Updated "Big Three" Revenue Outlook

Near-Term Revenue Outlook Improved but Future Challenges Remain. Our updated forecast anticipates revenues from the state’s three largest taxes (income, corporation, and sales) are likely to come in ahead of Governor’s Budget assumptions in the current year and about in line with assumptions in the budget year. This upgraded outlook is entirely attributable to higher expectations for income tax collections, which are being driven by enthusiasm around AI and the related stock market boom. As such, we continue to caution that these surging revenues likely are not sustainable. Our revenue outlook for 2027-28 and beyond remains similar to our November Fiscal Outlook, continuing to reflect the high risk of a revenue reversal, as discussed below. Under these revenues, our Fiscal Outlook estimated that the state would face structural deficits of around $35 billion annually starting in 2027-28. In a related post, we offer guidance on budgeting decisions in light of our latest revenue forecast. 

Stock Market Boom Continues to Fuel Strong Collections. Income tax collections continue to be boosted by a roaring stock market—which has doubled since 2020 and is up 70 percent in the last three years alone. December and January income tax payments to the Franchise Tax Board (which reflect non-wage income like investment and business earnings) were up more than 50 percent from a year ago. The state has seen similar growth only a handful of times, with notable examples coming during asset price booms in 2000 and 2021.

Expect Collections to Continue to Beat Projections…Driven by this strong growth, major tax collections in December and January exceeded Governor’s Budget projections by about $6 billion. Income taxes accounted for all of these surplus collections (a portion of the income tax strength showed up under the corporation tax as elective pass-through entity taxes.) So long as current stock market conditions persist, history suggests income tax collections will continue to race ahead of budget projections. Surplus collections were commonplace during past asset price booms. May Revisions in 2000, 2006, and 2021 included revenue upgrades of $12 billion (8 percent), $8 billion (4 percent), and $42 billion (13 percent).

…Until They Don’t. History, however, offers an additional lesson: asset price fueled revenue surges do not last and typically end in a bust. Not long after the big upgrade in May 2000, revenues dropped $13 billion (18 percent) in 2001-02. After the May 2006 upgrade, revenues were flat in 2007-08 and then dropped $16 billion (17 percent) in 2008-09. After the May 2021 upgrade, revenues dropped $45 billion (21 percent) in 2022-23. Beyond these parallels, other warning signs suggest history may be set to repeat in the not-too-distant future. As we discussed in our Fiscal Outlook, several historically-reliable signals suggest the stock market currently is overheated and due for a correction. Little has changed about our assessment since then. We continue to think the risk of a revenue downturn starting in the next year or so is too great to ignore.