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California waking up from tech dream

The nation's wealthiest state and home to high-tech heavyweights is learning a lesson as the market for tech stocks continues to decline, dragging the state's coffers along with it.

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Losing faith in tech stocks?
The word on the street
Live by technology, die by technology: That's the lesson California is learning as the market for tech stocks continues to decline, dragging the state's coffers along with it.

The nation's wealthiest state and home to numerous high-tech heavyweights reaped $8 billion in income tax on exercised stock options and another $8 billion in capital gains taxes last year.

Much of the windfall came from residents who sold stock in the state's largest technology players--including Cisco Systems, Sun Microsystems and Intel. Employees of San Jose, Calif.-based Cisco, for example, earned more than $7 billion exercising stock options in fiscal 2000, although not all are California residents.

Taxes collected on options and stock gains amounted to one-third of the state's $48 billion personal income tax revenue and 20.8 percent of the state's $76.9 billion in general revenue.

But state finance experts are now preparing legislators and residents for a leaner year, pointing out that the Nasdaq is off some 60 percent from its high in 2000 and that the shares of many large tech companies have tumbled by a similar amount.

Ted Gibson, chief economist for the California Department of Finance, estimates that the $16 billion the state gained from option- and capital gains-related taxes could dip to as low as $13.6 billion in 2001.

Without being able to forecast the degree or duration of the market slide, Gibson cannot assure legislatures that revenues will pick up anytime soon.

"The thing that's uncomfortable for us is that we are not capable of predicting the stock market," he said. "If I could, I wouldn't work here."

Statewide belt-tightening
Like many companies in the state that have laid off workers and tried to trim overhead costs in other ways, California has embarked on a belt-tightening campaign: It is not committing ongoing funds for one-time expenditures on projects ranging from transportation to beautification.

Based on revenue from tax receipts in 2000, the state dedicated $8 billion to one-time expenditures, including a $1.6 billion grant for transportation projects--money that previously would have come from the state's relatively expensive tax on gasoline. The state will revert to using the gas tax to fund future transportation projects if it doesn't receive enough personal income tax revenue this year.

But all is not gray in the Golden State.

California residents are more likely to pay a large amount of taxes on stock options when tax day comes April 15. That's because the vast majority of options are based on strike prices from three to 10 years ago. Even with the market's sustained downturn in the past year, many large technology companies have stock prices that are still dramatically higher than they were in the early and mid-1990s.

For example, an Intel worker who received 1,000 options in 1996 with a split-adjusted strike price of $7 could exercise them now and pocket the difference between the strike price and the current trading price of $28, for net proceeds of $21,000. Although that is far less than he would have received if he had sold when the stock was at $75.81 last fall, it's still a significant windfall--and the state will get a piece of it.

"We're reasonably comfortable that option income is not going to crash on us," Gibson said. "It's going to come down over the years, but it's not going to fall off a cliff, unless the Nasdaq takes a horrible shellacking throughout 2001."

Backup plan
Unlike the plethora of e-commerce niche companies that prospered and then collapsed in the past year throughout the San Francisco Bay Area, the state is relatively well guarded against total demise.

California's booming technology sector has grabbed headlines and made the state into what would be the world's eighth-largest economy if it were a separate nation, according to the January 2000 report from the state's Office of Economic Research. The state, which has a higher gross product than Brazil or Canada, collects significant revenue from the motion picture, biotech, medical and even manufacturing industries.

And although options have fallen out of favor at technology companies, which are offering workers more cash instead, options are still a significant source of revenue for the state. In fact, the state's first major chunk of tax revenue from options came in 1992, when Walt Disney CEO Michael Eisner exercised roughly $500 million in stock options.

Venerable Wells Fargo is also among the state's top 10 options payers. The San Francisco-based financial services giant has weathered the economic slowdown better than many technology companies. Wells Fargo stock has increased about 52 percent since January 2000.

Besides, Gibson noted, the state never received significant revenue from e-commerce companies or other small technology ventures.

"The bulk of the money is coming out of household names--the Ciscos, Intels, Hewlett-Packards, Suns, Oracles--the big, mainline Silicon Valley companies," Gibson said. "It's not coming out of dot-coms. In terms of bread-and-butter contributions, you'd want to look at the medical care industry or something unrelated to technology."

Paradise lost?
Nevertheless, optimism is waning in California, a destination once prized for its climate and scenic mountains but more recently maligned for its energy crisis and exorbitant cost of living.

Overall revenue growth for the state's newest budget is modest--4 percent to 5 percent for the fiscal year of June 2001 to June 2002. By contrast, the state had its largest-ever growth between June 1999 and June 2000, when tax revenue swelled from $58.2 billion to $70 billion.

Going from 20 percent growth to as little as 4 percent is tough for the state, Gibson admitted. In addition to the slowed growth of options and capital gains tax revenue, the state's large cash surplus triggered a quarter-cent cut in sales tax, which will likely cut revenue by $600 million.

"It's a tremendous slowdown," he said.