California’s projected $97.5 billion budget surplus has failed to materialize and the state now faces at least a $25 billion deficit that will require major adjustments.
Six months ago, while proposing a revised state budget, Gov. Gavin Newsom bragged about the state’s having a $97.5 billion surplus that would finance some landmark expansions of social and educational services.
“No other state in American history has ever experienced a surplus as large as this,” Newsom told reporters as he unveiled a 2022-23 fiscal year budget that topped $300 billion and, with a few tweaks, was eagerly adopted by the Legislature.
Last week, the Legislature’s budget advisor, Gabe Petek, issued a sobering report on the state’s finances, saying revenues are likely to fall $41 billion short of what Newsom and legislators anticipated, leaving the state with a $25 billion projected deficit for the 2023-24 budget. Moreover, he said, if recession hits, as many economists expect, the gap between income and outgo could be much higher.
If it’s just a $25 billion problem — as large as that number might seem — it could be handled relatively easily with some adjustments, such as throttling back on some of the spending the current budget contains, Petek said.
“It’s not insignificant, but it’s also manageable,” he told reporters. “We don’t think of this as a budget crisis, we just think of it as a notable budget problem.”
However, he cautioned against maintaining spending and using the state’s sizeable emergency reserves to cover the shortfall, because there is a strong chance that the current economic slowdown, being dictated by the Federal Reserve System to counter high inflation, could easily morph into a recession.
“Based on historical experience, should a recession occur soon, revenues could be $30 billion to $50 billion below our revenue outlook in the budget window. As such, we suggest the Legislature begin planning the 2023-24 budget without using general purpose reserves,” Petek said in his report.
Newsom’s budget staff did not dispute Petek’s rather gloomy fiscal forecast. California “is in its best-ever position to manage a downturn, by having built strong reserves and focusing on one-time commitments,” Department of Finance spokesman H.D. Palmer said.
That’s true, as far as it goes. Newsom and the Legislature did commit most of the supposed surplus to reserves and limited-time spending and in theory the latter could be cancelled or scaled back. A multi-billion-dollar cash giveaway, now being processed, is the largest example of such one-time expenditures.
However, one-time appropriations, while not legally required to be long-term commitments, raise expectations that the state will continue to finance what it started. The recipients of those funds, therefore, will press the Legislature to honor what they consider to be commitments to their particular programs and projects.
Hints that the state’s roaring economy might be slowing down surfaced within weeks of the current budget’s passage last June and Newsom vetoed dozens of bills for additional off-budget spending, citing economic uncertainty.
Ever since the budget’s enactment, state revenues have been running well below expectations, with virtually all of the shortfall in personal income taxes, which generally account for three-quarters of the state’s general fund revenues.
The vast majority of those taxes come from a relative few high-income taxpayers, whose incomes are intimately sensitive to fluctuations in the economy, particularly stocks and other capital investments. The stock market has taken a beating from the Federal Reserve’s sharp increases in interest rates and Silicon Valley, source of much of the state’s taxable income, is undergoing a retrenchment with massive layoffs of workers.
Petek’s report is another reminder that California’s budget depends on a very narrow and very volatile tax base and it is, therefore, foolish to make long-term financial commitments that assume the golden goose will always lay golden eggs.