Why Has Income Tax Withholding Lagged, Despite Job Growth?
Personal Income Tax (PIT) Withholding. California employers make regular income tax withholding payments for their employees. These amounts are reported every weekday, providing a real-time indication of the direction and magnitude of aggregate change in the employers’ payroll. Most withholding payments are for employees’ wages and salaries. However, income tax withholding also is due on salary bonuses and stock options employees receive.
PIT Withholding Down from Last Year. The graph below compares the running total of PIT withholding payments since the start of the 2022-23 fiscal year relative to the same period last year. To-date, personal income tax withholding is $575 million lower (2.2 percent) than last year. The main driver of withholding each year is statewide employment and wages. That is, when employment and wages increase, income tax withholding also tends to increase (and vice versa). With annual job growth of 4.2 percent (as of September) and similar wage growth, we would expect to see much stronger withholding growth so far this year.
Based on Recent Job Growth Alone, Would Expect Strong Growth in PIT Withholding. Based on the historical relationship between job growth and income tax withholding, we would expect income tax withholding to be 15 percent higher than last year. (At this point last year, tax withholding was up 23 percent above the prior year.) However, as shown in the figure below, income tax withholding is far below the historical relationship between withholding and job growth. The figure also highlights several other similarly off-trend years, all of which occurred following significant stock market declines.
Why Is Withholding Underperforming Relative to the Job Market? As noted above, income tax withholding also is due on bonuses and stock options employees receive. Below we present evidence suggesting that these sources of withholding have dropped sharply in recent months.
- Salary Bonuses Appear to Be Much Lower Than Last Year. Some private sector employers pay employees bonus salary at different times of the year. Some bonuses reflect the overall business climate—notably holiday and year-end bonuses—while other bonuses are based on productivity. Productivity bonuses are often paid more frequently, typically at the end of each month or quarter. So far this fiscal year, income tax withholding during the last few days of each month, when bonuses are typically withheld, is far below 2021 levels. Specifically, the figure below shows that withholding during the final week of each month is 12 percent lower this year, despite withholding from the first three weeks of each month being higher in 2022. This dynamic reflects growing employment overall but a potentially sharp drop-off in month-end bonuses.
- Initial Public Offerings (IPOs) Down Substantially from Last Year. The figure below shows the number of privately-held companies that went public each year since 1988. When a private company goes public by selling stock to regular investors for the first time, a large amount of one-time withholding often occurs. This is because many private companies pay employees with salary and equity. Equity typically comes in the form of restricted stock units (RSUs), which employees earn as they stay with the company but have no value until the company goes public. For tax purposes, RSUs are treated as supplemental income and thus subject to withholding. When the company goes public, employers hold back income tax withholding on the value of their employees’ RSUs. The drop-off in IPO activity likely has also contributed to the relatively weak withholding figures seen to-date.
While the typical share of withholding collections on bonuses and stock options is unknown, these types of incomes likely contributed to strong tax withholding growth in 2021. With those sources of income likely declining significantly, California is seeing lower withholding collections despite relatively strong employment and salary growth.