Six months ago, while proposing a revised state budget, Governor Gavin Newsom bragged that the state had a $97.5 billion surplus that would fund historic expansions of social services and educational.
“No other state in American history has ever had such a large surplus,” Newsom told reporters as he unveiled a budget for fiscal year 2022-23 that topped $300 billion and, with some adjustments, was eagerly adopted by the Legislative Assembly.
Last week, Legislature Budget Advisor Gabe Petek released a sobering report on state finances, saying revenue is set to fall $41 billion from what Newsom and lawmakers had planned, leaving the state with a projected deficit of $25 billion for 2023-24. budget. Also, he said, if the recession hits, as many economists predict, the gap between income and spending could be much higher.
While this is only a $25 billion problem – as large as that number may seem – it could be managed relatively easily with a few adjustments, such as limiting some of the spending contained in the current budget, Petek said.
“It’s not trivial, but it’s also manageable,” he told reporters. “We don’t see this as a budget crisis, we just think of it as a notable budget issue.”
However, he cautioned against maintaining spending and using the state’s large emergency reserves to cover the deficit, as there is a good chance that the current economic downturn, dictated by the Federal Reserve to countering high inflation, could easily turn into a recession.
“Based on historical experience, if a recession were to occur soon, revenues could be $30 billion to $50 billion below our revenue forecast in the fiscal window. As such, we suggest the Legislative Assembly to begin planning for the 2023-24 budget without using general purpose reserves,” Petek said in his report.
Newsom’s budget staff did not dispute Petek’s rather bleak budget forecast. California “is in its best position to manage a downturn, having built up strong reserves and focusing on one-time commitments,” Treasury Department spokesman HD Palmer said.
That’s right, as far as it goes. Newsom and the Legislature committed most of the supposed surplus to time-limited reserves and expenditures and, in theory, these could be canceled or reduced. A multi-billion dollar cash donation, currently being processed, is the largest example of such one-time expenditures.
However, one-time credits, while not legally required to be long-term commitments, provide hope that the state will continue to fund what it started. Recipients of these funds will therefore lobby the Legislative Assembly to honor what they see as commitments to their particular programs and projects.
Hints that the state’s roaring economy could be slowing emerged weeks after the current budget passed last June, and Newsom vetoed dozens of bills for additional off-budget spending, citing the economic uncertainty.
Since the enactment of the budget, state revenue has been well below expectations, with nearly all of the shortfall from personal income taxes, which typically account for three-quarters of state general fund revenue. .
The vast majority of these taxes come from a relatively small number of high-income taxpayers, whose incomes are intimately sensitive to fluctuations in the economy, particularly stocks and other capital investments. The stock market has been hit hard by the Federal Reserve’s sharp interest rate hikes and Silicon Valley, the source of much of the state’s taxable income, is suffering a downturn with massive worker layoffs.
Petek’s report is another reminder that the California budget depends on a very narrow and very volatile tax base and therefore it is foolish to make long-term financial commitments that assume the goose will always lay golden eggs.
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