Capitol Alert: Analyst: Higher California income tax refunds raise concerns

With tax filing season under way, Californians last month received significantly more in state income tax refunds than expected, curtailing previous enthusiasm for strong revenues.

The nonpartisan Legislative Analyst's Office reported that income tax refunds were 30 percent above the state Department of Finance's estimate for February, normally the third most active refund month of the year after March and April.

The reason for concern? As part of the 2009-10 budget solution, lawmakers and Gov. Arnold Schwarzenegger increased income tax withholding. It was an accounting maneuver that gave the state a one-year boost in revenues, with the state repaying the money to taxpayers in income tax refunds. The change took effect in November 2009, so 2010 was the first full tax year in which Californians overwithheld their state income taxes.

That means taxpayers are in line to receive larger refunds as they file their tax returns this spring. The Analyst's Office notes that if February is an indicator, the state will pay out even more in March and April, depressing overall tax revenues for the state.

Personal income tax represents the largest share of state revenues -- 51 percent in 2009-10 -- so large income tax refunds in March and April could erase earlier gains in state revenues, the Analyst's Office said.

Not all is bad news. Even though income tax rates fell in January as the 2009 income tax hike expired, income tax withholding was 12 percent above last February. The Analyst's Office said this suggests "that job and salary growth in the state's economy may be somewhat better than recent employment reports have indicated."

For the month of February, the Analyst's Office said, the state took in about $300 million less than expected in personal income, sales and corporate taxes. Because of earlier gains, California is still running ahead of its fiscal year projections for those "Big Three" revenues by $970 million, or 1.9 percent.

PHOTO CREDIT: Postal employee Martha Ruiz helps Ben Perry file for an extension of the deadline to file his income tax return Thursday, April 15, 2004 at the West Sacramento post office. Carl Costas / Sacramento Bee file photo