A Supply-Side Schwarzenegger
Jude Wanniski
November 18, 2003


Memo To: Rep. David Dreier [R CA]
From: Jude Wanniski
Re: Getting California Moving Again

So far, so good, David. Clearly with your guidance as his transition chairman, Governor Schwarzenegger in his first moves has shown the right stuff if he is to succeed in getting control of California’s economy and its finances, in that order. Rolling back the Gray Davis auto tax by executive order was a political necessity. His pledge to NOT raise taxes in other areas was an economic necessity. His recommendation of a $20 billion bond issue to cover most of the deficit instead of hiking taxes was exactly the right thing to do. And YOUR indication on CNN’s Crossfire last night that he would seek a reduction in the state’s 9.3% capital gains tax is the perfect complement to the other actions taken as the long process of renewal begins. You know I would have proposed the elimination of the capgains tax if I were he. You probably would have to, being the chairman of the Zero Capital Gains Caucus in the House of Representatives. It would be easier to get half a loaf if he’d have asked for the whole, but if he really does propose a 50% exclusion and work it through the Democratic legislature, the investment climate in California would definitely improve overnight.

By the way, I’ve been invited to California by the financial analysts’ societies of San Francisco and Los Angeles, and will speak to the SF association on December 4 and to the LA society on December 10. If you are in the neighborhood, please drop in. I’ll be talking about the national economy for the most part, but will also discuss the importance of what seems to be a second Reaganesque wind for the supply-side revolution in California. Lots of people have helped, but I think the role you have played was especially critical.

In case you’ve forgotten, here is how I put it in a letter to my clients on August 11, just a few days after Arnold announced that he would run for the governorship in the recall process:

"I am encouraged by the developments of recent days, especially with Arnold Schwarzenegger’s decision to run. His positions on social issues supposedly make him anathema to the state’s hard-right conservatives who lost badly last November when they tried to defeat Gray Davis with William Simon Jr. Of all the GOP entrants, though, Schwarzenegger is the one who could take the kinds of steps that Ronald Reagan would to pull the state out of its fiscal crisis – and be able to get the Democratic legislature to go along with him. The other Democrats in the field would be just as stymied as Davis. The other Republicans in the field might make the right proposals, but would not likely have the charm to get them through the legislature.

"The crisis is not all that critical, if you remember that the $38 billion deficit facing the state is really only $19 billion averaged over the two budget years. If we round out the numbers for a $2 trillion economy, the deficit is only 1% of the total. The state’s bond rating has slipped somewhat given all the dire predictions of where the crisis might lead. But the rating would bounce back if the Terminator recommended a Reaganesque approach, which I suggest would be the elimination of California’s capital gains tax. Most certainly there would be no need for any kind of tax increase, as the state’s economy is running a huge deficit because it is already burdened with excessive tax rates that are sending financial and human capital east.

"The top income-tax rate is 9% or higher in those jurisdictions that have local add-ons. California should have gotten rid of its capgains rate years ago, but it would be easy now that so little revenue from that source is dribbling into Sacramento. The state’s economy would suddenly become a magnet for capital formation, and the growth that would occur would bring higher revenues to every city, county and hamlet within its borders. At the margin, it would increase revenues in every state in the union. A Governor Schwarzenegger might have to settle for a 50% exclusion on capgains, but even at that rate Californians would be able to see the way out of the woods. That would be especially good as the national economy is now being helped with the second round of Bush tax cuts."