California's Budget Gets Boost From Tax Income

Staff Reporter

What happened to California's budget crisis?

Just this summer, the governor and Democratic-dominated Legislature locked horns over a $105.3 billion budget that papered over a long-term structural deficit through its heavy reliance on borrowing.

Yet over the past month, two Wall Street ratings agencies have given thumbs-up to the state, raising its credit ratings from near-junk status. The agencies cite not only the budget agreement but California's improving economy.

Since the start of the fiscal year on July 1, the state has raised $232 million more in revenue than was projected by the Schwarzenegger administration, according to the state Department of Finance.

While it's agreed the additional revenue would not close a $5 billion budget hole projected for the 2005-2006 fiscal year, the figures are good news that could revise policymaking and political strategies if economic growth is sustained.

"When you look at these numbers there are clearly signs of a turnaround," said finance department spokesman H.D. Palmer. "It is much different and welcome data."

Overall, the state is receiving 2.4 percent more general fund revenue than it had anticipated through Aug. 31, though the improvement is not across the board. Personal income and corporate tax receipts are up, but sales tax receipts fell off in August after rising in July not surprising given August's weak employment figures.

Still, finance department officials are optimistic about long-term trends, noting key economic indicators such as made-in-California exports and non-residential construction remain strong though not all agree with that assessment.

"The California economy is doing nominally better than that of the country, but nationally the economy is not performing at the point you would expect in an economic recovery," said Jean Ross, executive director of the California Budget Project, a left-leaning public policy think tank.

Wall Street pleased

Even so, the economic growth was noticeable enough that Standard & Poor's Rating Services and Fitch Ratings cited it as a key reason over the past month for raising the state's bond credit rating.

S & P; moved the rating to A from BBB on Aug. 24, while Fitch raised it to A-minus from BBB on Sept. 8. The actions followed a similar move by Moody's Investor Services in May as state-issued long-term bonds removed any chance the state would fail to meet its short-term debt obligations.

The upgrades ensure the bonds retain their investment-grade status, but California is still the lowest-rated state in the nation, with its structural budget deficit the primary reason.

"(The economy) has been improving. Assumedly it will assist in providing additional revenue. But the economy doesn't translate into structurally balanced operations," said Ruth Corson, a Fitch analyst who believes the state must either cut spending or raise taxes to alleviate the problem.

Raising taxes is something the governor has been loath to do, with Schwarzenegger instead counting on an economic recovery as well as a proposal for a massive restructuring of the state bureaucracy. The administration also plans to release a proposed overhaul of the Medi-Cal program in January.

So far, though, the economy has been helping out. If the state were to have revenue continue to come in at the current rate, it would put a dent of at least $1 billion in a projected $5 billion budget gap next year.

One contributor has been personal income growth, which translated into a 0.7 percent increase over projections, to $4.9 billion in revenue raised from personal income taxes in July and August. The figures are somewhat perplexing because the state economy added jobs at a much lower pace in August than the national economy.

Economist Stephen Levy, director of the Center for the Continuing Study of the California Economy, thinks the personal income gains might by attributable to capital gains taxes paid by residents cashing out of the recent stock market rally.

But Howard Roth, the finance department's chief economist, believes current employees may be working more overtime. "I do think that some of that is option income, but some of it can be people working longer," he said. He expects employers to add more staff in the fourth quarter.

More impressive is the revenue raised from corporate taxes, which exceeded projections by 29.5 percent in July and August, to $487 million.

This growth, while having less of an impact than personal income taxes, is consistent with the general improvement in other economic sectors, including goods exported to other states and countries. The value of California-made exports hit $27.4 billion in the second quarter, up 13.9 percent over the like period a year earlier.

Also booming is the state's construction market. The value of non-residential building hit $17.5 billion in June, a 29.7 percent improvement over the like month a year ago and the highest level since Aug. 2001. That figure tapered off in July to $16.2 billion.

Crystal ball

Brad Williams, chief economist for the non-partisan Legislative Analyst's Office, cautioned against extrapolating two months of improved revenue figures to the entire fiscal year, noting that much of the increase comes from ancillary increases, such as license fees and oil royalties. Moreover, Williams is projecting that the state's budget deficit will exceed the governor's $5 billion estimate by at least $1 billion.

There also is the question of the strength of the overall economy. The UCLA Anderson Forecast this month raised the possibility, however slight, that a recession might hit in the next year or two.

Finally, there is the precarious structure of the state budget. While the 2005-2006 deficit might hit $6 billion, the following year it could rise to $10 billion or more. That's because the current budget, as well as next year's, is being helped out with borrowing from local governments and schools that will need to be repaid.

"There is just complete shortsightedness up there (in Sacramento) that I don't understand," said Chris Thornberg, a senior economist with the Anderson forecast, who agreed there has been a moderate improvement in the state's financial fortunes, but that only big cuts or tax increases will solve the long-term problem.

For reprint and licensing requests for this article, CLICK HERE.