Newsom’s big plan relies on uncertain revenues

The most important section of the budgets that California governors propose — an initial one in January and a revised version in May — is a chart that projects revenues from major tax sources.

The chart’s numbers are the financial basis for what the governor wants to do over the forthcoming fiscal year and several years to follow.

The latest such chart, found on page 218 of Gov. Gavin Newsom’s revised budget, estimates that personal and corporate income taxes and sales taxes will generate $172.2 billion during the current year that ends on June 30, a whopping $33 billion increase from the previous year.

The chart also projects that the tax systems will produce another $170.4 billion in the 2021-22 fiscal year, growing to $181.3 billion in 2024-25.

The projections support Newsom’s “$100 billion California Comeback Plan” that he says will erase pandemic blues and bring prosperity and equity to the state, using surplus state funds and $27 billion in pandemic relief aid from the federal government.

The Legislature, dominated by Newsom’s fellow Democrats, is certain to enact his plan to sharply boost state spending on hundreds of new or expanded services and benefits, albeit with a few tweaks, thus endorsing his assumption that the money will be there when it’s time to spend it.

But will it be?

Tax revenue estimates are just educated guesses and California’s governors have a history of badly missing the markers they lay down. Our tax systems are notoriously volatile, making accurate forecasting difficult.

A look at recent revenue projections illustrates the syndrome.

Two years ago, before COVID-19 hit, Newsom’s budget expected revenues of $145.5 billion in the current 2020-21 fiscal year. One year ago, after the pandemic had struck and Newsom had ordered thousands of businesses to close, his May revision dropped that projection to $116.4 billion. But now it’s been boosted up to $170.4 billion.

Those are particularly wide swings, but we’ve seen similar, if less dramatic, versions in years and decades past. The volatility and unpredictability are almost entirely due to personal income taxes, which supply about 70% of the state’s general fund revenues.

Nearly half of those income taxes come from the top 1% of taxpayers, much of whose incomes are capital gains, making the budget highly dependent on predicting how their portfolios of stocks and other assets will perform.

Over the years, as income taxes and particularly taxes on the wealthy have provided ever-increasing shares of the revenue stream, volatility has increased. Twelve years ago, a blue ribbon commission appointed by then-Gov. Arnold Schwarzenegger and the Legislature recommended a major overhaul of the tax system to make it more predictable, but its report was ignored.

When Jerry Brown became governor, he championed the creation of a “rainy day fund” to soak up some surplus revenues and be available to cushion the impact of any unexpected economic downturn. The emergency fund was tapped last year, although it turned out the money was unneeded when revenues surprisingly ballooned as the incomes of the wealthy increased sharply despite the recession.

Reserves are a prudent tool, but they remain small in relation to the huge potential revenue swings that the governor’s prognosticators are unable to reliably predict because of the state’s lopsided revenue system.

The Legislature’s budget analyst, Gabe Petek, wisely suggests that Newsom and the Legislature spend less of the windfall and sock away more in reserves. However, with Newsom facing a recall election and legislators in a spending mood, they will likely commit the state to tens of billions of dollars in new spending with their fingers crossed.