August 9, 2011 / 7:41 PM / 6 years ago

Stock market turmoil a bad omen for California budget

SAN FRANCISCO (Reuters) - The stock market’s recent slump is reviving bad memories for California’s government and raising concerns about revenue estimates for its budget, a perennial concern in the U.S. municipal debt market.

The concern in the state capital of Sacramento is the slump hints at the potential for a stock market meltdown like the one in 2008. That sent California’s finances into disarray.

Heavy market losses could force California to trigger

spending cuts to politically popular programs and revive calls for tax increases, both sure to spark rows in the legislature that cause many investors to stay clear of the state’s debt.

“Watching the markets at a time like this is not for the faint of heart,” H.D. Palmer, a spokesman for California’s Department of Finance, said on Tuesday.

Governor Jerry Brown and lawmakers in June notched a budget plan that closed a multibillion dollar deficit and balanced the state’s books in part with a rosy revenue outlook.

Critics said the forecast was too optimistic given the state’s weak economy and the potential for reversals in financial markets. When they swoon, California’s revenue shrinks because it relies heavily on wealthy taxpayers and their capital gains to provide a large chunk of the personal income tax receipts.

Revenue for the state’s coffers dropped off severely in recent years due to the housing crash, mortgage-industry meltdown, recession, consumer-spending slump, a double-digit unemployment rate and stock market turmoil.

The market’s recovery from its March 2009 low earlier this year began to generate capital gains that bolstered collections of personal income taxes, California’s most important source of revenue.

That helped inform a view within Brown’s administration that revenue would be on the upswing through this year and would help give the state $4 billion more than initially expected, a view incorporated into the state budget plan.

The plan, however, also gave state officials a way to respond to weak revenue: If revenue falls short of forecast in December, spending cuts to higher education, health and human services and public safety will be triggered.

PRAYING FOR A RALLY

It’s too early to say if the cuts will have to be made but it’s clear California’s budget has a lot riding on how much wealth the stock market creates or destroys in coming months.

“The question is will the market rally after this sell-off?” Palmer said.

That question also is front and center at this week’s annual meeting of the National Association of State Budget Officers, said Michael Genest, director of California’s finance department when the stock market plunged in 2008.

Budget officers have been rattled by the stock market’s reaction to the Standard & Poor’s downgrade of U.S. debt, concerns about Europe’s finances and the potential for a double-dip recession, Genest said.

“There’s a great deal of nervousness,” Genest said, adding state officials are likely to concluding revenue will remain weak and more spending needs to be reined in.

“The best case scenario is another really rough four or five years with more belt-tightening,” Genest said.

Genest said he doubts Brown will be able to book the additional $4 billion penciled into California’s budget plan and that will spark spending cuts to popular programs and calls for tax increases.

If the stock market snaps back, California may be able to avoid all that. But if the mark falters, it could be 2008 all over again in Sacramento, Genest said, noting that, “Our revenues just completely fell off the cliff in 2008.”

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