It’s Raining IPOs, Hallelujah!
Silicon Valley and Wall Street aren’t the only ones celebrating IPOs this year – Sacramento is doing its share of the partying. That’s because the state is expected to receive a deluge of tax dollars over the next several years thanks to capital gains generated by the current hot IPO market. Lyft’s IPO in March, valued at $24 billion, was only the beginning. In one of the biggest wealth creation years in perhaps a decade, potential IPOs on the horizon include Uber, Pinterest, and Slack Technologies. All total, California based-companies expected to IPO this year are estimated to have a total market cap of close to $200 billion.
In California, capital gains are taxed at the same rate as wages — the top rate at 13.3 percent is the highest in the country. According to Wealthfront, as reported by CNBC, of the companies planning to IPO, founders, executives, and employees own about $60 billion. When they sell their options, the state could reap as much as $8 billion over the next few years. When Facebook went public in 2012 for instance, the state received $1.3 billion, according to California’s Department of Finance. The combined capital gains tax boon and a budget surplus of $21.5 billion in 2019 will have the state’s politicians wading in cash.
But you wouldn’t know it given all the tax hikes legislators are dreaming up. There’s the water tax, the tire tax, the battery tax, the phone tax, the firearm tax, even higher payroll taxes. And the legislative session isn’t even over. Given all this, you would think that the state is cash-strapped and suffering from a deep recession.
But just wait until a real recession comes along. After the dot-com bust of 2001, the state went from a surplus to a $12.4 billion deficit in a single year.
For more than a decade, PRI has counseled again and again to reform California’s tax structure. In 2008, PRI senior fellow and economist Robert Murphy authored the study “Ending the Revenue Rollercoaster.” Murphy wrote that a steeply graduated tax code – such as California’s — exaggerates revenue swings. During good times, people are earning more and are bumped into higher tax brackets, meaning that the larger tax base is hit with a larger rate. Add in capital gains taxes from IPOs and state coffers swell. So, in periods of prosperity, California tax revenues respond more than proportionately. And during an economic downturn, the opposite happens.
When the economy goes south, Murphy writes, not only are people making less income in general, but many of them are also taxed at a lower rate, since they fall into a lower bracket. The IPO market also dries up. As a result, tax revenues shrink more than proportionately. Generous spending programs that were put in place during the preceding boom years threaten to bankrupt the state. And so it goes – California booms and busts.
There’s no predicting whether we’ll be in the peak or trough of the revenue rollercoaster a year from now. But if we have a recession – even a mild one — the $15 billion rainy day fund could be wiped out in a year. Free-market economists from Robert Murphy to Wayne Winegarden and Arthur Laffer (Eureka, Pacific Research Institute, 2012) all agree that a state flat tax is the best solution to end California’s revenue rollercoaster. And with a proposal for a national flat tax during his presidential bid in 1992, former governor Jerry Brown should have been its champion.
Given the political climate these days, it’s hard to see a flat tax in California’s future. But having just read Andrew Robert’s Churchill: Walking with Destiny, I’m reminded of Churchill’s admonition: “Never, never, never, give up!”
Rowena Itchon is senior vice president of the Pacific Research Institute