State’s cash flood may be receding, economists fear

SACRAMENTO —  It’s familiar: A handful of Californians make a killing on investments, and their tax payments send state revenues soaring. Lawmakers go on a spending spree, without a plan for paying the bills when fortunes turn.

That was the late 1990s, when the dot-com boom made the state flush but the gains proved fleeting, and California came perilously close to running out of cash.

Now, as Gov. Arnold Schwarzenegger prepares a landmark program to expand healthcare coverage to millions of uninsured residents, economists say the state may not have the funds to pay for it. Although tax receipts rose this year, they say, California is once again on budget quicksand.

“I’m at a loss to see how they are going to balance this budget,” said Stephen Levy, director of the Center for the Continuing Study of the California Economy in Palo Alto. “The state got bailed out last time around by a surprise revenue surge. That is unlikely to happen again.”

The expanded programs in Schwarzenegger’s election-year budget were funded largely by Silicon Valley millionaires -- capital gains taxes on people who cashed in Google stock, for example, accounted for nearly $500 million in revenue, several experts said -- and by the bubble in the housing market that began to deflate after tax receipts that fueled this year’s spending were tallied.

“These surges don’t last forever,” said Ted Gibson, a former state economist. “At some point ... that revenue stream will either diminish or completely dry up.”

The governor Tuesday brushed aside warnings that state coffers could soon start to shrink. Referring to the $37-billion public-works borrowing package voters approved last week, Schwarzenegger said: “There will be so much construction activities going on that where the private sector will fall off, the public sector will pick up.

“With our infrastructure bonds, we will again stimulate the economy,” he said.

Others say the borrowing will compound the problem. The interest costs about as much as the principal: $36 billion over the life of the bonds the state will sell.

And there are other spending pressures that could crimp the governor’s agenda. Prison costs are up sharply, and health insurance benefits guaranteed to retired government workers are spiraling, costing billions of unforeseen dollars.

California has another problem, which the administration will be confronted with publicly today when Elizabeth Hill, the Legislature’s nonpartisan budget analyst, reports on the fiscal state of the state: It still has a hangover from the splurges of the late ‘90s.

Lawmakers did not use tax windfalls this year and last to balance the budget. They spent much of the money, and left themselves a deficit of about $5 billion to confront when the newly elected Legislature and the Schwarzenegger administration begin hammering out a spending plan in January.

That gap is almost as large as the share of the state budget that went to the University of California and California State University systems this year.

Key sectors of the economy are cooling. The real estate decline has led to a drop in sales tax revenue, and jobs in construction and mortgage lending are down. Many homeowners have stopped spending their equity.

“We’re going to have a big revenue problem,” said Christopher Thornberg, a partner at Beacon Economics in Los Angeles. “It is going to be a mess and Schwarzenegger in a year is going to wonder why he wanted to be reelected.... Sacramento is not going to have the cash to pay for things it wants.”

Gibson is more measured in his outlook, predicting at least several more months of stable revenues. But he too warns, “We still have the same basic problem we did in the late 1990s.”

In 1965, personal income taxes -- one of the most volatile sources of cash for the state -- accounted for less than a fifth of the state’s revenues. Now they make up nearly half.

Lately, that has worked in the government’s favor. When the rich do well, so does the state budget.

State records show, for example, that two Silicon Valley counties, where just 7% of the state’s population resides, accounted for a third of all the income tax payments of more than $100,000 received in April. Such large tax payments make up more than a third of the state’s revenues.

Profits from luxury home sales, which peaked in 2005, have also been a boon to the state. Speculators flipping properties led to a windfall in capital gains. So did sales from homeowners who made more than a half-million dollars on their properties.

As soon as taxpayers no longer report multimillion-dollar gains on real estate profits and the exercise of stock options or giant bonuses from employers, the amount of cash flowing to Sacramento slows dramatically.

At the depths of the last budget crisis, lawmakers resolved to fix the problem. They talked of reforming the tax system to create more stable sources of revenue. Ideas included replacing some personal income taxes with a higher property tax, and expanding sales taxes to include services.

But such changes don’t come easily. Proposition 13 limits on property tax hikes have become sacred to Californians, and the business lobby allied with GOP lawmakers to resist sales tax expansions.

Schwarzenegger came up with a more dramatic proposal: a cap on state spending that would force Sacramento to sock revenue windfalls away in a rainy-day fund. But after voters rejected his “Live Within Our Means Act” in last year’s special election, the governor changed course, supporting big spending increases for government programs.

Democrats, too, dropped their call for changes in the tax code as state coffers swelled and more money was on the table -- at least temporarily -- to fund their policy priorities.

Now, analysts say, the inaction may come back to haunt the state. The influx of cash “we’ve seen in the last couple of years could go in the other direction,” said Brad Williams, an economist in Hill’s office. “It is just a question of when.”

*

evan.halper@latimes.com

Times staff writer Peter Nicholas contributed to this report.

For exclusive web features, including the new Political Muscle blog, go to latimes.com/calpolitics.