California dreamin’: the budget surplus reflects asset bubble returns and no recession
Counter-productive, unsustainable, expanding social programs is in the Democratic Party’s DNA. Welfare and sanctuary states result in higher taxes, social costs, rising crime, and homelessness.
All the leaves are brown (all the leaves are brown)
And the sky is gray
California dreamin’ (California dreamin’)
On such a winter's day - the Mamas and the Papas (1965)
California’s almost $100 billion budget surplus will be reversed as bubble period capital gains taxes fall significantly in the next annual reporting period. The Democratic majority in the Legislature will naturally choose to expand social programs with the surplus.
The surplus is temporary; even Gavin Newsom, California’s governor, appears to misunderstand the real underlying issues plaguing the state. Excessive spending does not address soaring homelessness, rising crime, growing drug addiction, and overdose deaths, and why people and businesses are fleeing the state.
The surplus is being driven by California’s income taxes. Historically, and on average, these taxes make up 25% of state revenues; in the fiscal year 2022-23, they will constitute two-thirds. These estimates are rosy-scenario estimates that will not materialize.
The surplus is driven by the high marginal tax rate on high-income earners. When financial markets (stock and housing) are in a bubble, as they have been for the last two years, tax revenues surge.
The CA Dept. of Finance highlighted this in its revenue report when it showed the history of capital gains for taxpayers in the state. This is income earned from various forms of capital transactions — selling property or stocks far above their buying price, for example, or income from a tech company going public.
Such income accrues mainly to very high-income Californians, who are subject to the state’s excessively high marginal tax on high incomes. Over the last two years, state income from capital gains taxes has approached $250 billion, twice as high as before and four times the average.
A record surplus is no surprise, but I suspect that the plunge in stock market capital gains taxes this year will not be considered by the Democratic majority. All US publicly traded stocks, as represented by the Wilshire5000, a market-capitalization-weighted index, have fallen in value by $11 trillion (close on Oct 27) or 22% from its peak value of $48.9 trillion in November 2021 (chart). The budget estimates for 2022 and 2023 do not reflect this massive reduction in stock market values.
Based on a historical ratio of the market cap of the [stock] market to GDP, the market is still overvalued.
The last two periods of high capital gains occurred in the late 1990s when the dot-com and subprime mortgage bubbles overheated the economy in 2007. When those markets crashed, so did asset values and, of course, capital gains. Huge budget surpluses were followed by huge budget deficits. GDP growth and asset returns over the next decade will likely be well below potential and historical returns.
The next big shoe to drop is real estate values—likely by 20% or more over the next year or two.
Even when counter-productive and unsustainable, expanding social programs is in the Democratic Party’s DNA. Being a [woke progressive] welfare and sanctuary state has resulted in higher taxes, social costs, rising crime, and homelessness in California. People and businesses are fleeing the state in record numbers because of a declining quality of life and the high cost of living there. Spending more money on social issues is not working because it contributes to problems rather than solves them.
“California’s total state and local government debt now stands at almost $1.6 trillion, or about half the state’s GDP. That isn’t an alarming ratio when compared to the national debt, which has now soared to 128 percent of U.S. GDP with no end in sight. But Californians carry this $1.6 trillion state and local debt ($40,000 per capita) in addition to their share of the national debt (about $90,000 per capita).” — The California Policy Center (Feb 2022).
The gross national debt per taxpayer is $245,000 so the per capita data are misleading. Why, because the bottom 50% or so pay no federal taxes when offset by government transfer payment.
It's worse today given this is dated information. Market returns are lower, by a lot, so are bonds.
“California’s true debt overhang is not the officially recognized $1.0 trillion, or even the $1.6 trillion (or more) that accrues if pension analysts use more prudent financial assumptions when calculating the unfunded liability. Taking into account the cost for the public infrastructure that Californians deserve, and that should have been built by now, it is reasonable to assume California’s state and local public debt exceeds $2.0 trillion.
Whether it’s one trillion or two trillion, California’s total state and local government debt, given the size of its economy, may still not be unmanageable at the moment. But the choices California’s legislators and pension boards make over the next few years will determine whether a truly devastating financial and economic crisis materializes or, instead, government agency balance sheets acquire the resilience necessary to cope with the economic turbulence that could lie just ahead.” — The California Policy Center (Feb 2022).
Full report link: https://californiapolicycenter.org/california-state-and-local-liabilities-total-1-6-trillion/