Last week, the State’s Legislative Analyst’s Office released its review of the Governor’s proposed budget for Fiscal Year 2025-26. The LAO generally agreed with the Governor’s economic forecasts for the next fiscal year, however, the report expressed more concerned about future budget conditions.
In summary, the LAO concurred that the proposed budget is “roughly balanced.” While noting there were some differences between the two estimates, “. . . they do not substantively change our assessment of the budget condition.”
In fact, the LAO stressed “we are not describing the budget condition as having a surplus or a deficit at this time. These concepts are inherently tools of communication, not accounting, and are ultimately somewhat subjective.”
The LAO also accepted the Governor’s revenue estimates. While slightly higher than the LAO’s most recent forecasts, the Governor’s estimate is consistent with recent revenue trends, they stated.
Nevertheless, the LAO report cautioned about relying on these trends going forward. Much of the recent revenue increase is from capital gains, which are the result of a “booming” stock market. If that were to change, then revenues would again begin to decline.
The LAO also concurred with the Governor’s use of the State’s reserves, calling his proposal “reasonable.”
The LAO commended the Governor’s and the Legislature’s actions last June to address the massive budget problem facing the current fiscal year. Not only did this work resolve those problems, but it established a good foundation for the proposed budget year.
While the Governor’s revenue projections are $9 billion higher than LAO’s, the spending estimates are higher too.
But the LAO noted some significant changes in this proposal from the June solution. The largest ($1.3 billion) is the result of passage of Proposition 5 in November. This altered how California handles the Managed Care Organization tax, a tax on health plans. This revenue helps the Medi-Cal program.
Secondly, the State was not able to achieve a reduction of 10,000 vacant staff positions. The budget proposal projects 6,500 fewer vacant positions. Consequently, the potential savings is $620 million rather than the projected $1.5 billion. Also, the expected savings from greater operational efficiencies, such as less travel, will be about $1.1 billion less estimated.
In addition, the LAO noted that neither its spending projections nor the Administration’s anticipated what will be massive costs created by the devastating wildfire in Southern California this month.
While the LAO does not stress over these differences for the coming fiscal year, its report does highlight projected deficits of $13 billion in 2026-27, $19 billion in 2027-28, and $15 billion in 2028-29.
Consequently, the LAO urges the Legislature to again consider the budget decisions as part of a multi-year package. Revenue may decline, depending upon the condition of the stock market, and expenses will increase because of the massive wildfires. The latter will also affect revenue and likely result in a tax deadline deferral for taxpayers in the wildfire areas.
Concluding its budget review, the LAO “. . . recommend[ed] the Legislature maintain last year’s momentum by developing a plan for addressing the budget problems on the horizon.”
And the LAO also supported the Governor’s proposals to improve the State’s ability to increase reserve amounts. Newsom has proposed amending Prop 2, enacted in 2014, and Prop 4, approved in 1979. He wants to increase the Prop 2 10% limit of funds to the Budget Stabilization Account, also called the Rainy Day Fund, to 20%. In addition, Newsom is also wants to change to Prop 4 so that these funds are not deemed an expenditure.
“We agree that rethinking the state’s reserve policies is merited, particularly in light of increasing volatility in state revenues,” the LAO concluded. “The two changes proposed by the Governor are reasonable first steps, but additional changes are warranted.”
