Countdown to May Revise: Revenues Are Up, What’s Next?

The Governor will release the May Revision to his proposed 2011-12 budget next Monday, May 16. The good news is that going into May, year-to-date revenue collections were $1.3 billion above the Governor’s January forecast. As reported by the State Controller, collections from the “big three” – the personal income, sales, and corporate income – taxes were up by $2.5 billion, offset by a $1.2 billion drop in “other” revenues attributable to the canceled sale of state properties. The increase in current year collections will help offset lower-than-targeted savings from a number of proposals enacted in the March budget agreement and “erosion of solutions” due to stalled budget negotiations. Higher-than-anticipated revenue collections do portend some good news for the budget going forward – forecasters have solid grounds to increase 2011-12 estimates to reflect higher baseline revenue collections.

A closer look at the year-to-date collections raises some interesting questions and offers some important reminders for policymakers:

  • Nearly all of the higher-than-expected revenue collections are attributable to the state’s personal income tax. As of April 30, personal income tax collections were $3.1 billion (8.0 percent) above forecast levels. With growth in hourly earnings largely stagnant, this better-than-anticipated performance likely reflects strong growth at the high end of the income distribution that we’ve discussed previously. The lesson here? Any effort to “flatten” California’s personal income tax could seriously curtail growth in this one bright area of the budget.
  • Corporate income tax collections are extraordinarily weak – 8.4 percent ($664 million) below forecast levels despite a record growth in corporate profits. The disparity between corporate profits and corporate tax collections could mean that the massive corporate tax breaks enacted as part of the 2008 and 2009 budget agreements are costing far more than previously expected. Lawmakers “backloaded” these tax cuts to avoid having to score their impact on the budget at the time of enactment. The full brunt of the tax breaks will take effect beginning in 2011.
  • Sales tax collections were barely (0.4 percent) above forecasted levels, reflecting continuing weakness in the economy for most California consumers.

The big question remains: how will the Governor and Department of Finance officials adjust 2011-12 revenue estimates in response to recent collections? Even with the higher-than-anticipated collections, California still faces a significant budget gap that can only be closed responsibly by coupling recent spending reductions with additional tax revenues.

— Jean Ross

This week’s California Budget Bites will feature a Countdown to the Governor’s May Revision examining the impact of recent budget decisions and what they might mean for California’s future in preparation for the May 16 release of updated budget forecasts and proposals.