California Faces First Budget Gap Since 2018 as Stock Market Hits Taxes

(Bloomberg) — Governor Gavin Newsom said California will face a $22.5 billion budget deficit in the coming fiscal year, the first for the most populous US state since 2018 as the global stock market rout and efforts to cool inflation hammer its tax collections.

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Newsom detailed the shortfall in a $223.6 billion budget he proposed Tuesday for the fiscal year that begins July 1. His general-fund blueprint fills the gap mostly by tapping one-time funds.

The deficit brings an abrupt reversal for California, which enjoyed remarkable surpluses in the wake of the pandemic as the stock market rallied on the back of massive stimulus from the federal government. That delivered windfalls to wealthy residents who account for a large chunk of California’s income tax-revenue.

In addition to falling stock and real estate markets, the state also has seen layoffs at large California-based employers including Salesforce Inc., Meta Platforms Inc. and Twitter Inc., which may lower personal-income tax collections.

“What is consistent is the inconsistency of our revenue on the basis of a progressive tax structure,” Newsom said. “The good news is that because of leadership and because of support of the voters, we’ve been able to capture a lot of that volatility in terms of set asides that provide us a buffer.”

About Face

Newsom will update his proposal in May with the latest revenue collection figures. Legislators are required by law to pass a budget before the end of the day on June 15 or they forfeit their pay for each day they are late. Democrats control both chambers of the legislature. Lawmakers typically propose their own budget then strike a deal with the governor that combines portions of his and theirs.

The governor, a Democrat who was sworn in for a second term last week, enjoyed a record $97.5 billion budget surplus this year, about half of which he used for discretionary purposes. That included a $9.5 billion program that gave one-time inflation relief payments of up to $1,050 each to more than 16 million taxpayers and their dependents.

The fiscal about face in the nation’s biggest state may be an early sign of trouble for other governors who saw revenue surge after the pandemic, in part due to hundreds of billions of dollars in aid from President Joe Biden’s rescue plan. That funding has largely been spent or committed and the Federal Reserve has raised interest rates aggressively to curb inflation, which has raised the specter of a potential recession. The last two downturns were extremely painful for state governments as large budget shortfalls triggered numerous rounds of fiscal austerity.

A major challenge for Newsom will be delivering on his ambitious, progressive agenda for his second term as California’s budget tips into deficit after years of surplus that helped fund programs Newsom promoted to reduce homelessness, provide universal healthcare and preschool, free breakfast and lunch to all students who request meal assistance, regardless of family income.

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Newsom acknowledged in his inaugural address last week that the worsening economic climate would make it harder to resolve the overlapping crises of affordability, housing and homelessness he and the legislature were unable to resolve during his first term. He pledged “an honest accounting of where we’ve fallen short.”

Boom Bust

California has long been prone to booms and crippling deficits because of the sensitivity of its revenue to financial markets, and it has socked away billions to cover the hit of the next downturn. Lawmakers put $37.2 billion into reserves in the spending plan that began in July.

Newsom said personal income tax withholding receipts have contracted by 4.5% on average on a year-over-year basis from July to November. Revenue from capital gains as a percentage of total general fund tax revenue is projected to decline $17.6 billion in 2023 from $30.4 billion two years ago.

“That sums up California’s tax structure,” Newsom said. “That sums up the boom bust as it relates to revenue.”

In November, the state’s nonpartisan Legislative Analyst’s Office projected that the state would see a $24 billion deficit in its next fiscal year due to a shortfall in revenue.

California’s finances had benefited from rising stock prices and a boom in Silicon Valley. With tax revenue pouring in, Moody’s Investors Service and Fitch Ratings boosted the state’s credit rating in 2019 to the highest level since the dot-com boom over two decades ago. Its 10-year bonds yield only slightly more than the top-rated benchmark, showing investors see little risk to the securities.

Newsom has repeatedly denied that he intends a future presidential run, even as he cultivates his national profile as a Democratic leader capable of delivering on a progressive model of governance. In promising to “reconcile our shortcomings” and “bring everyone along in our prosperity,” Newsom risks not being able to deliver on expectations that California can spend its way out of deepening inequality.

–With assistance from Karen Breslau and Tiffany Stecker.

(Updates with governor’s comments in fifth paragraph, capital gains revenue in 12th paragraph)