The state expects tax collection to fall short of the money allocated for programs essential to millions of Californians in the upcoming budget year, forcing the governor to take a more conservative spending approach while trying to protect much of his marquee programs.
The governor’s proposal includes shifting funding to bonds, tapping into $450 million from the state’s safety net reserve and renewing a tax on managed care programs to support Medi-Cal while continuing plans to reduce increases for climate and transportation programs.
The projections indicate the largesse of Newsom’s first term is over and the extent to which he has to pull back now and in the years to come could have implications for Democrats in the state Legislature and his own political legacy.
“This was not an easy budget, but I hope you see we tried to do our best to hold the line and take care of the most vulnerable, most needy, but still maintain prudence,” Newsom said.
“I have been very mindful of how concerned people have been about the impact on these fundamental core issues: education, homeless housing, healthcare, mental health, climate policy, public safety, broadly, and of course the issues of economic development, jobs, workforce development,” Newsom said.
As anticipated, the state’s budget hole deepened from estimates in January of a $22.5-billion shortfall and mark a dramatic turn from last summer when Newsom touted a $100-billion surplus.
Newsom and Democrats anticipated the possibility of a budget deficit and have been careful in prior years to mostly avoid establishing costly new programs or entitlements, and instead budgeted most of the surplus revenues to one-time funding allocations.
The governor’s revised $306.5-billion budget proposal largely calls for the state to pare back funding increases for programs, with little to no calls for immediate reductions below current investment levels for programs and services.
Why are budget protections so uncertain this year?
Unlike in prior years, more uncertainty looms over California’s financial situation at this point in the budget process and raises the possibility of cuts on the horizon.
The federal and state governments extended income tax-filing deadlines from April to October for most Californians this year, delaying the state’s ability to get a more concrete picture of its revenues beyond estimates until this fall. In California, residents of 55 of 58 counties representing about 99% of the population are permitted to file late without consequence.
Newsom said the state projects that delayed cash receipts will total around $42 billion.
The federal government is also on the brink of defaulting on its debt, adding to the uncertainty.
How did the state swing so drastically from having too much money to too little?
The California state budget is highly dependent on revenues from income taxes paid by its highest earners and is therefore subject to the ebbs and flows of capital gains from the stock market, bonuses to executives and IPOs — initial public offerings when companies begin to sell stock to investors.
Chris Thornberg, an economist and founder of Beacon Economics in Los Angeles, said the shortfall was predictable and of politicians’ own making.
Federal COVID-19 stimulus funding artificially boosted state income taxes higher than ever before, resulting in the record surplus. And what goes up must come down, he said.
Newsom said during his presentation that capital gains made up 11.3% of personal income in California in 2021.
“If capital markets went up at a nice even pace on a year-to-year basis this wouldn’t happen, but they don’t,” Thornberg said. “They go surging up and then go collapsing back.”
The wise course of action would have been to set the surplus aside and not spend it instead of dedicating the money to one-time programs, Thornberg said.
Newsom has repeatedly emphasized his decision to restrict most new spending to one-time funds, a strategy that avoids creating new permanent demands on the state budget if revenues drop.
But even temporary programs can be costly. The governor and lawmakers provided $9.2 billion in gas rebates to 32 million Californians since approving the payments in a budget deal last June.
Thornberg said the state has seen the same kind of revenue swell and decline two others times in the last quarter-century, during in the late 1990s and mid 2000s.
“Both times the state was hit with $30-billion deficits in the wake of it,” Thornberg said. “It was completely obvious what was happening this time and they all pretended it wasn’t a problem, and then here we go again.”
Does this mean we’re in a recession?
The U.S. economy is not in a recession, a fact that Thornberg said is protecting the state from free falling into a larger budget crisis.
California’s unemployment rate remained at a low 4.4% in March, the most recent month for which figures are available. Jerry Nickelsburg, director of the UCLA Anderson Forecast and a professor of economics, said job numbers also hit record highs that month.
“The data is telling us that, sector by sector, California should fare better than the U.S. in the coming few years, and California has been growing faster than the U.S. for decades,” Nickelsburg said. “We expect that to be the case or, if there were to be a decline in 2023, that it would be more mild in California than in the U.S.”
Whether a recession is on the horizon remains an open question, Nickelsburg said.
The kinds of imbalances that normally cause a recession, such as the construction of too many homes or an overstock of cars for sale, do not currently exist. But the lagged impact of prior interest rate hikes have yet to fully materialize and the Federal Reserve could continue to raise rates, he said.
Thornberg was more optimistic.
“The reality is the economy’s fine,” Thornberg said. “Consumers have tons of money still. There’s no foreclosures. The housing market, while it’s overpriced, is solid. There’s no bad debt out there. The whole thing has been overstated.”
What’s next?
A governor’s revised May budget proposal traditionally serves as a catalyst for more intense spending negotiations with the Legislature. Lawmakers have until June 15 to pass a budget for the next fiscal year.
The two sides have already disagreed on how to move forward.
The state Senate introduced a plan late last month to offset the budget shortfall by increasing taxes on about 2,500 of the largest corporations operating in the state and deferring an existing tax credit for companies that post a net operating loss. Senate Budget Committee Chair Nancy Skinner (D-Berkeley) said the proposal would reverse some of the Trump-era corporate tax cuts. She estimated the change could generate $7 billion in the first year and $6 billion each subsequent year.
Newsom’s office responded with a hard “no.”
“Gov. Newsom cannot support the new tax increases and massive ongoing spending proposed by the Senate,” Anthony York, the governor’s communications advisor, said in a statement. “It would be irresponsible to jeopardize the progress we’ve all made together over the last decade to protect the most vulnerable while putting our state on sound fiscal footing.”
In January, Newsom proposed reducing funding increases for climate change programs and transportation and delaying investments for 20,000 new child-care slots.
Instead, Assembly Speaker Anthony Rendon (D-Lakewood) has suggested that the state dip into its rainy day fund, which he argued was created for these kinds of situations.
So far, Newsom has refused to tap into the $23.3-billion fund, given the economic uncertainty across the country and potential need for those funds later in the event of a recession.
Newsom’s budget plan suggests revenue declines could reach an additional $100 billion through 2026-27.