California awash in cash, thanks to booming market

As the pandemic raged last May, California was reeling. Spending on unemployment assistance and health care had jumped while tax revenues were on the verge of cratering. State officials, just months earlier counting on a $5.6 billion budget surplus, now anticipated a $54 billion shortfall. Severe cuts would be needed, making an already frightening recession even worse.

Gavin Newsom, the Democratic governor of California, warned of dark days ahead. “We are confronted with a steep and unprecedented economic crisis,” he wrote in his budget.

Then Wall Street came to the Golden State’s rescue.

The stock market, after a steep but brief downturn in March 2020, has soared to new heights, prompting a record number of companies — many of them based in California — to go public. The rising market minted new millionaires and padded the incomes of the state’s wealthiest residents, who typically own a lot of stock. And for California, that meant a windfall. Its taxes on such stockbased gains are the highest of any state, and its largest revenue source is personal income taxes.

According to its most recent forecast, California is expecting a roughly $15 billion budget surplus next fiscal year, which runs from July through June. It is putting money into its rainy day fund and is expected to reverse some cuts, including to the wages of state workers, which were imposed just a few months ago. The state is so flush that it is now running its own stimulus program, writing one-time checks of $600 or $1,200 to poorer households and spending some $2 billion on aid for small businesses.

California’s budget turnaround comes as President Joe Biden unveiled a proposal to nearly double the tax on capital gains on people earning $1 million or more a year, to help pay for his plans to revive the American economy.

The richest people in the United States pay 20% federal tax on capital gains, compared with 37% on ordinary income. The Biden plan would push the top rate paid on both types of income to 39.6%, taking a page out of California’s playbook — the state levies a 13.3% tax rate on both capital gains and ordinary income earned by its wealthiest residents.

Almost half of the personal income tax revenue that California collects comes from the top 1% of the state’s earners. Since much of that group’s income comes from stock holdings and stock-based compensation, their fortunes are tied to the performance of the stock market.

In the early days of the pandemic, no one would have looked to the stock market for salvation. From February to late March of last year, the S&P 500 suffered one of its sharpest crashes ever, falling nearly 34%. But once the U.S. government began pumping money into the markets and the economy through bond-buying programs and stimulus, the market began rebounding.

The surge in market value created a significant amount of wealth for executives and workers, including in the technology sector. Executives at major companies typically have pre-established stock sale programs in place that are constantly converting some of their shares into cash. As they’ve sold into a rising market over the past year, those gains have been especially large; last August, Apple’s chief executive, Tim Cook, sold more than $130 million worth of his stock.

“When the stock market does well, they do very well,” said David Hitchcock, the primary analyst on California for bond-rating firm S&P Global, of the state’s wealthy residents. “And in fact, it’s not just the stock market, but initial public offerings. Because with Silicon Valley, when entrepreneurs get stock grants that they exercise, or stock options, California makes out very well.”