Municipal Bond Forum
California’s health
Q
A majority of my retirement savings is in California muni bonds. In 2005, the unexpected increase in state income tax revenues has been a pleasant surprise. I would like to believe that, as your recent articles state “California’s move rewards bondholders“, California’s economy is strong. However, a fiscal analyst warned that with even a mild recession, California’s financial outlook would be very bleak. Because of Prop 13, the state’s economy does not have a steady source of revenue from property taxes. Instead, the state income tax is the main source of revenue. The New York Times recently had an article on the under-funding of state retirement benefits. The article highlighted what it termed a looming problem. This under-funding has occurred in California. California’s constitution requires that state government pension benefits, once committed to, cannot be diminished. I realize that the constitution sets as a priority, just below payment of pension benefits, the funding of GO bonds. Given California’s aging population, the radical increase in the cost of medical benefits and California’s dependence on income tax revenue, how will the state’s economy withstand a recession?
A
James A. Klotz responds:
We share some of your concerns but we are considerably more optimistic than the New York Times regarding the economic future of the state of California.
It is true that in California, enthusiasm for ballot initiatives has led to passage of propositions that have increased spending and dampened revenue sources. Mandatory annual spending increases for purposes such as education and transportation have increased the expenditure side of the equation, while limits on property taxes have led to increasing reliance on sales and income taxes.
As dire as this situation may appear, we think California’s economic condition is improving. California is rated A by the three major rating agencies, which had all dropped the state to BBB in 2003 when the fiscal problems, to which you refer, first surfaced. We continue to recommend California bonds to our clients. California has the sixth largest economy in the world and we feel it will continue to find resourceful solutions to its economic woes.
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The responses provided in this forum are meant to address specific questions posed by investors about their municipal bonds and to provide market insight for our general audience. Please note, your investments, objectives, results and experience may differ significantly. Our answers and any potential strategies discussed should not be construed as a solicitation to buy nor sell any security or investment product. All investing entails risk.
