As stock markets tumbled over the past two trading days, the threat of continuing losses cast a cloud over California’s future budgets. However, this year’s record market highs could provide a safety net, according to experts.
After the Dow Jones Industrial Average lost more than 1,000 points Aug. 5, the state’s Department of Finance said market volatility is not uncommon.
“While we are monitoring these recent developments, volatility is a fact of life, and it has affected—and will continue to affect—state revenues, given the role that capital gains and other market-based activity continue to play in California’s personal income tax,” H.D. Palmer, deputy director for external affairs for the state’s finance department and principal spokesman on fiscal and financial issues for Gov. Gavin Newsom, told The Epoch Times via email.
California’s tax revenues rely on capital gains taxes and stock options, and market volatility can greatly impact the state’s budget, as seen after market drops in 2022 led, in part, to California’s budget gaps.
The state is navigating a $73 billion deficit in the current fiscal year after facing a $31 billion deficit last year.
Uncertainty abounds as the stock market shows weakness after reaching record highs in July, with indexes demonstrating growth as high as 24 percent year-to-date at the peak.
With a global selloff underway in recent days, the Dow Jones Industrial Average fell 2.6 percent Aug. 5 after dropping 1.5 percent Aug. 2.
The Standard & Poor’s 500 index declined 3 percent Aug. 5 following a drop of more than 1.84 percent Aug. 2, and the Nasdaq composite index fell 3.43 percent Monday after a 2.44 percent decline Friday.
Still, after months of steady gains, the Dow closed Aug. 5 up 2.62 percent year-to-date, the Nasdaq up 9.7 percent, and the S&P 500 9.35 percent higher.
Palmer pointed to the indexes most relevant to California—the S&P 500 and the NASDAQ because of the many operations concentrated in the Golden State that are traded on the two markets—as evidence that recent downtrends should not significantly hurt the state.
“The market is still above what we projected in the Budget Act forecast,” he said.
He said that projecting revenues by looking at a few days’ worth of market activity is challenging and suggested things could change if the Federal Reserve brings interest rates down at its next meeting.
The recent correction was somewhat expected, according to experts.
“The market has been going up all the way now for several months,” Raymond Sfeir, director of the A. Gary Anderson Center for Economic Research and Anderson Chair of Economic Analysis for Chapman University, told The Epoch Times. “Even with all the declines on Friday and today, the [markets] are still up a lot ... and if you look at the whole year, there are still good returns.”
“Some people may have lost some money in the last few days and taken a hit, but others are still making money,” Sfeir said.
Citing employment figures that missed forecasts, he said the labor market is slowing but the economy is still strong.
“My feeling is no, there are no indications that we are going to have a recession,” Sfeir said.
He highlighted Federal Reserve efforts to slow inflation by keeping interest rates high, which could be slowing job growth, but said the move was intentional and not necessarily problematic.
“California’s revenues are highly dependent on personal income tax, including capital gains, which significantly fluctuate based on economic and stock market conditions,” Gov. Gavin Newsom’s office wrote in a May budget revision fact sheet. “As a result, California’s budget conditions, relying on fluctuating revenue, have always been volatile—across both Democrat and Republican administrations.”
Record high capital gains revenues in 2021 were followed by significant declines in subsequent years, creating a gap between spending promises and tax collections. While modest revenue growth of about 5 percent is expected in the coming years, a downturn would reduce collections.
The nonpartisan Legislative Analyst’s Office has also repeatedly noted the role stock market fluctuations play in the state’s collections. In reports published this year, in 2015, and in 2005, analysts pointed to market volatility hurting revenues and making accurate forecasts difficult.
“Further, the relationship between stock price gains and state revenues is complex,” analysts wrote in a January report.
