More on California Fiscal Policy: Revenue Volatility

Published April 9, 2014

Everyone knows California's General Fund has "volatile" revenue streams feeding it. Right? From year to year, certain tax streams — especially those associated with taxation of capital gains and stock options — have abrupt and unpredictable swings. In 2002, Senator Steve Peace (chair of the Senate budget committee) cautioned his legislative colleagues that revenues that go up very fast can crash just as quickly. Governor Arnold Schwarzenegger appointed a commission to explore possible tax reform, and that body came back with a recommendation to modify the tax on capital gains as a way to smooth year-to-year revenue variations. This year, Governor Jerry Brown proposes to siphon revenue from the General Fund if it experiences a spike attributable to swings in capital gains.

How does "volatility" manifest itself in the state budget? Short of adopting the proposals of the last two administrations, how has the State coped with revenue swings?

The figure below tracks revenue for the 11-year period starting in 2004-05. It shows General Fund dollars in red lines, and all other funds in blue lines. The associated dotted lines show the annual average growth over that 11-year period for each of the fund sources. The General Fund grew by less than 3 percent annually during this period, while all other State revenue sources grew at a rate that was more than twice as fast. A measure of the volatility of these fund sources can be seen by considering how the solid lines vary around the dotted lines. Compared to the General Fund, total non-General Fund revenues seem to show a similar pattern of variation over time.

The pattern of variation around the average annual lines seems to be a mirror reflection: When the General Fund revenues increase above the average annual growth line, the other funds revenues seem to dip below the average annual growth rate. The bars at the bottom of the figure show the amount of change for the fund types by year. They show that in all but one year, the change in General Fund revenues are offset in part by the opposite change in other funds. Not all special fund money can backfill General Fund losses, so it is too simplistic to say that the other funds are used to smooth General Fund reductions. To the extent the State is able to shift General Fund programs to other fund sources, the countervailing revenue swings would appear to help moderate the changes in annual General Fund revenue streams.

Some commentators suggest that prosperous times, such as now, are inopportune for adopting institutional reforms to smooth revenue spikes. During good times, when capital gains are flowing, the extra revenue makes a target for funding tax relief and program expansion. The timing of the solution seems just as important as the substance of the solution itself.


Figure 2: Comparison of General Fund and Non-General Fund Revenues, Reported by Year

2004-05 through 2014-15

Dollars in Billions

Comparison of General Fund and non-General Fund revenues, reported by year

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