Analysis of the 2008-09 Budget Bill: Perspectives and Issues

Perspectives on State Revenues


As discussed in “Part II” of this volume, significant economic slowing occurred in 2007 and very subdued economic performance is expected for the nation and state in 2008 and 2009. Given this, as shown in     Figure 1 , very modest revenue growth occurred in 2006–07 and is forecast for the remainder of 2007–08 and 2008–09. As a result, the Governor’s budget forecasts that underlying revenues for these three years are down by a combined $9.3 billion from what was forecast in the 2007–08 Budget Act. To partially offset this weakness in state income, the administration has proposed $5.5 billion in additional revenues, largely from borrowing and accounting changes. This leaves the administration’s revenues down $3.8 billion from what was projected at the time the 2007–08 budget was enacted. Our own estimate of revenues is down another $1.5 billion from the budget forecast.

Budget's Underlying Revenue Growth to be Modest

In this part, we provide background information relating to the revenue outlook, discuss recent revenue developments, summarize the budget’s revenue projections, and present our own revenue forecast.

The Budget’s Forecast for Total State Revenues

The 2008–09 Governor’s Budget projects that California state government will receive $129.8 billion in revenues in 2008–09. These revenues are deposited into either the General Fund or a variety of special funds. Figure 2 shows that:

State Revenues in 2008-09

As the figure shows, some revenues—namely, personal income and sales tax receipts—support both the General Fund and special funds.

Sources of General Fund Revenues. Figure 2 also indicates that about 95 percent of total General Fund receipts in the budget year are attributable to the state’s “Big 3” taxes—the personal income tax (PIT), the sales and use tax (SUT), and the corporation tax (CT). The remainder is related to a variety of smaller taxes (including insurance, tobacco, and alcoholic beverage taxes), investment earnings, tribal gambling compacts, state lands’ royalties, fees, and various transfers from special funds.  

Proposed Revenue–Related Changes

Although the budget does not include any significant tax changes to help deal with the budget problem, it does contain several proposals that would have significant impacts on state General Fund revenues. As shown in Figure 3, these proposals would generate roughly $5.5 billion in 2007–08 and 2008–09, and include:


Figure 3

2008-09 General Fund Revenue Changes
Proposed in the Governor's Budget

(In Millions)


Fiscal Impact





Sale of Deficit-Financing Bonds


Accrual Change




Personal Income Tax



Corporation Tax






Enforcement and Revenue-Enhancing Measures



Use Tax




One-year test for Vessels, Vehicles, and Aircraft









The Budget’s General Fund Revenue Outlook

The updated budget forecast assumes that underlying General Fund revenue growth (that is, growth after adjusting for the proceeds of the deficit–bond sale and accrual change) will be modest in both 2007–08 and 2008–09, as it was in 2006–07. The budget’s General Fund revenue projections are summarized in Figure 4.


Figure 4

Summary of the Budget's
General Fund Revenue Forecast

(Dollars in Millions)







Actual 2006-07

Estimated Amount

Percent Change


Projected Amount

Percent Change








Personal income







Sales and use




























Other Revenues, Transfers, and Loans




Deficit-financing bond



Other revenues




















    Detail may not add due to rounding.


2006–07 Actual. The budget shows that 2006–07 General Fund revenues and transfers totaled $95.9 billion, a 2.6 percent increase from 2005–06. This revised estimate is down $125 million from the level assumed in the 2007–08 Budget Act. This decline relative to the budget act is the net result of a variety of factors, including accrual adjustments by the State Controller and “settle–up” transfers from the General Fund to the Mental Health Fund relating to Proposition 63 (November 2004).  

2007–08 Estimate. The administration’s forecast assumes that current–year General Fund revenues and transfers will be $100.8 billion, a 5.1 percent increase from the prior year. Although this growth rate reflects the revenue–reducing effects of such economic factors as a slowdown in profits, taxable spending, and capital gains, it also is buoyed by the $3.3 billion in proceeds from the sale of additional deficit–financing bonds. Absent this one–time factor, the underlying growth rate is a very modest 1.6 percent. The revised current–year revenue figure is down $1.5 billion from the 2007–08 Budget Act.

2008–09 Forecast. The budget forecasts that budget–year General Fund revenues and transfers will be $102.9 billion, a 2.1 percent increase from 2007–08. After adjusting for one–time factors in both the current and budget years (the deficit–financing bonds and revenue accrual change), the underlying growth rate is about 3.5 percent. The revised budget–year revenue figure is down $2.2 billion from that assumed in the 2007–08 Budget Act.

The LAO’s General Fund Revenue Outlook

We Expect Lower Revenues—Down $1.5 Billion

Figure 5 shows our projections of General Fund revenues for 2007–08 through 2009–10. These projections are based on our economic and demographic forecasts presented in “Part II” of this volume and incorporate the impacts of the Governor’s revenue–related policy proposals. For the current and budget years combined, we are estimating that General Fund revenues will fall below the budget forecast by $1.5 billion. We specifically forecast that:


Figure 5

Summary of the LAO's General Fund Revenue Forecast

(Dollars in Millions)









Actual 2006‑07


Percent Change



Percent Change



Percent Change











Personal income










Sales and use








































Other Revenues, Transfers, and Loans







bond proceeds




Other revenues




























      Detail may not total due to rounding.


Consistent with the soft growth we are projecting for such key revenue–determining variables as taxable sales, corporate profits, and capital gains, our underlying revenue growth rates for each of the years are below our estimate of the change in statewide personal income.

Key Factors Underlying Our Lower Estimates

Deterioration in the Economy. The single most important factor explaining our lower revenue estimates is that economic conditions at both the national and state levels have deteriorated since the budget’s estimates were put together. As discussed in the following pages, this has reduced our projections for all key revenue–determining economic variables.

Mixed, Though on Balance Negative, Recent Revenue Receipts. The budget forecast is largely completed by the administration in early December, prior to when key information about year–end economic and revenue activity becomes available. Especially important is the strength of the PIT and CT estimated and miscellaneous tax payments that come in just before the end and right after the start of the calendar year. The performance of these payments has often been an early indicator of the strength of final PIT and CT payments remitted in the upcoming spring. The year–end December receipts include estimated and other payments made before 2007 ends in order to qualify for being deducted on 2007 federal PIT and CT tax returns. January revenues include the remainder of estimated payments on 2007 PIT liabilities, due on the 15th of that month. For 2007–08, the budget’s projected revenue collections for these two months was very substantial—over $20 billion. The available information, as of this writing, indicates that the performance of these recent revenue receipts and the SUT, while mixed, was on balance negative:

Although only time will tell if the department is correct, Figure 6 shows that the size of the administration’s CT receipts expected in March is very large compared to recent years, and thus an optimistic assumption.

Optimistic Assumption for March 2008 Corporate Tax Payments

Lower Estimate for Tribal Gambling Revenues. The administration is assuming $584 million in revenues from tribal gambling compacts in the current and budget years combined, primarily from the amended compacts approved by the voters earlier this month. We believe this amount is optimistic, by $173 million. This results from using more realistic assumptions than the administration about both the speed with which new slot machines would be put in place and the amount of revenues generated per machine.

Interest Income and Oil–Related Differences. As discussed later, we also are lower than the administration for interest income on invested General Fund balances, but higher on state lands’ royalties. When these partially offsetting factors are combined with the tribal gambling difference above, we are down on these three items from the administration for the current and budget year combined by $61 million.

The LAO’s Forecast for Major Revenue Sources

As indicated above, the great majority of General Fund revenues are attributable to the state’s three major taxes—the PIT, SUT, and CT. The performance of these taxes will have a dominating influence on the overall  revenue outlook. In the following sections, we discuss in more detail recent developments and the outlook for each of these key revenue sources.

Personal Income Tax


The PIT is, by far, the state’s largest revenue source, accounting for 55 percent of total estimated General Fund revenues in 2008–09. In general, the PIT is patterned after federal law with respect to reportable types of income, deductions, exemptions, exclusions, and credits. Under the PIT, taxable income is subject to marginal rates ranging from 1 percent to 9.3 percent, with the top rate applying to taxable income in excess of $89,628 for joint returns in 2007 (or $44,814 for taxpayers filing single returns). An additional 1 percent rate is imposed on the portion of incomes in excess of $1 million (for a total marginal rate of 10.3 percent for affected taxpayers). The proceeds of this surcharge, which was implemented following approval of Proposition 63 in November 2004, are allocated to a special fund to support various mental health programs. California also imposes a PIT Alternative Minimum Tax (AMT) of 7 percent along the lines of the federal AMT.

PIT Revenue Forecast

We forecast that PIT receipts will total $53.0 billion in 2007–08, a 2 percent increase from the prior year. We also forecast that PIT receipts will increase by 5.7 percent, to $56.0 billion, in 2008–09 and by an additional 5.2 percent, to $58.9 billion, in 2009–10. Compared to the budget forecast, our current projection of PIT revenues is up by $284 million in the current year and down by $491 million in 2008–09, or below the administration by $208 million for the two years combined.

Key Forecast Factors

The main determinants of PIT collections in a given fiscal year are the annual tax liabilities for the two income years falling within the fiscal year, any special adjustments that have to be made to these liabilities, and the timing of the cash payments associated with them. The latter include withholding, quarterly estimated payments, final payments, and refunds.

As noted at the outset, our forecast is based on the Governor’s policies. Therefore, our revenue estimates assume the Governor’s proposal to accrue a portion of the revenues associated with the September 2009 PIT prepayment into 2008–09, and to continue this thereafter. This increases our 2008–09 revenues by somewhat over $1 billion. Without this accrual change, PIT revenue growth in 2008–09 would be much lower—less than 4 percent.

We also include in our projections the administration’s adjustments totaling $74 million for the various PIT revenue–generating tax enforcement and compliance activities by FTB that the Governor has proposed.

Lastly, our projections, like the administration’s, include transfers out of the General Fund of PIT revenues equal to a bit over $400 million in both 2007–08 and 2008–09, to settle–up the Proposition 63 amount due to the Mental Health Fund.

Liability Growth. Figure 7 shows that, after growing quite rapidly in both 2004 and 2005, PIT liability growth eased in both 2006 and 2007 to under 5 percent. These reduced growth rates are consistent with the slowing in California’s economy and the state’s housing market downturn. These developments have especially taken a toll on real estate–related profits and capital gains. For example, we estimate that, after booming by 60 percent in 2004 and over 45 percent in 2005, capital gains grew by only 4 percent in 2006 and were flat in 2007. This, in turn, has had a magnified negative effect on California’s PIT liabilities, since business–related profits and capital gains tend to accrue to high–income taxpayers, which are subject to California’s top income tax rates.

Modest PIT Liability Growth Forecast

We project that PIT liability growth will drop to below 3 percent in 2008 when the economy will be at its weakest, before rising back to 5 percent in 2009. An important element in our forecast is our outlook for capital gains and stock options. Together, these items totaled close to $160 billion and accounted for more than $14 billion in PIT liabilities in 2006. Figure 8 shows that while we do not expect a major decline in their combined amount in the following three years, they will be fairly flat.

Capital Gains and Stock Options-Little Growth

Sales and Use Tax


The SUT is the General Fund’s second largest revenue source, accounting for 28 percent of estimated total revenues in 2008–09. The main SUT component is the sales tax, which is imposed on retail sales of tangible goods sold in California. Some examples of sales tax transactions include spending on clothing, furniture, computers, electronics, appliances, automobiles, and motor vehicle fuel. Purchases of building materials that go into the construction of homes and buildings are also subject to the sales tax, as are purchases of computers and other equipment used by businesses. The largest exemption from SUT is for most food items consumed at home. The great majority of services are not directly subject to the sales tax in California.

The second component of the SUT—the use tax—is imposed on products bought from out–of–state firms by California residents and businesses for use in this state. With the exception of purchases of vessels, vehicles, and aircraft (which must be registered), out–of–state purchases are difficult to monitor, and the state is prohibited under current federal law from requiring most out–of–state sellers to collect the use tax for California. As a result, use tax receipts account for only a small portion of total SUT revenues. 

SUT Rates

The total SUT rate levied in California is a combination of several different individual rates imposed by the state and various local governments. These include:

Combined SUT Rates Throughout California. The combined state and local SUT rate varies significantly across California due to differences in the local optional rates that are levied (see Figure 9). The combined SUT rate currently ranges from 7.25 percent (for those counties with no optional rates) up to 8.75 percent. On a weighted–average basis, calculated using the amount of taxable sales in different counties and their respective SUT rates, the statewide rate is currently 7.94 percent.

Sales Tax Rates Vary by County

SUT Revenue Forecast

We forecast that SUT receipts will total $27.5 billion in 2007–08, a weak 0.3 percent increase from the prior year. Revenues from this source are projected to increase to $29.0 billion in 2008–09 (up 5.4 percent from the current year) and to $30.4 billion in 2009–10 (a 4.7 percent increase). Compared to the budget forecast, our SUT revenue estimate is down $160 million in 2007–08 and by $202 million in 2007–08, for a two–year shortfall of $362 million.

Key Forecast Factors

The key factors behind our forecasted General Fund SUT collections are (1) modest increases in taxable sales and (2) large amounts are deposited in transportation–related special funds.

Taxable Sales. Figure 10 shows that taxable sales generally experienced strong growth in 2004 and 2005, but slowed sharply in 2006 as the economy started decelerating. Then, in 2007, growth dropped to only 0.8 percent. This deterioration has been especially driven by the decline in California’s real estate market and its adverse impact on sales of building materials, home furnishings, and related household items. However, it also is related to the negative impacts of higher gasoline prices on consumer spending on big–ticket items, particularly light vehicles sales (cars, smaller trucks, and SUVs). California also appears to have experienced a fairly soft holiday shopping season, which added to the underlying weakness related to housing and autos.

Taxable Sales Growth to Trail Personal Income

We expect that taxable sales growth will be a modest 3.6 percent in 2008, with the first one–half of the year especially weak. Then, we forecast that taxable sales growth will pick up a bit in 2009, averaging 3.8 percent, as the housing market continues to stabilize. As Figure 10 indicates, we expect taxable sales growth to trail growth in personal income in both years. Our taxable sales forecasts consider the effects of a variety of factors including personal income, housing activity, employment, the savings rate, unemployment, general inflation, and gasoline prices and consumption.

Public Transportation Account (PTA)–Related Revenues. A second factor depressing sales tax revenues to the General Fund in the current and budget years is a large and growing amount of revenues from gasoline and diesel fuel sales tax that goes to the PTA instead of the General Fund. These revenues include the so–called spillover of SUT revenues, gasoline sales tax revenue associated with Proposition 111, and diesel sales tax revenues. Currently, the largest of these items, the spillover, is based on a formula established in the early 1970s that basically compares taxable sales of gasoline to taxable sales of all other products. (This formula was established at the time California extended the SUT to gasoline sales and in exchange reduced the SUT rate, with the aim of the formula being to ensure that any extra monies raised by this action would go to transportation.) Under this formula, the transfer increases when the share of total taxable sales that is attributable to gasoline increases. Thus, it is sensitive to both gasoline prices and consumption. In practice, the spillover has tended to increase during periods of high gasoline prices, and decrease, or disappear, during periods of low gasoline prices. We forecast that PTA–related SUT revenues totaled $947 million in the prior year and will reach $1,137 million in 2007–08 and $1,247 million in 2008–09. These amounts are based on our forecasts for taxable sales and the prices and consumption of fuel. (As we discuss in a write–up in the Analysis of the 2008–09 Budget Bill, beginning in 2008–09, one–half of all spillover will be used each year to offset General Fund expenditures on transportation. Please see “Funding for Transportation Programs” in the “Transportation” chapter of the Analysis.)

Other Adjustments. Our SUT forecast also includes $58 million in budget–year revenues for the various SUT revenue–generating tax enforcement and compliance activities by BOE that the Governor has proposed. In addition, it includes revenues of $5 million in 2007–08 and $21 million in 2008–09 due to the Governor’s proposal to reinstate the 12–month rule for applying the use tax to out–of–state purchases of vessels, vehicles, and aircraft.

Corporation Tax


The CT is the third largest state revenue source, accounting for 12 percent of total estimated revenues in 2008–09. The tax is levied at a general rate of 8.84 percent on California taxable profits. Banks and other financial institutions subject to the CT pay an additional 2 percent tax, which is in lieu of most other state and local levies. Corporations that qualify for California Subchapter “S” status are subject to a reduced 1.5 percent corporate rate. In exchange, the income and losses from these corporations are “passed through” to their shareholders where they are subject to PIT. Similarly, businesses that are classified as Limited Liability Companies (LLCs) pay a minimum tax and fee at the corporate level. Their income and losses are passed through to their owners, where they are subject to the PIT. California also imposes a corporate minimum tax and a 6.65 percent AMT.

Approximately two–thirds of all CT revenues come from multistate and multinational corporations. These companies have their consolidated U.S. income apportioned to California based on a formula involving the share of their combined property, payroll, and sales that is attributable to this state.

California’s CT allows for a variety of exclusions, exemptions, deductions, and credits, many of which are related to, similar to, or identical to those provided under the federal corporate profits tax. Key examples include the research and development (R&D) tax credit and net operating loss carry forward provisions. Under the latter, companies can use operating losses incurred in one year as a deduction against earnings in subsequent years. Under legislation enacted in 2002, corporations were not able to use these losses to offset their income in tax years 2002 and 2003. However, such deductions were allowed again beginning in 2004, and the percentage of losses which may be carried forward and deducted against future tax liabilities jumped from 65 percent under prior law to 100 percent for losses incurred starting in 2004. In “Part V” we propose limiting allowable net operating loss deductions again, as well as R&D credits that may be claimed, to help deal with the budget problem.

Revenues Have Been Slowing. After many years of near–stagnant growth, revenue collections from the CT grew rapidly between 2001–02 and 2005–06. In 2006–07, however, growth slowed to around 8 percent, as corporate profits started to slow along with the economic activity generally.

CT Revenue Forecast

We forecast that CT receipts will be $10.3 billion in 2007–08, an 8 percent drop from the prior year. Thereafter, we forecast that revenues will grow to $11.5 billion in 2008–09 (a 12 percent increase) and remain at that level in 2009–10.

Our estimates take into account our projected changes in taxable business profits, as well as such factors as tax credits and audit collections. Our CT forecast also includes $14 million in budget–year revenues for the various CT revenue–generating tax enforcement and compliance activities by FTB that the Governor has proposed. Finally, as for the PIT, our revenue estimates assume the Governor’s proposal to accrue a portion of the revenues associated with the September 2009 CT prepayment into 2008–09, and to continue this thereafter. This latter factor increases our 2008–09 revenues by a bit over $760 million. Without this accrual change, our CT revenue growth in 2008–09 would be much lower—about 5 percent.

Our CT revenue forecast is below the budget estimate by $422 million for the current year and $403 million for the budget year, or $825 million for the two years combined.

Key Forecast Factors

The key determinant of CT tax revenues is California taxable profits. As shown in Figure 11, these profits were up by a strong 25 percent in 2004 and 22 percent in 2005, reflecting widespread earnings increases. Profits growth then started to drop off, coming in at a still healthy, but much slower, 8 percent in 2006 as the economy started to cool and the housing market’s problems started to emerge. In 2007, as these trends continued, profits growth slowed sharply to an estimated 4 percent.

Weakness in California Corporate Profits Expected

Further Profits Slowing Expected. Looking ahead, we forecast that taxable California corporate profit growth will deteriorate even more and experience an actual decline in 2008 of 3 percent, before returning to a modest growth of 4 percent in 2009 off of this lower base. Although some industry sectors will continue to experience gains, many others will not—especially those relating to the housing sector, real estate–related financial activities, manufacturing operations providing home construction materials, and financial firms associated with the mortgage market’s problems. Our California profits forecast considers the impacts of such factors as national profit trends (given that so many of our firms are multinational and multistate enterprises), proprietor’s income (which is closely related to profits and for which very timely data are available), employment activity, and financial market performance such as stock market developments.

Other Revenues and Transfers

The remaining 5 percent of total 2008–09 General Fund revenues and transfers consists primarily of taxes on insurance premiums, alcoholic beverages, and tobacco products. It also includes interest income; tribal gambling receipts; oil–related royalties; and a large number of fees, loans, and transfers.

We forecast that combined revenues from all of these other sources will rise from $5.3 billion in 2006–07 to $9.1 billion in 2007–08, before falling to $5.8 billion in 2008–09 and $5.4 billion in 2009–10. These totals and their year–to–year variation are affected by a variety of factors, some of a unique one–time nature and others of a more ongoing nature. Relative to the administration, our revenues in this category are down $637 million in the current year but up $553 million in the budget year, or down $84 million for the two–years combined.

Deficit–Financing Bonds— $3.3 Billion Included in the Revenue Totals

As noted earlier, 2007–08 revenues include $3.3 billion in one–time deficit–financing bond proceeds that will be used to help address the budget problem. These proceeds, which are borrowed money and not revenues in the true sense, are nevertheless included in the revenue totals for budgetary accounting purposes.

Insurance Taxes—Moderate Growth

This is the state’s fourth largest individual revenue source and involves a tax of 2.35 percent on most types of insurance premiums written. We project that revenues will reach $2.1 billion in 2007–08, $2.3 billion in 2008–09, and $2.4 billion in 2009–10. This moderate growth reflects steady increases in taxable insurance premiums for homeowners, automobiles, and other types of coverage, partially offset by declines for workers’ compensation. The projections include downward adjustments to revenues of $175 million in 2007–08 and $100 million in both 2008–09 and 2009–10 associated with a BOE appeals case. For the current and budget years combined, our projections are very close to the administration‘s—down $15 million.

Interest Income—Downward LAO Adjustment

We project that the interest income the state will receive from investing its idle funds on a short–term basis will be $478 million in 2007–08 and $420 million in 2008–09. This compares to $533 million in 2006–07. The drop reflects the combination of (1) declining interest yields earned on the state’s invested funds and (2) the state’s tighter fiscal situation, which affects its fund balances available to invest at any given time. For the current and budget years combined, our projections are down $104 million compared to the administration.

Tribal Gambling Proceeds—Also Overstated

The Governor’s budget assumes that tribal gambling compact payments to the General Fund will total $154 million in 2007–08 and $430 million in 2008–09. (The 2008–09 figure does not include $40 million of tribal payments to be transferred to the account that distributes funds to non–compact tribes.) We believe that these estimates are overstated. The administration has assumed that five Southern California tribes—including the four tribes affected by the recent approval of Propositions 94, 95, 96, and 97—grow their casinos’ customer bases and expand slot machine operations much more rapidly than we expect to be the case. For the current and budget years combined, we estimate that General Fund compact revenues will be below the budget forecast by $173 million.

State Lands Royalties—Upward LAO Adjustment

These monies, which largely represent the proceeds the state receives under profit–sharing agreements with the oil field operators, are projected to total $320 million in 2007–08 and $304 million in 2008–09 and thereafter. This high level of revenues compared to earlier years reflects the recent rise in world crude oil prices and, thus, the value of the oil that our properties produce. For the current and budget years combined, our projections are up $217 million above the administration‘s. This reflects an updated revenue projection by the State Lands Commission since the budget came out to capture the effects of recent oil price increases.

The Budget’s Forecast for Special Funds Revenues

Special funds revenues are related to a variety of sources:

Modest Underlying Growth Expected

As shown in Figure 12, the Governor’s budget assumes that special funds revenues will total $25.3 billion in the current year (a 2 percent increase) and $26.9 billion in 2008�09 (a 6.4 percent increase). A variety of


Figure 12

Summary of the Budget's
Special Funds Revenue Forecast

(Dollars in Millions)













Motor Vehicle Revenues







License fees (in lieu)







Fuel taxes







Registration, weight and
miscellaneous fees














Sales and Use Tax














Deficit-financing bonds





















Other Sources







Personal income tax







Cigarette and tobacco taxes







Interest earnings







Other revenues







Transfers and loans













   Detail may not total due to rounding.


factors are affecting the year–to–year growth rates, including varying amounts of sales tax spillover revenues going to transportation and other transfers between funds. Special funds revenues from ongoing tax sources are projected to increase by roughly 4 percent in 2007–08 and 7 percent in 2008–09. The budget–year growth rate reflects moderate increases in SUT and PIT special funds tax revenues, and modest increases in vehicle license fees, motor vehicle fuel taxes, and tobacco taxes.

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