California’s income tax revenue falls flat

The state is facing a $58 billion deficit over the next two years; economic factors contribute to gloomy fiscal outlook

The flags fly in front of Sacramento's Capital Building
Darren Fraser
Published December 7, 2023  • 
11:00 am

SACRAMENTO – According to a recent report from the Legislative Analyst Office (LAO), tax payments that had been postponed from April to October came in $26 billion lower than analysts forecasted. As a result, the LAO, projects a $58 billion state deficit lasting through to 2025.

Due to the winter storms at the start of the year that ravaged many parts of the state, both the IRS and the California Franchise Tax Board extended their tax filing deadlines. State tax payments received to date coupled with an increase in the state’s unemployment rate led the LAO to its gloomy forecast.

A MYSTERY BUDGET

With both the state and the federal government postponing tax filing deadlines, California legislators adopted the 2023-2024 state budget without a clear idea of how much revenue would fill the state’s coffers. But according to the LAO report, there were signs over the past 12 months that the state’s revenues were not entirely healthy.

The report notes that income taxes collected from paychecks were down 2% in the last 12 months. The report described sales tax revenue as essentially flat, despite a rise in consumer prices.

But it was the underwhelming results from tax payments that disclosed the dire situation of the state’s revenues. Based on the taxes collected since the extended filing deadline, the LAO concluded that total income taxes were down 25% in 2022 to 2023. The LAO compared the decline to what the state experienced during the Great Recession of 2007 to 2009 and the dotcom bust of March 2000.

UNEMPLOYMENT AND COOLING AN OVERHEATED ECONOMY

While many states have more jobs than workers to fill them, such is not the case with California. Since the summer of 2022, the number of unemployed workers in the state has risen to 200,000. The unemployment rate has increased from 3.8% to 4.8%.

Inflation has contributed to the state’s financial woes. Beginning with the first quarter of 2022 and continuing through the first quarter 2023, inflation-adjusted incomes declined for five straight quarters.

The LAO report notes that two years ago, the Federal Reserve implemented measures to “cool an overheated U.S. economy.” These included raising interest rates and reducing the money available for investment.

One of the repercussions of these measures for California residents is an increase in the average monthly mortgage payment. According to the report, the average monthly payment increased from $3,500 to $5,400.

California’s cooling economy is also reflected in the business sector. Investment in startups and technology companies has dropped precipitously. According to the LAO, the number of California companies that went public in 2022 and 2023 decreased by 80% from 2021.

CONTINUED WEAKNESS…THEN HOPE

Historically, economic downturns, such as the state is experiencing, spill over into next year. For example, an increase in unemployment, such as what occurred since 2022, will, inevitably, be followed by a period of elevated unemployment.

The same holds true for periods of revenue decline. The report notes that years with large revenue declines are, invariably, followed by at least one year of sluggish revenue performance.

Unfortunately, the LAO predicts revenue collections will be nearly flat in 2023 to 2024 – based on the fact that collections fell by 20% in 2022 to 2023. But all is not lost. The LAO expects revenue growth to return in 2024 to 2025 and beyond.

The report concludes with tentative optimism. The LAO admits its forecast is highly uncertain and that it is entirely possible state revenues could end up $15 billion for 2023 to 2024, and $30 billion higher for 2024 to 2025.

Of course, the report also states the forecasts could be $15 billion and $30 billion lower, respectively.

Darren Fraser
Reporter