How We Got Here: The Revenue Side of the Equation

In his State of the State address, the Governor reiterated his endorsement of the recommendations of the Commission on the 21st Century Economy (COTCE) citing the drop in state tax revenues attributable to the downturn in the economy. As we’ve blogged about before, the COTCE recommendations would shift the cost of state services from the wealthiest Californians to middle- and low-income Californians by reducing the state’s reliance on the personal income tax – particularly at the top end of the income distribution – and shifting the state toward consumption-based taxes. Our review of how actual state revenues and expenditures compare to the Legislative Analyst’s 2004 forecast strongly suggests that the Governor is barking up the wrong tree.

As we noted yesterday, the decline in 2009-10 General Fund spending relative to the 2004 forecast is larger than the drop in 2009-10 General Fund revenues. That might lead one to ask why the state faces a budget gap. The answer? Based on 2004 laws and policies, the state was expected to run shortfalls through the end of the forecast period.

Perhaps more interesting is a comparison of how the state’s “big three” revenue sources – the personal income, corporate, and sales taxes – fared relative to the 2004 forecast. Contrary to popular rhetoric, the state’s personal income tax actually performed the best of the state’s three major taxes, with actual collections falling 14.7 percent below the 2004 projection. Now that’s not good, but it is significantly better than the 21.2 percent difference between projected and actual sales tax revenues and 27.8 percent difference between projected and actual corporate income tax collections.

As we’ve noted before, there’s reason to expect that collections from the business net receipts tax (BNRT) proposed by COTCE would track the performance of the sales tax, since both are based on consumers’ purchases. While the BNRT would tax a broader “base” – a broader range of products, including services and groceries – consumer spending has been weak across the economy at large.

The one component of the state’s revenues that increased relative to forecast?: “other revenues and transfers.” This represents a relatively small part of the state’s revenues. Most of the $1.4 billion difference between the 2004 forecast amount and the 2009 forecast is attributable to the assumption that the state will receive $1 billion from the sale of a portion of the State Compensation Insurance Fund, an assumption that most analysts view as dubious, at best.

The bottom line: contrary to popular assertions, the current problem is not attributable to weakness in the state’s personal income tax, but rather to overall weakness in the economy and other factors. In future blog posts, we’ll examine how 2009 spending compares to prior projections, so stay tuned.

— Jean Ross

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