LAO Reports that California Budget Deficit Could Be Larger in May
The Legislative Analyst’s Office (LAO) projects that California’s budget problems could be worse than estimated. In its 2023-24 Budget Multiyear Assessment report, the LAO concludes that California likely faces a larger budget deficit in May, and the state will face large operating deficits through the 2026-2027 budget. The LAO reports that the state could collect enough revenue to cover the “baseline budget” and advises against using reserves now.
The projected budget deficits come less than a year after Governor Gavin Newsom signed into law a record $308 billion budget that included a projected surplus of nearly $97.5 billion along with a variety of new spending initiatives. (see Record Surpluses Show Need for Tax Reform) In October 2022, Fitch Ratings projected California as the only state with year-over-year tax revenue declines, and in November 2022, the LAO projected California’s budget deficit at $24 billion projected for the 2023-24 budget year. In January, Newsom introduced a $297 billion budget for the 2023-24 fiscal year with a projected $22.5 billion deficit due to sharp declines in tax revenues. Newsom plans to cover the deficit by shifting funds, delaying some spending, and some spending cuts.
Budget Problem Likely Larger in May 2023
The LAO reports that the state likely faces a budget problem in 2023‑24 due to deteriorating revenue relative to expectations from June 2022. The LAO calls the governor’s budget revenue estimates “reasonable” but “likely a bit too high.” The LAO estimates a 66% chance that state revenue will be lower than the governor’s budget estimates for 2022‑23 and 2023‑24 and estimates that it will be approximately $10 billion for those years. This implies a budget problem about $7 billion larger than the governor’s estimate. Nonetheless, anticipated revenues for 2023‑24 are still projected to be about 20% higher than before the pandemic.
Projected State Spending Likely to be Unaffordable
The governor’s office projects operating deficits of $9 billion in 2024‑25, $9 billion in 2025‑26, and $4 billion in 2026‑27. The LAO states that given California’s constitutional spending requirements, revenues would need to be higher “by more than these amounts for the state to be able to afford the spending level currently proposed.” The LAO concludes that such a level of revenue is unlikely, leading to a 20% chance that the state can afford current projected spending levels.
Baseline Budget Likely to be Affordable
The report, however, notes that the state has a much higher likelihood of covering its “baseline budget,” which is the spending level after removing reserves deposits and one‑time and temporary spending currently authorized or planned. In fact, the LAO projects an even chance that revenue would be sufficient for the state to pay for all of its baseline programs.
States Should Not Use Reserves Now
The LAO notes that state revenues are not consistent with recessionary levels and advises to hold off on using reserves. The LAO cautions that 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 LAO recommends that the legislature hold off on using reserves unless revenues decline by more than $10 billion through 2023‑24, as that would reflect levels below historical averages and could impact the state’s core spending level.
LAO Recommends other Actions for Addressing Budget Problem
The LAO identified a variety of other actions the legislature can take to address the additional shortfalls. These include: (1) suspending deposits into the state’s rainy‑day fund (requires action by the governor); (2) reducing more one‑time and temporary spending; (3) shifting more costs than currently proposed by the governor; and/or (4) increasing revenues, for example, on a temporary basis.