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Will Facebook’s Wealth Boom Save California?

Facebook IPO papers
Bloomberg via Getty Images
Facebook IPO papers

Facebook's IPO is expected to be one of the largest one-time wealth-creation events in history. All that new wealth is also expected to generate millions, if not billions, in tax revenues for California.

But can Facebook’s Wealth Effect rescue California from its latest budget crisis?

Not likely.

The obvious reason is that Facebook’s windfall is already baked into California’s budget. When Governor Brown announced Saturday that the state's budget deficit was suddenly $7 billion more than expected, he was already taking into account the $2 billion or so in tax revenue expected from all those newly minted Facebook millionaires and billionaires. (Zuckerberg’s federal and state tax bill alone could top $2 billion).

If for some reason the Facebook deal underperforms, or company executives hold on to their shares longer than expected, the $7 billion surprise could grow even larger.

But there’ a deeper reason Facebook can’t save California. And it has to do with one of the state’s most fundamental financial problems: an overdependence on the incomes of the wealthy.

California, like New York, New Jersey, and other high-earner states, relies heavily on personal income-tax collections of the wealthy. The top one percent of earners in California pay more than 40 percent of the state’s income taxes. In California, much of that revenue comes from capital gains from tech investors and entrepreneurs.

This works well when markets rise. But during recessions and weak market years like 2011, capital gains dry up – and so do California’s tax revenues. In 2009, capital gains collections crashed by more than two-thirds, blowing a hole in the state budget that remains today.

This reliance also makes it hard for California’s budget forecasters to predict revenues. Since the wealthy earn much of their income from stock sales, their income fluctuates wildly with markets. (See chart below.)

Personal Income Tax, Capital Gains by YearÊ

In $Millions
1994 $18,497
1995 $21,187
1996 $33,380
1997 $47,456
1998 $61,370
1999 $94,096
2000 $119,975
2001 $49,108
2002 $33,404
2003 $45,763
2004 $75,454
2005 $112,743
2006 $117,958
2007 $131,779
2008 $56,283
2009 $28,647
2010 $55,002
Source: California Franchise Tax Board

Sure enough, the most immediate cause of California’s current crisis is an overly optimistic projection in January that stock markets (and thus taxes from the wealthy) would keep soaring. They were wrong. So now the state is back in crisis.

Granted, Silicon Valley’s wealth may surprise on the upside in coming months. Yet Brad Williams, a former budget forecaster for the state, said that the state’s dependence on wealth derived from the stock market has made accurate forecasting more difficult.

“This super-reliance on capital gains, stock options, and non-recurring income by the top earners creates a casino-like environment for forecasting,” said Williams, now a senior partner at Capitol Matrix Consulting. “There’s a lack of precision and forecasters just say, ‘Well, why not be optimistic?”

This approach may work for Facebook investors. But not for the state of California.

Do you think Facebook will help save California?

-By CNBC's Robert Frank
Follow Robert Frank on Twitter: @robtfrank