Gavin Newsom’s new budget must close a projected deficit. How will Californians feel the pain?

During his first term as California governor, Gavin Newsom’s January budget briefings would run two-to-three hours, much of the time devoted to exulting in the state’s strong economic position and touting his plans to pour new money into ambitious policies.

But when he unveils his proposal Tuesday for the 2023-24 fiscal year, it will likely be marked by a shift in tone, if not length.

Facing economic headwinds from soaring interest rates and inflation, the state could swing from last year’s $100 billion surplus to a $24 billion budget deficit, California Legislative Analyst Gabriel Petek projected in November.

If the gloomy predictions bear out, Petek warned, it could lead to the state’s weakest economic performance since the Great Recession. He cited lower-than-forecast tax revenue as the source of what he called a “notable but manageable” budget problem.

Newsom is expected to reveal to what extent he agrees with Petek and his recommendations for bridging the gap. His proposal will set in motion months of negotiations with state lawmakers, who must pass a balanced budget by the constitutional deadline of June 15.

The anticipated shortfall has the potential to affect funding for a slew of the state’s highest priorities, including major transportation projects, health and human services initiatives and efforts to curb homelessness.

But state lawmakers and analysts have been optimistic about avoiding any drastic cuts.

“It’s not a terrific situation, but there’s no need to panic and start slashing and burning public services in California,” said Scott Graves, director of research for the nonprofit California Budget & Policy Center. “There are a lot of options that policymakers can use to balance the state budget in a way that isn’t being done on the backs of working Californians.”

Some of those options include dipping into the state’s reserves, borrowing from special state funds and pushing funding for ongoing projects into later years.

No matter what Newsom proposes this week, analysts caution that, like any fiscal projection, a lot could change before he revises his blueprint in May and reaches a deal with lawmakers by the June deadline.

“In May, you may end up with a totally different make and model,” Graves said. “This is all just sort of a first draft.”

California has historic reserves amid $24 billion shortfall forecast

Since 2015, California has socked away billions of dollars in a rainy-day account as a hedge against economic downturns.

Patek, however, has urged the governor and lawmakers to avoid relying on the state’s reserves to balance the budget, warning that a possible recession could land California in an even worse fiscal position.

Unlike his predecessor, Jerry Brown, Newsom has been more willing to spend big on ambitious progressive programs. Last year’s $300 billion-plus budget included funding to extend healthcare coverage to all undocumented immigrants, give money back to Californians in the form of tax refunds and provide free transitional kindergarten to all 4-year-olds.

Still, he and the state legislature have been prudent when handling the historic surpluses of the past two years. Instead of committing to ongoing investments, they focused the surplus dollars on one-time spending items.

That’s partly because California’s finances are especially sensitive to shifts in the economy. Personal income tax is the state’s main revenue source, and the wealthiest 1% of taxpayers account for nearly half of that. When the stock market is booming and the state’s highest earners are on the upswing, the state is, too. But when the economy slows and they’re not doing as well, as is occurring now, state finances tighten.

In late summer, just several weeks after the passage of the current budget, Newsom warned of an anticipated downturn as he vetoed a number of bills, citing a need for budgetary discipline.

“With our state facing lower-than-expected revenues over the first few months of this fiscal year, it is important to remain disciplined when it comes to spending, particularly spending that is ongoing,” he wrote in a veto message.

More funding for California schools

California’s public school systems, a beneficiary of surplus spending, are unlikely to see significant one-time allocations in this budget.

Kevin Gordon, a prominent California education lobbyist, said he does not anticipate education funding increasing much more than the required cost of living adjustment. Under Proposition 98, the complex formula that sets annual funding for TK-12 schools and community colleges, policymakers must account for an annual inflationary increase.

Consumer prices rose nearly 8% over the past year, so Gordon expects schools will see a comparable rise in their allocation.

He also anticipates the overall budget shortfall could derail future spending on school facilities.

For the first time last year, California set aside $1.3 billion in one-time money for school construction and maintenance. In doing so, policymakers indicated plans to invest another $3 billion over the subsequent two years — a pledge that likely won’t pan out given the deficit.

“Newsom may have to reel in some of the multi-year plans for spending so I wouldn’t count on those promises,” Gordon said. “Anything you don’t have in your hot little hand is going to be vulnerable.”

Despite the loss of additional one-time funding and contributions for capital improvement projects, Gordon said most public school systems across the state are in a good position for the coming fiscal year.

“Don’t expect districts to keep expanding programs. But broadly speaking, most districts are not going to see deep cuts,” he said. “Now, the year after next could be problematic, but the coming year, I think it’ll be barely a break-even year.”

Advocates hopeful about California healthcare funding

Last year, Newsom committed to one significant ongoing spending item: expanded healthcare coverage for all undocumented immigrants.

Healthcare advocates are hopeful the governor will proceed with his promise to extend Medi-Cal eligibility to include 700,000 undocumented residents ages 26 to 49 by January 2024.

But the expansion is expensive. It will likely cost the state about $2.6 billion every year.

Anthony Wright, executive director for Health Access California, said it’s vital that the state initiate the expansion on time, because revamped Medi-Cal plans will take effect in 2024 and were negotiated with an influx of new patients in mind.

“These Californians are already in our health system,” Wright said. “They’re just getting care in the least efficient, most expensive way possible. It’s better for the system if we get them in and get them in earlier, rather than push off them getting the primary and preventive care, especially with an ongoing pandemic and other issues.”

Wright, like Graves, doesn’t think the state will need to make drastic cuts to social service programs to stay afloat. He said leaders have likely learned their lesson from years like 2009, when the state removed dental, vision and other care from Medi-Cal plans as a cost-saving measure.

It took years to bring those services back — a plight that leaders would probably like to avoid in the future, Wright said.

“I think (Newsom’s) justifiably proud of some of the work that has been done to invest in improving and expanding Medi-Cal, in public health, in mental health and in reproductive health,” he said. “And that we’re not backtracking or delaying that.”

This story was originally published January 9, 2023 at 6:00 AM with the headline "Gavin Newsom’s new budget must close a projected deficit. How will Californians feel the pain?."