Trump tariffs and rising health care costs knock California budget back into deficit

Facing a long horizon of budget deficits, California officials stretched and scrimped and massaged the numbers to stabilize the state’s finances last year. But an unforeseen economic downturn, spurred by President Donald Trump’s chaotic tariffs strategy, has knocked California out of fiscal balance once again.

Gov. Gavin Newsom is now forecasting a $16 billion, or 4%, decline in tax revenues in his revised budget proposal, according to a memo provided by his office in advance of the announcement Wednesday. That plan is the opening salvo in negotiations with the Legislature, ahead of the start of the fiscal year in July.

It’s a sharp turnaround from January, when Newsom projected a modest surplus in his $322 billion spending plan. The memo, which dubs the revenue shortfall the “Trump Slump,” does not provide an updated figure for California’s budget deficit.

“We are seeing the slow-rolling impact of 'Liberation Day' and it's not a good one,” spokesperson H.D. Palmer said. “Conditions have definitely changed for the worse since January, in significant part because of those federal tariffs.”

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California’s financial picture was troubled even before the recent turmoil. Newsom and the Legislature took extraordinary steps last summer to close a budget gap projected in the tens of billions of dollars over two years, including by making sweeping cuts to state agencies and positions, clawing back funding increases for health care providers, eliminating affordable housing programs, delaying money for schools, suspending business tax credits and dipping into reserves.

And while tax revenues came in $6.8 billion above forecast through April, other problems were brewing.

A one-man 'wrecking ball' to California economy

Medi-Cal, the state’s health insurance program for low-income people, has reported a more than $6 billion cost overrun this year — in part because an expansion to include immigrants without legal status brought in more new enrollees than expected — and it needed an emergency cash infusion in March.

The devastating fires that hit Los Angeles in January also introduced new uncertainty for the budget, because the tax deadline for Los Angeles County — where a quarter of all Californians live — was delayed until October.

But the biggest risk is undoubtedly from Trump’s tariffs, which Newsom sued last month to block. Stock market declines are poised to take a bite out of future income tax revenue, because California relies disproportionately on capital gains earned by the wealthiest taxpayers; that accounts for $10 billion of the projected revenue decline. Higher costs from the tariffs are also imperiling major sectors such as manufacturing, agriculture, tourism and shipping in California, whose largest trading partner is China.

"It's one person that is taking a wrecking ball to our economy," state Senate President Pro Tem Mike McGuire, a Healdsburg Democrat, said last week during an event in Sacramento. "That is the existential threat to the state of California right now."

The grim outlook will almost certainly force more reductions to state programs, and legislative leaders will have their own ideas about what to target after Newsom puts forward his priorities today.

Bargaining will ramp up over the next month, with a June 15 deadline for the Legislature to pass a balanced budget or forgo its pay, though sometimes provisions of an overall deal drag out beyond that.

A binder showing Gov. Gavin Newsom’s revised budget proposal for 2023-24 during a press briefing at the state Natural Resources Agency in Sacramento on May 12, 2023.

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Rahul Lal

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CalMatters

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“Anyone who thinks we’re not going to make cuts this year is not in touch with reality,” Assemblymember Jesse Gabriel, an Encino Democrat who leads the Assembly budget committee, told CalMatters. “Advocates who are proposing major expansions of programs should stop wasting people’s time.”

One likely exception is a proposed $420 million annual increase of California’s film and television tax credit, more than doubling the pot of available subsidies and boosting the amount that individual productions can receive. It’s a priority for Newsom, with the strong backing of many Los Angeles-area legislators, especially as the region seeks a comeback after the fires.

Trump’s effort to slash federal spending is another looming question mark. Congressional Republicans have floated shifting more of the cost of social safety net programs to the states, though they are struggling to reach a budget agreement.

If they ultimately push through major changes to federal funding, lawmakers could be back in Sacramento later this year or early next year revising the state budget once again.

“Ninety percent of the ball game is in Washington,” Gabriel said. “It’s frustrating to me that this is beyond our control.”

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