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California's Existential Risk of Financial Default

California is facing an existential risk of financial default when the stock market suffers its normal 30-50 percent interim decline in an average recession.

The above graph from the California Legislative Analysts’ Office (LAO) from 1997 through 2014, to demonstrate that the State of California’s net capital gains collections due primarily from stock price increases have recessionary cyclical risk of a 70% annual decline for 3 consecutive years. The current average for net capital gains tax as a percentage of capital gains is over 11%. (effective capital gains tax rate)

The California Legislative Analysts’ Office estimated that FY Net Taxable Capital Gains driven primarily by increases in stock prices “spiked” from $110 billion in 2016-2017; to $150 billion in FY 2017-2018; and a budgeted estimate of $162 billion in FY 2018-2019. That means California budgeted about $17.82 billion net capital gains collection for FY 2018-2019.

Despite the historic cyclicality of California net taxable capital gains collections, the LAO estimates that an 8% decline in the S&P 500 in 2019 would only decrease in net capital gains of about $27 billion, and net capital gains tax collections of $3 billion. Over a 3 year recession, the revenue loss would be $9 billion, or about the $10 billion payroll and benefit cost for all California state workers.

But if the stock markets suffer there usually 30-50% decline and the usual 70% annual reduction in California net capital gains tax collection for 3 years, would be a $12.47 billion annual loss for 3 years, or $37.42 billion. California is expected to also lose about $15 billion per year income and corporate tax collection per year, or $45 billion over 3 years.

California is also at risk of losing another $5.5 billion if Prop 6 gas tax repeal passes (highly likely), over another $16.5 billion over the next 3 years.

Given that California only has a $9 billion reserve, a normal recession could cost California about $98.92 billion. I call this an existential problem, because there is no way that other state Congressmen and Senators are going to vote to bail-out California.

The only viable deal for Old California is to carve out a New California that will sell oil, water and land rights to buy their freedom. This deal is highly financeable.

Chriss W. Street

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