Summary of LAO Findings and Recommendations on the 2013-14 Budget

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	Program	Budget Issue	LAO Finding Or Recommendation	Last Updated
Go Back	Revenue	Update on strong California capital gains tax collections in September	This note provides an update on California revenue collections for the 2013-14 fiscal year, as of September 2013. (Updated: Sept. 30, 4:30 p.m.)	9-30-13

Detailed Narrative
(Updated: Monday, September 30, 4:30 p.m., Pacific time.) This note provides an update on 2013-14 state revenues, particularly the state’s personal income tax (PIT) and corporate tax collections. September is the first month of the fiscal year in which significant amounts of PIT and corporate tax “estimated payments” are submitted to the state’s Franchise Tax Board (FTB). PIT estimated payments—made principally by higher-income Californians on capital gains and business income—are a major indicator of capital gains-related state revenue that is driven largely by stock market gains and losses. *PIT Collections Strong…Corporate Taxes Again Appear Weak.* California’s 2013-14 state budget is based on the May 2013 revenue projections released by the Governor’s administration. As discussed below, PIT estimated payments appear to be finishing well above the administration’s projections in September 2013. This is an important development because capital gains-related tax revenue can cause state revenues to increase rapidly and exceed estimates at times when stock and housing markets are strong. At the same time, corporate tax payments, a much smaller state revenue source than the PIT, are once again falling short of expectations: both those of the administration and our office. For these two revenue sources combined, September 2013 collections are on track to end the month about $340 million above the administration’s projections (with one refund day for the month remaining to be booked). (Sales, insurance, and other tax collection information will be available in future days and reported in the Finance Bulletin, a monthly publication from the Department of Finance, in mid-October.) *Early Results for 2013-14 Promising…But Federal Impasse May Disrupt Economy.* Our office plans to release updated revenue and economic projections on November 20 (tentative), and there will be additional forecast updates before passage of the 2014-15 state budget in June 2014. Early results for 2013-14, on balance, seem promising for the state’s near-term fiscal health. The 2013-14 state budget was premised on the administration’s revenue projections, which were $2.8 billion lower than our office’s with regard to total General Fund revenue in 2013-14—mainly due to the administration’s lower projections of taxable capital gains this year. Collections of the state’s two largest revenue sources—PIT and sales taxes—are running broadly consistent with our office’s expectations. Collections of corporate taxes, the third-largest revenue source, are running below our office’s expectations. At the same time, it is early in the fiscal year, and the somewhat positive revenue trend to date could be disrupted in the near term if the current federal budget and debt ceiling debates negatively affect stock, housing, and labor markets. Personal Income Taxes Overall, considering both PIT withholding and non-withholding sources, September 2013 PIT collections are on track to end the month around $460 million above the administration’s projection for the month. *Capital Gains Taxes Running Above Administration Projections.* Nearly all PIT withholding is collected by the Employment Development Department (EDD), while the FTB collects non-withholding PIT revenue, including estimated payments (a key source of capital gains-related tax revenue), and disburses PIT refunds. Accordingly, PIT collections net of withholding and refunds (simplified below as “net FTB PIT collections”) generally are a good indicator of estimated payment trends in certain months, such as September, when taxpayers make those payments. In September 2012 (prior to passage of Proposition 30), net FTB PIT collections totaled approximately $1.45 billion. The administration’s 2013-14 budget forecast assumed that net FTB PIT collections in September 2013 would total about $1.64 billion, an increase of 13 percent. September 2013 collections, however, are on track to far exceed the administration’s projections. As of September 30 (with one day of September refunds left to book), net FTB PIT collections for September 2013 are on track to equal about $2.165 billion. This is 49 percent above September 2012 net FTB PIT collections and about $520 million (32 percent) over the administration’s projections for this revenue category. *PIT Withholding Appears Healthy So Far in 2013-14.* In 2013-14, the administration projected that PIT withholding—principally, amounts withheld from Californians’ taxable wages and salaries—will make up over 60 percent of total PIT collections. Through the end of September, PIT withholding collections in 2013-14 are running around 6 percent above collections from the same period of last fiscal year. For the 2013-14 fiscal year as a whole, the administration projected that withholding would grow by 3.7 percent. (This 3.7 percent growth figure is over 1 percentage point lower than it would be otherwise due to the one-time effects on withholding from Facebook, Inc.’s initial public offering last year, principally in October. In addition, withholding and other PIT totals in some months of 2012-13 were affected by taxpayers’ one-time acceleration of income sources to calendar year 2012 in order to avoid higher federal taxes that took effect in 2013.) Based on all of this data, we observe that withholding trends appear reasonably healthy for the fiscal year to date. For the month of September 2013 alone, preliminary EDD reports show that PIT withholding totaled approximately $3.225 billion. This is about $200 million (6.6 percent) above September 2012 levels and around $63 million below the administration’s projection for PIT withholding for the month of September 2013. Corporate Taxes *September Collections Below Administration Projections.* As of September 30 (with one day of September refunds left to book), net FTB corporate tax collections for September 2013 are on track to equal around $770 million. This is around 3.5 percent below September 2012 levels and around $120 million (14 percent) below the administration’s forecast. Our office’s corporate tax forecast for 2013-14 was slightly above the administration’s, and the September results are below our office’s expectations as well. Other Taxes Other major state taxes, including sales and insurance taxes, generally appear consistent with our office’s expectations for the fiscal year to date through the end of August. July and August sales tax collections were $153 million (4.3 percent) below the administration’s projections, but more consistent with our office’s lower forecast for this revenue source. September results for all of the other taxes will be available in mid-October in the DOF Finance Bulletin. Methodology *Agency Cash.* The data in this note is based on “agency cash”—the primary method used for revenue calculations in the annual state budget. The key source for monthly information on agency cash is the Department of Finance’s Finance Bulletin, which, among other things, compares monthly agency cash to the administration’s monthly projections. (“Controller’s cash” differs from agency cash based on the timing of certain receipts.) *A Note on “Year-to-Date” Agency Cash Revenue Estimates.* For the month of July 2013, the Finance Bulletin reported that PIT revenues ended the month $127 million below the administration’s projections for that month. July’s PIT receipts are overwhelmingly withholding payments from taxable wages and salaries. For July, the administration forecasted much faster growth of PIT withholding than our office expected and greater year-over-year growth than it assumed for any other month during the 2013-14 fiscal year. Specifically, the administration projected 18 percent year-over-year growth in PIT withholding in July, while no other month in the fiscal year was forecast to have more than 12 percent growth. If, for example, DOF had assumed 10 percent year-over-year growth of PIT withholding in July, PIT revenues for that month would have ended about $110 million above projections, rather than $127 million below projections. In turn, agency cash for 2013-14 to date, as of the end of August, would have been roughly on track for the fiscal year to date, rather than $256 million below projections, as shown in the most recent Finance Bulletin. In general, therefore, we view 2013-14 revenues through the end of August as roughly on track to meet budget act projections for the fiscal year. As noted above, September PIT receipts appear stronger than the budget act forecast, partially offset by weak corporate tax collections. Sales, insurance, and other tax collection information for September will be available in the next Finance Bulletin in mid-October.

Detailed Narrative

(Updated: Monday, September 30, 4:30 p.m., Pacific time.)

This note provides an update on 2013-14 state revenues, particularly the state’s personal income tax (PIT) and corporate tax collections. September is the first month of the fiscal year in which significant amounts of PIT and corporate tax “estimated payments” are submitted to the state’s Franchise Tax Board (FTB). PIT estimated payments—made principally by higher-income Californians on capital gains and business income—are a major indicator of capital gains-related state revenue that is driven largely by stock market gains and losses.

PIT Collections Strong…Corporate Taxes Again Appear Weak. California’s 2013-14 state budget is based on the May 2013 revenue projections released by the Governor’s administration. As discussed below, PIT estimated payments appear to be finishing well above the administration’s projections in September 2013. This is an important development because capital gains-related tax revenue can cause state revenues to increase rapidly and exceed estimates at times when stock and housing markets are strong. At the same time, corporate tax payments, a much smaller state revenue source than the PIT, are once again falling short of expectations: both those of the administration and our office.

For these two revenue sources combined, September 2013 collections are on track to end the month about $340 million above the administration’s projections (with one refund day for the month remaining to be booked). (Sales, insurance, and other tax collection information will be available in future days and reported in the Finance Bulletin, a monthly publication from the Department of Finance, in mid-October.)

Early Results for 2013-14 Promising…But Federal Impasse May Disrupt Economy. Our office plans to release updated revenue and economic projections on November 20 (tentative), and there will be additional forecast updates before passage of the 2014-15 state budget in June 2014. Early results for 2013-14, on balance, seem promising for the state’s near-term fiscal health. The 2013-14 state budget was premised on the administration’s revenue projections, which were $2.8 billion lower than our office’s with regard to total General Fund revenue in 2013-14—mainly due to the administration’s lower projections of taxable capital gains this year. Collections of the state’s two largest revenue sources—PIT and sales taxes—are running broadly consistent with our office’s expectations. Collections of corporate taxes, the third-largest revenue source, are running below our office’s expectations. At the same time, it is early in the fiscal year, and the somewhat positive revenue trend to date could be disrupted in the near term if the current federal budget and debt ceiling debates negatively affect stock, housing, and labor markets.

Personal Income Taxes

Overall, considering both PIT withholding and non-withholding sources, September 2013 PIT collections are on track to end the month around $460 million above the administration’s projection for the month.

Capital Gains Taxes Running Above Administration Projections. Nearly all PIT withholding is collected by the Employment Development Department (EDD), while the FTB collects non-withholding PIT revenue, including estimated payments (a key source of capital gains-related tax revenue), and disburses PIT refunds. Accordingly, PIT collections net of withholding and refunds (simplified below as “net FTB PIT collections”) generally are a good indicator of estimated payment trends in certain months, such as September, when taxpayers make those payments. In September 2012 (prior to passage of Proposition 30), net FTB PIT collections totaled approximately $1.45 billion. The administration’s 2013-14 budget forecast assumed that net FTB PIT collections in September 2013 would total about $1.64 billion, an increase of 13 percent. September 2013 collections, however, are on track to far exceed the administration’s projections. As of September 30 (with one day of September refunds left to book), net FTB PIT collections for September 2013 are on track to equal about $2.165 billion. This is 49 percent above September 2012 net FTB PIT collections and about $520 million (32 percent) over the administration’s projections for this revenue category.

PIT Withholding Appears Healthy So Far in 2013-14. In 2013-14, the administration projected that PIT withholding—principally, amounts withheld from Californians’ taxable wages and salaries—will make up over 60 percent of total PIT collections. Through the end of September, PIT withholding collections in 2013-14 are running around 6 percent above collections from the same period of last fiscal year. For the 2013-14 fiscal year as a whole, the administration projected that withholding would grow by 3.7 percent. (This 3.7 percent growth figure is over 1 percentage point lower than it would be otherwise due to the one-time effects on withholding from Facebook, Inc.’s initial public offering last year, principally in October. In addition, withholding and other PIT totals in some months of 2012-13 were affected by taxpayers’ one-time acceleration of income sources to calendar year 2012 in order to avoid higher federal taxes that took effect in 2013.) Based on all of this data, we observe that withholding trends appear reasonably healthy for the fiscal year to date.

For the month of September 2013 alone, preliminary EDD reports show that PIT withholding totaled approximately $3.225 billion. This is about $200 million (6.6 percent) above September 2012 levels and around $63 million below the administration’s projection for PIT withholding for the month of September 2013.

Corporate Taxes

September Collections Below Administration Projections. As of September 30 (with one day of September refunds left to book), net FTB corporate tax collections for September 2013 are on track to equal around $770 million. This is around 3.5 percent below September 2012 levels and around $120 million (14 percent) below the administration’s forecast. Our office’s corporate tax forecast for 2013-14 was slightly above the administration’s, and the September results are below our office’s expectations as well.

Other Taxes

Other major state taxes, including sales and insurance taxes, generally appear consistent with our office’s expectations for the fiscal year to date through the end of August. July and August sales tax collections were $153 million (4.3 percent) below the administration’s projections, but more consistent with our office’s lower forecast for this revenue source. September results for all of the other taxes will be available in mid-October in the DOF Finance Bulletin.

Methodology

Agency Cash. The data in this note is based on “agency cash”—the primary method used for revenue calculations in the annual state budget. The key source for monthly information on agency cash is the Department of Finance’s Finance Bulletin, which, among other things, compares monthly agency cash to the administration’s monthly projections. (“Controller’s cash” differs from agency cash based on the timing of certain receipts.)

A Note on “Year-to-Date” Agency Cash Revenue Estimates. For the month of July 2013, the Finance Bulletin reported that PIT revenues ended the month $127 million below the administration’s projections for that month. July’s PIT receipts are overwhelmingly withholding payments from taxable wages and salaries. For July, the administration forecasted much faster growth of PIT withholding than our office expected and greater year-over-year growth than it assumed for any other month during the 2013-14 fiscal year. Specifically, the administration projected 18 percent year-over-year growth in PIT withholding in July, while no other month in the fiscal year was forecast to have more than 12 percent growth. If, for example, DOF had assumed 10 percent year-over-year growth of PIT withholding in July, PIT revenues for that month would have ended about $110 million above projections, rather than $127 million below projections. In turn, agency cash for 2013-14 to date, as of the end of August, would have been roughly on track for the fiscal year to date, rather than $256 million below projections, as shown in the most recent Finance Bulletin. In general, therefore, we view 2013-14 revenues through the end of August as roughly on track to meet budget act projections for the fiscal year. As noted above, September PIT receipts appear stronger than the budget act forecast, partially offset by weak corporate tax collections. Sales, insurance, and other tax collection information for September will be available in the next Finance Bulletin in mid-October.