California dot.com boom went bust: the wild variations in California's revenue stream make budgeting really tough.

• Author: Weintraub, Daniel M.

Call it the Mickey Mouse effect.

Ted Gibson still remembers the winter of 1992 when California, mired deep in recession, suddenly saw a surge in withholding from the personal income tax. Gibson, the chief economist in the state Department of Finance, thought at first that the revenue burst meant the economy was turning around. Then he and other department analysts realized that the unexpected increase could be attributed entirely to one man: Disney Chairman Michael Eisner, who had just sold company stock options worth $126 million.

Eisner sold the stock to avoid a federal tax increase proposed by President-elect Bill Clinton. But the sale forced the entertainment mogul to pay state income taxes at California's highest rate. And while the windfall to California's treasury might not have signaled an immediate turnaround, it was a sign of things to come. Big things.

"That was the first inkling we had," says Gibson, who recently retired.

GOLDEN STATE IN FISCAL FUNK

By the end of the decade, the state's booming high-tech industry had replaced Hollywood as California's cash cow, and Sacramento was lapping up the milk. Taxes on stock options and capital gains rose from $2.5 billion in 1994 to nearly $18 billion in 2000, fueling a spending spree that left lawmakers giddy in disbelief. But the boom times ended as abruptly as they began, and the state's fiscal fortunes crashed right along with the NASDAQ index. Now California is facing a projected $14 billion gap between programmed expenses and anticipated revenues.

California is not the only state in a fiscal funk. Lawmakers in almost every capital in the country are looking at revenues falling short of expectations. But the Golden State's fortunes probably rose higher and fell faster than anyplace else. And the state's budgetary roller-coaster ride provides a cautionary tale to legislators and executives in other states who might one day be lucky enough to be showered by such a windfall.

Assemblyman Robert Hertzberg of Los Angeles County, who stepped down as speaker Feb. 6, says the revenue volatility is the "single biggest threat to the state of California." He sees a "revolution" coming, some dramatic realignment of the state's tax structure, possibly coupled with a shuffling of state and local revenue sources and responsibilities.

While the most recent swings have been attributed to gyrations in the personal income tax, Hertzberg believes the sales tax might soon become as volatile, particularly as more retail activity shifts to the Internet.

"The whole thing is like a house of cards," he said.

For now, though, California's highly progressive personal income tax stands alone at the center of the storm. The state's tax exempts families earning $35,000 or less from most income taxes, then rises quickly to a top rate of 9.3 percent. Coupled with the recent surge in income among the state's highest...