Gov. Gavin Newsom’s office on Friday forecast a “modest shortfall” of $2.9 billion for the upcoming fiscal year, down sharply from previous estimates in a nearly $349 billion budget proposal that relies heavily on continued windfalls from tech and AI stocks.
The governor’s 2026-27 budget proposal projects $9 billion more in revenue than anticipated, banking on the AI-driven economy to last. It’s significantly rosier than the grim outlook by the nonpartisan Legislative Analyst’s Office, which in November projected an $18 billion deficit.
“A downturn in the market is one of the top risks,” said state Department of Finance Director Joe Stephenshaw.
Newsom’s spending proposal is nearly $30 billion more than this year’s budget. It includes $248.3 billion in the general fund, the primary account for state operations, up by $18 billion.
The spike in spending is partly driven by the need to implement federal cuts to the Medi-Cal program and constitutional requirements to deposit portions of higher-than-expected revenue into education and state reserves.
The budget calls for the University of California to get $350 million more in 2026-27 and the California State University system to get $365 million more, largely to fulfill Newsom’s 2022 promise to increase the universities’ spending by 5% annually for five years.
Newsom’s budget doesn’t include any cuts to K-12 schools, and preserves some of his initiatives related to school meals, community schools, after-school and summer programs and transitional kindergarten. Per-pupil spending would jump slightly to $27,400. It also includes a $509 million increase in special education funding, and a 2.41% cost-of-living increase.
Newsom’s proposal is the opening salvo in months of budget negotiations that begin in earnest in June.
The projected deficit could balloon to $22 billion in fiscal year 2027-28, a problem the governor will address in an updated fiscal forecast in May, Stephenshaw said.
Other state departments will see less funding under Newsom’s spending plan, though Stephenshaw emphasized that there were no major cuts in the proposal. Newsom wants to spend $1.3 billion less on housing and homelessness next year, slashing the department’s budget by more than half. Stephenshaw said some one-time dollars for housing and homelessness have run out and the state is not proposing to renew them.
Newsom’s sunnier forecast could delay calls for long-term financial fixes such as new taxes.
Bolstering the rainy day fund
Nodding to “long-term structural challenge,” Newsom wants to deposit $3 billion into the state’s rainy day fund Budget Stabilization Account, as well as $8.6 billion into two other reserve accounts. He’s also proposed spending $11.8 billion over the next four years, including $3 billion this upcoming year, to pay down the state’s pension liabilities.
“There are encouraging signs in the California economy,” Newsom said in a written statement accompanying the budget. “Yet history teaches us that prosperity, if taken for granted, can vanish as quickly as it arrives. California’s responsibility is to act with steady hands and anticipate future instability.”
California's Director of Finance, Joe Stephenshaw, leads the budget proposal presentation for the 2026-27 fiscal year, at the Capitol Annex Swing Space in Sacramento, on Jan. 9, 2026. Photo by Fred Greaves for CalMatters Newsom did not attend Friday’s budget presentation, after he painted a rosy picture of California’s fiscal future during his State of the State address Thursday. Flashing top-line numbers, the Democratic governor touted billions of dollars more in revenue, proposed new investments in education and pledged more toward the state’s reserves and pension debt.
He avoided revealing the budget deficit and did not say whether closing the gap would require painful spending cuts to core services like child care, food assistance and Medi-Cal, the state’s health care coverage for low-income residents, especially as federal funding diminishes.
Newsom teased multiple new proposals, such as fully funding the state’s universal transitional kindergarten program and providing universal before and after-school programs at elementary schools.
The TK program will cost $1.9 billion annually, according to his budget proposal.
Newsom also proposed spending $1 billion to add high-needs community schools and redirecting $1 billion in Proposition 1 mental health funds annually for housing and homelessness.
County government officials were dismayed the budget doesn't include more robust funding to backfill federal cuts in Republicans' mega domestic policy bill passed last year.
"If the state doesn’t step up, communities across California will crumble,” said Graham Knaus, CEO of the California State Association of Counties, in a statement Friday.
Some Democratic lawmakers struck a cautious tone while largely blaming President Donald Trump for withholding funds from Californians in need.
“California will not be able to fill the holes that have been left by the federal government,” said newly elected Senate President Pro Tem Monique Limón, a Santa Barbara Democrat, on Thursday. “We have to go back and look (at) what is feasible.”
'How big is the bubble?'Senate Budget Committee Chair John Laird, a Santa Cruz DemocratSen. John Laird, a Santa Cruz Democrat and the new chair of the Senate Budget Committee, warned that the high revenue projection indicates a bubble. Laird, who was elected to the state Assembly in 2002 after the 2000 dot-com bubble burst, said he’s concerned the AI-driven boom may not last.
“I think everybody agrees that this level of revenue can’t be maintained, but how big is the bubble? That’s probably the question,” he told CalMatters before Friday's release.
The Legislature must start chipping away at the long-term structural deficit this year instead of punting the problem, he said.
“We’re gonna have to do a piece of it,” he said. “We can’t go into next year with a $30 or $37 billion shortfall, because the reserves amount doesn’t get anywhere near that.”
Less funding for housing, homelessness
Newsom’s final budget proposal represents a significant pull back of state spending on affordable housing. Every year since 2020, the state has tacked on an additional $500 million in spending to pad the federally funded Low Income Housing Tax Credit, the country’s premier funding source for affordable housing construction. This year’s spending plan includes no such proposal.
Newsom’s budget also slashes what had been a $1 billion infusion in spending for cities and counties to fund housing and services for homeless Californians to $500 million, “contingent on enhanced accountability and performance requirements” for local governments.
That all adds up to a more than 56% cut in overall spending for housing and homelessness.
“Not much in the way of good housing news,” said Ray Pearl, executive director of the California Housing Consortium, in a text message, though he stressed this was the first step in a half-year-long process.
In prior years, Newsom’s preliminary budget proposals have jettisoned such spending programs, only for the Legislature to add them back. Stephenshaw hinted as much in his presentation: “We'll obviously have conversations with the Legislature on what the appropriate level will be as we work through this process.”
The Governor's Budget Summary packet during the budget proposal presentation for the 2026-27 fiscal year, at the Capitol Annex Swing Space in Sacramento, on Jan. 9, 2026. Photo by Fred Greaves for CalMatters The counties association is hoping those conversations will lead to an increase in homelessness funding before the budget becomes final.
“We know it works,” Knaus said during a media briefing. “We know it has led to a significant reduction in homelessness in communities across California. And without those resources, that success that we have had is going to go away.”
Newsom has tussled with counties over homelessness funding for years as political pressure to resolve the state’s homeless crisis continues to mount. Newsom has blamed counties for failing to deliver results despite his $24 billion investment. Only a portion of the funding goes to county agencies and there is no dedicated annual funding to fight homelessness.
Newsom’s plan also startled county behavioral health service providers, who rely on Prop. 1 dollars for services.
“While these one-time bricks and mortar investments are promising, the $1 billion in funding for ongoing housing subsidies under Proposition 1 comes at the expense of redirected mental health treatment and prevention programs,” said Michelle Doty Cabrera, executive director of the County Behavioral Health Directors Association.
Medi-Cal a major challenge
Newsom’s budget includes $2 billion more this year and an additional $2.4 billion more next year on Medi-Cal, the state’s most expensive program that offers health care coverage for low-income Californians, primarily to respond to federal funding cuts.
The governor slammed Trump for passing a federal budget that could kick 1.8 million Californians off their insurance and raise the premiums for another 2 million. The state would have to spend at least $1.3 billion more than previously expected next year just to implement the federal law, the LAO previously estimated.
Assemblymember Mia Bonta, an Oakland Democrat who chairs the Assembly Health Committee, said the state must “use the bully pulpit” to fight the federal government, find ways to lower costs or even revive indigent care, a form of last-resort care that has largely become obsolete due to Medi-Cal.
“Because the alternative is, people are going to be dying on the streets,” Bonta said.
Bonta said the Legislature should explore new funding sources. Some advocates are already pushing for a pair of proposed wealth tax ballot measures to fund health care and education, which Newsom opposes.
“We need to think about ways that we can increase our revenue sources … (with) openness around looking at our tax structure,” Bonta said, adding that there are ways “to make sure that everybody’s carrying their fair share.”
CalMatters' Ben Christopher, Ana B. Ibarra Marissa Kendall, Carolyn Jones, Jeanne Kuang, Maya Miller and Mikhail Zinshteyn contributed to this report.
This article was originally published on CalMatters and was republished under the Creative Commons Attribution-NonCommercial-NoDerivatives license.
