A startling, multibillion-dollar flow of cash into the state budget appears to be evidence that California’s economy is on the mend.
In reality, what’s on the mend is Wall Street: The surge of an estimated $6.6 billion in cash is being driven in large measure by California’s wealthiest taxpayers who sold stock and other assets and paid income taxes on their proceeds.
It is a relatively small number of people, but they affect California’s financial health disproportionately. The level of unemployment in the state and the travails of the housing industry – two critical barometers of economic health – are largely untouched by the state budget’s spending. Currently the jobless rate is about 12 percent and the housing market is uncertain.
But the budget is affected dramatically by the income taxes paid by the wealthy.
Capital gains receipts were up by 60 percent in 2010 over the year before and they likely will climb another 45 percent in 2011 – more than doubling in two years – according to the Brown administration. Tax experts believe a Silicon Valley resurgence is partly fueling the cash boon, but the increase appears to be more widely spread than the cash bonanza of more than a decade ago.
The unanticipated revenue is desperately needed by the cash-strapped state struggling with a shortfall now put at $10 billion – nearly a third of the estimate five months ago. The shortage has been reduced mostly by some $11 million in cuts.
Fewer than 1 percent of California’s 14.8 million tax returns – perhaps 119,000 returns, those with $500,000 or more in adjusted gross income, or AGI – accounted for about 82.5 percent of all capital gains paid by personal income tax payers in 2008, or about $3.8 billion of the total $4.5 billion collected, according to recent figures.
In a dramatic contrast, taxpayers with AGI of less than $100,000 – that’s about four out of every five taxpayers – reported about 4.1 percent of all capital gains.
The 2009 and 2010 proportions are expected to be comparable. But it is likely that of the $6.6 billion in unanticipated revenue half to two-thirds represents capitol gains income.
“The higher up in wealth, the greater the proportion of income that comes from capital gains,” noted Jean Ross of the California Budget Project, an independent nonprofit group that studies the impact of state budgets on working families and others.
The surge in capital gains revenue reflects transactions that generally – although not exclusively – are the provenance of California’s most affluent taxpayers, because their income is derived not only from salaries but from buying and selling stock.
“Sure, there’s some recovery in the economy, there’s more payroll and people are getting more jobs, but that’s not really what’s going on here. The huge amount of this money is capital gains. It’s probably 60 percent of the $6.6 billion,” said Lenny Goldberg of the California Tax Reform Association, a labor-financed group that seeks the closure of corporate tax loopholes, among other goals.
“There have been jobs, but the main recovery has heavily been in the stock market,” he added. “The stock market has gone from 6,500 in 2008 to about 12,400 now.”
For those earning more than $500,000, capital gains accounted for about $1 in every $4 earned. For those between $100,000 and $200,000, the percentage was dramatically different: Capital gains income represented about $1 in every $100 earned.
The wealthy few aren’t the only ones paying income taxes. But they are the few paying huge amounts of taxes, even though the percentage of their income devoted to taxes can, in many cases, be shielded by a sophisticated use of tax laws and come in lower than that of the average taxpayer.
The fact that California’s volatile budget depends on the performance of California’s wealthiest taxpayers is not new. Tied to income levies that fluctuate with economic conditions, the state budget drifts with the ebb and flow of income tax revenue.
The timing of the collections also was a surprise this year.
At the end of April the state was $5 billion ahead of the revenue collected at the end of April last year. That is a critical index of recovery, said David Kline of the California Taxpayers Association, which generally views tax cuts as a way to stimulate business activity.
“That‘s the big difference between last year’s collection at this time and this year’s collections,” he said. “We are collecting a lot more just in personal income tax alone.”
“The assumption is that this will continue through 2011 and 2012, and that’s huge. Unemployment is still high and it remains to be seen the outlook for long-term improvement, but certainly this is a good sign that the state is collecting billions of dollars in new revenue under the existing tax rate.”
The health and future of the economy is difficult to pin down, but serves as the underpinning of Brown’s – and any governor’s – recast budget that he unveiled this week.
Improving by fits and starts from more than three years of recession, the state’s economy is the big player in Brown’s budget blueprint, which will require two-thirds votes in the Legislature because it contains proposals to extend existing taxes. Brown, who has declared he wouldn’t raise taxes without public approval, envisions going to the November ballot in a referendum.
Less than half the state’s surprise cash is in hand, but the expectation of budget writers is that it’s coming – a significant flow but not enough to erase the deficit or prevent long-planned, deep cuts.
An income tax surcharge, which appeared likely only weeks ago, is being put on hold for at least a year. His proposal to abolish enterprise zones also was halted, at least temporarily, because of opposition in the Capitol. Brown acknowledged that “we didn’t have the votes.”
Driven in part by the unanticipated revenue, the Democratic governor proposed giving schools about $3 billion more than he earlier sought.
In all, he proposed some $89 billion in spending for the 2011-12 fiscal year that begins July 1, and nearly half that amount goes to education.
The heaviest cuts in the budget were made in developmental services and social services, including Medi-Cal, welfare assistance, mental health services and a $420 million hit to In-Home Supportive Services.
Among the surprise cuts was the elimination of the California Postsecondary Education Commission.
The Brown administration said abolishing the 37-year-old panel would have little impact on higher education policy, although the commission has been closely identified with California’s Master Plan for Higher Education and has served as a policy and research resource for decades.
Another elimination: The California Unemployment Insurance Appeals Board, which for years has served as a haven for top political appointees and was created through a bipartisan agreement.