California’s personal income grew a moderate 2.8% in calendar year 2013 versus a 5.0% gain in 2012. Personal income growth nationally also slowed from 4.2% to 2.6%.
Two major forces led to some slowing in income growth last year. First, the two percentage point temporary drop in payroll taxes for Social Security (from 6.2% to 4.2%) that was in effect during 2011 and 2012 ended. Second, individuals tried to shift some income, such as bonus payments, into 2012 before higher federal tax rates went into effect in 2013. (California’s increase was retroactive to January 1, 2012).
As a result of these changes, wages and salaries net of Social Security taxes rose just 2.1% last year in California. Investment income -- including dividends, interest, and rent – increased by 4.1%. Various transfer payments -- including Social Security, Medicare, veterans’, and unemployment benefits -- also saw a strong 4.0% gain. Overall, last year, California ranked 16th in national income growth and was in the fourth quintile of state
performance.
In addition to growth in the core PIT base, including wages, investment income, and transfer payments, capital gains through the stock and real estate markets are major drivers of PIT. In his May Revision documentation, many expect the Governor to discuss how much taxable capital gains may add to 2013-14 and 2014-15 revenues.
What makes taxes on capital gains difficult to estimate? There are many reasons, but one important reason is that taxpayers often have discretion about when they “realize” a gain for purposes of taxation. They can defer selling a stock, for example, that has appreciated a year or two, as they manage their investment portfolio. For example, of the $74.7 billion in capital gains reported by taxpayers in 2011, $11.1 billion (15 percent) were from investments held for less than a year. The balance, which could include stocks and real estate, were held for an excess of 12 months. The holding period could be a very long time. The State’s revenue estimators have a difficult time estimating how much of these holdings have appreciated and when taxpayers might decide to realize their gains.
When trying to anticipate capital gains, revenue estimators must consider investment losses when trying to predict taxable gains, as losses can reduce tax liabilities on investment gains. For example, taxpayers reported capital losses of $25.7 billion in 2011. These losses were used to offset over one-third of the investment gains reported for the tax year.
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