In the introduction to his office’s November report, California’s legislative budget analyst painted a rosy picture of the Golden State’s fiscal situation. California is set to maintain a $2.8 billion surplus at the conclusion of the 2017-18 fiscal year, and has amassed enough budget reserves to “weather a mild recession without cutting spending or raising taxes.” Democrats, who hold supermajorities in both houses of the state legislature, have pushed to spend these surplus dollars, arguing that the state’s strong fiscal position merits increased financial commitments to Medicaid, students, welfare programs, and government workers.
Beneath the surface, however, California’s hot streak is on course to derail. By increasingly relying upon wealthy taxpayers to sustain its ballooning budgets, the state has set itself up for another budget crisis—only this time, thanks to Governor Brown and the ruling Democrats, it could be even worse than the one at the nadir of the Great Recession.
In 2014, the top one percent of earners in California supplied nearly half of all of the state’s income tax receipts, while the upper quintile—taxpayers making just about $95,000 per year and above—provided over 90 percent. And because personal income tax payments alone account for about 70 percent of the state budget, only a fifth of taxpayers covered nearly three-quarters of the $122.5 billion of general fund expenditures approved in June—and over three-fifths of the entire state budget.
Leaning so disproportionately upon the wealthy, as it turns out, is a recipe for disaster. After years of riding high on personal income tax revenues, the state budget collapsed in 2008 when wealthy taxpayers, whose fortunes contracted during the housing crisis, paid much less in taxes than expected. Driven by this decline in personal income tax revenues, overall state tax receipts plunged almost 10 percent, leaving big-spending legislators scrambling to cover a $28 billion hole. “The state’s already difficult budget situation was made worse … by a significant drop in revenues due to a sluggish economy,” began the budget report that year.
Unless California can wean itself off the fortunes of the wealthy, history will repeat itself when the next economic slowdown arrives.
But from this budget crisis—the IOUs issued to state workers, the forced furlough days, the tuition hikes at public universities—the state legislature learned no lessons. They shaved a mere 0.4 percent off the budget between 2007 and 2008 and, in 2012, hit wealthy Californians with a “temporary” tax increase, which voters extended by more than a decade this November after teachers’ unions warned of “devastating” cuts to K-12 schools and community colleges. Though the revenue from these tax hikes helped pull the state budget from a yawning deficit to a small surplus, the increases have pushed even more taxpayers to abandon the state’s hostile tax climate. In the three years following the tax hike, roughly 33,000 more people fled California than entered, taking with them over $6 billion—about $184,000 each, on average—in taxable income.
With this exodus of wealth, those taxpayers who remain are left with an even greater burden to carry. And as the state relies more and more on a shrinking share of willing cash cows, public expenditures become even more difficult to sustain, as the violently fluctuating fortunes of a few become the principal source of budget inflows. “Our revenue outlook depends, in large part, on our assumptions about the performance of the economy and the stock market,” explains the legislative analyst’s latest budget report. “In particular, revenues from the personal income tax … depend on highly volatile estimates of capital gains.” In fact, just the “[o]rdinary movement in the stock market … can result in billions of dollars in higher or lower revenues for the state.”
Unless California can wean itself off the fortunes of the wealthy and create a more stable tax system, history will repeat itself when the next economic slowdown arrives. Regardless of the moral merits or demerits of soaking the rich, doing so has intensified the state’s dangerous dependency upon its most wealthy residents for survival, even as it has forced these increasingly essential taxpayers leave the state to escape its crushing tax burdens.
Meanwhile, small surpluses, driven by a strong stock market and the ballooning fortunes of its small coterie of wealthy benefactors, have obscured these severe structural problems, giving politicians an excuse to avoid reforming taxation in California, curtailing irresponsible spending, and tackling unfunded pension and healthcare liabilities. But until these hard choices are made, the Golden State will teeter on the brink of budget crisis, waiting for the next economic downturn to propel it into the abyss.
Photo: The Sacramento Bee Blog