California Solvency Threatened by Silicon Valley Stock Crash

The California Legislative Analyst Office warned that a crash in Silicon Valley stock crash could threaten state solvency with $12 billion in annual capital gains tax losses.

The non-partisan Legislative Analyst's Office (LAO) has provided the California Legislature with fiscal analyses and budget advice for 75 years to ensure the “executive branch is implementing legislative policy in a cost efficient and effective manner.”

According to the LAO, California personal income tax (PIT) collections are the “single largest source of General Fund revenue.” Key to those collections are capital gains taxes associated with Silicon Valley stock gains. With the tech stock saturated NASDAQ Index up + 371.08 percent since 2009, California’s annual capital gains tax collection skyrocketed by +800 percent from about $2.1 billion in 2010 to $16 billion in 2018.

With California’s total budget spending for state employee wages and benefits at about $10 billion a year, the LAO warned in January that PIT collections for Fiscal Year 2018-2019 ending in June 30, were trending down by almost $2.7 billion, with mostly due to a 22 percent fourth quarter tank in the NASDAQ market index. Fortunately for state bureaucrats, Silicon Valley stocks spiked to an all-time-record high on April 29th, and the State of California was back on track to meeting its projected budget revenues.

Concerned by the continuing China Trade War and escalating antitrust actions against Google, Apple, Facebook and Amazon ending the Silicon Valley stock market boom, investor selling caused the NASDAQ Index to wipe out all its recent gains and plunge to a -2.84 percent loss for the last 12 months.

Worried about an even bigger budget deficit, the LAO issued a report titled ‘How Uncertain Are Capital Gains Revenue Estimates?’.

The new study argues that for the current FY 2018-2019, there is a 76 percent chance that California capital gains tax collections will vary by at least $1 billion and could fall to as low as $13.5 billion, or about -$2.5 billion below this year’s budget projected revenue. The LAO is now also warning that with a similar variability risk, capital gains tax collections shortfalls could increase dramatically over the next 4 years.

The LAO estimates that despite spectacular capital gains for insiders in the initial public offerings of Silicon Valley’s Lyft in March and Uber in April, FY2019-2020 capital gains tax collections could fall to as low as $7.5 billion, or about -$7.5 billion below budget.

The LAO estimates capital gains tax collection could nosedive to as low as $4 billion in each of the following 3 years, risking up to another -$36 billion in state budget shortfalls.

But the LAO points to its State Fiscal Health Index that tracks the strength of California economic conditions with ranges from 0 (representing the lowest level in the last 25 years) to 100 (representing the highest level in the last 25 years).

The State Fiscal Health was at a 9 year high of 96 in March, just below the cyclical record highs of 100 in November 1999 and 90 in March 2006. But California capital gains tax collections after both previous cyclical highs fell by about 80 percent over the next 2 years, from $10.5 billion to $2.7 billion in 2002 and from $11.7 billion to $2.1 billion in 2010.

The LAO hedged its concerns regarding a potential massive budget crisis with the statement: “Knowing when the state’s next budget slowdown will happen is impossible. Many economic factors outside the state’s control influence state revenues.”