California’s economy is especially sensitive to events in Asia. Its budget, meanwhile, is dangerously dependent on income taxes paid by a handful of wealthy Californians, largely on their capital investment profits.
We saw, just a few years ago, what happens when the global financial system hiccups. The wealthy got a financial cold, so to speak, and the state budget got pneumonia, with a $20 billion drop in annual revenue.
It should have warned us to change our tax system and become less dependent on our 1-percenters, but instead we largely raised taxes on the wealthy and became more dependent.
The gyrations in the stock market this week do not, unto themselves, pose a major threat to the budget, but were the declines to continue and/or recession once again rear its head, our brief period of balanced budgets could come to a screeching halt, as the Legislature’s budget analyst says in a briefing paper.
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More than most states, California depends heavily on taxing the wealthy, pulling about half its income tax revenue from just 1% of residents in recent years. A sustained, significant fall in capital gains could mean a return to budget crises, and the turmoil on Wall Street is a reminder of that vulnerability.
Gov. Jerry Brown’s administration isn’t ready to sound the alarm, especially since the last few years have been good ones as investment gains translated into rising revenue.
And Brown and lawmakers have taken steps to shore up the state’s defenses since the recession. They’ve been paying off debt incurred during down years, and stockpiling some revenue from capital gains — one of the least reliable sources of taxpayer money — in a rainy-day fund.
“The governor insisted on putting a good insurance policy in place,” said H.D. Palmer, spokesman for Brown’s Department of Finance.
Still, experts have long decried Sacramento’s dependence on a tax structure they say is dangerously lopsided.
“The state has done nothing to address the source of the problem, which is the tax system,” said Jeff Cummins, a Cal State Fresno political science professor.
One-tenth of the current budget’s $115 billion in general fund revenue is expected to come from capital gains — compared with 2.7% in 2009, during the depth of the recession. And Brown has repeatedly warned about the volatility of state finances, insisting on conservative revenue figures in the budget as a hedge.
Administration officials estimate that a moderate recession could cost the state $40 billion in income over three years, which would quickly wipe out the $3.5 billion that is expected to be in the rainy-day fund by next summer.
But the governor has also resisted efforts to make changes to the tax code, which probably would require making people who earn less money contribute more.
“I don’t know from the political point of view that’s very viable,” Brown said earlier this year.
Sen. Bob Hertzberg (D-Van Nuys), who has been working on a tax overhaul proposal of his own, said the recent stock market tumble lends urgency to the need for change.
Broadening the tax base — applying the sales tax to some services, for example — “would soften any major changes in the market,” Hertzberg said.
Stock market problems could also be felt in California’s pension funds. When investment returns don’t keep pace with goals set by state officials, taxpayers may need to fork over more money to cover the difference.
For example, in June 2014 lawmakers approved a three-decade plan for patching a $74-billion shortfall in the retirement system for teachers and other school employees. But that effort relies on hitting a 7.5% investment return; last year the fund had 4.8%, and it has had an average of 7% over the last 10 years.
There’s also the chance that technology firms will delay their initial public stock offerings. Although it’s rare that a single company is big enough to make its presence felt in California’s budget — Facebook’s IP0 in 2012 was an exception — state finances have benefited from robust activity in Silicon Valley.