California’s budget outlook is grim. Here’s what you need to know

Gov. Gavin Newsom opened this year with a rosy forecast: Buoyed by $17 billion more in revenue than previously planned, the state would have a modest surplus of $363 million for fiscal year 2025-26, he told reporters in January.

But life turns on a dime.

The January wildfires that ripped through Los Angeles forced the state to spend billions in disaster aid and delay tax filings for L.A. residents. The cost of Medi-Cal, the state-run health insurance program for low-income residents, ballooned to $6 billion more than anticipated. President Donald Trump’s on-again-off-again tariff policies rocked the stock market, which California heavily relies on for tax revenue. And the state lodged a flurry of lawsuits against the Trump administration over its threat to withhold federal funding for food assistance, disaster recovery and other grants.

By May, Newsom no longer predicted a modest surplus, but a $12 billion deficit.

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To plug the hole, Newsom initially proposed drastic cuts to Medi-Cal. But the final budget he negotiated with state lawmakers depended largely on internal borrowing, dipping into the state’s reserves and freezing Medi-Cal enrollment for undocumented immigrants to avoid deep cuts to other social services.

While Democratic leaders largely blamed the Trump administration for California’s budget problem, the volatility of state revenues is not new. California highly depends on taxing the income and capital gains of high earners, whose fortune is often at the mercy of the stock market. In 2022, the state saw a nearly $100 billion surplus, followed by a projected $56 billion deficit over the next two years.

2026 outlook

The deficit is projected to reach nearly $18 billion next year, mostly because the state is expected to spend so much money that it would offset, if not eclipse, the strong tax revenues driven by an AI boom, said the nonpartisan Legislative Analyst’s Office in its fiscal outlook last month.

If the estimate holds, it’ll be the fourth year in a row in Newsom’s tenure that California faces a deficit despite revenue growth.

Worse yet, the structural deficit could reach $35 billion annually by fiscal year 2027-28, the LAO said.

California is facing $6 billion in extra spending next year, including at least $1.3 billion because the state must now pay more to cover Medi-Cal benefits under Trump’s budget bill. The state also stands to lose more housing and homelessness funding from the federal government.

How can legislators fix it? The options are stretching thin, as the state already took one-time measures to balance the books. The LAO notes that solving an ongoing structural budget problem requires either finding more sustainable revenue streams, or making serious cuts, or both.

This article was originally published on CalMatters and was republished under the Creative Commons Attribution-NonCommercial-NoDerivatives license.