California revenues aren't quite as bad as expected amid coronavirus

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Better than anticipated tax revenues for June put California in better financial shape than anticipated a few months back, but a rocky road still lies ahead.

With the fuzzy numbers California used to pass a budget about to get clearer, state leaders will now have a better picture of just how much havoc the coronavirus has wreaked on the state’s economy. The state usually has cash receipts in hand from the April 15 income tax filing deadline, but with the deadline postponed to July 15 did not have solid numbers to use in passing a budget.

California Gov. Gavin Newsom will continue to push for federal aid as the state grapples with a coronavirus-driven deficit.

The Department of Finance’s monthly cash report that covers receipts for June painted a good news/bad news scenario.

Receipts for June were higher than expected, but the state still has a deficit to overcome.

California Gov. Gavin Newsom signed a $202.1 billion spending plan June 29 that eliminated a projected $54.3 billion budget gap for the current fiscal year and brought “the state’s resources and spending into balance while preserving reserves for future years,” according to the budget summary.

It did this by in part by drawing down $8.8 billion in reserves from the rainy day fund, $450 million from the safety net reserves and all the funds in the public school system stabilization account. The budget also includes $11.1 billion in reductions and deferrals that will be restored if at least $14 billion in federal funds are received by Oct. 15. The trigger includes $6.6 billion in deferred spending on schools and $970 million in funding for the state universities.

“While the budget is balanced for the current fiscal year, an operating deficit of $8.7 billion is still projected for fiscal year 2021-22, and projected state expenditures to combat the COVID-19 pandemic remain subject to significant change,” said H.D. Palmer, spokesman for the state’s Department of Finance.

The budget assumes spending of $5.7 billion to respond directly to the COVID-19 pandemic.

June receipts came in $1.05 billion above forecast for the month, putting them $1.084 billion above the $123.4 billion in revenues for year-end fiscal year 2019-20 assumed in this year’s budget act, Palmer said.

The independent Legislative Analyst’s Office noted in a Friday report that collections measured over the entire April-to-July tax season are $3.7 billion above budget projections.

California's automatic extension of the April 15 tax deadline for personal income taxes to July 15, matching a federal move, affected schools, social services and healthcare programs, which use figures from April and June tax collections to craft their own budgets.

The delay in the state’s tax filing deadline to July 15 will be “reflected in this month’s receipts, which to date are running ahead of projections,” Palmer said.

Lawmakers “significantly reduced the structural deficit over the next several years, but there is still more work to do to eliminate it,” according to 2020-21 budget documents.

To reduce the structural deficit in coming years, the budget “sustains the January 1, 2022 suspension of several ongoing programmatic expansions that were made in the 2019 Budget Act.”

Despite these measures, the administration forecasts an operating deficit of $8.7 billion in 2021-22, after accounting for reserves, according to budget documents.

“The coronavirus pandemic has impacted every sector of the state’s economy and has caused record high unemployment — almost 1 in 5 Californians who were employed in February were out of work in May — and further action from the federal government is needed given the magnitude of the crisis,” according to budget documents. The governor said he is continuing efforts to secure $1 trillion of flexible federal aid to state and local governments across the country.

In a muni strategy brief, Morgan Stanley analysts considered bear and bull scenarios around whether the federal government will pass a second coronavirus relief package that reflects the HEROES Act that passed the Democratic-controlled House, which would extend aid to states, local governments and hospitals. Such aid had faced a cold reception from the Republicans who control the Senate.

In the bull case, the bill is passed and munis get a boost and the funding sets the table for a V-shaped economic recovery.

If a relief bill doesn’t pass, however, analysts predicted a “bumpy path for munis,” and Morgan Stanley would move to a high-grade bias on an expectation of choppy demand, the caveat being that munis have a better starting point for valuations and enjoy Fed support through the Municipal Liquidity Facility, which limits jump-to-default risk in states and locals.

The Morgan Stanley analysts opined that a comprehensive $3 trillion HEROES Act bill would likely provide a third to a half of the total wish list local and state governments would like to see in fiscal stimulus to mitigate the economic effects of the coronavirus pandemic.

“In our view, there’s insufficient support for provisions that would have an impact on the budget beyond the near term,” Morgan Stanley analysts wrote. “Republicans may be able to support short-term deficit expansions, particularly in an election year, as a direct economic aid response to COVID-19. However, we think they would be less likely to go along with spending provisions, like an infrastructure package, that endure beyond the short term.”

California’s unemployment rate rose to a record-high 16.4% in April and May before decreasing to 14.9% in June, and is now 11 percentage points higher than the pre-recession low of 3.9% in February, according to the DOF’s monthly report. The U.S. unemployment rate increased to a record-high 14.7% in April before decreasing to 13.3% in May and to 11.1% in June, compared to the pre-recession low of 3.5% in February.

The August finance bulletin will reflect the final July totals, including an updated analysis of how much will be accrued back to the 2019-20 fiscal year, which has implications for K-14 funding and the budget overall, Palmer said.

When the governor signs the budget in July, budget work for the fiscal year ending June 30 is typically finished, but lawmakers had been warning since April that would not be the case this year.

Lawmakers are likely to take up budget discussions again in August and weigh giving more aid to K-12 schools to deal with the additional cost of online learning and to aid local governments battling the second wave of COVID-19 cases after the final tally on July tax payments is compiled.

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State of California State budgets Deficits Income taxes