Why state should bank its surprise tax windfall

Gov. Gavin Newsom and legislative leaders can be thankful for one surprise holiday gift: a huge windfall of tax dollars.

Sacramento Democrats should resist the temptation to quickly spend the billions on goodies.

The lawmakers’ chief nonpartisan policy adviser, Legislative Analyst Gabriel Petek, recommends a prudent 50-50 approach: Use half for rebuilding cash reserves, and the other half for onetime expenditures.

Petek delivered the unexpected package of surplus money last week, projecting a $26 billion tax windfall this fiscal year.

This came after Newsom and the Legislature thought they were facing a horrific $54 billion pandemic-induced shortfall.

The state is on course to spend $17.5 billion more than it takes in by mid2025, he cautioned.

Petek advised the Legislature to begin to fix the projected deficit spending.

“This could mean, for example, identifying ways to reduce spending or increase revenues in future years,” the analyst wrote in his fiscal outlook report.

But long-range planning goes against the nature of term-limited legislators.

For a tax hike, Democratic unity would be hard to achieve among moderates who perpetually face reelection. But if Democratic leaders face the dreaded prospect of cutting spending, it’s a good bet they’ll also try to balance this displeasure by raising taxes.

“We’re in the middle of a pandemic,” Petek said. “There’s high unemployment. I don’t expect them to allocate a lot of political capital to solve a future problem, but it would be prudent to start making plans.”

How did the $26 billion windfall develop?

The state’s economy “experienced a quicker rebound than expected,” Petek’s report reads. “While negative economic consequences of the pandemic have been severe, they do not appear to have been as catastrophic from a fiscal standpoint as the budget anticipated.”

Technology saved many jobs. Employees who work online kept getting paychecks. These people tended to be college- educated, higher-income workers who are the main targets of California’s very progressive personal income tax system.

In 2018, the top 10% of income earners supplied 78% of the personal income tax revenue. The top 20% paid 90% of the tax.

Their money kept flowing into state coffers.

In October, income tax revenue was 40% higher than what had been projected in June. All state taxes are up 22% over projections for the fiscal year that began July 1.

The stock market unexpectedly became robust, recently hitting record levels, Petek notes. That provides the state with hefty taxes on capital gains — unlike in a normal recession when that revenue stream slows to a trickle.

And the federal government kicked in $15 billion for the state, cities, counties and the unemployed, the Finance Department says. That was a big boost.

“Workers on the lower end bore the disproportionate brunt of the pandemic,” Petek said. “They tended to be the front-line workers, the service workers who interact with the public.”

Many of their restaurants, shops and offices closed temporarily or went out of business.

“Workers earning less than $20 per hour make up the vast majority of job losses,” the analyst’s report reads. “In contrast, employment among workers earning over $60 an hour remains at pre-pandemic levels.”

Unemployment in October dipped to 9.3% from 11% in September.

Finance Department spokesman H.D. Palmer pointed to the high unemployment rate as proof that California’s economy isn’t doing as well as the state banking account.

But Petek forecasts state tax revenues growing roughly 1% a year while general fund spending increases by 4.4%.

The Newsom administration basically “agrees with that trajectory,” Palmer said.

Newsom and the Legislature should make resolutions to resist spending for the indefinite future. That resolution is almost certain to be broken.