He recounted how Gov. Sam Brownback ran for office in 2010 “to turn the state into a low-tax paradise and eventually to eliminate the state income tax….The Brownback administration paid Laffer $75,000 for his advice on the tax cuts.” Effective in 2013, “The bottom rate was cut from 3.5 percent to 3 percent. The top rate, which starts at $15,000 of taxable income for singles, was lowered from 6.25 percent to 4.9 percent.”

Imagine that! A politician who actually kept the campaign promise under which people elected him. Indeed, Brownback last month was re-elected, despite concern that his tax cuts caused budget deficits. The Kansas City Star reported:

“After he addressed his supporters, Brownback told The Star he looked forward to the next four years.

“’We’ve done the hard things,’ he said. ‘Now we can do the things that we want to do. We can invest in education growth because we’ve made the tough decisions. Now we can work on issues like poverty and water because we’ve made the tough choices.’

Brownback also plans on reducing Kansas’ deficits by cutting waste, which as everywhere in government is larded as thick as on a holiday hog.

And with Brownback and his tax cuts now firmly entrenched, Kansas businesses can plan their prosperous futures. I suspect, just as Laffer’s theory predicts, the prosperity will increase the tax base, thus providing higher taxes which also will close the deficit.

“The same month the Kansas tax rate cuts began, tax rates rose in California,” Johnston wrote. But as we have seen, looked at in a slightly larger perspective, California’s taxes dropped $6 billion — which helped that other tax-cutting governor, Jerry Brown, also win re-election.

Bond rating

Johnston brought up state bonds:

“Moody’s Investors Service lowered the state’s credit rating after the $800 million of tax cuts took effect, a move Brownback dismissed as telling more about Moody’s policies than Kansas’ finances. Later Standard & Poor’s also downgraded Kansas bonds, citing ‘a structurally unbalanced budget,’ in which taxes were cut more than spending.”

He also could have cited how California’s bond rating was upgraded right after voters just passed Proposition 2, the “rainy day fund” initiative.

Except that, despite these changes, Kansas still has higher bond ratings. California’s S&P bond rating rose to “A-plus” from “A.” S&P defines that as, “Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.”

Kansas’ S&P rating, from the August downgrade, went to “AA-minus” from “AA.” S&P defines that as — note the lack of a cautionary note — “Very strong capacity to meet financial commitments.”

As to Moody’s, it rates California’s bonds “Aa3,” but Kansas’ higher, at “Aa2.” Both “Aa” ratings are defined as, “Obligations rated Aa are judged to be of high quality and are subject to very low credit risk.”

On bonds, Johnston summarized, “California’s credit rating improved. The Golden State can borrow at lower rates, while Kansas will have to pay more to compensate investors for the risk that the Sunflower State will lack the revenue to repay its debts.”

Except that Kansas’ rates still are lower that California’s and it will “have to pay” less overall “to compensate investors.”

Jobs

Folks care most about jobs. Johnston compared the two states:

“From January 2013 through September 2014, the latest data, California grew jobs at 3.4 times the rate of Kansas. Total nonfarm payroll jobs in Kansas increased 2.1 percent, in California 7.2 percent.”

He provided a nice graph:

Except that, as of October this year, Kansas’ unemployment rate was just 4.4 percent, 10th best of all the states and D.C.; compared to 7.3 percent in California, 47th best (4th worst).

According to Businessweek, “In the U.S. a full-employment economy more realistically is closer to the 3 percent to 4 percent mark….”

So Kansas is close to “full employment.” Those without jobs basically are between jobs. Or looking for Dorothy.

Employment can’t go up faster because everybody already has jobs. It’s like when your teenage son stops growing at 18, you don’t complain that he doesn’t keep rising to 10-feet tall.

So for working stiffs in Kansas, the Laffer-Brownback tax cuts worked!

Compensation

One area Kansas seems to lag is in compensation. Johnston wrote, “Compensation in California also grew faster than in Kansas. California’s average weekly wage of $1,165 in the first quarter of this year was 13.4 percent higher than in mid-2012, while the Kansas average of $840 was up only 10.1 percent.”

Except that, for the second year in a row, according to the U.S. Census Bureau, California suffers the nation’s highest poverty rate when the cost of living in this incredibly expensive state is taken into account. Part of the reason is that California’s high taxes, with the shocking 9.3 percent income tax rate digging in at about $55,000 of earned income, also gouge the middle class.

A shocking 8.9 million of our 38 million residents languish in poverty, or 23.4. That 8.9 million is three times Kansas entire population of 2.9 million.

By contrast, just 11.8 percent of Kansans are in poverty, less than half California’s percentage.

Education

Taxes go somewhere. The biggest item in both states’ budgets is education. In California, we even have an initiative, Proposition 98, which mandates about 40 percent of general-fund taxes go to public schools. And the Prop. 30 tax increase largely was justified as benefiting K-12 school kids.

According to the National Assessment of Educational Progress, “In 2013, the average score of fourth-grade students in Kansas was 223. This was higher than the average score of 221 for public school students in the nation.” But just barely higher. It was middling, causing Brownback to seek further reforms.

NAEP found for California, “In 2013, the average score of fourth-grade students in California was 213.” That was 8 points below the national average of 221; and it was 10 points below Kansas’ 223 average.

So, for all California spends on education, and all the high taxes Johnston says benefit us, our kids’ score worse than in low-tax Kansas.

As EdSource reported of the 2013 scores:

“California students performed about the same in reading and math on this year’s National Assessment of Educational Progress as they did in 2011, ranking among the 10 lowest performing states in the country.

“Results from this year’s assessment show that only 33 percent of California 4^th grade students and 28 percent of 8^th graders are proficient or better in math. In reading, 27 percent of 4^th graders and 29 percent of  8^thgraders are proficient or better.”

Conclusion

I’ll skip Johnston’s discussion of minimum-wage boosts, which he thinks will help California. With the wage going up even further due to initiatives in four states and three California cities, and more to come in 2016, we’ll soon have some really good comparisons on that. (My earlier articles on it are listed here.)

But just one more thing, as the late Steve Jobs used to say. Johnston wrote, “Tax hikes did not hurt California job growth because the taxes were not on jobs but on high incomes.”

Once again — strike up the band — taxes have gotten lower in California. But as to the Prop. 30 income taxes only on “high incomes,” when “the rich” pay more in taxes, all of us suffer, too. Because it’s largely the rich who use their money to invest in creating new businesses and jobs, as well as fund numerous charities.

Johnston concluded:

“Ultimately, real world results trump theory. Actual changes in the number of jobs and what they pay should be used to set policy, not ideology, assumptions and expectations…. Time will tell. The important thing is that policy should follow the facts, no matter where they go.”

Yep.

Correction: This piece originally had Kansas’ Moody’s rating downgraded to Aa1; in it was fact one notch lower, at Aa2, to which the text has been changed. We regret the error. We were informed of this by David Jacobson, AVP, Communications Strategist-Public Finance Group at Moody’s Investors Service. He wrote, “In spring of this year we downgraded Kansas from Aa1 to Aa2, and in June we upgraded California from A1 to Aa3.  So the correct rating on Kansas is Aa2, and although the states are moving in different directions, Kansas does remain one notch higher than California.  Our median state rating is Aa1.”

Why then don’t Republican candidates just follow Ronald Reagan’s successful economic recipe from the 1980s? Cut taxes; in his case, from the top income tax rate of 70 percent in 1980 to 28 percent in 1988. Keep money stable to prevent inflation. Reduce spending and regulations as much as you can. Simple.

Yet not one Republican president or candidate for the office since then has followed the Reagan recipe. President George H.W. Bush sat next to Reagan as vice president for eight years, solemnly gave his “Read my lips: No new taxes!” pledge at the 1988 GOP National Convention — then still raised taxes, crashed the economy and was booted from office in favor of Bill Clinton.

His son, President George W. Bush, did cut taxes twice — but the tax cuts expired in 2010, he imposed more business regulations through Sarbanes-Oxley and he turned Clinton’s surpluses into record deficits.

If Republicans want to return to Reaganomics, prosperity and victory at the polls, they again should return to the Reagan recipe by studying the new book, “The Pillars of Reaganomics: A Generation of Wisdom from Arthur Laffer and the Supply-Side Revolutionaries,” edited by Brian Domitrovic.” It is published by the Laffer Center at the Pacific Research Institute, CalWatchDog.com’s parent think tank.

Laffer will be speaking about the book at Noon, Thursday, Oct. 16 at the Pacific Club, 4110 MacArthur Blvd., Newport Beach. Info here. Those attending will receive a free copy of “Pillars.”

In addition to being the major economist who helped fashion Reagan’s program, he helped design its precursor, California’s Proposition 13 tax cuts in 1978, as well as numerous other tax cuts for states, cities and foreign countries.

Laffer has been a sage source of mine since I came to California in 1987 to write editorials for the Orange County Register. A couple years ago he took his own advice and moved to Tennessee, which has no state income tax. I still can’t escape the beach.

What supply-side economics is

The first thing to understand about supply-side economics is that it is not designed to “put money in people’s pockets.” Yet that’s often how it’s described,

Rather, as its name indicates, supply-side economics emphasizes encouraging supply — that is, long-term production, doing stuff, making stuff; instead of demand — that is, buying stuff.

That’s why G.W. Bush’s early 2008 “stimulus” of $168 billion, which rebated up to $600 a person ($1,200 for a couple), didn’t prevent the economic crash that September and the subsequent Great Recession. It was a demand-side stimulus that had no long-term effect.

Supply takes place in the long term. It takes years to gear up producing such goods as cars, cell phones and equipment.

So just giving people a little more waking-around money — demand-side thinking — does nothing to encourage production, and so nothing to help the economy. Demand-side thinking usually comes from the Keynesianism most people learned in college in Econ. 101. But impoverished Haiti has plenty of demands; what it lacks is production. Conversely, Switzerland is rich because it produces — it supplies — at the highest level in the world. Not surprisingly, Haiti is a morass of high taxes and regulations, whereas Switzerland is a Lafferite free-market paradise.

Laffer Curve

That’s where the famous Laffer Curve comes in. In the book, Domitrovic describes it:

“The Laffer Curve is a simple theoretical diagram, a bell curve…that compares tax revenues that are gained under all tax rates between 0 percent and 100 percent. At one end (the 0 percent tax rate), tax revenues are zero, at at the other (the 100 percent rate), tax revenues are also zero, because no one chooses to earn money when the government confiscates every penny. In between there is a bulge. And at one point, that bulge peaks — implying that any tax rate increase beyond it will result in lower revenue….

“Laffer…had used the curve often in the classroom, as a teaching tool. Then in December 1974, he sketched the curve on the restaurant napkin before two high staffers of the Gerald Ford administration, Donald Rumsfeld and Richard B. Cheney, along with his friend, Wall Street Journal editorialist Jude Wanniski.”

Alas, Ford did not embrace supply-side tax cuts, the economy continued to stagnate and in 1976, voters canned him for Jimmy Carter.

Laffer himself notes others before him said something similar. The earliest apparently was 14th century philosopher and sociologist Ibn Khaldun, who wrote in words Reagan sometimes quoted:

“It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments.”

What Laffer invented was the graph that dramatically shows how the Laffer Curve works.

Laffer also details two previous supply-side tax cuts that boosted the economy. The first was by presidents Warren G. Harding and Calvin Coolidge in the 1920s, when the top federal income tax rate dropped to 25 percent from 77 percent. The second was by presidents John F. Kennedy, who touted them before his 1963 assassination, and President Lyndon B. Johnson, who signed the tax-cuts into law in 1964. Yes, Democrats can cut taxes, too.

Basically, the Laffer Curve is just common sense. If you tax something at 100 percent, nobody will pay the tax. If you tax something at 0 percent, no tax will be collected. The art of the Laffer Curve is finding the right recipe in between — that is, 1 percent to 99 percent tax rates — that maximizes both economic growth and tax revenues.

LBJ-JFK tax cuts

The LBJ-JFK tax cuts, and how they were enacted, are described in detail in the fourth volume of Robert Caro’s magisterial biography of LBJ, “The Passage of Power: The Years of Lyndon Johnson.” Unfortunately, Caro, although brilliant on the biographical and political aspects, doesn’t “get” why supply-side economics works, or the connection to Reagan’s tax cuts.

Here’s Laffer’s explanation:

“The 1964 tax cut reduced the top marginal personal income tax rate from 91 percent [!] to 70 percent by 1965. The cut reduced lower-bracket rates as well. In the four years prior to the 1965 tax-rate cuts, federal government income tax revenue, adjusted for inflation, had increased at an average annual rate of 2.1 percent, while total government income tax revenue (federal plus state and local) had increased 2.6 percent per year. In the four years following the tax cut these two measures or revenue growth rose to 8.6 percent and 9.0 percent, respectively. Government income tax revenue not only increased in the years following the tax cut, it increased at a much faster rate in spite of the tax cuts.

“The Kennedy tax cut set the example that Reagan would follow some 17 years later. By increasing incentives to work, produce and invest, real GDP growth increased in the years following the tax cuts, more people worked and the tax base expanded. Additionally, the expenditure side of the budget benefited as well because the unemployment rate was significantly reduced.”

And click this audio YouTube for JFK’s own 1962 explanation of his tax cuts.

Reagan deficits

Didn’t Reagan’s tax cuts increase the deficits? Yes, but the economy grew even faster than the deficits; and in his eight years in office, federal revenues actually increased 75 percent — from $517 billion in 1980, the year he was elected, to $909.2 billion in 1988, his last year in office. (See p. 24 here for this and the data below.) It’s like taking out a higher mortgage on a newer home after getting a raise.

Moreover, Reagan’s deficits came about for one reason: He was increasing defense spending to break the back of the demonic Soviet Union. It was a one-time deal. It worked when the Berlin Wall fell in 1989, a couple months after the Gipper left office. The deficits also were dropping fast, from $221 billion in 1986, to $150 billion in 1987 and $155 billion in 1988.

The reverse side of the Laffer Curve — that tax increases often make things worse — also was proven when Reaganomics was abandoned by President Bush with his 1990 “read my lips” tax increases. Instead of the deficits going down, the Bush tax-increase recession zoomed them back up — doubling to $289 billion in 1992.

What about the Clinton boom of the late 1990s? Didn’t he increase taxes in 1993? Yep. But after the Gingrich Republican Congress was elected in 1994, Clinton worked with the GOP to sharply cut capital gains tax cuts. It was Reaganomics with an Arkansas accent.

Gold standard

People sometimes say I write too much on the importance of the gold standard to stabilized money. But it is important as the means to stabilize the dollar and prevent inflation. Briefly…

The book includes a Laffer essay from 1980, “The Case for a Gold-Backed Dollar,” that resonates just as much today. Reagan, and especially Paul Volcker, the chairman of the Federal Reserve Board at the time and a Democrat, actually took Laffer’s advice and pegged the dollar to about $350 an ounce. That policy continued after Alan Greenspan became Fed honcho in 1987, until 2001. Unfortunately, after 9/11, Greenspan inflated the dollar, a policy continued under his successor, Ben Bernanke, driving gold up to as high as $1,800 an ounce.

Wonder why prices are rising? That’s it. Inflation takes about 15 years to work through the economy.

In 2012, Bernanke began stabilizing the dollar again at about $1,200 an ounce, a policy Janet Yellen, who became Fed chairman this year, has continued — a positive, Lafferite development.

“A properly designed program should have as its initial goal the stabilization of prices generally at or near their current level,” Laffer wrote in 1980. “Stated simply, a workable system of gold/dollar convertibility must not permit the economy to experience wrenching adjustments because of changes in gold….

“Based upon his posturing since the late 1960s it is, in my opinion, quite conceivable that Volcker could actually lead the search for a new order.”

That’s just what happened.

Back to Reagan

I highlighted Laffer’s writing. But “Pillars” also includes contributions by the late Warren Brookes, George Gilder, Charles W. Kadlec, Stuart J. Sweet, David Booth, Jeffrey Thompson and Reagan administration economist Bruce Bartlett.

When you remove the dustjacket, the book cover shows a good-as-gold engraving of Reagan holding a drawing of the Laffer Curve. My iPhone snapshot is nearby.  In these digital days, it’s still great to read a beautifully crafted physical book — 1980s style.

In conclusion, if Republicans finally want to get their act together and start not just winning elections, but governing for prosperity, they should start with this book. The Reagan prosperity recipe worked — and can work again.

Laffer also heads the Laffer Center at the Pacific Research Institute, CalWatchDog.com’s parent think tank.

His new article explains why people are fleeing California:

Commentary

May 7, 2012

By Wayne Lusvardi

San Diego’s recent transfer of excess agricultural water from Imperial County has been the only major addition to urban water sources for Southern California for decades. The transfer is the largest agriculture-to-urban water transfer in U.S. history. And it originated in the lining of irrigation canals by the San Diego County Water Authority. This resulted in bringing enough previously wasted farm water to serve 1.2 million people in the San Diego area.

But a partially market-driven water system, as recently proposed by economist Art Laffer, might offer a better solution to California’s dysfunctional water system.

Under- or Over-Charging?

Is the rate charged for San Diego County to convey excess agricultural water through the Colorado River Aqueduct to San Diego a fair deal?  Sociologist Steven Erie of the University of San Diego thinks so.  He even goes further and says the Metropolitan Water District of Southern California has been subsidizing San Diego water rates for decades.

As evidence for his claim that MWD is not overcharging, but subsidizing, water rates for San Diego, professor Erie cites a recent study he co-authored with Greg Freeman for the Los Angeles Economic Development Corporation. The study is titled, “The Cost of Water in San Diego: The Imperial Irrigation District Water Transfer and San Diego County Water Authority Water Rates.” The study was commissioned by MWD.

San Diego Waterboards Prof. Erie

But first: What do water purchase rates have to do with “water wheeling” rates?

Water wheeling is a utility industry term. Wheeling is the conveying of water through the unused capacity in a pipeline or aqueduct by another water provider.  Water wheeling is provided for under Section 1810 of the California Water Code.

It isn’t the price of water that is at issue, but the cost to transport it in unused space or excess capacity called “freeboard” in a pipeline or aqueduct. Freeboard is defined as the distance between the normal water level and the top of a pipe or the top of the canal bank of an aqueduct.

As the San Diego County Water Authority states on its website “MWD Facts”:

“1. The price San Diego pays the Imperial Irrigation District for its transfer supplies has nothing to do with whether or not MWD’s transportation rates are legal.
“2.  San Diego’s court challenge is over the price that the Metropolitan Water District of Southern California charges San Diego to transport water purchased from Imperial County. San Diego is not suing Imperial County over the price it pays for water supplies.
“3. All of Southern California has benefitted from this additional supply of water, not just San Diego.” 

So Erie’s argument that San Diego’s water rates have been subsidized for decades is irrelevant to the issue of the proper water transport rate in the ongoing legal dispute between San Diego County and MWD.  Any attempt to introduce such data would likely be ruled as irrelevant in the San Diego versus MWD water rate overcharging court case.

San Diego paid $491 per acre-foot for excess farm water from Imperial County. If this was a bad bargain, why does the city of San Francisco consider $700 per acre-foot for its purchase of water from the Modesto Irrigation District a bargain price? According to San Francisco officials, the answer is: because a $700 per acre-foot water transfer beats the cost of alternatives such as recycling, conservation, groundwater and desalinization.

And if California water law forbids charging more than the recovery of a proportionate share of “full system costs,” how is it that the Modesto Irrigation District brags that it upgraded its facilities and will only use “some” of the income to catch water before it flows into nearby rivers for diversion to San Francisco?

San Diego’s View of Water Dispute

What is at really in dispute is the water rate that MWD can lawfully charge San Diego to wheel water through the Colorado River and San Diego Pipeline systems.  MWD is required by law to charge rates that reflect only the actual, reasonable and proportionate costs of serving each class of its customers (urban or agricultural).

Erie claims, however, that San Diego paid too much for agricultural water and is now trying to fend off a water ratepayer revolt.  The initial water price for San Diego’s acquisition of surplus farm water is $491 per acre-foot of water.  An acre-foot of water is an acre of land flooded with one foot high of water.  An acre-foot is enough water to supply two urban families for one year or irrigate about one-third of an acre of cropland for a year.

San Diego County’s lawsuit claims MWD is overcharging in the three water sub-rates that make up its water transportation charge. According to MWD’s Water Rates posted online, the three rates that make up the transportation charge are as follows:

MWD Water Transport Rate

.

Once again, the above total transport rate of $396 per acre-foot of water for 2012 cannot be compared with San Diego’s excess farm water rate of $491 per acre-foot.  That would be like comparing the wholesale price of an un-harvested apple on a tree with the retail price of an apple for sale in a store.  That is not an “apples to apples” price comparison.

Is MWD Double Dipping? 

San Diego claims that MWD is overcharging for its water transport rate. This is because the sub-rates that comprise the transport rate allegedly overlap, leading to possible double charging. See the graph below.

San Diego is geographically “at the end of the pipeline” of MWD’s system.  It would thus pay the greatest transport costs compared to other water agencies that are members of MWD.  If San Diego’s contention were proven in a court of law, MWD’s water transport rate would be a subsidy to water ratepayers in Los Angeles and an overcharge on San Diego ratepayers. This is the opposite of professor Erie’s unsupported contention that MWD is subsidizing San Diego’s water rates.

Water Wheeling Reduces Water System Fixed Costs

Arguably, San Diego’s conveyance of an additional 200,000 acre feet of water acquired from farmers through the Colorado River Aqueduct would hypothetically lower the aqueduct’s fixed operational costs by 5 percent of the 4.4 million acre-feet of water it conveys annually.  Power costs would have to be deducted for pumping the water;  200,000 acre-feet is enough water to serve 1.2 million people.

The transfer of water from Imperial County farmers to urban San Diego County also frees up an equal 200,000 acre-feet of water in MWD’s system for use by its other member agencies in Los Angeles, Orange, Riverside, San Bernardino and Ventura counties.

MWD Prevailed In Prior Lawsuit

San Diego County initially prevailed in court in prior water wheeling rate disputes with MWD. However, the Second District Court of Appeal overturned that decision holding MWD: (1) was entitled to recover its system-wide costs not just the incremental cost caused by the wheeling transaction; (2) may base its charges on a one price “postage stamp” basis instead of charging only for the part of MWD’s system; and (3) is not prohibited from setting a fixed wheeling rate for all wheeling transactions.

In a socialized water system, a regional water wholesaler such as MWD is apparently entitled to charge for wheeling another water agency’s water based on a pro rata share of total system costs.  San Diego’s contention that it should only be charged for the additional cost to the affected part of MWD’s system was denied.  San Diego’s wheeling of 200,000 acre feet of water per year through MWD’s total system would reflect about 3.1 percent of MWD’s average annual 6.4 million acre-feet of imported water.

In a market system, both costs and benefits could be considered, rather than only costs.  San Diego’s 200,000 acre-feet of wheeled water per year would reflect $79.2 million of additional annual revenue to offset fixed costs of operating the Colorado River Aqueduct (200,000 x $396/Acre-Foot). This is perhaps another fatal flaw in a socialized water system.

However, that MWD can charge full system costs for water wheeling is apparent not the issue in the current court case.  San Diego asserts that the formula MWD uses for its water transportation rate overcharges by doubling up components of the fee.

The Appeals Court ratified MWD’s policy of charging full system cost over its six county service area rather than only the costs for the Colorado River-San Diego Pipeline system.  This appears to run against past recommendations of the Committee on Water Rates of the American Water Works Association.

In the past, the American Water Works Association has recommended that the appropriate rate set between two pure government entities for allocating “joint capacity costs” should not exceed the demonstrable additional costs involved in providing such a service.  An example would be the rate set for a fire protection service to wheel water through a municipal water line.  According to the AWWA, “[T]he costs allocated to fire protection should not exceed the demonstrable additional costs involved in rendering such service” (cited in Paul J. Garfield and Wallace F. Lovejoy, Public Utility Economics, 1964: p. 233).

By setting a standard of having to pay “full system costs,” the courts have not only deterred a water market, but water transfers between pure government entities that could alleviate California’s water crisis.  Again, this reflects more dysfunction in California’s water system.

Are There Alternatives to Paying Wheeling Fees?

Neither the local nor the appeals court indicated, however, if San Diego was prohibited from using eminent domain to acquire a specific co-location wheeling easement or leasehold in the freeboard excess capacity within specified aqueducts and pipelines of MWD.  If so, San Diego might be able to pay “Fair Market Value” for wheeling water through the unused portion of a pipeline instead of a monopoly unit price of the total MWD system cost.

In 1999 to 2001, a market price for co-location easements supplanted eminent domain just compensation for telecom communications corridors for regulated public utilities. San Diego is exploring building its own pipeline to Imperial County.  Perhaps San Diego could co-locate its own pipe in the rights of way for the Colorado River Aqueduct.

Various aquifers around the Salton Sea may flow into each other.  But suppose water was put in upstream in exchange for withdrawal rights at the other end of the slope closer to San Diego to cut pipeline and right of way acquisition costs?

Socialized Water System Has No Incentive for Conservation

Economist Art Laffer points out that California could solve nearly all of its many raging water wars if it shifted to a modified market water system, albeit with some set asides for environmental water.  Laffer cites a study by Dorothy Robyn of California’s water pricing system.  Robyn’s study indicates that a reduction in private water rights “removed the incentive for conservation” because in a socialized system “there is little reason to avoid waste.”

Thus, a socialized water system ends up with water agencies like San Diego’s having to get a court order to compel farmers to conserve water. San Diego County filed a lawsuit against Imperial County and Coachella Valley to allow San Diego to line irrigation canals with concrete to avoid leakage. The canal lining was at San Diego’s expense.

In a market system, farmers would have an incentive to conserve their excess water and re-sell it for a profit.  And according to Lawrence Livermore Labs, the Salton Sea might have enough water in rechargeable groundwater basins to supplant a large share of the Colorado River water now shipped to San Diego.

Water Runs Downhill Toward Politics

It once was probably true that in California that “water ran uphill toward money.”  But the system California now has allows water to go to the most politically connected.  Perhaps farmers need a separate water system such as the Federal Central Valley Project.  But environmentalists oppose farmers reselling water for a profit, even though such a system would result in more water conservation.

This is why San Diego alleges that a cabal of water agencies in the Metropolitan Water District is overcharging for excess water wheeled through its regional plumbing system.  In a socialized system, there is an incentive to game the system for gain.

San Diego doesn’t want to pay for all the contrived jobs programs of MWD.  MWD’s origins were as a 1930’s Works Progress Administration style “stimulus” jobs program.  MWD’s policy has been to launch large public works projects during economic recessions to stimulate the regional economy.

Below is a chart of what San Diego County contends is the amount of subsidy it pays to MWD’s other water agencies and the amount of overcharge in the water wheeling rate it must pay.

Why California Water System Is Dysfunctional

California is dysfunctional not because of too few taxes, or lack of supermajority rule of the Legislature or the courts. Its water system is not dysfunctional because of lack of voter approval of yet another water bond.

It is dysfunctional partly because it has replaced private property rights and markets with a socialized water system.  This is partly why California only has about a half-year of water storage in both the State and federal water systems, while the Colorado River system has four to 10 years of water storage. And it is why California has squandered five “waterless” water bonds totaling $18.7 billion on mostly open space land acquisitions with no storage reservoirs to show for it.

And what California has done to water rights has also flooded the entire governmental regulation of the economy. Such a system encourages the formation of political coalitions of academics, technical consultants, and activists who all become parasites off the dysfunctional water system.  The more such special interests advocate, the less functional the system becomes.

The number of people now dependent for their livelihood on such a parasitic system is so large that is nearly impossible to reverse it.  And it is sinking the economy and with it government budgets at every level.

A Wall Street Journal editorial headline today branded Gov. Jerrry Brown: “Governor 13.3%.” That’s the percentage California’s top income tax rate would be if he finagles voters into passing his tax hike this November.

It’s a great headline. And I’m going to use the phrase to refer to him in the future: Governor 13.3%.

The 13.3 percent tax top tax rate would be by far the highest in the country, well head of the current top states, Oregon and Hawaii’s rate of 11 percent. California’s current top rate is 10.3 percent.

Wall Street comments:

“It’s hard to believe now, but Jerry Brown once ran for President as a reformer who favored a flat tax with a 13% top federal rate. That was 1992. Nowadays in his second stint as Governor, he’s running to give California alone a higher top income-tax rate.”

That’s right. In 1992, presidential candidate Jerry Brown proposed that the top federal rate — the one paid by everybody — should be just 13 percent. (Currently in 2012, the top U.S. rate is 35 percent, although President Obama wants to jack that up to 39 percent.)

People like to say that “California is the world’s 8th largest economy,” but this is ridiculous. In fact, we’re not a country, but a state. And we compete against other states, such as: Nevada, Texas, Washington, New Hampshire and Florida, all of which have zero state income tax.

For Governor 13.3% to propose a state income tax higher than the entire federal income tax he proposed 20 years ago is absurd.

Highest Taxes

Wall Street:

“The top 1% in California pay between one third and half of all state income tax revenues, depending on the condition of the economy….

“So for the privilege of living in California, a millionaire would pay close to $125,000 a year more in income tax than someone in Nevada, Texas or Florida. A Californian earning $10 million would pay an extra $1 million or more than if she moved to a state without an income tax, or nearly $500,000 than an average tax state.

“Even Mr. Brown, in one of his saner moments earlier this year, said that relying on millionaires to pay the bills causes “more volatility” in revenue collections, which has meant “a more or less constant state” of deficits. He was right. Capital gains collections collapsed to $734 million in 2009-10 from $1.6 billion in the boom years. So why would Mr. Brown make that problem worse?”

Wall Street also made the point that Supply Side economists do: That when taxes get this high, people don’t pay them. They leave the state or country. So the government fails to collect not only the tax increase, but the previous tax that the wealthy person was paying.

Paradoxically, that means if California wants to increase revenues to the state it must make this state more enticing to taxpayers — by cutting taxes. Wall Street points this out:

“One of the last states to have a tax rate as high as California is proposing was Delaware in the 1970s. Its rate hit 19.8%. Then-Governor Pete du Pont cut the rate to 10.3% in 1979 and later to 5.95%, and after five years the state’s revenues had nearly doubled and its credit rating went from the worst to one of the best.”

Governor 13.3% used to understand that. He talked to economics Arthur Laffer, the Supply Side economist who designed Brown’s excellent 1992 flat tax proposal. He should talk to Laffer again.

Laffer has produced a new study, “Eureka! How to Fix California,” for the Pacific Research Institute, CalWatchDog.com’s parent think tank. He calls for a 5.8 percent flat-tax for all Californians.

Laffer will be launching his new new book and signing copies at The City Club of San Francisco on March 27, from 5:30 to 7 pm.

And he’ll signing his new book on Wednesday, March 28, at the Pacific Club in Newport Beach.

March 26, 2012

By JOHN SEILER

California’s stagnating economy suffered more bad news by ranking 47th of the 50 states for economic outlook. The ranking comes from the new, fourth edition of “Rich States, Poor States: The ALEC-Laffer State Economic Competitiveness Index.” It combines 15 economic rankings, such as top marginal personal income tax rate and average workers’ compensation costs.

I received an advanced copy of the rankings, and will discuss them here. It will be released tomorrow, June 22, by the American Legislative Exchange Council, a nonpartisan group of state legislators. I’ll put up a link to it then. (Update: Here’s the link.)

In addition to ranking 47th in economic outlook, California ranked an almost-as-dismal 46th in economic performance for the previous decade, 2000-2009. It really was a “lost decade” for the state’s economy under the fumbling governorships of the recalled Gray Davis and his satyric replacement, Arnold Schwarzenegger.

The only states ranking worse on the economic outlook were New York, rock-bottom 50th, followed by Vermont and Maine. Along with California, all are high-tax, high-regulation, jobs-killing states. The three other states have bad weather.

The rankings put California’s income tax at fourth worst, assuming the top rate remains at 10.3 percent and Gov. Jerry Brown’s call for increasing that and other taxes are not heeded.

But California is rock-bottom worst in income tax progressivity. Our second highest rate, 9.3 percent, kicks in at around $50,000 of income, meaning the middle-class really gets gouged. It’s a high price to pay for the sunshine.

Hope for California

I asked if the state tax hikes are likely to go through. “I don’t think so,” the rankings’ co-author Arthur Laffer replied. “The Legislature didn’t put it on the ballot. And Jerry Brown just vetoed the unbalanced budget. There’s a lot of hope for the state.”

Laffer heads Laffer Associates in Tennessee, which he moved there a few years ago from San Diego to take advantage of the Volunteer State’s zero percent state income tax rate. Laffer helped craft President Reagan’s federal tax cuts in 1981 and 1986, which formed the foundation of 30 years of national economic growth.

And last week it was announced that Laffer would be working on the new California Recovery Project of the Pacific Research Institute, CalWatchDog.com’s parent think tank. Laffer already has produced an outline for a book he’s working on about how to get California’s economy moving again. The outline is a good overview of California’s political and economic past, and potential future recovery.

He also told me that he’s optimistic about Jerry Brown’s governorship, despite the governor’s plea for tax increases. “I’ve been associated with Jerry Brown for years.” He said that, during Brown’s first governorship in the 1970s and early 1980s, he worked with Brown to implement the Proposition 13 tax limitation, get voter approval for the Gann Limit on spending and repeal the state inheritance tax (the “death tax”).

Always enthusiastic, Laffer said, “If there’s one person who can transform California, it’s Jerry Brown. When he ran for president in 1992, he came out for a flat tax,” which was designed by Laffer. “It’s very exciting.”

The ongoing budget crisis, Laffer said, is essential to reach real reform. “You need sturm und drang to get revolutionary change,” he said. “California is a great place to live — except for the policies.”

Golden State Positives

On the positive side, the ALEC-Laffer rankings found some luster left on the Golden State. In addition to the great weather and the lack of a death tax, California ranks fourth best on tax limitations, thanks to Prop. 13 and other caps on taxing.

The state ranks seventh-best for public employees being 5 percent of the population. And…that’s about it on the positive side.

Other negatives include: 46th ranking for recently legislated tax changes (Schwarzenegger’s 2009 tax increases, which should expire on July 1), debt service as a share of tax revenue (at 8.5 percent, ranks 31st), 29th for sales tax burden and 46th for “tort litigation treatment and judicial impartiality” — even our courts are a mess.

Despite Prop. 13’s limits on property tax increases, which tax-increasers always are trying to repeal, California ranks only 31st on property tax burden. The problem there is that real estate here costs so much, even a low percentage tax brings in high revenues.

“Taxes matter a whole lot on economic growth,” co-author Jonathan Williams explained; he’s the director of ALEC’s Tax and Fiscal Policy Task Force. “The 2010 U.S. Census showed that people vote against income taxes and taxes on capital by leaving high-tax states.”

He pointed out how Texas and other low-tax states have benefited in the past decade by seeing an influx of businesses, jobs and workers. While high-tax states such as New York have seen an exodus.

California’s population grew the past decade — but, for the first time in its history, only at the national average. And its growth entirely was due to immigration from foreign countries.

The study concludes:

Over the past decade, the 10 biggest population gainers had an average state and local tax burden of $3,098. The average for the 10 states with the lowest population gain was $3,735—more than 20 percent greater. The average top personal income tax rate in the 10 fastest growing states was just more than 4 percent versus more than 7 percent in the 10 slowest growing states. Clearly, states with the steepest tax rates, poor labor policy, excessive levels of government spending and hiring, overregulation of business, and tort laws that encourage frivolous lawsuits end up chasing jobs, businesses, and families to other states. In contrast, low tax states were magnets for new residents.

In the years 2000-09, California also saw a net of 1.5 million residents leave the state for greener pastures in other states. Only New York saw more residents leave. These commonly were people with skills to earn middle-class incomes — and pay middle-class taxes.

Texas, Here They Come

During the economic recovery of the past two years, four out of 10 new jobs were created in just one state, Texas, co-author Stephen Moore pointed out; he’s a member of the Wall Street Journal editorial board. Yet Texas has just 8 percent of the U.S. population — and bad weather. So, it’s creating jobs at a rate five times the national average.

The major reasons, Moore explained, are that Texas has no state income tax and is a “right to work” state — meaning workers aren’t forced to join unions.

Pension Tsunami

The rankings also warned that, as bad as current state budget deficits are,

these budget gaps are overshadowed in size and scope by unfunded liabilities in state pension and health care systems for public employees, which are trillions of dollars in the red. These are unsustainable cost drivers that threaten the financial solvency of the states. Without fundamental pension reform, expect the news stories discussing the possibility of state bankruptcy to continue.

The ALEC survey cited three other studies on the scope of state pension liabilities. For California, a PEW Center for the States study found the liability at “only” $59 billion. But an American Enterprise Institute study calculated it to be $398 billion. And a Novy-Marx and Raugh study calculated it at $370 billion.

The latter two numbers are similar to the more than $500 billion found in a Stanford University study last year. The ALEC-Laffer survey concluded that the PEW numbers were underestimating the true magnitude of state pension liabilities, and that the higher numbers are more accurate.

However you look at it, California’s  unfunded pension liabilities are immense.

On a positive note, the ALEC-Laffer survey found that pension reform is advancing. In the lead is Utah, which also topped the survey as the state with the best economic outlook. It quoted state Senator Dan Liljenquist of Utah, an ALEC member, who testified before the U.S. Congress:

Utah closed its defined-benefit pension plans to new enrollees, creating a new retirement system for new employees hired after July 1, 2011. Under Utah’s new retirement system, public employees will receive a defined employer contribution towards retirement. New public employees will be able to choose between (1) a 401(k)style program, or (2) a hybrid pension program (where they may pool market risk with other employees). Regardless of the program employees choose, Utah will only contribute at a set amount towards retirement. Utah’s recent pension reforms will, over time, reduce and eliminate Utah’s pension related bankruptcy risk. This is a big win for Utah taxpayers.

Reforms Needed

Ultimately, California and other states will need to adopt Utah-style pension reforms to avoid pension payments gobbling up 100 percent of a state or local government’s budget.

The ALEC-Laffer rankings also serve as a blueprint for reforms in high-tax, high-regulations states such as California. The only way the state can back on track to economic growth is to reduce the immense burden government places on taxpayers.