The state must increase budget reserves, stop the boom and bust

By Peter Weber and Chris Thornberg, especially for CalMatters

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Five gubernatorial candidates met at a recent debate organized by a coalition of groups called Jewish California. How the state should oppose its own structural budget deficitsasked the candidates. Should California raise taxes or do better with the money the state already takes in?

Eric Swalwell and Tom Steyer support higher taxes. Matt Mahan, Steve Hilton and Antonio Villaraigosa argued for better results from the revenue the state already has.

Despite their responses, California’s course may be set before the next governor takes office.

The Office of the Legislative Analyst designs sustainable structural budget deficits for California — $18 billion in fiscal years 2026-2027 and up to $35 billion in 2027-2028 and beyond.

How Gov. Gavin Newsom and the Legislature deal with this gap will set the course for years. And how voters decide some measures on the November ballot, including a proposed wealth tax, could further bind the next governor.

Fiscal discipline marked the Jerry Brown years, at least while he helped “temporarily” turn California into a state with the highest marginal income tax rate in 2012. Since then, many things have happened that no governor could have predicted: catastrophic wildfires, a global pandemic, cascading housing and homelessness crises, among others.

Over the past seven years, California’s general fund spending has increased by about 66%. Inflation only explains about a third of that. Also, the number of government employees per resident increased by 19%, while the state’s net population decreased by 450,000.

A total of 1.8 million Californians have left the state, partially offset by growth in immigrants and births. Between 2018 and 2022, about 57,000 wealthy people left, taking with them about $1.1 trillion in personal wealth.

The message is clear. California has a spending problem and taxpayers are getting a pittance in return.

California has the highest unemployment rate in America, the lowest affordability in the continental United States, declining homeownership, median home prices twice the national average, $23 billion spent on homelessness as the homeless population increased by 40%, and infrastructure that is near the bottom of the national rankings.

The main reasons include chronic budget instability, weak fiscal discipline, poor accountability and grossly ineffective government. Employers also cite taxes, regulations and red tape as reasons to invest elsewhere, fueling a weak labor market.

We can’t boil the ocean, so let’s tackle the first two problems—budget instability and fiscal discipline.

California’s tax structure depends disproportionately on high earners and capital gains, making revenues highly sensitive to market fluctuations. During a boom, Sacramento treats windfalls as permanent. In lean years, it fights to cut services or raise taxes.

Consider the administration $165 billion in overstated revenue in 2022. This created a surplus of $98 billion and offset spending commitments. But the excess was imaginary; the costs were not.

The Legislative Analyst’s Office suggested a sensible fix: building much larger reserves into the budget. Current law limits reserves to 10 percent of general fund tax revenue — too low for a state as volatile as California. Under current policy, reserves would cover only about a third of the projected shortfall.

Raise the cap to 50% and the state could cover closer to three-quarters. The idea is to build toward that level over several budget cycles, improving stability without crowding out vital programs.

This reform would also create a tax revenue “rate” based on a 20-year extrapolation. Revenues above the norm will be treated as windfalls and deposited into reserves; revenues below it would mark years of scarcity when these reserves could be tapped.

That fix would require the Legislature to place a measure on the ballot. On a question so important for the future of the country, this is exactly the right answer.

Fiscal discipline is not austerity; it’s accountability. That means insisting that every dollar has real value for taxpayers.

California doesn’t need bigger government. It needs a better one.

This article was originally published on CalMatters and is republished under Creative Commons Attribution-NonCommercial-No Derivatives license.