The Breakdown | Explaining Southern California's economy

The Facebook Effect and the problem of California's budget

Facebook founder and CEO Mark Zuckerberg speaks during a news conference at Facebook headquarters on October 6, 2010 in Palo Alto, California.
Facebook founder and CEO Mark Zuckerberg speaks during a news conference at Facebook headquarters on October 6, 2010 in Palo Alto, California.
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What exactly is the "Facebook Effect" and why could be both a boon and bane for California's budget crisis? According to the Legislative Analyst's Office, it's the massive amount of money that will be infused into California's sagging revenues when Facebook launches its anticipated IPO later this year.

Facebook isn't even going to sell that many shares to the public — it will probably continue a trend of "low float" IPOs in tech offerings, designed to elevate valuations (fewer shares equals higher demands equals higher prices). But it's still expected to raise $10 billion and achieve, overnight, a market valuation of $100 billion.

The capital gains from the creation of all those new Facebook millionaires will bring...well, billions to the state's coffers. As Bloomberg (via the San Francisco Chronicle) reports, Gov. Jerry Brown is estimating that 2012 will see $96 billion in total capital gains earned as income. The LAO figures rather less: $64 billion. 

Brown's budget plan calculates that this will mean almost $9 billion in revenue — close to 9 percent of general fund revenue, according to Bloomberg. So if the Facebook Effect doesn't match his math, he'll fail to realize his ultimate objective of ridding the state of its structural deficit and generating a billion-plus surplus.

Brown also expects those taxpayers who are exposed to capital gains to pay them this year rather than next — on the assumption that the Bush era tax cuts will expire. The LAO expects the cuts to be extended. So there's a bit of an accounting "con game" being run here, pivoting on the politics of taxation in an election year.

Regardless of the scale of the numbers or who pays what when, the Facebook Effect sounds great. And when viewed in the context of California's innovative tech economy, it is. Remember, it won't just be Facebook that IPOs this year; other tech companies will as well.

However, relying so heavily on capital gains — the money that made from investments, like selling stock or collecting dividends, or suddenly getting shares of stock as an employee of a company that's IPOing — isn't necessarily a formula for stable state finances.

The governor's budget plan admits as much. The summary that was released last week points specifically to the difficulty of projecting the income of the wealthiest taxpayers as a critical budgetary problem. Capital gains, which are taxed at 9.3 percent in California (they're treated the same as ordinary income, whereas at the federal level they're taxed at 15 percent), are tricky. They fluctuate wildly, depending on how the capital gains parts of the economy, mainly the markets, are doing.

In California, the wealthiest taxpayers now account for 22 percent of all income, up from around 10 percent in 1980. This messes with forecasting. When times are good, they're very good. When times are bad, the deficit grows and grows and spending cuts plus new taxes — as Brown has proposed — as required. Bloomberg points out that this plays havoc with the state's credit rating. It's now A-, per Standard & Poor's, rather than AA. This means that when the state issues debt to pay its bills and refinance existing debt, is has to pay higher interest rates than it would if revenues were more predictable.

It should be fairly obvious that California relies too heavily on its richest residents for yearly tax revenues. At one level, this is a good problem to have. The state does have a nearly $2 trillion economy, and it didn't get there by discouraging the Facebook Effect. When Meg Whitman, the former CEO of eBay, ran for governor, she argued that the capital gains tax in the state should be ended — some state have cap gains rates of zero. Shocking, given how much Whitman has probably paid in cap gains tax over the years.

No matter how you feel about the question, income that isn't taxed as capital gains is important to smooth out the budgeting process and ensure that California can plan its spending from year to year. So while it's great that Facebook may soon mint many millionaires, it needs to think about creating jobs that will provide stable tax revenues from the millions of Californians who won't be shopping for yachts, mansion, and second and third homes in the years ahead.

Follow Matthew DeBord and the DeBord Report on Twitter.