It is no secret that California has ridden the rollercoaster of revenue volatility for many years. The ups and downs of which are largely attributable to the state’s progressive personal income tax structure and dependency on the small, top 1% of earners’ monetary boom or bust. As we saw in 2007, capital gains represented approximately 8.9% ($10.9 billion) of California’s general fund tax revenues to quickly drop to 3.4% by 2009.¹ By 2014, California voters enacted Proposition 2 governing budget stabilization account deposits. Under the measure, the state must set aside 1.5% of general fund revenues plus a portion of capital gains revenue that exceeds a specified threshold. Until 2029-2030, the state must allocate half to increase the balance in the rainy day fund and the other half to pay down debt. Beginning in 2030-2031, the entire annual transfer will go to the budget stabilization account.²
In more recent years, unpredictability in revenues remained with the state projecting a budget deficit of $54.3 billion in 2020, to later show a record-breaking surplus of $75.7 billion in the California Comeback Plan for 2021.³ In the last audited fiscal year period ending 2021, personal income tax totaled $143.62 billion, or 62.34% of all state General Fund revenues. According to the state, General Fund personal income tax receipts for the current fiscal year (2022-2023) totaled $72.19 billion through March 31, 2023, which was 4.59% lower than anticipated in the FY2023-24 budget proposal released in January.⁴ This is, in part, due to the extension of income tax filing deadline to October, leaving the state with less assurance around budgeted revenues.
Source: Pew Charitable Trusts; Fiscal 50: State Trends and Analysis | The Pew Charitable Trusts (pewtrusts.org)
While the revenue volatilities continue to persist, the state remains buoyed by a historic level of reserves. A projected record $37.8 billion has been set aside in the 2023-2024 budget, including the state’s constitutional maximum mandatory deposit limit of 10% General Fund tax proceeds, or $22.3 billion.⁵ This follows $37.2 billion in budgetary reserves for fiscal 2022-2023 year. According to Pew Charitable Trusts, for the last five plus years, the state has held a rainy day fund balance higher than the 50-state median.
Source: Pew Charitable Trusts; https://www.pewtrusts.org/en/research-and-analysis/data-visualizations/2014/fiscal-50#ind5
Although the state’s high level of reserves continues to act as a safeguard against any potential revenue uncertainty, Governor Gavin Newsom stated, “Administration has taken steps in this (2023-2024) budget, such as not using the state’s reserves…”. The budget, instead, bridges the ~$31.7 billion shortfall by shifting funds out of General Fund and into others, reductions and delays of previously approved spending, one-time borrowing from special funds, and triggering certain reductions. While some of the band aids are a one-time fix, the Governor also vowed to protect previous commitments of education funding under Proposition 98.
Proposition 98 is a voter-approved provision in the State’s Constitution directing money to be set aside first to be applied for public school and higher education support, prior to general obligation bond payments from the State General Fund. According to the State’s website, “Proposition 98 Guarantee reflects a total of $110.6 billion in 2021-22, $107.3 billion in 2022-2023, and roughly $108.3 billion in 2023-24.”⁴ This guarantee, backing the priority payment of K-12 public-school bonds, outweighs the state’s full faith and credit general obligation pledge. While the Proposition 98 funding requirement will be tied directly to revenues, meaning lower requirements when lower revenues received, APA still finds value in the state’s school bonds as a great alternative to the state’s highly rated general obligation bonds. The local school districts not only offer additional security of priority payment but also bring more issuer diversity within our clients’ portfolios.
California issuance year-to-date, stands at only $36.4 billion, compared to their previous six-year average of over $65.1 billion, on trend for a net-negative supply by year end for the state. This is ahead of the state’s record $2.6 billion general obligation bond sale pricing this week. Although Moody’s recently placed their Aa2 rating on negative watch, we expect the large new issue deal to get absorbed by individuals in the state that are still hungry for tax-free income, in addition to many other general market participants that will take advantage of the highly liquid name at a slight spread concession.
Source: Bloomberg, APA
Sources:
1. RevenueEstimates.pdf (SECURED) (ca.gov) https://ebudget.ca.gov/2020-21/pdf/BudgetSummary/RevenueEstimates.pdf
2. Guide to the California State Budget Process - California Budget and Policy Center (calbudgetcenter.org) https://calbudgetcenter.org/resources/a-guide-to-the-california-state-budget-process/
3. California Roars Back: Governor Newsom Signs $100 Billion California Comeback Plan to Accelerate State’s Recovery and Tackle Persistent Challenges | California Governor https://www.gov.ca.gov/2021/07/12/california-roars-back-governor-newsom-signs-100-billion-california-comeback-plan-to-accelerate-states-recovery-and-tackle-persistent-challenges/
4. April 2023 California Personal Income Tax Daily Revenue Tracker https://sco.ca.gov/2023_personal_income_tax_tracker.html
5. Introduction.pdf (SECURED) (ca.gov) Enacted Budget, https://ebudget.ca.gov/2023-24/pdf/Enacted/BudgetSummary/Introduction.pdf