California looking at $2 billion deficit after lawmakers, Newsom slashed spending
California lawmakers and Gov. Gavin Newsom may have to fill a $2 billion deficit during the next fiscal year, according to a report released Wednesday by the nonpartisan Legislative Analyst’s Office that also contained warning signs for California’s economy.
Chief Legislative Analyst Gabriel Petek described the budget as “roughly balanced” and “in fair shape.”
It’s a dramatic improvement over last year’s budget picture, when the LAO initially projected a $68 billion shortfall. Lawmakers and Newsom took early action to trim spending and draw from budget reserves, shrinking the deficit to about $47 billion for the current fiscal year.
The turnaround is driven by a budget approved earlier this year, which cut about $11 billion in spending and increased business taxes to bring an additional $5.5 billion. It also assumes lawmakers will withdraw $7 billion from the rainy day fund next year as previously planned.
The budget forecast released Wednesday morning provides an early look at the state’s expected revenues during the current fiscal year, which ends June 30.
Democratic leaders signaled a willingness to maintain disciplined spending based on the analysis.
“We need to show restraint with this year’s budget,” Assembly Speaker Robert Rivas, D-Hollister, said in a statement.
“We need to continue to buckle down on spending and be incredibly strategic on any future fiscal expansion,” Senate President pro Tem Mike McGuire, D-Healdsburg, said. “Folks are doing their best to make ends meet, and it’s our responsibility to implement policies and secure investments that will make their lives more affordable.”
The report warns state leaders that revenues are unlikely to keep up with recent spending growth, driven in part by more people enrolling in state health programs. It advises Newsom and the Democratic-led legislature against taking on new spending commitments next year.
“While the budget picture is fair for the upcoming year, our outlook suggests that the state faces double‑digit operating deficits in the years to come,” the report reads.
Assembly Republican Leader James Gallagher said the potential deficits in future years is concerning. “Democrats got us into this mess and I have no confidence in their ability to fix things without inflicting real pain on Californians,” he said in a statement.
Another Republican lawmaker saw an opportunity in one of the report’s few recommendations: increased legislative oversight of spending programs.
“We need a robust assessment of the effectiveness of existing programs to figure out if they’re accomplishing what they’re supposed to accomplish,” Sen. Roger Niello, R-Fair Oaks said in an interview. “And if not, that’s where the expense reductions can come from to begin to balance those deficits (projected) in the out years.”
The report notes that these types of budget forecasts “are always highly uncertain.” That’s due largely to the structure of California’s tax system, which relies heavily on wealthy earners and makes the state budget vulnerable to extreme volatility.
The report contained some alarm bells for California’s economy, including a lackluster job market, decreased consumer spending and lower income for business owners during the first two quarters of the year. Petek said the higher forecasted revenue means the budget is “disconnected from the broader economy.”
The revenue bounce is driven largely by stock market appreciation, particularly in the artificial intelligence sector, according to the report. Legislative analysts said during the first half of 2024, stock pay at four tech companies — Meta, Apple, Nvidia and Alphabet, which owns Google — accounted for 10 percent of income tax withholdings.
“That, to us, feels a little more gregarious than if it were built on more robust job growth” and consumer spending, Petek said during a call with reporters. “When it’s based on the markets, markets and sentiment can change very quickly and it’s very unpredictable.”
That could be particularly true for an emerging technology like AI, analysts said.
The Trump factor
Democrats in California are bracing for President-elect Donald Trump’s second term beginning in January, setting up another stretch of unfriendly or even hostile relations with the White House and a Republican-controlled Congress.
“We have the added uncertainty of dramatic changes in federal policy next year under a new administration,” Department of Finance spokesman H.D. Palmer said in an email. “Higher tariffs and changes in legal immigration could add additional costs that affect not only the California economy overall, but our bottom line as well.”
Trump has already threatened to withhold natural disaster aid unless Newsom diverts more water to farmers. His administration could reject waivers for Medi-Cal, the state’s Medicaid program, including one that lawmakers have recently used to pull more funding from insurance companies and the federal government.
These hypotheticals were not taken into account for the LAO’s analysis, however.
“We know that there’s some potential, of course, for California to be in the bullseye but it’s not something we built into this forecast,” Petek said. “We aren’t trying to speculate here. We’re really trying to give the legislature as clear a picture as we can about the state’s financial position as it is now.”
State workforce savings unclear
The budget plan adopted earlier this year included a sweep of 10,000 vacant state jobs which would result in about $2 billion in savings.
“We have not been able to get any information from the administration about how those efforts are going,” Petek said. The fiscal outlook “does not assume all of those efficiencies or reversions materialized as assumed.”
The Department of Finance is “still in the process of updating and assessing the progress that’s been made on this front, as well as other areas of efficiencies in the budget,” Palmer said, and that the administration would have more information in January.
Another question mark is how much the recent health care minimum wage hike will impact state coffers. According to the LAO, estimates range anywhere from the low hundreds of millions of dollars to the low billions of dollars annually.
State leaders closed a $47 billion deficit in June by dipping into the rainy day fund, trimming the prison budget and cutting state operations and workforce positions. The state also delayed implementation of minimum wage hikes for health care industry workers, which took effect in October of this year.
The numbers are subject to change depending on several economic factors including the stock market, which fuels capital gains taxes, and income tax filing among the state’s wealthiest earners.
Lawmakers and Gov. Gavin Newsom begin the six-month budget crafting process in January, when Newsom is constitutionally required to unveil his spending priorities for the following fiscal year.
This story was originally published November 20, 2024 at 10:21 AM with the headline "California looking at $2 billion deficit after lawmakers, Newsom slashed spending."
