California staring at $58 billion shortfall in next two years

(CN) — California faces a $58 billion revenue shortfall over the next two fiscal years, according to a new report released on Friday by the state’s nonpartisan Legislative Analyst’s Office. Projections for the 2022-23 fiscal year were revised down by $26 billion below what was expected in the budget.

The shortfall is in part a result of postponed income tax receipts, which came in far below expected. “Total income tax collections down 25% in 2022-23,” the analyst’s report says.

The analyst blamed the drop on interest rates, which were raised by the Federal Reserve to cool inflation. The rate hike had the effect of cooling the state’s economy significantly: home sales have fallen roughly by half, and the number of California companies that went public in 2022 and 2023 “is down over 80% from 2021,” the analyst said.

Unemployment in the state has risen to 4.8%, from 3.8% in the summer of 2022. And inflation-adjusted incomes have declined for five straight quarters since the start of 2022.

“This decline is similar to those seen during the Great Recession and dot-com bust,” the report says, ominously referencing the two biggest non-Covid-related economic downturns in recent memory. “While the slowdown of investment in California companies and corresponding broader economic weakness likely was a primary driver of this decline, another important factor was financial market distress in 2022.”

California has a highly progressive income tax rate comprising nine different tax brackets. Its top 1% of earners pay close to 10% income tax to the state (in addition to the income tax they pay to the federal government). The next 4% of earners pay close to 6%. The system leaves California uniquely vulnerable to economic downturns. When the top 5% of earners take a hit, tax receipts nosedive.

The report likely comes as a gut punch to Democratic lawmakers — not that they are showing any signs of panic. In a statement posted on the social media platform X, formerly Twitter, Assembly Speaker Robert Rivas said, “California is more prepared than ever to navigate this latest challenge,” given the state’s “record reserves” of $37.8 billion, and he expressed hope that when the next budget is due in June 2024, there will be “a more crystallized understanding of our revenues and overall economic landscape.”

California Governor Gavin Newsom, who spent Thursday night in Georgia debating Florida Governor Ron DeSantis live on Fox News, has not yet issued a statement on the revised budget projections.

Rivas’s optimism not withstanding, the analyst’s report signaled a less-rosy perspective on the future.

“Whether the recent weakness will continue is difficult to say,” the report says. “However, the odds do not appear to be in the state’s favor. Past downturns similar to this recent episode have tended to be followed by additional weakness.”

A revenue shortfall is not the same thing as a projected budget gap. The legislative analyst will likely release a report on that next week.

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