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California faces $25 billion budget deficit in worst revenue year since Great Recession

Lawmakers should look for ways to design a budget that accounts for ongoing revenue losses — and a possible recession.

SACRAMENTO, Calif. (CN) — The Golden State's fiscal outlook looks decidedly less golden with declining revenue leading to a budget deficit of more than $20 billion — a figure that could worsen if a recession hits.

A new report from the nonpartisan Legislative Analyst's Office published Wednesday says that during 2023-2024, the state will be in the hole by $25 billion due to inflation. But its funding already set aside for schools and community colleges is safe, according to the current projection. 

The report comes just months after Governor Gavin Newsom said the state actually has a surplus proposed a massive budget that eventually grew to $308 billion when the Legislature passed it this past summer. The budget included $53.9 billion in climate change responses like fire protection and drought management, $9.5 billion in economic stimuluses, more than $4 billion in clean energy infrastructure and more than $200 million in reproductive health care.

Revenue has increased steadily in California for the past decade and this year the $72.4 billion surplus pushed total state spending to more than $300 billion for the first time. But the analysis prepared by Ann Hollingshead and other analysts, reviewed by Carolyn Chu and Anthony Simbol, says the state’s budget problem is mainly due to revenue estimates dropping by $41 billion. They say that over the coming years, annual deficits would decline from $17 billion to $8 billion. 

The Legislative Analyst's Office predicts a $25 billion deficit in California unless lawmakers work to craft a more robust budget. (Image via Legislative Analyst's Office)

The S&P 500, a key indicator of the health of the stock market that drives the incomes of the super rich, has fallen more than 17% since its peak in January.

“Our revenue estimates represent the weakest performance the state has experienced since the Great Recession,” the LAO report said.

Although employment in California remains strong — the 3.9% unemployment rate in September tied for the lowest since 1976 — the high-wage tech industry has been roiled by a series of recent job cuts. Facebook parent Meta announced last week that it would layoff 11,000 people, or 13% of its workforce.

California has money set aside already for schools and community colleges as required by Proposition 98, using about 40% of the General Fund spending. The new estimate accounts for the rest of the budget or 60%, without reflecting a recession scenario. If a recession does occur soon, the analysts predict revenues could be between $30 billion to $50 billion lower than their current projection. 

The Legislative Analyst's Office predicts a $25 billion deficit in California unless lawmakers work to craft a more robust budget. (Image via Legislative Analyst's Office)

The LAO report advises lawmakers designing the 2023-2024 budget to balance the risks of adopting overly optimistic revenues "which fail to account for the potential of an economic downturn," and the fact that a recession is not certain. 

LAO’s report assumes the state makes all required pension contributions to the California Public Employees’ Retirement System. It also assumes congressional funding for most state Medicaid programs will last until January 2023, resulting in an increase in General Fund costs of Medicaid programs in the fourth quarter. The experts noted the U.S. Department of Health and Human Services did not say the emergency would end in January, and predict that it’s likely to continue past January. 

The LAO suggests the Legislature start planning the budget without general purpose reserves until more information about the budget condition comes in May after Californians file their taxes. If revenues are significantly lower, the Legislature will need reserves and other budget solutions but can ease on reductions if revenues climb.

The Legislative Analyst's Office predicts a $25 billion deficit in California unless lawmakers work to craft a more robust budget. (Image via Legislative Analyst's Office)

“On the one hand, pausing automatic adjustments could free up resources and mitigate the need for other reductions,” the analysts said.

“On the other hand, for those programs whose costs have not recently been adjusted for inflation, budget reductions would result in greater reductions in service. If the Legislature wants to provide inflation adjustments in some areas in response to higher prices, the size of the budget problem would increase, meaning corresponding reductions to other areas also would be required.”

They also recommend that lawmakers identify recent funding increases that could be paused. For example, the 2021-2022 budget committed $39 billion in General Fund resources to one-time purposes, compared to $36 million in the 2022-2023 budget.

“If augmentations have not yet been distributed, the Legislature has an opportunity to reevaluate those expenditures. Moreover, in light of the magnitude of the recent augmentations, programs may not be working as expected, capacity issues may have constrained implementation, or other unforeseen challenges may have emerged,” they added. 

However, all of this depends on if a recession does hit. The Federal Reserve has repeatedly increased interest rates this year to cool the economy, but the LAO says the longer inflation persists, the greater the economic risk. 

“The chances that the Federal Reserve can tame inflation without inducing a recession are narrow,” the experts concluded.

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