California Analyst Sees Annual Surpluses of $10 Billion

California may reach annual budget surpluses of almost $10 billion, much of it from gains in stocks, by the time higher sales and income taxes expire in 2018, the nonpartisan Legislative Analyst’s Office forecast.

The surplus outlined in a report yesterday marks a turnabout for the most-populous U.S. state, which fought $100 billion in cumulative deficits for four years ending in 2012.

The gains may allow Governor Jerry Brown, a 75-year-old Democrat, to begin building an $8 billion reserve, pay down debt and address unfunded liabilities for the second-largest U.S. pension, the California State Teachers’ Retirement System, as well as retiree health care and University of California pensions, Legislative Analyst Mac Taylor said.

“The state’s budgetary condition is stronger than at any point in the past decade,” Taylor said in the report. “The state’s structural deficit —- in which ongoing spending commitments were greater than projected revenues -— is no more.”

Brown championed a 2012 ballot measure that helped close deficits by temporarily raising the statewide sales-tax rate to the highest in the U.S. and boosting levies on income of $250,000 or more. The rate reaches 13.3 percent on those making $1 million or more, the most of any state.

Brown forecast an $817 million surplus this year, the first in almost a decade. The actual year-end surplus will be $2.2 billion, rising to $3.2 billion in the year ending June 30, 2015, and peaking at $9.6 billion in 2018, as the last of the higher taxes expire, according to the report.

Capital Gains

Income taxes, fueled by capital gains from the performance of the stock market, cover 61 percent of general-fund spending last year. Those taxes are expected to yield $66 billion this year, of which about $10 billion is attributable to capital gains, according to Jason Sisney, a deputy state legislative analyst.

The Standard & Poor’s 500 Index has gained about 25 percent this year, after a 13.4 percent increase in 2012.

The $170 billion teachers’ retirement system has a $70 billion long-term funding shortfall, according to its website. Unlike the California Public Employees’ Retirement System, the largest U.S. pension, Calstrs’ annual contributions from teachers, school districts and the state are fixed and can only change through legislation.

The state’s relative borrowing costs have declined this year as its fiscal outlook has improved.

Investors demand about 0.35 percentage point of extra yield to own 10-year California debt rather than top-rated bonds, down from a gap of about 0.6 percentage point in January, data compiled by Bloomberg show.

Phase Out

Standard & Poor’s raised the state’s credit rating to A, sixth-highest, in January, the first boost since 2006. Fitch Ratings did likewise in August. Moody’s Investors Service grades it four steps below the top.

Standard & Poor’s may raise the state’s credit rating again if lawmakers continue to exercise fiscal discipline and build a cushion against economic downturns, Standard & Poor’s analyst Gabriel Petek said by e-mail.

“It’s useful to recall that despite the recent revenue improvement, the state still does not have a rainy day fund, which makes retiring its budgetary loans and deferrals all the more important from a credit standpoint,” Petek wrote. “Repaying those loans effectively builds capacity to redeploy those as stop-gap measures in the event that an unexpected budget shortfall were to emerge.”

California had about $103 billion of gross tax-supported debt in 2012, ranking it first among U.S. states, according to Moody’s. It placed seventh on a debt-per-capita basis.

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