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Disappointing Revenues or Stealth Cuts?


These updated projections make it abundantly clear how unrealistic the Budget Act assumptions. It is important to understand that the “Big 3” revenues—personal income tax (PIT), corporation tax (CORP), and sales and use taxes (SUT)—represent roughly 90% of all General Fund revenues. The extra $4 billion that was forecast at the time of the Budget Act’s passage in August was lumped on top of the Department of Finance’s forecast of the Big 3. In other words, none of the Big 3 were forecast to generate an additional $4 billion in revenues this year, but rather an additional $4 billion was forecast to come in on top of Big 3 revenues from some undisclosed source. In a best case scenario, this forecast was Pollyannaish. A more sinister interpretation is that it was always known that the $4 billion would not materialize, but provided political cover for achieving the $2 billion in trigger cuts. It was fairly clear at the time that the forecasts contained pie-in-the-sky assumptions, and that suggests that the cuts were the ultimate goal but were politically too unpalatable to pursue directly.

Outside of this difference, the LAO is forecasting that the Big 3 revenue will actually end up being roughly $400 million higher than anticipated in the Budget Act, which offsets a small part of the $4 billion that was forecast. This is an important point to make in today’s media climate, where we are constantly being bombarded by negative economic stories. The recovery continues to improve, and this is translating into General Fund revenues that are expected to be higher than forecast just a few months ago.

This $400 million in additional Big 3 revenues relative to the Budget Act is accounted for in the LAO forecast in increased Personal Income Tax (PIT) revenues. The LAO is also forecasting that Corporation Taxes (CORP) will be higher than forecast in the Budget Act by $471 million, but that this will be entirely offset by Sales/Use Tax (SUT) revenues that will come in $478 million lower than previously forecast. Although we largely agree with this overall analysis, there is some potential for consumer spending to pick up and drive a smaller than expected variance in SUT.

Beacon Economics agrees with the assessment that Big 3 revenues will finish out the 2011-12 fiscal year roughly $400 million higher than previously anticipated. Through September, Big 3 revenues were tracking roughly $101 million above the estimates, and although October came in particularly weak in terms of PIT and CORP, SUT came in slightly higher than anticipated. Additionally, based upon data from the Franchise Tax Board, timing seems to have played a significant role in the poor numbers California saw during October. Far more PIT and CORP receipts were collected during the first week of November than the State has seen in the previous three years. In fact, California collected more CORP receipts during first week of November 2011 than it did during the first week of November in 2008, 2009, and 2010 combined.

Receipts between 11/1 and 11/7
Year PIT ($000s) CORP ($000s)
2008 99,140 25,228
2009 75,824 21,445
2010 64,606 17,604
2011 183,963 84,115


Given this evidence, Beacon Economics does not feel that the poor October showing is indicative of a slowdown in revenue growth, but instead is based upon mechanical considerations associated with the revenue collection process. As such, we expect November’s cash report to show that revenues outperform expectations and that the remainder of the 2011-12 year will see Big 3 revenues do well. If the Big 3 finish the year in line with the LAO estimates, that would mean that California finishes the year up 0.5% from the Budget Act forecast. Through September, the Big 3 sources of revenue were tracking 0.6% higher. Based upon this information and the indications that revenues will exceed expectations during the current month, Beacon Economics agrees that Big 3 revenues will come in roughly 0.5% higher than previously forecasted in the Budget Act.

However, this does not mean that the State’s fiscal woes are behind it. The failure of the $4 billion dollars in “Not Otherwise Classified” revenues predicted/hoped for in the Budget Act means that most of the Automatic Triggers are likely to be pulled. This will mean more cuts to education on top of already difficult program reductions made to address budget shortfalls over the past few years. These cuts will be even more painful.

The LAO projects that more than $200 million will be cut from the UC and CSU systems, and $30 million from the community colleges. Nearly $400 million will also be cut from a variety of social services in the state, including preschool, child care, developmental services, libraries, and others. And that’s just Tier 1 of the automatic triggers. Tier 2 triggers, which are forecast to be pulled as well, reduce Prop 98 funding by $1.44 billion, which will ultimately have a large effect on our K-12 system and the community colleges.

These seemingly inevitable trigger cuts are coming at a time when there is a growing skills-gap in the labor force. Many of the sectors that are leading the jobs recovery are in sectors that require at least some level of post-secondary education. In addition, these are not only the jobs that are forecast to lead California out of the Great Recession, but are expected to become the growth engines for our economy over the long term. However, the majority of unemployed Californians currently lack any formal degree or certificate training, with a not-insignificant amount of those lacking even a high school diploma. As such, these deep cuts to the state’s educational infrastructure create challenges for accelerating the recovery, but could also put our long-run interests at stake.

In addition, the expenditure side of the equation continues to face other challenges as well. The state has yet to be able to achieve the cost savings that were anticipated in the Budget Act. Many of the temporary solutions enacted over the past few years as stop-gap measures have or will expire soon, which is estimated to create additional strain. Corporations will begin to be able to deduct operating losses from their overall tax liability—a practice that was put on hold during the depths of the downturn so that the State could cover budget shortfalls over the last few years. Other similar temporary stop-gap measures either have or will also expire soon.

Still, things are looking much better than was forecasted one year ago. Big 3 revenues are expected to do even better than was forecast at the time the Budget Act was enacted. Ultimately, it was the unrealistic expectations regarding the $4 billion that are letting folks down. Beacon Economics remains optimistic that California’s economic recovery will continue—albeit at a slower pace than is needed to rapidly repair the damage done by the Great Recession. With income back to its pre-recession peaks and corporate profits doing well, PIT and CORP are expected to continue to improve. Consumer spending, which has shown mixed results lately, is forecast to continue growing as well. Add it all up and slow but steady improvement in General Fund revenues are expected to continue over the next 18 months.

CATEGORY: General Economy

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