That seemingly endless flow of cash has begun to dry up as state tax collections have fallen short of expectations for four months in a row. There’s now an 80% chance California will be about $8 billion short at the end of next summer’s fiscal year, according to the latest estimate from the nonpartisan Legislative Analysis Bureau.
There is still plenty of time for a comeback, but the trend of declining sales is already showing. Democratic Gov. Gavin Newsom last month blocked tax cuts for manufacturers, halted the expansion of full-day kindergarten programs and ended unemployment benefits for immigrants living in the country without legal authorization — all citing potential state shortages.
“These shortfalls are not only going to come, they’re going to be big and we’re going to have to make some adjustments,” Newsom said. “That’s what we’re working on with the legislation.”
Despite this shortfall, California is unlikely to be headed for another cash crisis like the one that gripped the state during the Great Recession more than a decade ago. California had less than $8 billion on hand at the end of September 2008 during the Great Recession. This year, California has more than $130 billion available, including $37.2 billion in various savings accounts.
“I think the state is much better positioned for a potential economic downturn this time than it has been in recent history,” said Chris Hoene, executive director of the California Budget & Policy Center.
What’s happening in California could be a sign of troubling things to come for other states. Nationally, tax collections in most states appear to be ahead of expectations so far, according to Brian Sigritz, director of state fiscal studies for the National Association of State Budget Officials. But sales are growing much more slowly, with states expecting an average increase of 1.4% this year, compared to a 16.5% jump in 2021.
Jobs aren’t the problem in California because there are plenty of people working and paying taxes in the state. California’s unemployment rate hit a record low in September, and employment nearly returned to pre-pandemic levels — even as hiring has slowed in recent months.
Instead, the problem is a falling stock market — which means rich people aren’t making as much money. That’s a problem in California, where a progressive tax system means the top 1% of earners pay nearly half of the state’s income taxes.
The biggest factor was the government’s attempts to slow the skyrocketing prices of goods and services due to inflation. The Federal Reserve did this by raising the key interest rate, which had a cascading effect on the rest of the economy. As a result, the S&P 500, an index of 500 publicly traded companies in leading U.S. industries, has fallen more than 18% from its January high.
A falling stock market means tech startups have less incentive to start selling shares to the public. Tech company “IPOs” have been a reliable source of money for the California government because they make a lot of people very rich very quickly – and all money that is taxable.
Last year, 206 California-based companies went public, generating huge tax revenue for the state. Fewer than 50 California-based companies will go public this year, according to an estimate by the California Department of Finance, the Newsom administration’s budget agency.
“It doesn’t mean technology itself isn’t a source of strength, even if it may not be a source of rapidly growing revenue like it was a year ago for the state’s general fund,” said Jerry Nickelsburg, UCLA’s director of faculty. Anderson Forecast, which projects economic trends.
California collects most of its income taxes in April, which is the deadline for people to file their state tax returns. But the state receives money each month from “withholding taxes” — money that companies withhold from employee paychecks each month and send to the government. These revenues have fallen significantly since June.
“What that suggests to our forecasters is … that there have been layoffs and cutbacks in some high-wage, high-tech sectors of the state economy,” Treasury spokesman HD Palmer said. “It’s a reflection of the volatility of stock markets.”
It could also signal some volatility between Newsom and California’s Democratic state legislature. This year, Newsom berated lawmakers for passing bills at the end of the session that, when added up, would allow $22 billion in new spending that wasn’t included in the state budget.
Newsom called the proposed spending “remarkable.” He blocked most of it by vetoing those bills in September.
“I’ve made it clear that we’re seeing economic headwinds,” Newsom said.
Assembly Speaker Anthony Rendon, Democrat of Los Angeles, said lawmakers are making proposals that benefit their districts and the people of California.
“It’s remarkable that the Senate and Assembly have been able to come together on the budget in recent years,” Rendon said. “We’ve worked with the administration to make California’s budget stronger, more resilient and just plain better. We now have more reserves and more cash than ever before. Our differences pale in comparison to this achievement.”
Toni Atkins, the Democratic president pro tempore of the California Senate, said it’s too early to know what next year’s budget will look like. But she said “we are more prepared than ever to protect our progress and withstand revenue declines without damaging program cuts or tax increases on the middle class.”