State Expects Tech Sector Losses to Hurt

California’s total personal income shrank 0.7% in the third quarter of 2001, the first such decline in more than three decades, according to data released Friday by the state Department of Finance.

The drop underscored just how dependent California has become on income from the technology sector and the performance of the stock market. The major culprit, analysts said, was the loss of income from employee stock options, which had fueled spectacular wealth creation in recent years. In 2000, for example, personal income in California grew at a 9.8% annual rate, as tech workers and other professionals reaped fat bonuses and options tied to the performance of their companies’ shares.

Workers armed with Wall Street winnings bought homes, cars and other big-ticket goods during the tech-stoked bull market. By one estimate, stock market gains boosted consumer spending in California by at least $10 billion in 1999 alone.

But what Wall Street giveth, it taketh away. Now the very same forces that juiced California’s economy during the tech boom are sapping the incomes of many of its most highly compensated workers.

The fallout can be seen in declines in retail sales as well as lower median home prices in the Bay Area, where tech sector wealth powered a run-up in property values. But the biggest loser is undoubtedly the state treasury, inexorably linked to the ups and downs of the stock market.

In fiscal 2000, $17.7 billion--fully 25%--of the revenue flowing into California’s general fund came from taxes on capital gains, stock options and bonus income. That figure was sliced nearly in half in 2001 after the tech bubble burst, and it isn’t likely to improve much this year.

It’s a big reason why California is facing a budget shortfall variously described as $14.5 billion to $17 billion, and why nearly all residents are going to feel the squeeze on the state’s coffers.

“We’re now dealing with the consequences of the collapse in the tech sector,” said Howard Roth, chief economist for the Department of Finance. “We lost a huge amount of income between 2000 and 2001.”

Personal income is a key measure of how the state economy is performing. It includes a variety of revenue streams flowing into California households, including wages, bonuses, stock options, rental income and government payments such as Social Security. The figures do not include capital gains income, which is tracked separately.

Employee wages represent the lion’s share of total personal income. But in California and other states with large technology sectors, option and bonus income has become an increasingly important part of the mix as firms have linked compensation to their share prices.

Friday’s data illustrated the impact of the tech and stock market meltdown. Total personal income in the third quarter of 2001 was $1.107 trillion on an annualized basis, down from $1.115 trillion during the same period in 2000, due mainly to the plunge in option and bonus income. Finance’s Roth said that’s the first year-over-year quarterly drop since at least 1970.

The personal income decline stands in marked contrast to recent economic indicators that show the state and national economies on the mend. California has held up relatively well compared to the rest of the nation despite its tech doldrums, thanks to a robust housing market in most areas of the state and employment diversity in Southern California.

But although many economists think the national recession is probably over, California’s budget woes are not. That’s because the state has come to rely on personal income taxes to fund nearly 60% of its general fund. But the rising importance of capital gains and stock option revenue in that mix has made the personal income tax an extremely volatile revenue source.

California isn’t alone in its increasing reliance on the stock market. The Nelson A. Rockefeller Institute of Government in Albany, N.Y., has identified 14 other states, including technology hotbeds such as Oregon and Massachusetts, that have come to rely on capital gains income for a higher-than-average share of their general revenue.

The formula is politically popular because it hits only the wealthiest workers, said Nicholas W. Jenny, senior policy analyst with the Rockefeller Institute. And he noted that it proved incredibly lucrative for California and other states when the bull market was in full swing.

“The downside is that when you hit a recession, it can go away astonishingly quickly,” Jenny said. “Huge deficits can open up fast. We’re seeing that in California more than any other state right now.”

Case in point: capital gains. After raking in a record $10.6 billion in taxes from capital gains in 2000, California is expected to see that revenue plunge by 45% to $5.9 billion for 2001 after Californians file their returns in April, according to Department of Finance projections.

That has state officials scrambling to slash spending and come up with other solutions to plug immediate holes in California’s $100-billion budget. But economy watchers say the shortfall highlights a longer-term structural problem with California’s tax base, which has come to rely on large, highly volatile contributions from a small group of workers.

A recent report from the legislative analyst’s office system calculated that the top 5% of California taxpayers were liable for a 68% share of the personal income tax in 2000.

“If you are a government, you want a tax base that’s stable and spread across a broad group of people,” said Ted Gibson, formerly the state’s chief economist and now a senior economic advisor for Metropolitan West. “California has neither.”

Department of Finance economist Roth is projecting that California’s total personal income will move higher in 2002 now that the stock market has stabilized and the economy continues to strengthen.

But he and others say the drop in personal income and subsequent budget woes are a reminder that California’s heavy dependence on high tech has its hazards.

“Long-term it’s a strength,” said Tom Lieser, senior economist with the UCLA Anderson Forecast. “But if you live by the stock market, you perish by the stock market” when times get tough.

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Times staff writer Julie Tamaki in Sacramento contributed to this report.