CA Forecasts $25B Budget Deficit Next Year Amid 'Threat Of Recession'

CALIFORNIA — California is likely to face a $25 billion budget deficit next year, which could coincide with a potential recession, state officials announced this week.

Wednesday's forecast from the Legislative Analyst's Office marks an end a two-year string of historic budget surpluses and serves as a warning to other states of a looming recession.

The Democratic-controlled Golden State is typically among the first states to suffer budget issues when the economy starts to falter. That's because the state taxes rich people more than other states — and the wealthy don't make as much when the markets falter.

Nearly two years ago, Newsom noted how well "the folks at the top," were doing despite a year of pandemic closures, when the state reported a staggering $75.7 billion.

The S&P 500, a key indicator of the health of the stock market that drives the income of the superrich, has fallen more than 17 percent since its peak in January.

The state's coffers have been bulging in recent years in part thanks to Silicon Valley — home to a sector that is seeing mass layoffs across Facebook, Amazon, Lyft, Robinhood, Netflix, Twitter and more.

Although employment in California remains strong — the 3.9 percent unemployment rate for September is 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 percent of its workforce.

"The chances that the Federal Reserve can tame inflation without inducing a recession are narrow," according to the report from the nonpartisan Legislative Analysts Office. "Reflecting the threat of a recession, our revenue estimates represent the weakest performance the state has experienced since the Great Recession."

State revenues are now $41 billion below expectations, according to the outlook published Wednesday by the Legislative Analyst's Office. The estimated deficit is lower because some of those revenue losses were offset by lower spending in other parts of the budget.

In next year's shortfall, some of California's major expansions could remain safe, including free kindergarten for 4-year-olds and free health care for low-income immigrants living in the country without legal permission.

But some cuts are sure to be made to balance the budget, Democratic Gov. Gavin Newsom's administration said.

“While we’re in fact better prepared, that doesn’t mean that the decisions to close the coming budget gap won’t be difficult — particularly if the economic conditions that have slowed the economy continue, or get worse,” California Department of Finance spokesman H.D. Palmer said.

The deficit could mean cuts in funding for transportation, education and housing, according to the outlook.

Despite the gloomy outlook, California is in a better position to weather an economic downturn than it has been in the past. The state has $37.2 billion stored in its various savings accounts. And it has plenty of cash available to meet its obligations this year.

“It’s not insignificant, but it’s also manageable,” Legislative Analyst Gabriel Petek said of the deficit. “We don’t think of this as a budget crisis.”

It's important to note that California's budget projections have been infamously volatile. Two years ago, the state forecast a $54 billion deficit during the height of the pandemic. That shortfall never happened since the wealthy continued to carry the economy.

However, the latest projections are likely to stick.

Soaring inflation has made everything more expensive. The Federal Reserve has tried to rein in inflation by raising a key interest rate. A higher interest rate makes it more expensive to borrow money, which eventually causes people to spend less. Although that would control price increases, it also cuts demand for goods and services. That leads to layoffs, meaning people pay less in taxes.

The report did not surprise Republicans, who said they have been warning against California's massive increase in public spending for years, with Republican Assembly member Vince Fong calling it “unsustainable.”

“Today’s report is another wake-up call to those warnings. We must refocus on fiscal responsibility,” said Fong, who is vice chair of the Assembly Budget Committee.

Newsom's administration wasn't surprised, either, calling the $25 billion deficit estimate “realistic and reasonable.”

“The good news is that as we prepare to close a budget shortfall, the state is in its best-ever position to manage a downturn, by having built strong reserves and focusing on one-time commitments,” said Palmer, the Department of Finance spokesman.

California lawmakers could conceivably cover all of the deficit with the money it has in its savings accounts, but the Legislative Analyst's Office warned not to do that. The outlook predicts deficits not just for this year, but the next three years — although the size of the deficit decreases each year.

Instead, the Legislative Analyst's Office says lawmakers should delay some of the $75 billion in one-time spending they approved over the past two years. As an example, they pointed to a $500 million program to clean up homeless encampments across the state.

“That's a very good example of the type of pause we had in mind,” Petek said.

Palmer said the Newsom administration will begin making budget decisions next month. A change in statewide homelessness funding appears to be unlikely, given Newsom's commitment to addressing the issue. Newsom did pause $1 billion in homelessness spending earlier this month, but that decision wasn't related to sinking revenues.

Toni Atkins, the Democratic president pro tempore of the California Senate, said she is confident the state can pass a budget this year “without ongoing cuts to schools and other core programs or taxing middle class families.”

Democratic Assembly Speaker Anthony Rendon said lawmakers “can and will protect the progress of recent years' budgets.”

“In particular, the Assembly will protect California’s historic school funding gains, as districts must continue to invest in retaining and recruiting staff to help kids advance and recover from the pandemic," Rendon said.

Going into the midterm election last week, Californians said the economy, jobs and inflation were the top issues plaguing the state, according to a September survey from the Public Policy Institute of California.

Although gas prices continued to fall after the state authorized an early transition to winter-blend gasoline — a cheaper yet more polluting alternative — inflation remained relatively high. Californians reported that they were continuing to experience financial hardship amid skyrocketing prices, PPIC reported.

And as Golden Staters continue to weather a lingering pandemic and inflation, interest rate hikes and a volatile stock market are now raising concerns of an upcoming recession.

The Associated Press contributed to this report.