California’s notorious tax-revenue roller coaster is on the way up again. How many times do we need to see this movie before we remember how it ends?
Tax receipts in January soared nearly $5 billion above the projections Gov. Jerry Brown’s best experts made just a month earlier. Withholding from paychecks was 12 percent above projections while estimated payments from taxpayers came in at more than double what the governor and his staff anticipated.
Even in a state as big as California, $5 billion is still real money. That’s enough to pay for the entire budgets of the state’s biggest welfare programs – aid to poor families and assistance for the aged, blind and disabled. It’s more than half of the entire budget for prisons and parole. It is more than taxpayers spend in a year on the University of California and the California State University budgets combined.
That’s an astonishing jump in revenues for a single month. But it’s no discredit to the number crunchers in Brown’s Department of Finance that they didn’t see it coming. The green eyeshades did predict that the state would see a revenue bump this year, for many reasons. They just didn’t expect so much money, so soon.
The spike is most likely the result of upper-income Californians cashing in investments late in 2012 before an anticipated federal tax hike took effect.
The “fiscal cliff” agreement reached in Washington on New Years Day allowed the tax on capital gains to rise from 15 percent to 20 percent for single people earning more than $400,000 and couples with incomes above $450,000. Also, a new tax of 3.8 percent to help fund federal health reform took effect Jan. 1 on investment income for singles making more than $200,000 and couples earning more than $250,000. Federal taxes on ordinary income rose to 39.6 percent from 35 percent, and many upper-income people will also see valuable tax deductions phased out this year.
Proposition 30, the state tax increase Brown proposed and the voters passed in November, also increased taxes on upper-income people. But that tax increase applied retroactively to income earned since Jan. 1, 2012, so it provided no incentive for people to sell their investments and pocket earnings before the new year. Still, some of those taxpayers might have increased their estimated payments in January to catch up with higher taxes they now suddenly owe on incomes earned last year.
Finally, it is also possible that some of the revenue bump is simply the result of economic growth. After all, California job growth has been greater than the national average for the past year, and US figures for December showed that personal income rose sharply across the country. Perhaps people were earning even more money than the experts thought.
The months ahead will yield more clues about the source of the state’s good fortune. It is possible that revenues will decline between now and the tax deadline in April, or that refunds will climb, offsetting some if not all of these gains. And if later numbers fail to show a big jump in economic activity, analysts will probably conclude that the spike is a one-time event that won’t change projections for revenue in the next fiscal year.
In fact, Gov. Brown has already signaled that he will try to put a lid on the ambitions of his fellow Democrats in the Legislature. Brown ran on a pledge to get the state’s finances under control, and he risked most of his limited political capital to pass the tax hike in November. The last thing he wants to do now is approve permanent spending increases that depend on revenues that are most likely temporary.
But even if those are his instincts, Brown will face at least one major obstacle: Proposition 98, the state’s constitutional guarantee of minimum funding for the schools. One part of that law requires the state’s contribution to schools to increase along with tax revenues, and it does not matter whether the economic experts say a revenue spike is temporary. So Brown might be required to spend much of that $5 billion on the schools unless two-thirds of legislators vote to suspend the guarantee and set the money aside.
No matter how that issue plays out, though, the spike is another reminder of how volatile California’s revenue system is, and how much the state depends on taxes paid by its wealthiest residents to provide the services the rest of us need and desire. Because the income of high-end investors swings wildly from year to year, every time the economy grows, tax revenues grow like mad, and every time it slows, revenues stall or crash.
Reformers have argued for years that the state needs some kind of law to control the impulses of lawmakers and governors in times like this. The idea would be to automatically set aside money in good times so that the state would have a reserve to cushion the blow when the economy slowed again.
This was a pet cause of former Gov. Arnold Schwarzenegger. He won voter approval for one ballot measure in 2004 that he said would force the state to build a reserve, but it lacked the teeth to get the job done. He tried stronger versions in 2005 and 2009, but both voters rejected both after divisive campaigns that focused on other issues. Finally, as part of his last budget deal in 2010, Schwarzenegger persuaded legislators to place another budget control measure on the ballot in 2012, but it was later removed from the ballot and now sits in political limbo.
Brown may yet revive that measure, rewrite it and send it to the voters next year. Or, he might simply do what Schwarzenegger did not: use the powers of his office, and his veto pen, to discipline the Legislature and ensure that the state has a healthy rainy day fund.
One thing he will have to resist is the temptation to reward friends, allies and supporters with more spending than the state’s economy and its tax system can sustain.
Daniel Weintraub has covered California public policy for 25 years. He is editor of the The California Health Report at www.healthycal.org.