As a dean at Berkeley, Hal Varian has a personal interest in California. In his column today, he offers some plain-spoken economics lessons.

Most California voters think the electricity crisis contributed to the state budget deficit. If only things were that simple. In reality, not a cent of the deficit was caused by electricity prices: the cost of the crisis will show up solely in future electricity bills.

The basic economic lesson is this: a deregulated wholesale market and a regulated retail market is a recipe for disaster. If you tell a supplier, “I’ll buy the same amount no matter what you charge,” don’t be surprised if you are charged a high price.

…California was the epicenter of the dot-com boom of the late 1990’s, and tax receipts flowed to Sacramento. Tax revenue from stock-option grants and capital gains alone rose from $7.5 billion in 1998-9 to $12.7 billion in 1999-2000 to $17.6 billion in 2000-1.

…This brings us to the second lesson in economics: don’t spend transitory income on permanent commitments.

For Discussion. Varian argues that it is important for states to understand the cyclical component of revenues and to make spending commitments based only on the stable portion of their tax base. What institutional mechanisms might be put in place to ensure this?