In the four months since the Legislature and Gov. Gavin Newsom enacted a new state budget, revenues – primarily from personal income taxes — have outstripped expectations by several billion dollars.
The uptick has buoyed hopes within the Capitol that California’s chronic budget deficits might disappear if the revenue surge continues. That would spare Newsom and legislators from having to dream up more accounting gimmicks, deferrals and loans to cover the gap between income and outgo.
However, the Legislature’s fiscal advisor, Legislative Analyst Gabe Petek, threw cold water on those rosy scenarios Wednesday. He sees recent revenue gains as a spike driven by an artificial intelligence boomlet in Silicon Valley that’s likely to implode, as have previous tech-related bubbles.
“With so much exuberance surrounding AI, it now appears time to take seriously the notion that the stock market has become overheated,” Petek says in his annual fiscal overview, which predates the governor’s introduction of a new budget. “History suggests that the stock market is prone to overreact to major technological advances, even if the technology itself turns out to be revolutionary.”
Instead of savoring a surge in revenues that would erase what officials are calling a “structural deficit” that is somewhere in the $10-20 billion range, officials should anticipate a larger gap, Petek says.
“Under our revenue and spending estimates, the Legislature faces an almost $18 billion budget problem in 2026‑27,” Petek says. “This is about $5 billion larger than the budget problem anticipated by the administration in June, despite improvements in revenue.”
The analyst notes that California’s constitution requires the state put money toward public schools and reserves, which will “almost entirely offset revenue gains,” and toward other spending that’s running about $6 billion over the current budget’s estimates.
“Starting in 2027‑28, we estimate structural deficits to grow to about $35 billion annually due to spending growth continuing to outstrip revenue growth,” Petek says.
It should be noted, not for the first time, that California’s chronic deficit is not caused by an economic downturn, which has occurred in the past, but rather by an enormous error by Newsom and his budget advisors three years ago.
In 2022, they projected a permanent increase in revenues, based on a one-time spike, leading Newsom to declare a $97.5 billion budget surplus, boasting “No other state in American history has ever experienced a surplus as large as this.”
Confident that the money would be there, Newsom and lawmakers fattened up the spending side of the budget, only to learn that the supposed surplus was based on what was later acknowledged to be a $165 billion overstatement of revenues over four years.
Ever since, revenues have failed to cover the elevated spending, and Newsom and lawmakers have covered the gaps with the aforementioned gimmicks. They have incurred more than $20 billion in internal loans from special funds that must be repaid. They also have drawn down reserves that were supposed to cover genuine emergencies, not political shortsightedness.
Newsom and his staff are now in the final throes of drafting an initial 2026-27 budget that will be his last as governor and will be unveiled in January. The question is whether he will face the fiscal music and finally write a truly balanced budget or employ more short-term fixes and dump the problem on his successor.
That would mean either making real cuts in spending or raising taxes, both of which would take some courage. The past has not been encouraging.
