ELIZABETH G. HILL • LEGISLATIVE ANALYST
LAO
60 YEARS OF SERVICE
Revenue VolatilityIn California
Following the boom-bust revenue cycle in re-cent years, concerns have developed aboutvolatility in California’s General Fund revenues.This brief quantifies the amount of revenuevolatility experienced in California during thepast quarter century, identifies the main causesof the volatility, and discusses the outlookfor volatility in the future. We also highlightsome options for reducing future impacts ofvolatility—both those involving changes to thetax system and budgetary changes—anddiscuss the trade-offs inherent in each of thealternatives.
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January 2005
 
2LEGISLATIVE ANALYST’S OFFICE AN LAO REPORT
 Acknowledgments
This report was prepared by Brad Williams andJon David Vasché. The Legislative Analyst’sOffice (LAO) is a nonpartisan office whichprovides fiscal and policy information andadvice to the Legislature.
LAO Publications
To request publications call (916) 445-4656.This report and others, as well as an E-mailsubscription service, are available on theLAO’s Internet site at www.lao.ca.gov. TheLAO is located at 925 L Street, Suite 1000,Sacramento, CA 95814.
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3LEGISLATIVE ANALYST’S OFFICE AN LAO REPORT
INTRODUCTION
California’s system of taxes that supports theGeneral Fund has been in place for many years.Its main elements—the personal income tax(PIT), sales and use tax (SUT), and corporationtax (CT)—were established over half a centuryago. The system has performed relatively wellthrough most of the intervening period and hasgenerally received good marks from econo-mists and public finance experts. For example, itis diversified and relatively broad-based, therebyensuring that all types of individuals, businesses,income, and economic activity contribute to thefinancing of public services. It also providesrevenues that increase over time in response togrowth in the state’s population and economy,thus helping ensure that the state can fund thepublic services that demographic growth re-quires, such as education and infrastructure.Despite its generally positive features, thereare certain areas where California’s tax systemcould benefit from reforms, such as thosemaking it more reflective of the state’s moderneconomy and more neutral with respect to itseffects on economic decision-making. Oneparticular concern which has emerged in recentyears is the current system’s relatively highdegree of volatility. As shown in Figure 1 (seenext page), annual fluctuations in General Fundtaxes have been quite significant. These fluctua-tions have been considerably more pronouncedthan the volatility in California’s overalleconomy, and more substantial than the rev-enue fluctuations experienced in other states.This revenue volatility has contributed to majorproblems for state policymakers attempting tomanage and balance California’s state govern-ment budget. This has been particularly trueduring the past five years, when General Fundrevenues increased by as much as 20 percent in1999-00 but then plunged by a dramatic 17 per-cent in 2001-02.Given its significance, this report focuses onthe revenue volatility issue. In it we define andquantify the amount of revenue volatility Califor-nia has actually experienced, identify and discussthe main factors contributing to this volatility,and examine the key policy options available tothe Legislature for dealing with such volatility inthe future.
WHAT EXACTLY IS MEANT BY REVENUE VOLATILITY?
As noted above, revenue volatility in broadterms refers to fluctuations over time in taxreceipts. Actually, however, there are a numberof different characteristics and dimensions thatsuch revenue fluctuations can have, which inturn can determine both the challenges volatilityposes for policymakers and the best options fordealing with it. These factors include:
➢
 Amount and Frequency of Variability.
There can be year-to-year growthfluctuations that are frequent but of modest size, fluctuations that are infre-quent but of more dramatic magnitude,or any number of other possible pat-terns. (There can also be dramaticrevenue fluctuations
within
fiscal years,
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