|Budget Issue:||LAO commentary on Facebook IPO and state revenue forecasts|
|Finding or Recommendation:||This provides an update to the Legislature on the state's revenue situation, following the revision of revenue estimates by the Governor on May 14, 2012.|
The administration released its updated revenue estimates yesterday (May 14, 2012) as part of the Governor’s May Revision. Our office now has completed most of its updated revenue forecasts as well.
Our office’s overall state General Fund forecasts now are fairly similar to the administration’s in both 2011-12 and 2012-13, with just a few hundred million dollars of bottom-line differences each year in assumed collections of baseline (current-law) tax revenues. (We are still in the process of evaluating various May Revision proposals, such as newly proposed loans and transfers to the General Fund.)
Comparisons with prior forecasts are complicated, given the changes since January in the Governor’s proposed tax measure and the recent inclusion of revenues related to Friday’s planned initial public offering (IPO) of stock by Facebook, Inc. Adjusted for these changes, the administration’s overall 2011-12 revenue estimates fell since January to basically match those that we released in February. With regard to 2012-13, the administration’s estimates for the state’s personal income tax (PIT) base fell, while ours rose, meeting roughly in the middle. We will discuss the overall revenue forecast, as well as the administration’s expenditure proposals, in our Overview of the May Revision publication scheduled for publication later this week. In light of the significant interest in Friday’s planned IPO, however, we are releasing the following description of our office’s Facebook revenue estimates a few days early. The assumed Facebook IPO revenues represent a small part—less than 2 percent—of the state’s overall revenue forecasts in 2012-13.
Based on publicly available information, state PIT revenues will be generated from the following types of IPO-related financial transactions: (1) settlement of options-like assets known as “restricted stock units” (RSUs) by Facebook employees and others beginning late in 2012, (2) options transactions by Facebook’s founder and chief executive officer, Mark Zuckerberg, both at the time of the IPO and at some other points in time over the next three years, and (3) various other stock and options transactions, principally by current Facebook “insiders” (investors, employees, and former employees), over the next few years.
As we discussed in our February publication, The 2012-13 Budget: Economic and Revenue Update, the amount of IPO-related tax revenues cannot be predicted with any degree of precision. There are many reasons for the difficulties in forecasting these tax revenues. For example, as of now, we do not know for sure what the IPO share price will be and, much more importantly for state revenues, what the company’s share price and market capitalization will be roughly six months from now when various large stock-related transactions will occur. While Facebook’s recent editions of its form S-1 (its preliminary IPO prospectus) contain much helpful information for state revenue forecasters, they still lack many details. For example, the prospectus does not describe in detail the precise manner in which various transactions will (or will not) result in withholding obligations to federal and state tax agencies. It cannot tell us the extent to which RSU, options, and other transactions will occur with individuals who are obligated to report income to California versus other states. It also cannot reveal the extent to which Facebook insiders—especially the company’s largest investors—have or will undertake other transactions that would result in extraordinary deductions, credits, or other reductions to reported California taxable income. All of these matters and many others are subject to considerable uncertainty. State tax revenue estimates regarding Facebook, therefore, require numerous assumptions.
Because of these factors, there is a large margin of error surrounding both our Facebook revenue estimates and those of the administration. Typically, for state revenue forecasting, we analyze revenue and economic data using statistical tools (such as regressions based on historical experience) that aim to reveal the most likely level of state revenues, with roughly equal “upside” and “downside” to the estimate. This is difficult to do with the Facebook IPO estimate. While share prices and other factors could be weaker than those now assumed by the administration and our office on the date of the IPO, six months from now, and at other points in time, it seems more likely—based on commentary by market analysts and past history of certain high-profile technology IPOs—that Facebook’s share price and other factors involved in our revenue estimates will prove to be more favorable. Accordingly, while state revenues could be hundreds of millions below both our estimates and the administration’s in some scenarios, the revenues could also be $1 billion or $2 billion above our respective estimates in 2012-13 in some scenarios. This is particularly the case if share prices and/or the level of California taxable transactions related to the IPO are higher than assumed.
Administration’s Estimates. The administration now assumes in its revenue forecasts that the General Fund (including the Education Protection Account proposed in the Governor’s initiative) will receive $1.9 billion over roughly the next 13 months. Of this amount, about $500 million would be attributed to 2011-12, and $1.4 billion would be attributed to 2012-13. Of the $1.9 billion, around $400 million would be generated as a result of the proposed higher tax rates under the Governor’s tax initiative, and $1.5 billion would be generated under current law. The administration also forecasts that around $80 million would be generated in IPO-related PIT revenues in both 2013-14 and 2014-15. The administration’s estimates assume a $35 IPO share price and a $35 share price roughly six months from now when a large volume of RSU settlement activity is scheduled to occur.
LAO Estimates. Our updated Facebook revenue forecasts now assume a $38 IPO share price, which would rise to $45 in six months, with additional share price growth in later years. We estimate that this would result in $2.1 billion of General Fund revenue collections over the next 13 months, of which about $500 million would be attributed to 2011-12 and about $1.6 billion to 2012-13. Of the $2.1 billion over the two fiscal years, about $500 million would be generated as a result of the proposed higher tax rates under the Governor's tax initiative, and $1.6 billion would be generated under current law. Principally because we assume that a large 60-million-share options transaction referenced in recent versions of the prospectus will occur in 2014, we also estimate the receipt of about $650 million of Facebook-related revenue in 2013-14, with about $150 million more in 2014-15 and small additional amounts in the tens of millions of dollars per year through 2016-17. (The administration’s estimates do not appear to account for this 60-million-share options transaction. While we have attributed revenues from this transaction to the 2013-14 fiscal year, it could occur earlier and boost 2012-13 revenues above our estimate by several hundred million dollars.)
About One-Fifth of 2012 Personal Income Growth Will Relate to the IPO. It appears that the bulk of income that will be attributable to Californians due to the IPO will be classified as a type of wage income, although there likely will be substantial capital gains activity as well. Because the IPO will result in a market capitalization approaching or even exceeding $100 billion and well over $10 billion of income will be generated for California residents, it should result in the state’s wages and personal income (a key economic statistic not necessarily directly comparable to taxable income) being higher than they otherwise would be, particularly in 2012, when the bulk of IPO-related income is projected to be received by taxpayers. The administration’s May Revision revenue forecast, for example, assumes 4.9 percent personal income growth in the state in 2012. If the Facebook IPO were excluded, this figure would total 4.0 percent. Accordingly, around 20 percent of the state’s personal income growth in 2012—and nearly 1 percent of all personal income in the state this year—is expected to be related to Facebook.
State revenue forecasting models rely on historical economic data to project future tax collections. An extraordinary economic event like Facebook’s IPO has the potential to skew economic data in ways that hinder current and future revenue forecasting. Like our office, the administration ran its revenue forecasting models based on an economic forecast that excluded Facebook IPO income in order to address this problem. Essentially, to avoid “double counting” the Facebook income, this means that both of our revenue estimates consider the economy without Facebook and then add PIT revenues on top of those estimates to account for the IPO. When we present our economic forecast summary later this week, it will omit Facebook IPO income and thus require adjustments to be comparable to the administration’s published economic forecast.
Effects on Other State and Local Revenues. While our office’s state revenue forecast displays Facebook revenues only in the PIT, we acknowledge that the huge amount of wealth resulting from the company’s IPO will benefit other state and local revenue sources in the near term. In particular, there will be localized increases in property and sales and use tax bases that otherwise would not have occurred. Such increases could be noticeable for some localities in the Bay Area, but they are not likely to be significant for the state as a whole. We believe our forecasts are consistent with the small expected statewide increase in these tax bases.
In addition, the Facebook IPO apparently will generate significant tax deductions for the company, which will effectively reduce federal tax revenues and tax revenues in various states below what they otherwise would be. Facebook’s state tax obligations, however, are spread across the entire country. This means that while California will receive the vast majority of state personal income taxes resulting from the IPO (as most Facebook employees appear, based on publicly available information, to be California taxpayers), only a small portion of corporate tax losses related to the IPO are likely to be attributed to California.