Summary of LAO Findings and Recommendations on the 2012-13 Budget

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	Program	Budget Issue	LAO Finding Or Recommendation	Last Updated
Go Back	Revenues	Frequently asked questions concerning Facebook and California's General Fund	This item lists answers to frequently asked questions concerning Facebook's stock and California's General Fund budget for 2012-13.	8-01-12

Detailed Narrative
We receive frequent inquiries concerning Facebook's stock price, the company's May initial public offering (IPO), and how they affect the California state budget. This note provides responses to some frequently asked questions concerning Facebook. (This page may be updated as the year progresses.) *How Much "Facebook Revenue" Is Assumed in California's 2012-13 Budget Plan?* The State of California's 2012-13 budget plan--signed into law by Governor Brown on June 27, 2012--is based on the Department of Finance's May 2012 revenue estimates. As such, the budget assumes the state receives about $1.9 billion in 2011-12 and 2012-13 combined due to the Facebook IPO and resulting taxable income. Of this $1.9 billion, approximately $1.5 billion results from current-law income tax rates, with the remaining approximately $400 million relating to the budget plan's assumption that voters approve the Governor's proposed tax measure, Proposition 30, in the November election. (The budget plan also includes "trigger cuts" affecting education and other public services in the event that Proposition 30 does not go into effect.) We discussed the administration's Facebook forecast--as well as our office's independent Facebook revenue forecast--in more detail in an online note just before the IPO in May, which noted the "large margin of error" surrounding both forecasts. At the time of the May Revision, we also presented information comparing our office's Facebook personal income tax projections with those of the administration in Figures 4 and 6 of this online note. (Our office's Facebook revenue projections were higher than the administration's in May based largely on our assumption at the time that Facebook share prices would rise between May and November 2012.) *Are These Estimates Based on Assumptions About When Investors Will Sell Stock?* No, not in general. The vast majority of the taxable income events assumed in all of the state's revenue projections concerned stock-related transactions that were disclosed by the company in its IPO documents and scheduled to take place, often on or near a specific date. The clearest examples of these are the assumed income tax payments related to the company's scheduled settlement of restricted stock units (RSUs) with current and past employees in October/November 2012 and thereafter. Because the state's Facebook estimates assumed little in the way of discretionary stock trading activity, it is possible (but not certain) that elevated trading activity related to the stock could help state tax revenues to some extent. For example, if the recent weakness in Facebook stock causes a significant portion of worried "inside investors" (those with large blocks of Facebook stock prior to the IPO) to sell their shares in 2012, this increased stock trade activity--and resulting income tax payments--could offset some of the state revenue weakness that otherwise could result from Facebook's depressed share price. *Why Were Facebook Revenues Included in State Revenue Estimates?* Under the State Constitution, the Legislature determines the revenue estimate upon which the annual state budget is based. Our office's budgetary revenue projections, as well as those of the Department of Finance, are used by the Legislature for this purpose and in determining the amount of funding required to be provided to schools and community colleges under Proposition 98. (A higher level of state revenues, in general, means a higher amount of required school funding.) As such, we focus our budget forecast process on developing the most accurate revenue estimates that are possible. We avoid trying to make our projections either too cautious or too optimistic. Facebook's IPO clearly is resulting in significant new tax revenue for the state. Accordingly, given the goal of developing an accurate revenue estimate, an effort to estimate Facebook-related revenues was necessary. *How Does Facebook's Depressed Stock Price Affect the State Budget?* All of the state's Facebook revenue projections were developed prior to the IPO in May in line with California's standard budget calendar. As such, both the administration and our office had to make assumptions about what would happen to Facebook's stock price in the months following the IPO. The administration's projection--incorporated in the 2012-13 budget plan--assumed a $35 share price at the time of the IPO and $35 in November, when the RSU settlement activity mentioned above will occur. The magnitude of various significant taxable transactions is linked to the company's share prices. Thus, the IPO share price--being higher than that assumed in the budget--provides a small benefit to the budget. More recently, Facebook share prices have fallen far below levels assumed in the state's revenue projections. Between now and November, the company's stock price could be affected by various factors, including the company's third-quarter financial results (which may be released as soon as October). If, however, the lower share prices persist through November and December, hundreds of millions of dollars of income tax revenue assumed in the state budget plan are at risk. In particular, actual tax revenue related to settlement of the RSUs could be less than projected. As discussed in our previous online notes and above, both our office's estimates and the administration's estimates omitted various categories of Facebook stock sales and options activity that could occur in 2012 and 2013, but were not scheduled to occur on a specific date during that period. To the extent that these stock and option transactions do occur in 2012 and 2013, they may offset some of the revenue weakness related to the depressed share price. *Is This A Major Risk for the State Budget?* Assuming passage of Proposition 30, California's General Fund revenues are budgeted to be $87 billion in 2011-12 and $96 billion in 2012-13--$183 billion across the two fiscal years combined. Facebook is assumed to generate under $2 billion (about 1 percent) of this total, and much of that revenue should still materialize even if the company's stock price remains depressed. As noted above, if the company's stock price remains depressed, hundreds of millions of income tax dollars assumed in the 2012-13 state budget plan are at risk. As our office described to the Legislature in May, there currently is an unusual degree of uncertainty concerning the state's revenue estimates, such that policy makers "should not be surprised if 2012–13 state revenues end up several billion dollars lower (or higher) than current projections." Other budgetary uncertainties relate to various expenditure projections included in the budget. Beyond Facebook, the federal "fiscal cliff," volatile trends in the overall stock market, trends in consumer confidence, and the economic situation in parts of Europe and Asia are significant uncertainties that could result in larger revenue decreases (or increases) than Facebook alone. *When Will the State's Facebook Revenue Estimates Be Updated?* California has a routine annual budget schedule guided by deadlines in the Constitution and state law. Our office generally updates its revenue estimates each year in November. In January, the administration updates its revenue estimates when presenting the Governor's proposed annual budget plan. Facebook estimates are likely to be updated in line with this standard schedule. As we have noted in prior publications and legislative testimony (see, for example, page 26 of our February 2012 state revenue update), the confidentiality of individual taxpayer information means that there will never be a precise figure concerning the actual amount of Facebook IPO-related taxes paid to the state. Moreover, it takes many months for data concerning a tax year's payments to be processed by the state's tax agencies. At some point in the future, for these and other reasons, state revenue estimates likely will change to display Facebook-related revenues as simply "lumped in" with the state's other taxes. (State tax agency data on actual tax payments, for example, cannot indicate in detail which specific company's stock sales and related transactions resulted in a given amount of tax revenue.)

Detailed Narrative

We receive frequent inquiries concerning Facebook's stock price, the company's May initial public offering (IPO), and how they affect the California state budget. This note provides responses to some frequently asked questions concerning Facebook. (This page may be updated as the year progresses.)

How Much "Facebook Revenue" Is Assumed in California's 2012-13 Budget Plan? The State of California's 2012-13 budget plan--signed into law by Governor Brown on June 27, 2012--is based on the Department of Finance's May 2012 revenue estimates. As such, the budget assumes the state receives about $1.9 billion in 2011-12 and 2012-13 combined due to the Facebook IPO and resulting taxable income. Of this $1.9 billion, approximately $1.5 billion results from current-law income tax rates, with the remaining approximately $400 million relating to the budget plan's assumption that voters approve the Governor's proposed tax measure, Proposition 30, in the November election. (The budget plan also includes "trigger cuts" affecting education and other public services in the event that Proposition 30 does not go into effect.)

We discussed the administration's Facebook forecast--as well as our office's independent Facebook revenue forecast--in more detail in an online note just before the IPO in May, which noted the "large margin of error" surrounding both forecasts. At the time of the May Revision, we also presented information comparing our office's Facebook personal income tax projections with those of the administration in Figures 4 and 6 of this online note. (Our office's Facebook revenue projections were higher than the administration's in May based largely on our assumption at the time that Facebook share prices would rise between May and November 2012.)

Are These Estimates Based on Assumptions About When Investors Will Sell Stock? No, not in general. The vast majority of the taxable income events assumed in all of the state's revenue projections concerned stock-related transactions that were disclosed by the company in its IPO documents and scheduled to take place, often on or near a specific date. The clearest examples of these are the assumed income tax payments related to the company's scheduled settlement of restricted stock units (RSUs) with current and past employees in October/November 2012 and thereafter.

Because the state's Facebook estimates assumed little in the way of discretionary stock trading activity, it is possible (but not certain) that elevated trading activity related to the stock could help state tax revenues to some extent. For example, if the recent weakness in Facebook stock causes a significant portion of worried "inside investors" (those with large blocks of Facebook stock prior to the IPO) to sell their shares in 2012, this increased stock trade activity--and resulting income tax payments--could offset some of the state revenue weakness that otherwise could result from Facebook's depressed share price.

Why Were Facebook Revenues Included in State Revenue Estimates? Under the State Constitution, the Legislature determines the revenue estimate upon which the annual state budget is based. Our office's budgetary revenue projections, as well as those of the Department of Finance, are used by the Legislature for this purpose and in determining the amount of funding required to be provided to schools and community colleges under Proposition 98. (A higher level of state revenues, in general, means a higher amount of required school funding.) As such, we focus our budget forecast process on developing the most accurate revenue estimates that are possible. We avoid trying to make our projections either too cautious or too optimistic. Facebook's IPO clearly is resulting in significant new tax revenue for the state. Accordingly, given the goal of developing an accurate revenue estimate, an effort to estimate Facebook-related revenues was necessary.

How Does Facebook's Depressed Stock Price Affect the State Budget? All of the state's Facebook revenue projections were developed prior to the IPO in May in line with California's standard budget calendar. As such, both the administration and our office had to make assumptions about what would happen to Facebook's stock price in the months following the IPO. The administration's projection--incorporated in the 2012-13 budget plan--assumed a $35 share price at the time of the IPO and $35 in November, when the RSU settlement activity mentioned above will occur.

The magnitude of various significant taxable transactions is linked to the company's share prices. Thus, the IPO share price--being higher than that assumed in the budget--provides a small benefit to the budget.

More recently, Facebook share prices have fallen far below levels assumed in the state's revenue projections. Between now and November, the company's stock price could be affected by various factors, including the company's third-quarter financial results (which may be released as soon as October). If, however, the lower share prices persist through November and December, hundreds of millions of dollars of income tax revenue assumed in the state budget plan are at risk. In particular, actual tax revenue related to settlement of the RSUs could be less than projected.

As discussed in our previous online notes and above, both our office's estimates and the administration's estimates omitted various categories of Facebook stock sales and options activity that could occur in 2012 and 2013, but were not scheduled to occur on a specific date during that period. To the extent that these stock and option transactions do occur in 2012 and 2013, they may offset some of the revenue weakness related to the depressed share price.

Is This A Major Risk for the State Budget? Assuming passage of Proposition 30, California's General Fund revenues are budgeted to be $87 billion in 2011-12 and $96 billion in 2012-13--$183 billion across the two fiscal years combined. Facebook is assumed to generate under $2 billion (about 1 percent) of this total, and much of that revenue should still materialize even if the company's stock price remains depressed. As noted above, if the company's stock price remains depressed, hundreds of millions of income tax dollars assumed in the 2012-13 state budget plan are at risk.

As our office described to the Legislature in May, there currently is an unusual degree of uncertainty concerning the state's revenue estimates, such that policy makers "should not be surprised if 2012–13 state revenues end up several billion dollars lower (or higher) than current projections." Other budgetary uncertainties relate to various expenditure projections included in the budget. Beyond Facebook, the federal "fiscal cliff," volatile trends in the overall stock market, trends in consumer confidence, and the economic situation in parts of Europe and Asia are significant uncertainties that could result in larger revenue decreases (or increases) than Facebook alone.

When Will the State's Facebook Revenue Estimates Be Updated? California has a routine annual budget schedule guided by deadlines in the Constitution and state law. Our office generally updates its revenue estimates each year in November. In January, the administration updates its revenue estimates when presenting the Governor's proposed annual budget plan. Facebook estimates are likely to be updated in line with this standard schedule.

As we have noted in prior publications and legislative testimony (see, for example, page 26 of our February 2012 state revenue update), the confidentiality of individual taxpayer information means that there will never be a precise figure concerning the actual amount of Facebook IPO-related taxes paid to the state. Moreover, it takes many months for data concerning a tax year's payments to be processed by the state's tax agencies. At some point in the future, for these and other reasons, state revenue estimates likely will change to display Facebook-related revenues as simply "lumped in" with the state's other taxes. (State tax agency data on actual tax payments, for example, cannot indicate in detail which specific company's stock sales and related transactions resulted in a given amount of tax revenue.)