California receives about half of its personal income tax revenue from people who sell assets and pay the state income tax on that gain.
Happily, the stock market is doing so well that at least this portion of California’s expected state revenues seems relatively safe.
The state of California, unlike many other states and unlike the federal government’s Internal Revenue Service, doesn’t care how long the tax payer owned the asset sold. Elsewhere, assets held longer than a year before they are sold are oftentimes taxed at a substantially lower “capital gains” tax rate. But not in California.
In many states, real estate or land interests related to energy extraction are very important asset classes that give rise to capital gains taxes.
In California, gains from stock investments are particularly important. Many highly paid people in Silicon Valley in the north, and Hollywood and “Pharma Beach” in the south, benefit from stock options or long-term gains from shares they had been granted, or from occasionally selling stocks of companies they had founded.
Some parts of the California economy have been heavily damaged by the shelter-In-place restrictions and other public safety restrictions—think of all those cleaning staff personnel at all those hotels in Anaheim and Buena Park and along Century Boulevard.
These folks all need unemployment benefits and other state- and county- funded services. A lot of the money that pays for those comes from capital gains derived from the sale of appreciated stocks.
So a rising stock market is really beneficial to California and its ability to fund social services.
The NASDAQ 100 index tracks 103 of the top technology companies. Looking at Invesco’s tracking fund, with the ticker QQQ, the value of the Nasdaq has increased from about $185 in May 2019 to about $302 now—an increase of some 63 percent since that time, when California’s Legislative Analyst’s Office (LAO) made a series of projections regarding future tax revenues derived from capital gains.
The S&P 500 index tracks the share prices of America’s largest companies. There are about 500 companies in the index (the number goes up and down due to mergers and other corporate actions). In May 2020, the LAO provided two scenarios—an optimistic “U-shaped“ recovery and a pessimistic “L-shaped” recovery. Under the U-shaped recovery assumption—the optimistic one—the LAO assumed the S&P 500 index would recover up to 2,700 by the end of 2020, rise a little more in 2021, and then get to about 3,100 by the end of 2022.
The S&P 500 index is already at well over 3,500.
A quick look at both indices demonstrates why they are so important to the California economy.
And looking at the S&P 500 proxy investment offered by Vanguard, with the ticker VOO, three of the top nine companies (Alphabet, the owner of Google, has two stocks) are based in California: Apple, Facebook, and Alphabet. Those three represent more than 10 percent of the value of the entire index. The S&P 500 index is used by many professional financial-planning professionals as a proxy for the entire U.S. stock market.
As these companies continue to benefit from consumers’ need to work, play, and study from home, the capital gains derived from California shareholders selling them will at least be one silver lining in perhaps an otherwise gloomy cloud-filled California economy.