California’s Revenue Roller Coaster
Last week, while admiring the seals frolicking on a San Diego beach, I read some good news about California’s tax collections. State officials had just announced that Fiscal Year 2010-2011 revenues will likely exceed expectations by $2 billion, largely because personal income tax receipts are running ahead of projections. Though still below 2010 levels, April withholding exceeded estimates by $250 million and 2010 tax return payments were up $400 million. This good news followed earlier worries that higher-than-expected refunds in February would continue throughout the filing season and wipe out earlier projected revenue gains. What should we make of those conflicting trends? And why is it so important for California to have a day-by-day report on its April income tax revenues?
My sense is the news is better but still not great. And, paradoxically, these few short-term positives could hurt the state’s fiscal situation in the long run.
California personal income tax revenues are a big deal because the state relies so heavily on the tax, which is highly sensitive to business cycles due in part to its progressive rate structure. In 2009-2010, personal income taxes accounted for 53 percent of general fund revenue. Fully a sixth of those receipts showed up in April. Revenues rose sharply as the state’s economy boomed and then collapsed in the Great Recession. And the state’s budget never really recovered from the Internet bust a decade ago.
What accounts for the conflicting news about the state’s income tax revenues? Those February refunds were probably the downside of a budget gimmick California used to help balance its 2009-2010budget. In passing it’s budget the state increased income tax withholding but didn’t actually raise tax rates. As a result, Californians effectively gave the state a one-year interest-free loan that was repaid in the form of refunds during the recent tax season. People who expected higher refunds probably filed early, while those who figured they still owed tax waited until April to file.
The higher income tax receipts may also be the result of questionable federal tax policy that let individuals convert regular IRAs to Roth IRAs in 2010 . True, taxpayers could have postponed paying the taxes associated with these conversions until 2011 and 2012. But many—myself included—opted to pay now to avoid potentially higher future federal taxes. Depending on how many did that, those higher short-run tax revenues may result in lower collections down the road when retirees withdraw Roth funds tax-free.
None of this totally discounts this week’s good news. The increase in April income tax receipts probably reflects both an improved economy and some one-time revenues from IRA conversions. But the outlook isn’t totally rosy: indeed corporate tax revenues are down for the year.
However, even with the new-found $2-$3 billion in revenues, California still faces expected annual budget shortfalls of $10 billion or more for the next four or five years. The state still has to make major structural changes in both revenues and spending. Unfortunately, this year’s higher revenues might make it politically more difficult for Governor Jerry Brown to convince newly-complacent voters to approve an initiative extending temporary taxes for another five years.
Last month the Economist wondered if reform was ever possible, given California’s reliance on direct democracy and its seemingly endless voter initiatives. The magazine ultimately expressed cautious optimism about reform of both the budget and initiative processes. I hope they’re right, because the state has to find a way to make its revenue peaks and dips a little less dizzying. The California Adventure Roller Coaster should be a ride in Disneyland, not a description of state tax policy.