The 2012-13 Budget:
Economic and Revenue Update

Figure 15

LAO Forecasts Lower Revenues Than the Administration

General Fund, Assumes Bush Tax Cuts Expire at End of 2012 (In Millions)

Effect on Budget Problem. Lower revenues make it more difficult for the state to balance its budget in any given fiscal year. If our revenue forecast proves to be more accurate than the administration’s, it means that the Legislature and the Governor will have to identify other budgetary solutions to bring the 2012–13 state spending plan into balance. The net effect of our lower revenue assumptions on the near–term budget problem, however, will depend on how the forecast affects the Proposition 98 minimum guarantee for schools and community colleges. We expect to develop updated Proposition 98 estimates in the coming weeks.

Assumptions Concerning Taxpayer Behavior. As discussed in more detail below, our PIT forecast, in particular, reflects various assumptions about federal tax policy and how they might affect taxpayer behavior. The forecast data shown in Figures 14 and 15 adhere to similar basic assumptions as those included in the administration’s January revenue forecast in order to allow for simpler comparisons. Later in this section, we discuss how changes in some of those assumptions could affect the revenue outlook for 2011–12 and beyond.

Personal Income Tax

PIT Forecast Affected by Rate Changes and Facebook. General Fund PIT revenues for 2010–11 are estimated to have totaled $49.5 billion. Midway through 2010–11, temporary legislative measures to increase PIT revenues expired. These temporary measures adopted in 2009 included a 0.25 percentage point increase in each PIT marginal tax rate and a decrease in the value of the state’s dependent credit. The expiration of the temporary measures has reduced the growth of PIT revenues in 2011–12—the first full fiscal year after the expiration of the temporary increases—by a few percentage points compared to what their growth otherwise would have been. Despite this effect, we forecast that growth in the income of California taxpayers will be sufficient to keep PIT collections roughly steady in 2011–12 at $49.4 billion, excluding the effects of the Governor’s proposed tax initiative and the possible Facebook IPO. When those additional effects are included, our base PIT forecast for 2011–12 rises to $51.4 billion, a 3.9 percent increase above 2010–11.

In 2012–13, the first full fiscal year in which the Governor’s proposed tax initiative would affect budget revenues, our base PIT forecast rises to $55.7 billion, up 8.4 percent from 2011–12. About one–fourth of this increase is attributable to there being a full year of PIT revenues in 2012–13 resulting from the Governor’s initiative (as compared to the half year of initiative revenues assumed to be accrued to 2011–12). Another one–fourth of the annual increase is attributable to our assumption concerning Facebook IPO–related tax collections (discussed in more detail below), which the company’s prospectus hints will peak during the 2012–13 fiscal year. Over 4 percentage points of the growth—around one half of the total—is attributable to assumed taxable income increases. These various factors are summarized in the “Base Scenario” section of Figure 16, which makes similar assumptions concerning federal tax policy and accelerations of capital gains and other income as those included in the administration’s January budget estimates. Other scenarios listed in Figure 16 use different assumptions, as discussed below.

Near–Term Collections May Be Affected by Behavioral Responses to Tax Policy Changes. As discussed earlier in this report, there currently exists a significant amount of uncertainty concerning a variety of elements of future federal tax policy. Tax policy changes may have a significant effect over the next few years on when and how some taxpayers choose to realize stock market and other asset gains and even other kinds of income. In particular, wealthy taxpayers—who pay a significant share of California’s income taxes—have considerable opportunity to accelerate or delay their realization of capital gains, as well as certain other forms of income, in response to tax policy changes. To the extent such taxpayers respond in this manner, the state may collect certain revenues earlier or later than it otherwise would.

For example, in our base forecast scenario, we now assume—like the administration—that the Bush tax cuts expire as required under current federal law at the end of 2012. The Bush tax cuts include reductions of taxes on long–term capital gain and qualified dividend income, as well as other types of income. In addition to the scheduled expiration of the Bush tax cuts, the federal Patient Protection and Affordable Care Act imposes a 3.8 percent Medicare tax on certain categories of unearned income (such as certain investment–related income) for certain high–income taxpayers, which will go into effect on January 1, 2013. This means that under current federal law, taxpayers will pay a higher tax rate on income realized after the beginning of 2013. To the extent that a taxpayer can accelerate 2013 income to 2012, therefore, the taxpayer may be able to pay a lower tax rate. Accordingly, in our base forecast scenario, we assume that about 20 percent of capital gains income; 5 percent of dividend, interest, and rent income; and 1 percent of wages and salaries that otherwise would be realized in 2013 will be accelerated to 2012. This tends to increase certain categories of state revenue collections in 2011–12 and 2012–13, with offsetting reductions in various revenue categories, particularly in 2012–13 and 2013–14. For the most part, these behavioral responses would affect the state’s high–income taxpayers, who pay the highest marginal PIT rates.

Many economists’ revenue forecasts—including both our own and the administration’s January 2012 economic forecast—assume that Congress and the President will agree to various fiscal and tax measures later this year to provide additional support to the fragile economy, including an extension of the Bush tax cuts for at least one year. Figure 16 displays such an alternate scenario (listed as “Alternate Scenario 1”), which assumes that the Bush tax cuts expire instead at the end of 2013. In this scenario, since the Medicare tax takes effect in 2013, we are now assuming that this tax causes taxpayers to accelerate receipts of 15 percent of their 2013 capital gains and 4 percent of their 2013 dividends, interest, and rent from 2013 to 2012. Furthermore, in Alternate Scenario 1, we assume that the expiration of the Bush tax cuts at the end of 2013 causes acceleration of 15 percent of capital gains; 4 percent of dividends, interest, and rent; and 1 percent of wages to be accelerated from 2014 to 2013.

Figure 16 displays another scenario (“Alternate Scenario 2”), in which the Bush tax cuts never expire and there is no behavioral response other than the response related to the Medicare tax described in Alternate Scenario 1. Thus, all three scenarios shown in Figure 16 assume accelerations of 2013 income to 2012. (Our November forecast did not.)

Behavioral responses of the types included in our base forecast and the alternate scenarios are impossible to predict with precision and difficult to evaluate even in retrospect, given tax agencies’ inability to know which capital gains and other income were accelerated and which were not. In fact, many other scenarios are possible. For example, assuming that Congress and the President do not make major decisions on federal tax policy until very late in the year (after the November 2012 election), some taxpayers will accelerate income no matter what final decision is made regarding extension of the Bush tax cuts. In addition, in any of these scenarios, we cannot predict well when taxpayers will begin to make payments to the state, which could affect the fiscal years to which revenue is accrued under existing and proposed revenue accrual policies (discussed later in this report). Moreover, while there may be several tax proposals on the November 2012 statewide ballot, none of our scenarios assume that taxpayer accelerations are increased more due to possible state tax policy changes. All of these challenges in predicting the precise nature and degree of behavioral responses could easily drive PIT revenues higher or lower by hundreds of millions of dollars per year over the next few years.

Capital Gains Income Notoriously Difficult to Forecast. In our January 2012 Overview of the Governor’s Budget, we discussed our concerns that the administration’s current method of forecasting high–income tax filers’ income—especially capital gains—tended to overestimate PIT growth over the next few years, including revenue growth that would result from the Governor’s tax initiative. In a statement released on February 10, DOF noted that one reason for weaker–than–projected estimated payments by PIT taxpayers in December and January could be that 2011 capital gains were lower than assumed in the Governor’s budget. Our updated forecast assumes that this is the case. Moreover, given the assumptions about future stock market and home price growth embedded in our economic forecast (which we believe are similar to the administration’s), we can identify no strong rationale for the administration’s assumption that capital gains will grow very rapidly in 2012 and later years. Our much lower forecast of future capital gains growth—along with key forecast assumptions concerning stock and home prices—is summarized in Figure 17.

The level of net capital gains realized by California taxpayers each year is dependent on a complex variety of factors, including recent growth of asset prices (such as stock, bond, or home prices) and the “carryover effect” of prior–year declines in asset prices. In recent years, as shown in Figure 17, both house and stock prices declined significantly, which resulted not only in near–term reductions in net capital gains but also reductions in the value of assets destined to be sold in the future for either a capital gain or loss. Taking all of these effects together, our revenue forecasting models show that net capital gains have increased during periods of sustained growth in asset markets (2004 through 2007, for instance), decreased during periods of asset market declines (2008 and 2009), and increase thereafter, but from a lower base level (as shown in 2010). Our 2010 capital gains forecast generally reflects preliminary Franchise Tax Board data, which showed that despite the significant stock market gains of that year, the level of capital gains was significantly depressed from its pre–recession bubble levels and about $14 billion lower than assumed in our November forecast.

In 2011, stock market gains were less notable than they were in 2010, and these gains were unevenly distributed throughout the calendar year, as markets climbed for much of the first half of the year (far above their levels from early 2010) and then sharply decreased in the summer and fall before climbing again late in the year. Thus, while the S&P 500 index, on average, was about 11 percent higher during 2011 than in 2010, an individual investor might have sold a security for significant gains at one point in the year but for little or no gain (or even a loss) at some other point in 2011. Overall, our forecasting model suggests these trends will lead to a small increase in California capital gains in 2011. In 2012, our base capital gains forecast is elevated by the accelerations related to federal tax policy, as discussed earlier.

In general, assuming steady, moderate upward growth in stock and home prices, we believe capital gains will tend to climb a few percent per year in the future. Strong stock and housing market years could produce some of the very strong capital gains reflected in the administration’s forecast. In our view, however, the economic conditions supporting such an outcome are not yet in evidence.

High–Income Taxpayers’ Wage and Other Income Continues to Increase. In our May 2011 publication, The 2011–12 Budget: Overview of the May Revision, we discussed differences between our forecast and the administration’s forecast concerning wage and salary growth for both upper–income taxpayers and other taxpayers. Differing assumptions on wage levels and growth for 2010 and later years have marked recent forecasts. These assumptions are important to PIT forecasts, given the state’s reliance on tax payments by higher–income individuals. Developing these wage forecasts recently has been very challenging since both our office and the administration have to estimate how taxpayer income will recover from the recent, unprecedented recession, and hard data on these topics from FTB is not received until well after the year in question has ended.

Since last May, differences between our two forecasts have narrowed, as the administration has increased its estimates of 2010 wage and salary growth for taxpayers with under $200,000 of adjusted gross income (AGI) and decreased its estimates for wage growth of taxpayers with over $200,000 of AGI. At the same time, based on the data available to us, our office has increased our estimate of 2010 wage growth for upper–income taxpayers and decreased slightly our wage growth assumptions for lower–income taxpayers. Our current forecasts’ assumptions concerning wage growth are summarized in Figure 18.

Since our November forecast, we have increased our wage forecasts somewhat, and we have also increased substantially our forecasts for annuity income (which is received by lower–income and middle–income tax filers, in particular). Other income forecasts have been adjusted downward based largely on data received from FTB after our November forecast, especially dividends, interest, and rent income (received primarily by higher–income filers). On net, we now generally assume higher taxable incomes than we did in November for California tax filers with $5 million and over in annual income, higher income in some forecast years for filers with $1 million to $5 million in income, and somewhat lower income in some years for filers with $500,000 to $1 million in income. These changes in assumptions affect not only our forecast of current–law PIT revenues, but also our forecast of PIT revenues that would be generated by the Governor’s initiative (now up by a few hundred million dollars in some years, compared to our prior estimates).

Our income distribution model discussed above does not consider the effects of the possible Facebook IPO, which could generate extraordinary, one–time changes in high–income taxpayer data in 2012 and 2013.

Facebook’s IPO, if It Occurs, Would Help State Revenues. In this forecast, we make an initial—and very rough—effort to incorporate PIT revenues the state would receive due to the possible Facebook IPO, which is widely expected to occur later this spring with an initial market capitalization (the overall value of the business in the stock market) of around $100 billion. Facebook’s Form S–1, its preliminary prospectus in advance of the possible IPO, contains hints about future anticipated tax liabilities of both Facebook investors and employees and the company itself. In particular, the prospectus discusses in varying levels of detail the IPO–related tax liabilities of (1) Facebook employees and others with option–like assets known as “restricted stock units” and (2) the company’s founder and chief executive officer, Mark Zuckerberg. While the prospectus contains important information in this regard, it lacks many details, some of which will be clarified in the days prior to the IPO and some of which will not. For example, the prospectus does not contain certain detailed information on several types of compensation provided to Facebook employees and executives, such as a description of the full variety of instances in which those persons could delay receipt of such compensation to later dates. Importantly, the prospectus also does not describe in detail the precise manner in which various stock–related transactions with executives, employees, and others will result in withholding obligations to federal and state tax agencies. The prospectus also cannot tell us which of the company’s current major investors are Californians and when they may be motivated to sell their Facebook shares. Perhaps most significantly, the preliminary prospectus does not tell us when the IPO will occur and at what stock price, which will affect when (and in what fiscal years) tax revenues materialize and in what dollar amounts.

Given all of these uncertainties, there is a very large range of error around our initial Facebook PIT estimates, which are shown in Figure 16. Specifically, we are assuming in our forecast receipt of $500 million of PIT revenue in 2011–12 (assuming an IPO prior to the end of the current fiscal year results in significant PIT withholding or estimated payments in 2011–12), $1.5 billion in 2012–13, and much smaller amounts thereafter through 2015–16. Should the IPO proceed, it appears virtually certain that the state revenue impact will be at least in the hundreds of millions of dollars, spread across a few fiscal years. On the other hand, if the IPO results in a market capitalization of well over $100 billion and/or Facebook’s stock price climbs significantly above its IPO level (particularly in the first 6 to 12 months after the IPO), the state revenue benefit could be $1 billion or more over the level we assume, spread across a few fiscal years. At this time, based on the limited information available to us, we believe the numbers included in our forecast are a reasonable initial estimate. As we discussed in the Overview of the Governor’s Budget, the Facebook impact on state revenues cannot be predicted in advance and will never be known retrospectively with any degree of precision. Yet, given that an IPO clearly would benefit state revenues, we believe it is appropriate for policymakers to incorporate this into their budgetary discussions—whether they decide to expend Facebook–related PIT revenues in advance of their receipt or, alternatively, to adopt a more cautious approach in light of the many uncertainties in this area.

Revenue Accrual Policies Increasingly Challenging to Model. We last discussed the state’s approach to accruing (attributing) PIT and other revenues to particular fiscal years in our 2011 report, The 2011–12 Budget: The Administration’s Revenue Accrual Approach. The Legislature rejected the administration’s accrual modification proposal in 2011, but the administration now proposes to accrue a small portion of PIT revenue—principally that related to the Governor’s initiative—under a similar method as that proposed last year. In our forecasting models, we attempt to apply the administration’s revenue accrual practices, but we acknowledge that our ability to do so accurately is limited for a variety of reasons, including recently adopted tax policy provisions that have changed markedly the dates when some tax payments are received, which in turn can affect when revenues are accrued. The various uncertainties in the accrual policies and the resulting forecast difficulties mean that our projections easily can be hundreds of millions of dollars too high or too low in any given fiscal year due to accrual and payment date issues. We suspect that these uncertainties will persist for a while, until at least several years have passed without significant PIT timing, accrual, or other major tax policy changes.

We continue to observe, as we did last year, that the state’s current and proposed revenue accrual practices make it more difficult to accurately estimate revenues, risk inconsistency among the state departments that develop and audit financial records, and promote confusion for bond investors who use the state’s financial statements. In some years, the state’s overall accrual practices may allow it to spend more than it can afford and in other years may result in lower Proposition 98 spending requirements than otherwise would be the case. The inconsistencies embedded in the state’s budgetary revenue and expenditure accounting have multiplied in recent years, which we find to be a troubling trend. The administration’s proposed changes to accruals have some merit, as we noted last year, but over the longer term, the state should move in a direction of adhering to consistent, appropriate, and publicly transparent accrual methods for all sources of revenue.

Sales and Use Taxes

We estimate that General Fund sales and use tax (SUT) revenues will total $18.6 billion in 2011–12. In 2012–13, assuming passage of the Governor’s proposed tax initiative, we estimate that General Fund SUT revenues will increase to $21.2 billion, a 13.8 percent increase from 2011–12. Approximately half of this increase is due to the Governor’s initiative proposal, which would increase the General Fund portion of the SUT rate by 0.5 percentage points (from 3.9375 percent to 4.4375 percent) for four calendar years—from January 1, 2013 through December 31, 2016. The other half is the result of underlying growth in the SUT base of 7 percent. The SUT revenues follow a similar trend in 2013–14—the first full–year effect of the Governor’s initiative proposal—increasing 13.5 percent to $24 billion.

Taxable Sales Fell Disproportionately During the Recession. The main determinant of SUT revenues is taxable sales. California taxes sales and use of most tangible products but excludes virtually all services. About two–thirds of taxable sales result from retail spending by consumers, including a significant portion on vehicles and large household purchases, both of which declined sharply during the recession. Other important categories of taxable sales are the purchase of building materials involved in new construction and business–to–business taxable transactions, where the purchasing business is the final consumer of the sold item.

Between the second quarter of 2008 and the second quarter of 2009, taxable sales declined by 17 percent while personal income fell by just 6 percent. The reduction in taxable sales relative to income—illustrated in Figure 19—was the result of: (1) consumers and businesses curtailing costly purchases such as household appliances, new vehicles, and business machinery; (2) increased household savings rates; and (3) the long–term trend toward greater consumption of nontaxable goods (services and other products, such as those purchased online, for which the collection of SUT is limited) as a fraction of total consumption.

Taxable Sales Now Making Up Lost Ground. Since the start of the recovery, taxable sales have rebounded faster than personal income, signaling a correction to the decline in taxable sales discussed above. Thus, in Figure 19, taxable sales as a percent of personal income has been growing since 2010. We expect this trend to continue throughout the forecast period, as consumers and businesses gradually return to more normal levels of taxable spending relative to income.

Risks and Uncertainties in the SUT Forecast. Taxable sales are heavily influenced by (1) employment and income growth, (2) household savings rates, (3) the availability of consumer and business credit, and (4) overall confidence in the economy. These factors could differ from our forecast in several ways.

• Incomes, Employment, and Prices Affect Consumption. We project that personal income and employment in California will increase modestly throughout 2012 and 2013. Should actual incomes grow faster, or slower, than we project, SUT revenues could vary significantly from our forecast. Other factors, such as gasoline and grocery prices—even though the state does not collect General Fund sales taxes on these items—could influence taxable sales as well. This is because consumers may reduce spending on taxable items in order to pay higher prices of other goods such as these.
• Household Savings Rates Influence Spending Decisions. In recent months, national household savings rates have fallen to pre–recession levels, likely indicating that savings built up over the past few years have supported some recent growth in taxable sales. Should this decline indicate that consumers are becoming more confident about their personal finances, taxable sales could be somewhat higher than we project. If, on the other hand, lower savings rates are more the result of households’ difficult financial circumstances, stagnant wages, and stubbornly high unemployment, consumers may end up curbing spending on taxable items more than reflected in our projections.
• Consumer and Business Credit Availability Influences Spending Decisions. In recent months credit availability has improved somewhat, although lending standards remain relatively tight compared to pre–recession levels. Households tend to use credit to finance large taxable purchases—such as vehicles, appliances, personal electronics, and home improvements—and business credit allows firms to make fixed investments in equipment, computer systems, and buildings that often are too costly to finance in any single year. Our forecast assumes that this trend toward more expansive credit continues in future years.
• Consumer Confidence About the Economy May Affect Future Spending. Taxable sales in California sustained a pronounced recovery through the summer months—increasing at an annual rate of 9 percent during the second quarter and 8 percent during the third quarter—despite the fact that the economy slowed considerably and consumer sentiment fell to recession–levels. As the economy has improved in recent months, so has consumer sentiment (also known as consumer confidence). Consumer confidence now appears to be a significant factor in recent taxable sales growth. Our economic forecast makes assumptions about consumer confidence trends, as measured by the Reuters/University of Michigan Consumer Sentiment Index. In general, we assume that consumer confidence continues to climb through 2013 and then generally stabilizes for the remainder of our forecast period.

Policy Changes That Occurred in 2010 Have Reduced General Fund SUT Receipts. In 2011–12, General Fund SUT receipts will decline significantly from 2010–11 levels, reflecting the net effect of: (1) the “fuel tax swap” passed by the Legislature in 2010, under which the state no longer collects sales tax on gasoline, (2) the shift of some state responsibilities to local government—known as “realignment”—which redirects over $5 billion in SUT receipts to cities and counties (see box below), (3) the expiration of the temporary 1 percent SUT rate increase adopted in 2009, and (4) projected growth in the SUT tax base of 6.6 percent. Policy changes and underlying growth, taken together, reduce state General Fund SUT revenue from $27 billion in 2010–11 to a projected $18.6 billion in 2011–12.

Corporation Tax

Despite Higher Profits, Corporation Tax Likely to Decline Through 2012–13. Corporation tax (CT) revenues for 2010–11 are estimated to have totaled $9.6 billion. As we have discussed in recent publications, the Legislature made several significant changes to CT policies in recent years, several of which were intended to accelerate CT collections. Such actions helped the state balance its General Fund budget over the last few years but are now beginning to have a negative impact on the state budgetary situation, as we discuss below. In large part due to the lingering effects of these policy changes, we project that the state’s CT revenues will be slightly lower in 2011–12 and 2012–13—$9.4 billion and $9.3 billion, respectively—before growing to reach $10.8 billion in 2016–17. Under our projections, CT revenue would remain below the pre–recession high ($11.8 billion in 2007–08) through at least 2016–17.

Recent CT Policy Changes Now Resulting in Lower State Revenues. Despite significant growth in corporate profits, tax revenues have fallen due largely to significant tax policy changes of recent years. It is difficult to isolate the revenue impacts of these changes from other factors affecting revenues. That said, our best estimate is that in 2007–08, 2008–09, and 2009–10, policy changes had the net impact of increasing CT revenues, as shown in Figure 20. This was intentional, as the state implemented policies that accelerated CT collections from future years in order to help cope with budgetary challenges resulting from the recession. These actions include the suspension, for 2008 through 2011, of larger businesses’ use of net operating loss deductions. In addition, penalties on corporate taxpayers who are found to have significantly underpaid their taxes also serve to accelerate CT collections. This occurs as businesses try to avoid penalties by paying up front some of the tax they might have paid later following an audit.

In addition to the revenue accelerations, Figure 20 also includes the effects of recent policy changes that reduced CT revenues, rather than just accelerating their collection. The most significant of these is the elective single sales factor—the new option for multistate businesses to choose each year which method they use to determine their California taxable income. This provision is estimated to reduce CT revenues by around $1 billion per year. Under another major policy change, tax credits are now easier to use due to a law that allows transfers of certain credits between companies that are treated as parts of a single business group for tax purposes.

By 2011–12, the expected net effect of the recent CT policy changes (including both revenue accelerations and tax reductions) has been to lower revenues by around $1.2 billion, compared to estimates of what revenues would have been without these major tax policy changes. This net negative effect is expected to grow to around $2 billion annually for the remainder of our forecast period. Due in part to the recent changes, our model now suggests that corporations pay an effective state tax rate of around 5 percent. (This is the percentage of corporate profits actually paid in taxes, after considering all credits, deductions, and other factors that reduce tax payments below the statutory rates.)

New Information Drives Changes Since Our Last Forecast. Our updated CT projections are somewhat lower than those in our November 2011 CT forecast—by over $150 million in 2012–13 and several hundred million dollars per year thereafter. These changes are the net result of new and revised data in two main areas: corporate profits and tax credit usage.

First, corporate profits taxable by California—the main driver of our CT revenue forecast—now are projected to be slightly higher through 2013 than we previously projected and slightly lower in 2014 and beyond. This is shown in Figure 21.

A more significant factor in driving forecast CT revenues downward since November is updated data concerning usage of the state’s largest CT credit, the research and development (R&D) credit. A major surprise in taxpayer data from the 2010 tax year—which was not available when we prepared our November 2011 forecast—was the degree to which the rebound in corporate profits was offset by greater use of tax credits, especially the R&D credit. Figure 22 shows the sharp increase in R&D credit usage in 2010. This change has led us to increase our estimates of R&D credit usage for future years as well. On its own, this revision reduces 2011–12 revenues by roughly $600 million and later years’ revenues by roughly $300 million per year.

Tax credit use is hard to predict in part because the link between credit use and profits is complex. Profits drive pre–credit tax liabilities, and when pre–credit tax liabilities increase, tax credit use essentially increases dollar for dollar in the group of taxpayers that have enough accumulated credits to minimize their tax liabilities. In contrast, for the group of taxpayers that do not have as many accumulated credits, use of credits can increase by less than pre–credit tax liabilities do. While we observe and forecast changes in aggregate corporate profits, it is impossible to predict with precision how increased profits will be distributed to the groups of companies with the two profiles described above.

There is a significant likelihood that future years’ tax data will reveal even more surprises about use of the R&D and other CT credits and deductions. For example, recent legislation allowing transfers of certain tax credits between business entities within a single family of companies will introduce more uncertainty into future CT forecasting. To a large extent, how this and other policy changes will affect CT revenues will not be known until companies file future tax returns.

Conclusion

Economic data currently is providing plenty of mixed signals to California’s policymakers, as they continue to craft state and local budgets in a constrained fiscal environment. California’s economy now is clearly improving in many important ways, including employment growth. Nevertheless, significant impediments block the state’s path to a more robust recovery from the recent, staggering economic downturn.

Like the economic data, reports concerning state revenues also have been delivering some mixed messages recently, with recent weakness in income tax payments accompanied by speculation concerning a future bonanza of tax revenues due to the possible Facebook IPO.

If our revenue forecast proves to be more accurate than the administration’s, the Legislature and the Governor will have to identify additional budgetary solutions to bring the 2012–13 state spending plan into balance. Much more information will become available by the end of April, when a large amount of income tax payments are received by the state and refund payments are made. The Legislature will want to wait until after this data is analyzed in the May Revision process before making its 2012–13 budget decisions. We hope that the information provided in this update will help set the stage for the work of legislative budget subcommittees in addressing the state’s fiscal situation.