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LAO: California faces a $68 billion shortfall

California Gov. Gavin Newsom will need to close a $68 billion shortfall as he wraps up work on the proposed budget for fiscal 2024 that he will present to lawmakers in January.

The upshot is that the flooding and massive storms that hit California in early 2023 and pushed income tax filings in the state from April 15 to November meant that adjustments to account for lesser revenues based on 2022’s income tax filings were not made when the fiscal 2022-23 budget was adopted in June.

The state Legislative Analyst’s Office discussed the ramifications of their fiscal report — that included a break down of the massive projected shortfall — during a zoom press conference with reporters Thursday.

“The Federal Reserve’s tightening of monetary policy has had an outside effect on California’s economy,” said Legislative Analyst Gabriel Petek.

Legislative Analyst’s Office

Given what Legislative Analyst Gabriel Petek called an economic slowdown in California that began at the end of 2022, which is expected to continue for the next few years, the LAO is also anticipating budget gaps of $30 billion in the next three upcoming budget cycles through fiscal 2028 if spending remains the same.

Revenues came in $58 billion lower than the fiscal 2022-23 budget act projections with total income tax collections down 25%, according to the LAO’s report. Other issues, included that Proposition 98, which establishes minimum spending on schools, would have allocated $4 billion less in the fiscal 2023 budget approved in June, based on reduced revenues, had income tax filing not been delayed to November. Typically, the state does it’s May budget revision with income tax revenue filings from April 15 in hand.

The state has $24 billion in reserves and there are options to reduce spending on schools and community colleges that could address nearly $17 billion of the budget problem, according to the LAO. The other solution would mean cutting $8.6 billion of one-time spending proposed for fiscal 2024-25. This includes spending cuts of $2.2 billion in transportation, $1.9 billion in natural resources and the environment and $1.6 billion in education.

Petek also suggested that the state could issue bonds for projects, rather than using general fund cash as it did in the fiscal 2023 budget.

In addition to the shortfall in this fiscal year, the LAO also predicts a total multi-year shortfall of $155 billion through fiscal 2028, because they are projecting revenues will be less than current projected expenditures by $30 billion in each of the next three budget years.

“Why are we facing this problem when the national data indicates the economy is strong? We had so much growth in fiscal 2021-22 that there is a reversion-to-the-mean effect,” Petek said. “The Federal Reserve’s tightening of monetary policy has had an outsized effect on California’s economy.”

The volatility in the state’s tax structure, and dependence on high-net taxpayers — roughly 40% of income tax revenues come from the wealthiest 1% of the state’s residents — can cause massive economic swings, the LAO office said. It also means that the state’s income tax revenues are dependent on capital gains, so the state’s fortunes tend to track the stock market.

The state began experiencing an economic slowdown in fourth quarter 2022, as the S&P 500 fell 28%, Petek said.

The stark tech sector drop off, decline in the number of initial public offerings and drop in venture capital spending that resulted in the Silicon Valley Bank failure in March, have also hit state revenues hard, Petek said.

But even accounting for the state’s baked-in revenue volatility, the swing from having nearly $100 billion surplus in fiscal 2021 to a $68 billion deficit heading into budget season is pretty dramatic.

The governor and lawmakers will be grappling with closing the gap as they craft the fiscal 2024 budget in the six months leading up to budget passage in July 2024.

“The LAO’s Fiscal Outlook includes challenging news — we can withstand this, but we will need to be cautious and mindful as we approach our budgeting and legislation next year and in the years to come,” Senate President pro Tempore Toni Atkins, D-San Diego said in a statement. “California is prepared to withstand these budget challenges. Our record reserves and other budgeting tools will help us weather this shortfall, while at the same time protecting middle class taxpayers and the programs and resources that help Californians and families.”

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