Tax on Rich Didn't Cause California's Deficit Magic

It seems like a Democrat's dream.

In November, California hikes taxes on its top earners to the highest rate in the country. A month later, income-tax revenues explode. And the governor announces that the state's famous multi-billion-dollar deficit is pretty much gone.

Hence the proof: raising taxes on the rich raises revenue and can help solve even the toughest fiscal shortfalls.

Some Democrats in the California legislature – where the Dems have a super-majority – are pushing for even more tax hikes.

"The legislature is just a pinata full of goodies and a lot groups will want to take a whack at it," Jack Pitney, professor of government at Claremont McKenna College, told Reuters. "Just about anybody who benefits from state services will want more."

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But a closer look at the recent revenue boom shows that the sudden wealth in the fourth quarter may be have been short lived. And it's unclear what the real, ongoing revenues will be from that new tax hike.

First, let's look at the December boom first. According to the California State Controller's Office, personal income taxes for December came in $767.6 million higher than expected. That windfall caused the governor and others to boost their projections for 2013 – thus helping to erase that deficit.

But budget experts say the tax hikes on the rich have yet to really take effect. While the tax rate of up to 13.3 percent on top earners is retroactive to January 1, the revenues won't really start coming in until sometime early in 2013 because of delayed withholding.

The big windfall, experts say, came largely from top earners shifting their income or asset sales from 2013 to the fourth quarter of 2012 to avoid the federal tax increase. That's likely to lead to a big drop off early in 2013.

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"We suspect those added revenues were related to the federal tax changes and acceleration of income, rather than the new state tax rates," said Brad Williams, a California budget expert with Capitol Matrix Consulting in Sacramento.

Williams said it will be years before the noise of the federal tax changes and income-shifting in California dies down and the real ongoing revenues from the tax hike become apparent.

Of course, it's possible that the revenues from December continue, given the state's stronger job market, real-estate recovery and economic growth. And Gov. Brown is pushing a long-overdue plan to create a rainy-day fund to help bridge California's future income gaps.

But if there's one thing California has learned over the past four years, it's that revenues from the wealthy are extremely volatile and discretionary. And making budget plans based in part on a single month's boom can be a risky proposition.