(Bloomberg) — California Governor Gavin Newsom has had an enviable problem for years. His state was flooded with money.
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Thanks to the booming tech industry and federal money during the pandemic, California was spending record amounts and still had a surplus — nearly $100 billion last year. That’s when Newsom, a rising star in the Democratic Party, sent checks for up to $1,050 to millions of residents. The Los Angeles Times editorial declared him the luckiest governor in its history.
Now, in the wake of the tech crash and the end of Covid funding, the surplus has been replaced by a $32 billion deficit, forcing lawmakers to cut the state’s lofty agenda on the climate change, delay financing and increase internal borrowing.
California is an extreme case of a state that relies heavily on its wealthier residents for its tax base. But that’s not the only one: Revenues in 16 other states are down in this fiscal year through April, according to the Urban Institute, partly reflecting market volatility and population shifts. In Florida and Texas – red states where levies are mostly collected on sales rather than income – the situation is different. Although the pace of tax collections has slowed, they are among a dozen states that are seeing revenue rise 5% or more this year as consumers continue to spend.
“You’re starting to see this divergence,” said Emily Mandel, economist at Moody’s Analytics. “It’s definitely something we see in the data.”
The differing fortunes highlight the growing divisions between the largest Democratic- and Republican-led states at a time when they compete for the relocation of businesses and people, and their leaders often shoot each other over policies ranging from the immigration to taxation. Texas Governor Greg Abbott is seeking further tax cuts with a record $33 billion surplus, while Florida’s 9% rise in revenue so far this year is fueling record spending – giving a boost to Governor Ron DeSantis as he battles for the Republican presidential nomination.
Marc Goldwein, senior policy director for the Committee for a Responsible Federal Budget, said the dynamic reflects fundamental differences between state tax bases. California and New York saw their populations shrink by about 294,000 in the year to July 1, 2022, while Florida and Texas added about 888,000 collectively, data from the Census Bureau.
Read more: A $100 billion migration of wealth is tipping the US economy south
“Part of what’s happening is changes in the population – people are moving around,” he said. Another aspect is “the dependence on capital gains taxes and other taxes of very high earners whose incomes fluctuate widely. A large portion of these capital gains are in California and New York, which is the center of technology and the center of finance.
California’s personal income tax collections are its main source of income and about half comes from the top 1%. This leaves the budget particularly vulnerable to financial shocks affecting this small subset of taxpayers.
What Bloomberg Economics says…
“California is in a recession right now, tax revenue is down, and they’re projecting a deficit this year — because states have to run a balanced budget, being flushed with cash during the pandemic doesn’t necessarily smooth out the problems during the bad times – although it helps at the margin.
— Anna Wong, Chief Economist
Other states with high income taxes are also experiencing revenue pressures. In Hawaii, which has a top rate of 11%, the governor cut $1 billion from the budget to balance it in June.
Total state tax revenue fell 25% in April, a key month for such collections, according to the most recent data available from the Urban Institute. Thirty-seven states saw their revenues plummet that month.
Meanwhile, Florida and Texas rely on sales taxes, which have held up well as Americans continue to spend, surprising economists. These levies have also been reinforced by inflation.
However, in the event of a recession, which some economists say could still hit the U.S. economy, rising unemployment would likely push consumers back, hurting sales tax revenue. “No state would be immune to the fiscal impacts of a recession,” said Justin Theal, state fiscal health project manager at Pew Charitable Trusts.
Comptroller Glenn Hegar of Texas, the fastest growing state economy, said he expects tax revenue to grow, but at a slower pace. Texas is allocating billions of dollars to infrastructure projects and lawmakers are bickering over the amount of property tax cuts. “It just won’t be as dynamic as what we’ve had for the past few years,” he said in an interview.
Red flag
There are nuances in the data. In California, part of the decline in income is due to the deadline for filing state tax returns after a series of natural disasters. But Lucy Dadayan, senior research associate at the Urban-Brookings Center for Tax Policy, said the state’s tax picture is a taste of what’s to come for others.
“Unfortunately, governors will have to deal with budget shortfalls if the economy continues to weaken,” Dadayan said.
Some of the revenue cuts come as no surprise as lawmakers have gone on a tax-cutting spree. Half of U.S. states have cut personal or corporate income tax rates, and in many cases both, between 2021 and 2023, according to the Center on Budget and Policy Priorities.
Read more: US states cut taxes the most in decades on big budget surpluses
The tax cut fever that has gripped state homes has shown no signs of stopping, even as officials face a weaker fiscal environment. New Jersey officials are passing property tax relief for seniors, setting aside a total of $600 million for the program over the next three fiscal years. That’s despite Treasurer Elizabeth Muoio announcing in May that New Jersey expects $1.1 billion less in tax revenue for 2023 and $1.2 billion less for the fiscal year. which begins July 1.
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Of course, US states – from California to North Carolina – have never been better prepared for a downturn. They have accumulated record fund balances for rainy days.
California, known for its ups and downs, has a reserve of $38 billion, considered the largest of any state in US history, according to a report by the legislative budget committee. The report says the Treasury has “never” had as much liquidity and resilience as it did in 2023.
And the stock market is recovering again with the S&P 500 up 15% year-to-date. HD Palmer, spokesman for the California Department of Finance, said fiscal analysts are breathing easier this year as the stock market rebounds from the 2022 rout.
“There’s this normalization of state tax revenue starting to happen,” said Tammy Gamerman, director of Fitch Ratings. “The days of these booming revenues are over.”
–With help from Martin Z. Braun, Shelly Hagan, Elise Young, Reade Pickert and Michelle Kaske.
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