On Wednesday, KPCC's Julie Small caught up with the California state finance department and reported on the "Facebook Effect" that failed to live up to intial expectations. The state of California had anticipated a windfall from the sale of stock by employees of the gargantuan social network after its initial public offering.
We all know how the IPO went: it was a massive disappointment. Facebook opened at $38 a share and hasn't climbed back to that offering price since Day 1 of trading. Now it's bumping around in the high $20 range, but it fell below $18 earlier this year.
California still collected a decent amount of tax revenue from Facebook employees and investors who sold stock. But the finance department had initially projected almost $2 billion; it got half that.
This is sad, but there's a far sadder factor at play, and it's called...the "Facebook Effect!"
Let me clarify: the fact that the state was even counting on a Facebook payout to deal with budget imbalances highlights a problem with the way the state funds itself.
Bloomberg delved into the issue at the beginning of 2012, long before the Facebook IPO occurred:
That kind of unanticipated boost [from the sale of Facebook stock] shows the boom-and-bust cycle that capital gains taxes often inflict on California’s budget. In fact, capital-gains tax revenue as a percentage of the state’s general fund plummeted from 12 percent to just 3 percent between 2007 and 2009 as investors pulled away from the stock market, a decline of $9.3 billion, according to state finance department figures.
Governor Jerry Brown proposed a budget that assumes California taxpayers will earn $96 billion in capital gains in 2012, more than three times as much as at the height of the recession in 2009. He also estimates that the state will take in $8.6 billion in taxes on those capital gains, about 9 percent of general fund revenue.
California isn’t alone in its reliance on capital gains. New York in the fiscal year that ended March 31 collected about $2 billion from taxes on capital gains, or about 3 percent of total tax collections, according to figures provided by the state comptroller’s office. Wall Street-related activities accounted for about 14 percent of total state collections.
At about the same time as the Bloomberg story, I picked up the theme:
[In California] the wealthiest taxpayers now account for 22 percent of all income, up from 10.5 percent in 1980.
So we rely on the richest Californians for nearly a quarter of all taxed income. No wonder it's become so difficult to get a good sense of what future tax revenues will be. Mind you, it's not that the rich are doing badly — booming and busting, rapidly cycling from caviar to hot dogs.
But they make the bulk of their money from capital gains, money earned by investing...money. Or by collecting rents on assets. This means that they're disproportionately exposed to market volatility. And the markets have been plenty volatile over the past couple of years.
Numerous credit analysts I've spoken with — from the big ratings agency such as Moody's, Fitch, and Standard & Poor's — have pointed to this over-reliance on the incomes of the wealthy as a drag on the state's credit outlook. Among U.S. states, California has the biggest economy — but one of the worst credit scores, so to speak.
One reason for this is Prop 13, the landmark 1970s ballot measure that shifted taxation in the state away from assets — homes, basically, and their gradually ascending property taxes — to income. Since then, California's finances have been held hostage to the incomes of the wealthy, relying on capital gains taxes to make the budget work.
When the capital gains don't show up at projected levels, the state winds up with shortfalls that, as in the most recent case, threatened to hack billions from education budgets. Only the passage of Prop 30 — the latest in a series of measures to deal with Prop 13's challenging legacy — in November prevented a $6 billion hit. But Prop 30 simply ups the ante on California's over-reliance on the incomes of the rich, by taxing millionaires at a rate above 13 percent. That's higher than any other U.S. state.
What this will mean in practice is that as long as the rich keep getting richer, they state will stand a chance of closing the budget gaps. But when the rich get poorer — and they always do, even though "poor" for the richest Californians means that they can't reap big gains from the sale of assets like stocks and real estate — the state will be right back where it started, looking for new "Facebook Effects" to balance the books.