Why California's Tech Industry Tax Contributions Are a Double-Edged Sword

If you’re a California resident, you use tax-funded roads, schools and other services, so you’re on the Silicon Valley financial roller coaster whether you know it or not.

The tech industry has contributed an increasing amount to the state budget, and even the way tech companies pay their employees has become a growing source of the state’s income tax revenue, a new analysis shows.

Many tech companies pay their employees base wages as well as stock options. Vested stock options — options that have matured and are fully owned by employees who can choose to sell them — are treated like ordinary income for tax purposes. Companies must pay withholding taxes on part of that income to state and federal governments. Last year, those taxes paid by the four largest tech companies in the state — Apple, Google, Meta and Nvidia — grew to at least $5 billion, making up more than 6% of all of the state’s income-tax withholding, the Legislative Analyst’s Office estimated.

That’s up from 4% to 5% pre-pandemic, has more than doubled since 2016 and quadrupled over the past decade. That increase has come as those companies have grown tremendously in market value — the four of them are now worth more than $7 trillion. Last year, the withholding taxes they paid helped offset the effects of fewer initial public offerings on the state’s revenue.

Chas Alamo, the principal fiscal and policy analyst for the office, did the analysis. He said that if he had the resources to do a deeper dive and had tallied the stock-equity withholding from all large tech companies in the state instead of just the biggest four, it might make up as much as 10% of all income-tax withholding. That’s on top of what the tech industry contributes to the state’s income-tax revenue, which makes it even more dependent on tech’s ups and downs.

Historically, “withholding has been a stable barometer of how the state’s economy is doing,” Alamo said. “It hasn’t been subject to the volatility of the stock market. But that has changed over the last several years.”

All Californians have a stake in the health of the tech industry because the state relies so heavily on personal income taxes for revenue. In light of a multibillion-dollar budget deficit and mixed signals around tech — which, on the one hand, continues to lay off employees but, on the other hand, is seeing an artificial intelligence boom that has translated into gains on Wall Street — income-tax withholding from both tech employee wages, as well as the withholding from their stock options, matter more than ever.

Pinpointing exactly how much tech-industry employment contributes to the state’s coffers can be tricky because tech companies have many different types of employees, but consider this: Software developers in the state earned about $48.9 billion, based on average annual earnings of about $190,000, according to data from the Employment Development Department as of the first quarter of last year. That total from just one segment of the industry was more than what the state received in total income-tax revenue from all sectors of the labor force through November: $47.2 billion, according to the State Controller’s tracker.

As for the rise in stock-equity withholding, it was the result of a great 2023 for the large tech companies whose financial filings Alamo analyzed, especially Meta and Nvidia. Shares in chip company Nvidia, whose graphics processing units dominate the artificial intelligence market, ended last year up about 239% from the previous year. Facebook parent company Meta’s investments in artificial intelligence helped propel its stock 198% higher year over year. Meanwhile, the stocks of Apple and Google ended 2023 up 49% and 59% year over year, respectively.

If artificial intelligence continues to lead to stock-market gains for tech companies, the state will keep reaping the rewards.

Some experts and economists are plenty optimistic about artificial intelligence.

“AI is going to power the next wave of economic growth in the state and nation,” said Ahmad Thomas, chief executive of Silicon Valley Leadership Group, a tech policy advocacy group whose hundreds of member companies include some of the biggest names in tech and business. Thomas called the Bay Area the “epicenter” of artificial intelligence because most hot startups in the space are based in San Francisco or elsewhere in the Bay Area.

Stephen Levy, a longtime economist and director of the Center for Continuing Study of the California Economy, an independent, private research organization, said that despite more than 260,000 layoffs in the tech industry worldwide last year, according to one count, the number of tech jobs is now higher than what it was before the coronavirus pandemic.

The California Center echoes that for Jobs and the Economy, the information arm of the California Business Roundtable, an advocacy organization made up of top executives of the state’s major employers. The center said there were about 1.4 million jobs it considers part of the tech industry as of November 2023, about 76,000 more than the total tech jobs in the state in February 2020.

Levy said there is a “rebalancing” that’s going on in tech after all the hiring companies did during the pandemic, but that electric vehicles, cleantech infrastructure and artificial intelligence are “three areas [where he expects] massive amounts of money over the next five years.”

The budget Gov. Gavin Newsom proposed on Wednesday mentioned expectations for continued slower and more moderate job growth, which his staff also attributed to “reverting to historical trends as the labor market is now in the post-pandemic recovery period.”

In the past couple of years, fewer initial public offerings for companies in California — 195 in 2021 vs. 30 in 2023, according to data from PitchBook, which keeps track of capital markets — have meant fewer newly minted multimillionaire tech employees and less state revenue from income-tax withholding and capital gains, which is the profit investors make when they sell stock.

PitchBook’s 2024 venture capital outlook, though, said that if inflation continues to ease and the Federal Reserve does not raise interest rates, IPOs could make a comeback.

Yet Alamo, of the Legislative Analyst’s Office, cautioned that just as companies’ stock-price surges can result in a bump in revenue from withholding, “the same could happen on the opposite side.”

That’s one reason the Center for Jobs and the Economy has warned against the state’s heavy dependence on one region and has said the state needs to regulate — and spend — less. The tech-heavy Bay Area contributes more than 40% of personal income-tax revenue to the state, according to U.S. Bureau of Economic Analysis figures cited by the group. And, as Newsom’s budget also pointed out this week, the top 1% earners in the state, most of whose income comes from stock-based compensation and capital gains, contributed half of all personal income taxes to the state in 2021.

“The problem is it really disguises the true economy of California,” said Brooke Armour, president of the California Center for Jobs and the Economy. “When you have one small part of the economy that carries the state, that papers over the affordability crisis.”