Before California legislators even begin next year’s budget discussion in earnest, analysts are painting a dire picture.

The Legislative Analyst’s Office forecast a $68 billion deficit for the upcoming 2024-25 budget. That figure more than doubles the $30 billion deficit that lawmakers and Gov. Gavin Newsom faced when deciding this year’s budget.

Analysts say “severe” declines in tax revenue are to blame. Because of flooding in 2023, the IRS gave tax filers in 55 of California’s 58 counties until October to file their taxes. With delayed tax returns, legislators drew up a budget with only broad estimates about state income tax revenues.

Tax income to the state came in $58 billion less than expected, said Ann Hollingshead, principal fiscal and policy analyst with the LAO.

“Our projections are lower than budget act projections by $58 billion, so that’s like the lion’s share of the $68 billion deficit,” Hollingshead said.

Assembly budget vice chair Vince Fong (R-Bakersfield) places blame on increased spending as the California economy slows.

“The alarm bells continue to ring. After ignoring my warnings of overspending at a time of economic uncertainty, the state is glaring at a $68 billion budget deficit that will not go away on its own. In fact, it continues to get worse over time, burdening every Californian,” Fong said.

Tax Revenue Declines Exacerbated Budget Shortfall

When lawmakers finished the 2023-24 budget, they planned for a $14 billion deficit, Hollingshead said.

In total, income tax collections dropped 25% from the previous year. Declines in income, especially among high-income earners, accounted for much of the decrease, according to LAO.

Finance experts long have said that the state’s boom-or-bust taxation system needs fixing, but governors and lawmakers have ignored the calls for correction.

Sales tax collections have been flat despite above-average growth in consumer prices.

“This decline is similar to those seen during the Great Recession and dot-com bust,” the report stated.

Higher interest rates uniquely affected California considering the state’s already high property values.

Home sales dropped by half, according to the LAO. Meanwhile, the typical monthly mortgage rose from $3,500 to $5,400.

Interest rates also affected investments.

“In particular, investment in California startups and technology companies is especially sensitive to financial conditions and, as a result, has dropped significantly,” the report stated.

The number of California companies that went public in 2022 and 2023 declined by 80% compared to 2021, according to the report.

Legislature Will Have to Make Serious Choices About Funding

Analysts gave legislators a series of options to address the budget shortfall. The first comes in the $24 billion reserve the state has built. To access that, Gov. Gavin Newsom would have to declare a budget emergency.

The LAO identified $17 billion that could come from schools and community colleges. Reserves created by the 1988 Proposition 98 hold about $8.1 billion. The state could tap into $7.7 billion of that. Doing so would take some financial chicanery.

In 2022-23, the Legislature funded schools above the mandated minimum set by Proposition 98.

A change in that budget level could free up that money while still “keeping schools whole,” Hollingshead said.

The LAO also identified $1.1 billion in grants that haven’t yet been awarded to schools.

Decreases in one-time spending could find another $10 billion.

The LAO points out $2.2 billion in one-transportation funding, $1.9 billion in natural resources and environment spending, and $1.8 billion in various education programs.

Newsom’s office said that their fiscal responsibility in previous years will help dull the blow from the deficit.

“The Governor has maintained strict fiscal responsibility since taking office, building up the state’s reserves to historic levels reaching the maximum allowed by the state constitution to be put in reserves and paying down debts — putting California in a strong position to deal with budget shortfalls,” said Erin Mellon, communications director for Newsom.

Is 24/25 California Budget Situation the Worst of the Coming Years?

Analysts forecast revenues to rebound after this budget year. They predict flat revenue for this year and some recovery in the following years.

But unemployment numbers bear a bleaker picture. Along with California’s slowing economy comes a marked increase in unemployment. Since summer 2022, unemployment has increased from 3.4% to 4.8%. Three consecutive months of unemployment increasing by .5% triggers what analysts call the Sahm Rule. The Sahm Rule has followed each of the past six recessions.

The LAO said it is difficult to say how severe it will be, but “the odds do not appear to be in the state’s favor,” the report states. Economic weakness has followed periods of similar downturns.

“In January, the Governor will introduce a balanced budget proposal that addresses our challenges, protects vital services and public safety, and brings increased focus on how the state’s investments are being implemented, while ensuring accountability and judicious use of taxpayer money,” Mellon said.