SALT cap drives Golden State revenue uncertainty

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California revenues plunged in December and January, putting the state more than $2.3 billion shy of the expectations set by Gov. Gavin Newsom's budget, in what state officials said was a short-term effect of the 2017 law that put a cap on the state and local tax deduction.

State officials said they were hopeful that the shortfall stemmed mostly from a shift in timing by taxpayers, and that much of the money will re-appear in April's coffers.

“Clearly a number of that magnitude is eye catching, but our folks who track this and economic development closely say that this shortfall is not a function of economic weakness, but timing payments tied back to the federal tax bill,” said H.D. Palmer, a Department of Finance spokesman.

California joins New York, New Jersey, Massachusetts and Virginia in reporting that December income tax collections came in billions less than expected, according to a Moody’s Investors Service report. The shift hits high-tax states, though income tax dependent Oregon may be affected, too.

“It is something we have been watching and it’s not unique to California,” said Matt Butler, a Moody’s Investors Service analyst.

In New York, personal income tax receipts for December and January were $2.3 billion below forecasts, forcing revisions to Gov. Andrew Cuomo’s state budget.

Golden state economists expressed confidence that the majority of the money will show up in April, even though close to $1 billion may be due to investor’s taking losses from last year’s stock market dive, according to Carolyn Chu, a deputy legislative analyst in California’s Legislative Analyst’s Office, which provides fiscal and policy guidance to the Legislature.

California's situation differs from New York's. The Empire State's fiscal year ends on March 31, before the April 15 federal tax deadline. California’s new fiscal year begins on July 1, and the state budget introduced by Newsom in January goes through a May revision that can take into account April revenues, if the shortfall does appear there.

Newsom’s $209 billion 2019-20 spending plan represents a 4% increase over last year’s budget, with 80% of the increases attributable to one-time costs.

If the money doesn’t materialize in April, Butler said California would still have a sizeable surplus, and in a recession has options it wouldn’t have had in the past.

The state’s estimated budget surplus in the governor’s spending plan was $21 billion.

“There is a substantial surplus estimated for the budget this year,” Chu said. “So, if the revenues are somewhat below the governor’s estimate in January, he might need to curtail some one-time spending. But the governor also has included a significant debt and liability proposal. The Legislature would have to decide how to distribute the revenue and act accordingly.”

The LAO would like to see the Legislature allocate more money to reserves. The state analysts have estimated that the state needs to have $25 billion in reserve in a moderate recession to avoid cuts to programs, Chu said.

“The governor’s proposal is $18 billion, so there is a delta there,” Chu said. “We do think the governor paying down debt and liability is meritorious, but in our report we say we would focus on the high interest debt as opposed to some of the proposals in the governor’s budget.”

Republicans in Congress created the tax overhaul bill signed into law by President Donald Trump in December 2017. The law cut the total amount of state and local taxes that can be deducted from what is paid to the federal government. Californians previously wrote off an average of $22,000 in so-called SALT deductions. The law capped that at $10,000.

Filers making state estimated payments often prepaid their January estimated payments and anticipated April final payments in December. As a result of the tax bill change, wealthy taxpayers, who used to make an estimated tax payment in December, so they could use it as a federal tax deduction, no longer have an incentive to do so.

California’s estimated payments in December were $1.1 billion, compared with $7.7 billion in 2017 and $4.6 billion in 2016. The number for 2017 spiked because taxpayers were trying to get ahead of the SALT deduction elimination in the tax law, according to the LAO’s economic tax blog on the subject.

“Consistent with the expectation that some of the December/January shortfall will be made up in April, estimated payments for federal personal income taxes did not show any obvious signs of weakness in January,” according to the blog. “Instead they rose from $92.2 billion in 2018 to $100.6 billion in 2019.”

The state’s economists initially believed when the funds didn’t show up in December, they would appear in state coffers in January. They now think taxpayers will hang on to the money until April 15 and accrue interest, Palmer said.

“Whether it’s a good revenue month or very bad, I always caution that people shouldn’t extrapolate long-term trends off one month,” Palmer said. “If the payments hit a couple days after the forecast, it could swing the numbers hundreds of millions in a different direction.”

Some of the decline could be due to wealthy tax payers deciding to take investment losses to offset other gains in their portfolio. The losses cut the overall tax burden for those taxpayers reducing tax revenues for the state and cities.

“There was a lot of volatility in the stock market last year, so that could play a role,” Butler said.

By the end of December, stock prices were 15% below their September 2018 peak, according to the blog.

In previous years, the December-January period has been an important bellwether for state income tax collections because many taxpayers make estimated payments, usually on a quarterly basis, for non-wage income, according to a Moody’s report. The last estimated payment period provides an opportunity to “true up” tax payments with their expected liability from capital gains; analysts said, and a strong year in the equity markets tends to boost this last payment as households cash in on investments.

“Relative to the forecasts through January, the state is down. But if you compare it to last year, the state is flat,” Butler said. “We will still have the rest of the year to see if the state will be able to bounce back and see revenue growth on an annual basis.”

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