California banks on Facebook stock recovery

In this image provided by Facebook, Facebook founder, chairman and CEO Mark Zuckerberg, center, applauds at the opening bell of the Nasdaq stock market on May 18, 2012, from Facebook headquarters in Menlo Park, Calif.
AP Photo/Nasdaq via Facebook, Zef Nikolla

(MoneyWatch) The state of California has a $2.1 billion bet on Facebook stock - and an even bigger bet on the market as a whole.

The economically beleaguered state, which is attempting to hike tax rates in order to close a yawning budget deficit, estimates that 155 million restricted stock units that will be given to Facebook (FB) insiders over the next six months will net the Golden State a $2.1 billion tax payday. But that's predicated on the now seemingly optimistic notion that Facebook shares would pop after the offering and sell for $45 by November.

With Facebook shares down roughly 25% from the $38 IPO price, that projection is looking tenuous. Jason Sisney, deputy legislative analyst, says that if the shares remain depressed the state will take a hit amounting to hundreds of millions of dollars.

In fact, that hit may be even greater over time, considering that Facebook has granted nearly 2 billion stock options and restricted stock units to a group of insiders at a paltry $1 exercise price. Generally speaking the difference between the going market price - now around $29 - and the exercise price is a taxable gain. These insiders will be able to exercise those options and sell their shares after 3-to-6-month "lock-up" periods expire in August and November. However, no one knows how many of those shares will be exercised, triggering taxation, and not all the holders live in California. Thus state tax officials are not yet banking on that windfall.

However, the state is attempting to hike rates on the rich, partly to capitalize on all the newfound Facebook millionaires. Gov. Jerry Brown's proposed budget would hike income tax rates on those earning more than $250,000 annually to 10.3% from the current 9.71% rate; and he'd impose an 11.3% tax on those earning more than $350,000.

Indeed, California's government believes Menlo Park-based Facebook will be so pivotal to the state's well-being that the legislative analyst estimates that one-fifth of personal income growth in the state over the next few years could be directly or indirectly attributed to the social network's initial public offering.

Thus the slump in Facebook's share price is a significant concern. But an even bigger concern is the overall market decline that has hit virtually every investor - and is thus likely to create a broad-based decline in state tax revenues, if it doesn't reverse soon.

 "It's unusual that a small, but noticeable, portion of California's revenue will come from the stock-related activity of a single company. That is an extraordinary thing," says Sisney. "But one cannot ignore the stock market when it produces - or reduces - revenues significantly. A continuation of the recent slump in the broader stock market, or failure of the market to reverse course, could affect state revenues by billions of dollars in the next year."