Recovering U.S. State Budgets Run Headlong Into Stock Declines

  • Correction May Pinch Income Taxes, 31% of Their Revenue
  • California Already Forecast 9% Drop in Capital-Gains Tax Money

The gradual recovery of U.S. state budgets, which collectively anticipated 3.1 percent more revenue this year, may be reversed by stock market declines that imperil income taxes, their largest source of money.

Since 2011, states have been restoring education, health care and other programs slashed during the recession, and the trend was forecast to continue this year, according to the National Association of State Budget Officers in Washington.

Monday’s 3.9 percent decrease in the Standard & Poor’s 500 Index, continuing the index’s worst downturn since the financial crisis in 2009, spells trouble for states like California whose reliance on capital-gains taxes makes them vulnerable to swings in equity markets. The market correction comes after a rout in oil prices that has stung states including Alaska and Texas that rely on revenue from petroleum production.

“Before the last week-and-a-half or so, states have been in the best relative fiscal health since the end of the Great Recession,” said Arturo Perez, fiscal program director for the National Conference of State Legislatures in Denver. “This is a big game of wait-and-see.”

In surveys of fiscal officers from all 50 states conducted between February and April, the budget officers group found that states were expecting to spend 3.1 percent more in the year that began July 1, a slower rate of growth than the 4.6 percent in the year that ended June 30.

U.S. stocks fell the most in almost four years after China unexpectedly devalued the yuan Aug. 11, which raised concerns about the depth of the the slowdown in the world’s second-largest economy. The slump in Chinese equities hammered emerging-market assets and sank commodities from oil to metals.

The state with the most at stake may be California, where slumping income tax collections during the recession in 2009 led to credit downgrades by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings, pushing the most-populous state to the ratings basement. California is uniquely vulnerable because more than 11 percent of revenue last year came from taxes on capital gains, the highest proportion in the country, according to its Finance Department.

Still, Democratic Governor Jerry Brown’s budget advisers aren’t panicking. In fact, they saw it coming.

In May, as Brown counted on “slow but steady” growth in the global economy to boost funding for schools, health care for the poor and emergency drought response, his Finance Department noted the prospect of a stock-market correction and slowdowns in China and Europe.

“We telegraphed this back in the spring,” said H.D. Palmer, spokesman for Brown’s Finance Department. “Predating the market correction in the last several days, we’d already predicted a moderation in capital-gains revenue.”

California took in $12.7 billion in taxes on capital gains in the year ended June 30 and predicts $11.66 billion this fiscal year, a decrease of 8.5 percent. The state anticipates increased income-tax collections generally, as well as increases in the other two major revenue sources: taxes on sales and use, and on corporations.

The market plunge shows the value in relying on conservative assumptions given the state’s reliance on income taxes driven by market gains, said Gabriel Petek, a credit analyst at Standard & Poor’s in San Francisco.

“The market correction that we’re seeing is a harsh reminder California’s revenue base is susceptible to that,” Petek said. “Until they can somehow reduce their reliance on capital gains related tax revenues, they will be better off looking at that from a cautious standpoint.”

Last year, California voters approved a measure to increase the amount of money in the rainy-day account, with $2 billion in capital-gains proceeds during good years earmarked for that purpose. The account now has about $3.6 billion, Palmer said.

“This uncertainty about whether an economic downturn is upon us or still over the distant horizon vindicates California’s push to build a fiscal shock absorber,” Treasurer John Chiang said in an e-mailed statement.

A dip in revenue on Wall Street could weigh on New York’s budget, which in fiscal 2014 raised about $13.2 billion, or about 19 percent of total collections, from corporate and personal income levies on Wall Street firms and their workers. 

The budget for the fiscal year that ends March 31 anticipates a 5.8 percent increase in personal income-tax revenue after it increased 3.2 percent in fiscal 2015. Corporate tax growth, which includes bank taxes, was projected to be almost flat.

Morris Peters, a spokesman for Democratic Governor Andrew Cuomo’s budget division, declined to comment on the potential effect of the market’s decline on the budget.

In Texas, the nation’s largest oil producer, it’s becoming harder to ignore the downward march of prices. In June, state sales-tax revenues were down year over year for the first time in 62 months, according to Chris Bryan, spokesman at the Comptroller’s office. Last month, sales-tax revenue was back up, but only slightly.

“We are definitely seeing a pullback and a slowdown,” said Bryan. “There is an element of a ripple effect if you’ve got folks out of work who were pulling in a good salary on the rigs. They’re not going out to eat; they’re looking to tighten their belts.”

Still the state is much less reliant on the oil and gas industry compared with the 1980s, when as bust caused a statewide recession. Also, the lower prices are offset by production levels that have increased or stayed the same in recent months, according to the Texas Railroad Commission, which oversees the industry.