California Budget Rollercoaster: Analyst Predicts $68 Billion Deficit

With tax revenues in a free fall comparable to the Great Recession and the dot-com bust, California faces a projected $68 billion budget deficit next year that will require spending cuts and reserve funds to close, state finance officials said today.

The new estimate from the nonpartisan Legislative Analyst’s Office, released as Gov. Gavin Newsom finalizes his January budget proposal, reflects a substantially delayed tax-filing period this fall where collections came in far below what lawmakers expected when they adopted a spending plan over the summer.

This projected deficit would be a record for California. But officials noted that it is partly because the budget has grown so much in recent years — the most recent was more than $300 billion — and that the state has closed similar or worse spending gaps, by percentage, in the past.

Legislative analyst Gabriel Petek cautioned that California is better prepared to respond to the situation than during the economic recession 15 years ago, because it has since built several multibillion-dollar rainy-day funds, though the state is also looking at a structural deficit of about $30 billion annually going forward.

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“I go with the word ‘serious.’ A serious budget problem,” Petek said during a briefing with journalists. “I would stop short of calling it a crisis.”

H.D. Palmer, a spokesperson for Newsom’s Department of Finance, said the administration will have different numbers when the governor presents his 2024-25 spending plan next month, but Newsom is preparing to address a significant deficit.

“Both the Governor and the Legislature have a substantial challenge before them in closing a very large revenue gap in this budget,” Palmer told CalMatters. “The IRS, with the best of intentions, created a situation this year that is entirely new territory.”

Severe winter storms prompted the federal government to delay the income tax filing deadline for most Californians from April until November, and the state followed suit, giving an incomplete picture when legislators and the governor crafted the budget this summer.

It already accounted for a $30 billion deficit, after two years of record surpluses driven by economic recovery and federal aid related to the coronavirus pandemic. But those collections were ultimately another $26 billion below estimates — a drop of 25% from the prior year — digging a financial hole based on money the state committed in its spending plan.

This year looks weak as well, according to finance officials. California has been hit particularly hard by inflation, which pinched the housing market; a stock market downturn, affecting capital gains; and a drop in investments in the tech industry, which has pulled back on initial public offerings. Overall tax revenues are projected to be $58 billion below assumptions in the multi-year budget window.

Though the Legislative Analyst’s Office estimates that tax revenues will begin growing again next year, the recovery is likely to be slow, opening up long-term funding shortfalls that could affect essential programs in future years.

“There are enough options available to address this immediate problem,” Petek said. “Our high-level suggestion to the Legislature is just to be judicious about reserves because there’s a lot of uncertainty ahead, so preserving some of that resilience would be helpful.”

His office recommended that Newsom declare a fiscal emergency, allowing the state to dip into as much as $24 billion of its rainy-day funds, and that legislators pull back on one-time spending allocations that have not yet been distributed, potentially saving $10 billion or more that had previously been set aside for transportation, environmental and education programs.

Petek also suggested that California could cut the deficit by nearly $17 billion over the next three years by recalculating its constitutionally-mandated funding obligation to schools and community colleges, known as Proposition 98, based on the lower revenues. Though this would decrease the state’s base education funding over the long term, Petek said the immediate effects could be offset with reserves.

That option, in particular, could encounter stiff resistance in the Legislature. Assembly Speaker Robert Rivas, a Hollister Democrat, released a statement last week, when it became clear that tax revenues would be substantially below estimates, committing to a budget that “protects classroom funding.”

Newsom and lawmakers are also likely to confront months of tremendous pressure from advocates arguing that their priorities should be protected in any budget solutions. Statements started rolling out mere minutes after the Legislative Analyst’s Office published its report.

“California leaders have stepped up before to prioritize Californians who are struggling to get by and they must continue this in 2024,” said Pete Manzo, president & CEO of United Ways of California.

Republican legislators chastised their Democratic colleagues for continuing to make new spending commitments in recent budget cycles even as it became clear that the economy was increasingly shaky.

“Hopefully, the supermajority will see it is time for a more realistic budget strategy,” Senate Republican Leader Brian Jones of San Diego said in a statement, “instead of throwing money at a laundry list of projects that sounds nice on the national television debate stage.”