Newsom finally aligns with Legislature’s gloomier budget outlook, blaming ‘massive volatility’

When Gov. Gavin Newsom proposed a 2024-25 state budget in January, he declared that the state faced a $38 billion deficit and chided journalists for citing wider projections in the gap between income and outgo from the Legislature’s budget analyst.

Nevertheless, state legislative analyst Gabe Petek stuck by his guns and a month later increased his deficit estimate during a three-year “budget window” to $73 billion, citing a $24 billion shortfall in revenue estimates over the period.

On Friday, Newsom unveiled his revised budget, covering the current fiscal year, the 2024-25 year and 2025-26, and tabbed the deficit at $44.9 billion through 2024-25. He estimated an additional $28.4 billion in 2025-26, totaling $73.3 billion.

Newsom, indirectly agreeing with Petek’s gloomy revenue picture, blamed “massive volatility” in the state’s revenue system, particularly difficulty in projecting income taxes on capital gains, for the wide fluctuations in revenue estimates and reality. Over four years, he noted, revenues have fallen $165 billion short of estimates.

It’s not a new phenomenon. Over several decades, the state has become overwhelmingly dependent on personal income taxes to finance its budget, particularly taxes on high-income taxpayers and their investment earnings.

As that dependency increased, the state would experience massive windfalls during some years and deep revenue declines in others. When the state treasury was flush, governors and legislators would increase spending, and when revenues declined, they would face multibillion-dollar deficits.

The peaks have increased. Just two years ago, Newsom boasted of a $97.5 billion budget surplus. “No other state in American history has ever experienced a surplus as large as this,” he said as he unveiled a $300-plus billion budget that the Legislature eagerly adopted with a few tweaks.

Likewise, the valleys have deepened, with this year’s massive deficit a prime example – and the revenue cycles bear only passing relationship to the overall economy.

Newsom, like his predecessors, says that volatility could be tamed were the state to overhaul its revenue system and reduce its dependence on taxing the rich. But he, like the others, is obviously unwilling to do the heavy lifting that a tax reform would require.

Gov. Arnold Schwarzenegger and the Legislature appointed a blue-ribbon commission to study revenue volatility and recommend systemic changes. The commission was sharply divided but issued a report proposing fundamental changes, but it was quickly filed away and ignored.

Having acknowledged the much larger deficit, Newsom proposes two changes in the budgetary process to cope with the volatility factor: including future budgets in the annual calculations and not spending erratic revenue sources, such as capital gains, until they are realized.

Newsom said that were the Legislature to adopt his revised budget and the current revenue estimates proved accurate, the state could get its budget balanced by 2026 – which would coincide with the last year of his governorship.

The budget closes the gap with a melange of spending cuts, deferrals, tapping into emergency reserves, some increased taxes and some accounting gimmicks. Over two years, the state would use about $13 billion in emergency reserves, plus another $8 billion for schools from a separate reserve.

The initial version made few true spending reductions. But with a wider deficit, the revised budget contains some real cuts, including the partial closure of some prisons, and shrinkage in some of the appropriations made when it appeared the state had a big surplus.

“I prefer not to make these cuts,” Newsom told reporters, adding, “You’ve got to do it.”

Whether the Legislature can resist pressure from advocates for the programs Newsom would cut remains to be seen.

For the record: This commentary has been updated to reflect the correct total for the governor’s multi-year estimate of the budget shortfall.