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California’s Budget Square Dance


The California Department of Finance (DOF) and the state’s Legislative Analyst’s Office (LAO) each recently published new, and somewhat conflicting, revenue forecasts for the next few years. The latest estimates have sparked debate in Sacramento, and prompted Governor Brown to defend the DOF’s more conservative estimate in a recent press conference (Jerry Brown Downplays Analyst's Budget Forecast, Pledges To 'Stay The Course).

The differences between how the two see the state ending the 2012-13 fiscal year are relatively minor – the LAO has General Fund revenues finishing roughly $690 million ahead (0.7%) of the DOF’s current estimates. However, their forecasts for 2013-14 diverge more substantially. Specifically, the LAO has General Fund revenues increasing by roughly $1.1 billion next fiscal year, while the DOF’s May Revise shows revenues declining by $942 million. The differences between the forecasts have caused a bit of an uproar across the state because the DOF’s forecast comes to almost $2.8 billion less revenue next year than the LAO's forecast. For many public agencies, these differences make it difficult to understand what their budgets might look like next year. Schools, for instance, are funded through formulas mandated by Proposition 98 and receive a minimum percentage of the state budget.

  2012-13 2012-2013 2012-2013 2013-2014 2013-2014 2013-2014
DOF May Revise LAO Difference DOF May Revise LAO Difference
Personal Income 63,901 64,453 0.9% 60,827 64,320 5.7%
Sales & Use Taxes 20,240 20,394 0.8% 22,983 22,194 -3.4%
Corporate Taxes 7,509 7,500 -0.1% 8,508 8,600 1.1%
Other 6,545 6,537 -0.1% 4,935 4,914 -0.4%
Total 98,195 98,884 0.7% 97,253 100,028 2.9%

The DOF’s revenue forecast is the more pessimistic of the two revenue projections and it is especially dour in light of their economic outlook, which has California’s economy improving next year. And while the DOF’s economic forecast is also slightly more pessimistic than the LAO’s, both show continued recovery in the upcoming fiscal year. Thus, the forecast for deteriorating revenues by the DOF has left many scratching their heads.

Beacon Economics’ forecast for the state’s economy is slightly more optimistic than either the DOF’s or LAO’s, suggesting to us that the LAO revenue forecast is closer to the mark. However, given the passage of Proposition 30, which raised rates on only the state’s top income earners, California’s income tax base has grown even narrower. As a result, revenues could be more volatile in the coming years. With so much of the General Fund dependent on high-income individuals, a misstep in the stock market or the property market could send revenues tumbling. Of course, neither of these is currently likely, given recent trends.

Still, knowing all this, the DOF’s admittedly conservative estimates of revenue may actually be a prudent course of action. Indeed, the Governor has defended the conservative approach to forecasting, stating that California “… spend[s] money that you think is going to be there year after year, and it isn't.”

Overall, Beacon Economics agrees with the LAO that the revenue forecast contained within the DOF’s May Revision estimate is likely too pessimistic. However, the hyper-cyclical revenue base that California has established with its increasingly progressive tax structure also means that there could be more long-term value for the state in being conservative than in being right.

In navigating California’s complex budget dance, it is helpful to benchmark the projections against what is happening with state finances currently. Through the first 10 months of fiscal 2012-13 year, General Fund revenues have been tracking well above their 2011-12 levels. In total, revenues are 21.4% above where they were through the end of April 2012. The change has been driven almost entirely by an upsurge in personal income tax revenues. Due to the increase in the income tax rate following the passage of Proposition 30, equity markets have returned to all-time highs. Personal income tax receipts have increased by 36.7% over the same point in 2011-12—a difference of almost $15 billion. Also, to date, California has added back more than 750,000 of the 1.3 million jobs lost during the downturn. The state’s unemployment rate has dipped to 9%. As a result of higher employment, the Bureau of Economic Analysis estimates that total personal income has increased by 16.1% since the economy hit bottom in the third quarter of 2009. Together with rising tax rates, these trends have led California’s General Fund revenues to surge.

Sales tax receipts also increased over last year’s total, but only by 1.2% (less than $200 million). The temporary sales tax rate increase that was put into place to preserve cash during the economic downturn, expired at the end of the 2010-11 fiscal year. That kept receipts flat in 2011-12 despite taxable sales levels rising across the state. However, effective January 1, the state’s sales tax rate increased by 0.25 percentage points due to the passage of Proposition 30. And in each month since, sales tax receipts have outperformed 2011-12. Unfortunately, the sales tax gains were partially offset by weaker Corporate Tax receipts, which fell short of 2011-12 levels by 15% at the end of April 2013.

Relative to the 2013-14 Governor’s Budget, which foresaw the Proposition 30 tax rate increases, General Fund revenues are still ahead through April. Sales taxes came in slightly weaker than forecasted, but both personal income and corporate tax receipts are tracking higher than expected. Overall, total General Fund revenues are more than 6%, or almost $4.6 billion, ahead of estimates so far this year.

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