A confluence of weaker than expected state revenues, delayed tax deadlines and overspending based on inaccurate budget projections created the budget shortfall. From a high of a $100-billion budget surplus during the COVID-19 pandemic, the state has experienced back-to-back deficits as uncertainty continues to loom over the U.S. economy.
Newsom described the upcoming budget as an example of revenue “normalization after a period of tremendous amounts of distortion” during a presentation Wednesday as he outlined his $291.5-billion budget proposal for fiscal year 2024-25 in Sacramento.
“All of this uncertainty happened because we experienced something we’ve never experienced in modern history: The state didn’t collect taxes in April of last year,” Newsom said.
The deficit deepens state government’s economic challenges and could pose political problems for Newsom this year as he grapples with lawmakers and interest groups to cut $8.5 billion in planned spending, including from housing and climate programs.
His budget proposal indicates that he wants to work with lawmakers to add funding restrictions to a law he signed last year that increases the minimum wage for healthcare workers to $25 per hour, a move that could delay the pay hike from taking effect if state revenues drop below a certain level.
The governor’s plan seeks to maintain funding for many of his expensive policy promises, including the expansion of Medi-Cal eligibility to all immigrants regardless of legal status.
But his decision to dip into the $37.9 billion in budgetary reserves sounds a new alarm for the Golden State. Until now, Newsom has rebuffed calls from Democratic lawmakers to tap into the state’s rainy-day fund and other reserves, which act as a piggy bank that can be cracked open during a financial crisis to avoid cuts to critical services and social safety net programs.
The governor is proposing that he declare a budget emergency this summer, which is required by law to draw down the reserve accounts. His plan to spend $13.1 billion of the reserves means less funding will be available to backfill spending if revenues continue to decrease, possibly forcing more painful and drastic cuts in the years ahead.
Newsom is also looking to dip into the reserves at a time when he’s proposing decreased annual spending. The 2024-25 budget marks a decline of nearly $20 billion in spending from the budget lawmakers passed in June.
California’s state budget difficulties were compounded last year when California and the federal government delayed the deadline to file 2022 income tax returns from April to November due to winter storms that pummeled coastal California and flooded parts of the state. The extended deadline affected more than 99% of California taxpayers in 55 of the state’s 58 counties, according to the Department of Finance.
In a typical budget year, state government has state tax receipts in hand before Newsom unveils his revised budget proposal in mid-May and prior to reaching a final spending agreement with lawmakers in June. The delay forced lawmakers and the governor to enact the current budget in July based on estimates of how much money the state expected to collect in tax revenues by the November deadline.
The Department of Finance last year anticipated a nearly $32-billion shortfall in the current fiscal year that ends on June 30, which forced lawmakers and the governor to trim their spending plans.
The state budget is highly dependent on income taxes paid by California’s highest earners. Revenues are prone to volatility, hinging on capital gains from investments, bonuses to executives and tax windfalls from new stock offerings.
Newsom and lawmakers anticipated additional revenue declines driven by a declining stock market, high interest rates and increased inflation.
Now state leaders must cut spending in the upcoming fiscal year to make up for last year’s actual revenue shortfall and an anticipated deficit in the coming year.
“The timing challenge related to this deficit estimate is definitely unique,” said Gabriel Petek of the Legislative Analyst’s Office.
Despite the budget challenges, there’s no indication of a larger economic crisis in California.
“So up until now, California has been growing faster than the U.S., on a per capita basis, and has been one of the fastest growing states in the U.S.,” said Jerry Nickelsburg, director of the UCLA Anderson Forecast and a professor of economics. “And now it’s growing at about the rate of the U.S. as really everyone sort of slows down a bit.”
He noted that there’s more geopolitical risk worldwide and the presidential election could have an impact on U.S. economic policy into the near future.
But Nickelsburg said that slow growth is expected to be short-lived, with economic growth accelerating again later this year and into 2025.
Newsom’s January budget proposal begins a six-month process of hearings and negotiations with the California Asembly and Senate, both of which will have new leaders by the time the budget talks intensify.
He promised to provide a more complete fiscal plan in May when the state has a more accurate understanding of 2023 income tax collections.