Surplus Gives State Choices in Spending

New highways or tax cuts. School buildings or tuition breaks. Let the grand debate begin.

For Gov. Gray Davis and the California Legislature, lack of available money is no longer an excuse for lack of spending on key projects or cutting taxes, or both.

A projected tidal wave of $9 billion in new state revenue since the close of the 1998-1999 fiscal year, mostly from capital gains and stock options in California’s dot-com economy, is expected to produce a surplus unprecedented since the late 1970s, when Gov. Jerry Brown was at the helm and the late Jesse Unruh was state treasurer.

“If those highways really are serious to us,” said Stephen Levy, director of the Center for Continuing Study of the California Economy in Palo Alto, “we now have the opportunity to build them. On the other hand, we really can afford a tax cut if we want to go that direction.”

But how much can the state continue to depend on the windfall it’s reaping from high-tech public stock offerings and capital gains trading of Internet stocks? Recent statistics show the market value of Internet stocks at more than $1 trillion for companies that recorded only $29.5 billion in sales and a profit of negative 3.4%.

Economists say that the state’s new good fortune is part of a brave new world they don’t fully understand. What happens if the vertiginous NASDAQ index, trading arena for most of the high-flying high-tech stocks, suddenly swoons? And how does government adjust to the new way that Californians are being compensated through stock options and other means?

The independent state legislative analyst, Elizabeth G. Hill, reported recently that capital gains and stock options accounted for 5% to 10% of all state personal income tax revenue, up from almost nothing only a decade ago.

“California is flush,” Davis said in unveiling his record $88.1-billion budget earlier this month.

A few days later, Hill forecast an additional $2.9 billion in revenue for the prior and current year. Some economists predict that when revised figures are released in May the number will vault even higher.

Because of automatic budgeting requirements, such as the 40% slice for education required by law, some of the new money is already obligated. But Democrats and Republicans agree that $3 billion to $5 billion will be left for discretionary spending.

Once-in-a-Lifetime Opportunity Seen

“This is a tremendous opportunity and it is never going to come again in our lifetime,” said Senate Republican Caucus Chairman Jim Brulte (R-Cucamonga). “These kind of resources were unimaginable only five years ago. If we fail to use them responsibly, we should all be run out of office.”

Brulte and other Senate Republicans have proposed using the money in a series of one-time and ongoing expenditures for education, transportation infrastructure and tax cuts.

In his budget proposal, Davis squirreled away some of the money in reserves and legal contingency funds. The Democratic governor, who presents himself as a fiscal conservative, also favors one-time, pay-as-you-go expenditures.

Other officials, ranging from Assembly Speaker Antonio Villaraigosa to state Controller Kathleen Connell, have their own ideas of what to do with the money. One capitol staffer compared the moment to finding a $20 bill in the gutter:

“What do you do with this money? Spend it on a new hat, a one-time expenditure, or take out a subscription to cable TV and hope you find another $20 bill?”

In fact, how to handle this state bounty will be the center of debate in the Legislature in coming months, leading up to the adoption of the fiscal 2001 budget this summer.

But while the debate is joined, there is no doubt about the source of California’s suddenly bulging state coffers. The last time the state had what former Speaker Unruh described as an “obscene surplus,” it was produced not by the stock market but by a combination of double-digit inflation and rapidly rising wages.

According to the Finance Department, capital gains on California tax returns quadrupled from 1995 to 1999, reaching nearly $80 billion last year. State tax revenue from that income was estimated at more than $6 billion.

Revenue from stock options--an increasingly popular way to compensate workers--is more difficult to calculate. By examining the annual reports of companies with large stock option programs, however, the legislative analyst came up with an estimate of 5% to 10% of total personal income tax receipts, or $1.8 billion to $3.6 billion.

Combining the two growing sources of revenue accounts for all or nearly all of the extra $9 billion the state is expected to receive by the end of the next fiscal year. Without that money from the stock market, state revenues probably would be flat.

Capital gains and money from cashed-in stock options are taxed as personal income. As recently as 1994, the state’s revenues from sales and income tax were about equal at $17 billion. But by 2001, personal income tax revenue is expected to top $36 billion--double what it was only five years ago and $13 billion more than what the state will receive from sales taxes.

In addition, because the dot-com culture has made thousands of Californians into paper millionaires, it gives them more confidence to spend, boosting the state’s sales tax receipts.

Todd Carter, director of investment banking at San Francisco-based Robertson Stephens, which last year raised $4.5 billion in 62 public offerings for high-tech firms, says the power of the Silicon Valley economy cannot be measured in stock alone.

“There is an enormous ecosystem of attorneys and accountants and brokers that has been structured today to provide the support network to build and grow these companies,” Carter said.

The Internet ride may occasionally be scary. The legislative analyst has noted that nearly two-thirds of all transactions involve stocks held for less than one year. According to market analysts Bain & Co., stocks in Internet companies such as Yahoo, Priceline.com, and Amazon.com are held for an average of less than a week. That compares to a 33-month holding period for a traditional blue-chip stock such as General Electric.

“We have become the world capital of Internet business, both manufacturing and services. Everyone agrees it is good that we have it and not someone else,” said Tom Lieser, an economist with UCLA’s Anderson Business Forecast. “But the big question is: How long will it last?”

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State Gains

California residents’ capital gains and money from cashed-in stock options are growing sources of state tax revenue, contributing to a projected $9 billion in new state revenue since the close of the 1998-99 fiscal year. Both sources are taxed as personal income.

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Source: California Finance Dept.