As the state teeters on the brink of a recession, California is in for a dizzying reversal likely to send us plunging from a record $100 billion surplus to a projected $25 billion shortfall next year, according to sobering new data from the state’s fiscal analyst.
The grim news isn’t as shocking as the numbers — the entire nation is grappling with inflation and soaring interest rates, and Gov. Gavin Newsom has been warning a downturn is coming. But the gloomy predictions — which, if true, would reflect the state’s weakest performance since the Great Recession — could impact everything from efforts to fight homelessness and climate change to the state’s ability to finish key transportation projects to Newsom’s political future.
“The numbers are pretty stark,” said Matt Regan, senior vice president of public policy for the Bay Area Council. “$25 billion is a very, very large sum of money.”
And the deficit isn’t expected to disappear anytime soon. Following a predicted budget shortfall of $25 billion during the 2023-2024 fiscal year, the state likely will be short $17 billion the following year — and deficits will continue at least through the 2026-27 fiscal year, according to the report by the state’s Legislative Analyst’s Office.
On the bright side, California has $23 billion available in general fund reserves — but the report doesn’t recommend tapping into it yet. That’s because if a recession does hit, the state’s finances could end up looking even worse than the current projections. So for now, the report suggests legislators reexamine funds from the current budget that have been allocated but not yet distributed and look for places where funds can be cut or put on hold.
Thanks to those reserves, the state is in its “best-ever” position to weather a downturn, said H.D. Palmer, deputy director for external affairs in the state’s Department of Finance.
“But 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,” he said in an emailed statement.
The current outlook marks a big shift from this past year as California enjoyed an unprecedented surplus of about $100 billion. Half of that money had to be earmarked for education and other set areas. But the rest allowed Newsom — who signed a budget totaling more than $300 billion this year — to give money back to Californians in the form of tax refunds, invest in new programs designed to stem homelessness and climate change, and fund infrastructure projects.
Nearly all of that was in the form of one-time spending, rather than ongoing investments — a decision that spurred backlash but now may turn out to be wise. Housing and homeless service providers, for example, said they can’t fund the type of long-term solutions that will make a dent in the homelessness crisis with nothing but piecemeal, one-time grants. But experts say it was a fiscally responsible move that helped prepare the state for the coming crunch.
“Had the governor been less prudent, we’d be in big trouble,” Regan said.
The downswing stems from the massive inflation the U.S. has suffered as it exited the COVID-19 pandemic — consumer prices rose 8% over the past year, according to the report. The Federal Reserve responded by raising interest rates to combat inflation, making everything from buying a house to getting a car loan more expensive. Now, home and car sales have dropped, stock prices have plummeted and Bay Area tech titans are laying people off in droves.
And it’s likely going to get worse. At this point, the odds of the Federal Reserve mitigating inflation without causing a full-blown recession are “narrow,” according to the LAO report.
California is especially susceptible to the boom and bust of the economy: When the housing and stock markets are roaring, capital gains fuel the state budget. In downturns, that source of revenue dries up.
That could hinder Newsom’s attempts to curtail the homelessness crisis that he’s made one of his top priorities, spending about $15 billion on housing, services and encampment cleanups over the past two years. As the money dries up, it could slow down the state’s progress.
“I think this is a time when the rubber really meets the road,” said Ray Bramson, chief operating officer for Santa Clara County-based Destination: Home. “When we’re in a downturn, are we going to be able to continue to invest? And I hope the answer is yes, because this is the crisis of our time.”
A worsening deficit also could spell difficulties for Bay Area mega-projects and transit agencies. Under last year’s budget, $4 billion was promised to transit infrastructure through 2025, although that money has not been allocated. Legislators could seek to claw back those funds, possibly delaying Caltrain’s nearly finished electrification project and BART to Silicon Valley.
Beyond mega-projects, transit agencies also are looking to the state to help fill a nearly $2 billion deficit in their costs to keep buses, ferries and subways running over the next five fiscal years.
The downturn even could impact the political future of the governor, who coasted easily to a second term this month and who experts say likely has presidential ambitions. Patting himself on the back for California’s strong economy while campaigning will be harder as the state grapples with a deficit.
Newsom is tasked with proposing an initial budget in January, followed by a revised version in May based on updated economic forecasts. The Legislature then makes its changes, and the governor will sign a final version this summer.
Staff writer Eliyahu Kamisher contributed to this report.