The Legislative Analyst’s Office economic and budget analysis issued yesterday should give pause to those hoping that California’s budget woes will be solved by raising income taxes on the rich. The report says it is “notoriously difficult” to determine income from capital gains taxes, which California’s budget relies upon so heavily. Capital gains taxes are paid, for the most part, by taxpayers in the upper tax brackets so naturally one wonders what would happen if the income tax increase measures aimed at the rich pass.

Economists have pointed out for years that California’s rollercoaster budget ride is the result of heavy reliance on a progressive income tax. When the upper end taxpayers do well and cash in their investments on capital gains, the state treasury flourishes. When those taxpayers see investment money fall in a poor economy or don’t cash in their investments because of high tax rates, the state coffers are found wanting.

The big three efforts to raise taxes in the state via the initiative process – authored by Governor Jerry Brown, the California Federation of Teachers and civil rights attorney Molly Munger – all rely heavily, or exclusively, on raising the top income tax rates. The actions – or should we say reactions – of those upper income tax payers to an increase in the income tax rate will affect California’s bottom line.

Here’s one example: The LAO took into consideration the benefit of the proposed Facebook IPO, valued at anywhere between $75 billion and $100 billion. If the stock sale hits those numbers, The Wall Street Journal estimates chief executive Mark Zuckerberg could reap over $28 billion.

But the big question is: How much stock would Zuckerberg and other newly minted millionaire shareholders sell after the IPO?

As I wrote in a previous post, some of the young new millionaires who work for Facebook might decide to wait out the five years in which Brown’s tax proposal will run and avoid the higher tax rate before cashing in those capital gains. Facebook founder Zuckerberg is only 27 years old and he and many of the young people who work for him might decide they can afford to wait for the higher tax rate to expire and reap a larger benefit.

The Munger tax increase goes for 12 years and the CFT increase is permanent. Reactions of taxpayers if those measures pass would undoubtedly be different. To avoid permanent higher taxes, some newly rich could pack up and leave. It has been said the growth of no-income tax Incline Village, Nevada is the result of high California income tax rates.  Even if only a few leave, the state budget will continue to be at the mercy of the financial decisions concerning capital gains of a relatively small number of taxpayers.

The LAO report once again points out the problem of the state budget relying so heavily on the progressive income tax.