Raising California’s revenue won’t erase the budget deficit

from Dan WaltersCalMatters

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In the four months since the Legislature and Gov. Gavin Newsom passed a new state budget, revenue — mostly from personal income taxes — has exceeded expectations by several billion dollars.

The uptick boosted hopes in the Capitol more than in California chronic budget deficit may disappear if revenue growth continues. That would save Newsom and lawmakers from having to dream more accounting tricksdeferrals and loans to cover the difference between income and expenditure.

However, the Legislature’s fiscal adviser, legislative analyst Gabe Petek, poured cold water on those rosy scenarios Wednesday. He sees the recent gains in revenue as a surge fueled by Silicon Valley’s artificial intelligence boom, which is likely to collapse like previous tech bubbles.

“With so much exuberance around AI, now seems like the time to take seriously the idea that the stock market is overheated,” Petek says in his annual fiscal reviewwhich precedes the introduction of a new budget by the governor. “History shows that the stock market tends to overreact to major technological advances, even if the technology itself turns out to be revolutionary.”

Instead of enjoying a surge in revenue that would erase what officials call a “structural deficit,” which is somewhere in the $10 billion to $20 billion range, officials should anticipate a larger gap, Petek says.

“According to our revenue and spending projections, the Legislature faces a budget challenge of almost $18 billion in 2026-27,” Petek says. “That’s about $5 billion more than the budget shortfall the administration expected in June, despite revenue improvements.”

The analyst noted that California’s constitution requires the state to set aside money for public schools and reservations, which would “almost fully offset the revenue gains,” as well as other expenses that are about $6 billion above current budget projections.

“Beginning in 2027-28, we estimate that structural deficits will grow to about $35 billion annually as spending growth continues to outpace revenue growth,” Petek says.

It should be noted, not for the first time, that California’s chronic deficit was not caused by an economic downturn that occurred in the past, but rather by a huge mistake by Newsom and his budget advisers three years ago.

In 2022, they projected a steady increase in revenue based on a one-time spike, prompting Newsom to announce a $97.5 billion budget surplus, boasting, “No other state in American history has had a surplus as large as this one.”

Confident that the money would be there, Newsom and lawmakers increased the spending portion of the budget, only to learn that the supposed surplus was based on what was later recognized as $165 billion in overstated revenue over four years.

Since then, revenue has failed to cover increased spending, and Newsom and lawmakers have covered the gaps with the aforementioned gimmicks. They have taken more than $20 billion in domestic loans from special funds that must be repaid. They have also drawn down reserves that should have covered genuine emergencies, not political short-sightedness.

Newsom and his staff are now in the final throes of crafting an initial budget for 2026-27, which will be his last as governor and will be presented in January. The question is whether he will face the fiscal music and finally write a truly balanced budget, or use shorter-term fixes and pass the problem on to his successor.

That would mean either real spending cuts or tax increases, both of which would require some courage. The past was not encouraging.

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