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California’s Budget Blues

By Jason Lane, SVP, Director of Government Relations

This past year, the legislature passed a staggering $308 billion budget, which included a healthy surplus. Lawmakers used the surplus to provide $17 billion in inflation relief to Californians, including $9.5 billion in tax rebates. This is in addition to the $54 billion in climate related investments. Now, just six months removed from the passage of the 2022-23 budget, the state faces a fiscal test.

California is heavily dependent on income tax revenue. Consider that in 1963-1964, personal income tax represented 18 percent of general fund revenues. By 2003-2004 that number climbed to 45 percent and in 2022 personal income tax accounted for nearly 70 percent of the state’s general fund. Chiefly led by job losses in the tech sector, California’s income tax revenue has plummeted in 2022, and capital gains tax revenue has flatlined due to a lackluster stock market. Revenue estimates are lower than budget projections from 2021‑22 through 2023‑24 by $41 billion. In total, lawmakers will grapple with a $24 billion deficit when the legislature reconvenes for the 2023 session. But that number is illusory and subject to change as lawmakers look to pass a balanced budget by June 15th.

The extent of the state’s budget woes is partly determined by the rate of inflation. According to the November report by the Legislative Analyst Office, titled The 2023‑24 Budget: California’s Fiscal Outlook, “…programmatic spending is adjusted somewhat automatically for inflation—either through formulas or administrative decisions…In other cases, spending increases are determined through legislative deliberation and are directly approved by the Legislature. Because our outlook reflects the current law and policy of the Legislature, our spending estimates only incorporate the effects of inflation on budgetary spending when there are existing policy mechanisms for doing so. This means that the actual costs to maintain the state’s service level are higher than what our outlook reflects. Consequently, our estimate of a $24 billion budget problem understates the actual budget problem in inflation‑adjusted terms. That is, assuming the Legislature wanted to maintain its current level of services, additional spending would be necessary.” If economic conditions continue to deteriorate, the Legislative Analyst’s Office predicts that revenue numbers could fall short as much as $50 billion by the time the legislature approves a spending plan this summer.

The good news is that California seems poised to weather the economic storm in the near term. Fiscal estimates show that the state will end the 2022-23 budget year with $28 billion in the budget reserve account. Additionally, the Proposition 98 reserve account, which is dedicated to school spending, will end the year with a $9.8 billion surplus. Assembly Democrats, who released their budget priories in early December, feel confident that these existing budget reserves will prevent major cuts to programs and services in the 2022-23 fiscal year. Beyond that, however, the future of the state’s fiscal condition seems dependent on a variety or external economic conditions, and the severity of the looming national recession.

Few lawmakers or legislative staff remain as holdovers from the dark days of the early 2000’s when California faced multi-year, multi- billion-dollar deficits. Then, programs and services were slashed, state workers were furloughed, tax refunds were delayed and IOU’s were issued by the State Controller’s office to keep the lights on. If lawmakers wish to avoid repeating history, legislative leaders and Governor Newsom may need to make some tough decisions and exercise fiscal discipline, all while managing a freshman class of legislators eager to make splash.