California’s budget deficit may be even larger than predicted

Eight months ago, energized by projections of a nearly a $100 billion surplus, Gov. Gavin Newsom and the Legislature wrote a $307 billion budget that lavished money on new and expanded services and rebated billions of dollars back to taxpayers.

Newsom crowed that “no other state in American history has ever experienced a surplus as large as this.”

Last month, Newsom had to eat those words because the immense – on paper – surplus had suddenly morphed into what he said was a $22.5 billion deficit due to sharp declines in tax revenues. He proposed a $297 billion budget for the 2023-24 fiscal year that clawed back some of the money than had not yet been spent.

Predictably, advocates for programs and services that wouldn’t receive the extra spending the previous budget had promised began complaining and demanding restoration. Environmentalists and leaders of the state’s financially perilous transit systems were among the loudest.

Political fallout from the sudden reversal of fortunes promises to make this year’s version of the annual budget process much more contentious than last year’s euphoria. Legislative allies of the aggrieved stakeholders are being squeezed between their demands and fiscal reality.

As difficult as this year’s budget process may be, the situation is likely worse than what Newsom projects in his proposed budget.

Last week, the Legislature’s budget analyst, Gabe Petek, declared that revenues will probably be markedly lower than what Newsom assumed, and the governor’s budget is “likely unaffordable in future years.”

“In particular, using recent revenue collections and economic data, we estimate there is a two‑in‑three chance that state revenues will be lower than the governor’s budget estimates for 2022‑23 and 2023‑24,” Petek wrote in a new analysis. “Our best estimate is that revenues for these two years will be roughly $10 billion lower – implying a larger budget problem by about $7 billion.”

Basically, Petek was saying, as tough as the spending cuts Newsom proposes may be, he and the Legislature need to tighten more to cover an even larger deficit.

There is another option that would ease the political pressure on lawmakers: Dipping into the state’s “rainy day” reserves.

Newsom’s proposal doesn’t tap the reserves, agreeing with Petek that it would be imprudent because no one knows whether the state will experience a serious recession in the near future.

The Federal Reserve System has been hiking interest rates in hopes of cooling off the economy and damping inflation without triggering a recession, but economists differ on whether it will succeed.

The shortfalls projected by Newsom and Petek assume that the state will avoid recession, but if it strikes, the budget deficit could increase by many billions of dollars and the reserves would be needed to maintain basic services.

“Although state revenues are moderating from a historic peak, they are not yet consistent with recessionary levels,” Petek told the Legislature. “Using reserves now to maintain the recent spending peak would mean the state would have less reserves available to pay for its core services if revenues declined further or in the event of a recession.”

The annual budget exercise is still in its early phases. Affected interest groups are making their pitches, privately and publicly, for exemption from the reductions that would be needed to balance the budget. Over the next few months, the budget committees of both legislative houses will be reviewing what the governor wants and what Patek is advising.

The crunch will hit in May when Newsom releases a revised budget, one that likely to be starkly different from last May’s version which projected the much-vaunted but illusory $97.5 billion surplus.