LOS ANGELES – Stock market gains are expected to boost California revenues in fiscal 2018, according to an S&P Global Ratings report.

Strong stock market performance has lifted expected 2017 capital gains income in California by 20% relative to its January forecast, according to S&P.

The outlook for fiscal 2018 was improved in Gov. Jerry Brown’s revised $183.4 billion May budget as compared to January’s forecast, though revenues for fiscal 2017 are below expectations.

The governor’s May forecast predicts that revenues for the current fiscal year will be off $3.3 billion from earlier projections.

Gabriel Petek of S&P Global Ratings in 2010.
California revenues should get a boost from the stock market in fiscal 2018, said Gabriel Petek, a managing director for S&P Global Ratings. Bloomberg

The Department of Finance forecast for fiscal 2018 anticipates $2.5 billion more in revenues than what was forecast in January.

“The difference is that one is cash in hand and the other is where things are headed,” said Gabriel Petek, a managing director for S&P Global.

California’s missed projections on revenues for fiscal 2017 are consistent with what S&P is seeing in other states, Petek said.

There is a theory that states are seeing less revenue from capital gains this April, Petek said, because investors are waiting to see whether the Trump administration will lower taxes on capital gains before selling stocks. If that theory holds, he said, states could realize the benefit of recent stock market gains during next year’s tax filing season.

S&P is also seeing slow economic growth rates in other states, he said.

The governor has reversed some of the reductions in spending he made in January’s proposed budget as a result of the improved outlook. Education and the rainy day fund will receive more money through triggers set up by voter-approved propositions when revenues grow.

The S&P report was largely upbeat though it did end with a cautionary note about the deficits predicted by the DOF in its multi-year forecast. The state forecasts a balanced budget through fiscal 2019 and then operating deficits of $1.4 billion in 2020 and $1.5 billion in 2021.

“The state is vulnerable in an adverse economy – and it is vulnerable to stock market shocks if something more significant happens then what they are accounting for in their forecast,” Petek said.

California has AA-minus ratings on its general obligation bonds from both S&P and Fitch Ratings. Moody’s Investors Service provides an Aa3 rating. The state has stable outlooks from all three.

The state is very reliant on income taxes – and particularly those paid by the top 1% of earners, who, Petek said, pay 48% of all income tax in the state.

The state remains dependent on that narrow segment of the taxpayer base correlated with the financial markets as people in that income tax bracket get most of their income from capital gains and investments, he said.

In fact, Petek said, the state doubled-down on its dependence on its most affluent residents.

He lauded the state for paying down the $20 billion in debt that comprised its structural deficit and voters for approving Proposition 2, part of which goes into a rainy day fund while the other half is used to pay down debt.

“They have brought revenues into alignment and paid off the bulk of debt as well as putting money into the Rainy Day fund,” Petek said.

While those were good steps, Petek said, it’s offset by the fact the revenue base remains as volatile as ever.

“If anything, they doubled-down on the dependence on high-income earners with Proposition 30 – and then again by extending the tax on high income earners through Proposition 55,” he said.

The temporary taxes approved in 2012 by voters in Proposition 30 were a quarter-cent sales tax that expired at the end of 2016 and a personal income tax increase for residents who earn more than $250,000 that was supposed to expire at the end of 2018.

Through Proposition 55, voters approved extending the income tax on higher earners another 12 years. The money helps fund education.

The deficits projected by the Department of Finance are based on the fact the economy is more or less at full employment, he said.

“From an economic standpoint, once you are that level, the rate of growth is likely to slow going forward,” he said. “It is not uncommon for a state to have out-year imbalances they have to contend with.”

He added that he expects lawmakers to come up with solutions in one form or another.

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