By William Selway and Michael B. Marois | Bloomberg.com
Oct. 12 (Bloomberg) -- A $2.1 billion drop in California tax collection is opening a hole in Governor Arnold Schwarzenegger’s budget only three months after lawmakers in the most-populous state slashed spending for the second time in a year.
General fund revenue in the state accounting for 13 percent of the U.S. gross domestic product dropped to $19.4 billion during the fiscal year’s first three months, according to figures Democratic Controller John Chiang released Oct. 9. The total for the period ended Sept. 30 trailed by $1.1 billion, or 5.3 percent, forecasts in the annual budget the Republican governor signed July 28.
“This reinforces that state’s budget problems aren’t over, and as the year goes on, we’re likely to see growing budget deficit projections,” said David Blair, an analyst with Pacific Investment Management Co. in Newport Beach, California, which invests $20 billion in municipal bonds. “This clearly is going to continue to put pressure on the Legislature and the governor.”
The latest report underscores how states including California, the largest municipal bond issuer in the U.S., are still dealing with fallout from the recession even as the economy begins its recovery. The state last week was forced to raise yields to attract buyers to a $4.1 billion debt sale, after cutting the issue from $4.5 billion.
California’s decision helped push up borrowing costs in the municipal market by the most in almost four months even as states prepare new issues of taxable Build America Bonds, whose sales already total $40.2 billion. The Treasury pays 35 percent of interest costs for the debt, part of the federal economic stimulus plan approved in February.
State governments are particularly hard hit by a continuing loss of jobs, which dampens the income- and sales-tax collections upon which they depend. From April through June, states and localities recorded a 12 percent tax revenue decline from a year earlier, the third consecutive quarterly drop, according to the U.S. Census. The national unemployment rate in September was 9.8 percent, the highest since 1983, according to the U.S. Labor Department.
In New York, Governor David Paterson on Oct. 6 ordered state agencies to cut spending amid predictions that the deficit for the year ending March 31 may grow to $3 billion, $900 million more than budget officials estimated in July. Pennsylvania, acting 101 days into the fiscal year, enacted a $27.8 billion budget on Oct. 9 that raises cigarette taxes and expands gambling to boost revenue. Ohio confronts an $844 billion gap, while Connecticut will borrow $2.25 billion over the next two years, beginning with a $1 billion debt sale in November, to balance its budget.
“California’s problems, while somewhat unique and self- inflicted, are really America’s problems,” said Bill Gross, co-chief investment officer of the world’s biggest bond fund wrote on Oct. 1. State and federal lawmakers, unable to comprehend the extent of consumer borrowing, “reflect a lack of vision to perceive that the strong growth in revenues was driven by the same excess leverage and the same delusionary asset appreciation that was bound to approach cliff’s edge.”
The state has been among the hardest hit and its Legislature, requiring a two-thirds vote to raise taxes or pass a budget, has struggled to respond swiftly as the state’s fiscal strains worsened this year. Since February, Schwarzenegger and lawmakers have slashed $32 billion from spending, cutting into funding for schools, universities and welfare programs. They also raised taxes by $12.5 billion to balance the $85 billion budget.
’ Court Decision
Chiang, the controller, said the state’s latest figures show that Schwarzenegger and the Legislature must prepare for “more difficult decisions ahead.” California was also handed a defeat on Oct. 2 by the state’s Supreme Court, which let stand a ruling that the governor and lawmakers illegally used $3.6 billion of money meant for local transportation agencies to balance the budget since 2007.
“Revenues more than $1 billion under estimates and recent adverse court rulings are dealing a major blow to a budget that is barely 10-weeks old,” Chiang said in a statement Oct. 9. “While there are encouraging signs that California’s economy is preparing for a comeback, the recession continues to drag state revenues down.”
California isn’t at immediate risk for running out of cash as it did in July, when it resorted to issuing IOUs to pay some vendors and tax refunds as lawmakers fought over how to shore up finances. Last month, it borrowed $8.8 billion by selling notes, an advance on the tax it will collect later in the budget year.
Schwarzenegger’s administration said it’s too soon to tell whether the slide in tax receipts through September foretells a worsening trend. Should revenue continue slipping, California lawmakers may find it difficult to make up for the gaps, given how deeply they have already cut and resistance among Republicans to further tax increases.
Schwarzenegger, 62, who can’t seek re-election because of term limits, doesn’t have to present his budget for the next 12- month fiscal period until January, and he has given no indication that he is planning to call an emergency session beforehand, as he did last year.
“Clearly, the numbers are cause for concern but the issue now for us is to determine if this is a one-time event or whether it has one more long-term implications,” said H.D. Palmer, a spokesman for Schwarzenegger’s finance department.
The tax collection figures were released after the conclusion of a $4.1 billion bond sale, which was trimmed by about $400 million after investors demanded higher yields than the state was willing to pay on some of the securities. The sale came after a rally in demand for municipal bonds pushed state- and local-government borrowing costs to a 42-year low.
Watching for Deterioration
David Blair, the Pimco analyst, said the pullback was caused by the low yields California offered amid lingering investor concern that the state’s fiscal condition may deteriorate further.
“They just got a little aggressive in where they wanted to price it,” Blair said. “Most people still recognize that there’s budget deficits the state is trying to deal with this year and going forward.”
The difference between a 10-year California bond and a top- rated municipal security reached as much as 1.71 percentage points on July 1, when the California debt yielded 5.21 percent, according to Bloomberg data. The difference slipped to 1.06 percent on Sept. 11 before ending at 1.21 percent on Oct. 9.
Future Debt Sales
California plans to sell as much as $15 billion more in bonds this year and its deficits, while not projected to reach the $60 billion it dealt with in the two years that end in July, are persistent. The state will face a $7.4 billion gap in the fiscal year beginning on June 30 and about $15 billion in each of the following two fiscal periods, California Treasurer Bill Lockyer said in his annual report on the state’s debt, released ahead of the bond sale.
Tom Dresslar, a spokesman for the treasurer, said his office has alerted investors that the fiscal troubles are far from over and the latest tax data did little to alter the outlook.
“The state has been very clear that our budget problems aren’t behind us,” Dresslar said. “This shouldn’t be a big surprise to anybody.”
Last Updated: October 12, 2009 00:01 EDT