California will likely run a $25 billion budget deficit next year, state officials said Wednesday, ending a streak of historic surpluses and acting as a warning to other states of a possible recession.
The deficit will likely lead to painful spending decisions in the nation’s most populous state. But that likely won’t affect the state’s biggest expansions of government services — including free kindergarten for 4-year-olds and free health care for low-income immigrants living in the country without legal permission.
Incomes have grown steadily in California over the past decade. This year, a $72.4 billion surplus pushed total government spending to more than $300 billion for the first time.
But tax collections have slowed significantly since Democratic Gov. Gavin Newsom signed into law that budget. This year, revenue fell short of expectations by $41 billion, according to an outlook released Wednesday by the Office of the Nonpartisan Legislative Analyst.
Democratic-controlled California taxes the wealthy more than other states, and most of the drop in income is because the wealthiest aren’t making as much money as they used to. The S&P 500, a key indicator of the health of the stock market that drives the incomes of the super rich, has fallen more than 17% since its peak in January.
“Our revenue estimates represent the state’s weakest performance since the Great Recession,” LAO’s report said.
The future looks bleak. Rampant inflation has made everything more expensive. The Federal Reserve tried to contain inflation by raising a key rate. A higher interest rate makes it more expensive to borrow money, which ultimately makes people spend less. Although this would control price increases, it would also reduce the demand for goods and services. This leads to layoffs, which means people pay less tax.
“The longer inflation persists and the more the Federal Reserve raises interest rates in response, the greater the risk to the economy,” the AJO said. “The chances that the Federal Reserve can control inflation without causing a recession are slim.”
Although California’s employment remains strong — the unemployment rate of 3.9% for September is the lowest since 1976 — the high-wage tech industry has been rocked by a series of recent job cuts. Facebook’s parent company, Meta, announced last week that it would lay off 11,000 people, or 13% of its workforce.
California’s skyrocketing income has fueled a big expansion of government services, including making 4-year-old kindergarten free for all and paying for health care for low-income immigrants who live in the country without legal permission.
But California is in a much better position to weather a potential recession than it has been in the past. The state has more than $37.2 billion stored in its various savings accounts. And the state has plenty of cash available to meet its obligations this year.
The Office of the Legislative Analyst has not recommended that lawmakers reverse ongoing spending on things like kindergarten or expanding health care. Instead, they urged lawmakers to withdraw some one-time spending increases planned for this year. Lawmakers agreed to $75 billion in one-time spending over the past two years.
“To address the budget problem for the coming year, these cases could provide the Legislative Assembly with areas for pause, delay or reassessment,” the AJO wrote.
Democratic House Speaker Anthony Rendon said Democrats had worked with Newsom to increase state savings accounts over the past few years.
“We can and will protect the progress of the budgets of the past few years,” Rendon said. “In particular, the Assembly will protect historic funding gains for California schools, as districts must continue to invest in staff retention and recruitment to help children thrive and recover from the pandemic.”