California revenues decline amid economic worries

The good times might soon be over for California's government.

The nation's most populous state has had so much cash lately that lawmakers have spent freely — handing out free health care to low-income immigrants, paying for every 4-year-old to attend kindergarten and sending more than $21 billion in stimulus checks to taxpayers over the past two years.

That seemingly endless flow of money has started to dry up as state tax collections have fallen below expectations for four months in a row. There's now an 80% chance California will be about $8 billion short when its fiscal year ends next summer, according to the latest estimate from the nonpartisan Legislative Analyst's Office.

There's still plenty of time for a comeback, but the trend of declining revenues is already having an impact. Last month, Democratic Gov. Gavin Newsom blocked a tax cut for manufacturers, halted an expansion of full-day kindergarten programs and nixed unemployment benefits for immigrants living in the country without legal permission — all while citing the state's potential shortfall.

“Those shortfalls not only will be coming, they will be ample and we'll have to make some adjustments,” Newsom said. “We're working with the Legislature right now to do just that.”

Despite the shortfall, California is likely not headed toward another cash crisis like the one that engulfed the state during the Great Recession more than a decade ago. California had less than $8 billion available to spend at the end of September 2008 during the Great Recession. This year, California has more than $130 billion available, including $37.2 billion in its various savings accounts.

“I think the state is far better positioned for a potential economic downturn this time around than it has been in contemporary 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 above expectations so far, according to Brian Sigritz, director of state fiscal studies for the National Association of State Budget Officers. But revenue is growing much slower, with states anticipating a 1.4% average increase this year compared to a 16.5% jump in 2021.

The problem in California is not jobs, as the state has plenty of people working and paying taxes. California's unemployment rate tied a record low in September, and employment has nearly returned to what it was before the pandemic — even as hiring has slowed in recent months.

Instead, the problem is a declining stock market — meaning rich people aren't making as much money. That's an issue in California, where a progressive tax system means the top 1% of earners pay close to half of the state's income taxes.

The biggest factor has been the government's attempts to slow down the soaring costs of goods and services because of inflation. The Federal Reserve has done this by raising a key interest rate, which has had a cascading effect on the rest of the economy. The S&P 500, an index of the 500 publicly traded companies in leading U.S. industries, has fallen more than 18% from its peak in January as a result.

A declining stock market means there's less incentive for tech startups to begin selling shares of stock to the public. Tech companies “going public” has been a reliable source of cash for California's government, because it makes a lot of people very rich very fast — and all money that is taxable.

Last year, 206 California-based companies went public, creating a huge windfall of tax revenue for the state. This year, less than 50 California-based companies will go public, according to an estimate from the California Department of Finance — the Newsom administration's budget agency.

“It doesn't mean that tech itself is not a source of strength, though it may not be a source of as rapidly increasing revenues as it was a year ago for the state general fund,” said Jerry Nickelsburg, faculty director for the UCLA Anderson Forecast, which projects economic trends.

California collects the majority of its income taxes in April, the deadline for people to file their state tax returns. But the state does get money each month from “withholding taxes" — money companies withhold from workers' paychecks each month and send to the government. That revenue has been down significantly since June.

“What that suggests to our forecasters is ... there have been layoffs and cutbacks in some of the high-wage, high-tech sectors of the state's economy," Department of Finance spokesperson H.D. Palmer said. “It's a reflection of the volatility of the stock markets."

It could also signal some volatility between Newsom and California's Democratic-controlled state Legislature. This year, Newsom scolded lawmakers for passing bills at the end of the session that, when added all together, would have allowed $22 billion in new spending that was not accounted for in the state budget.

Newsom called the proposed spending “remarkable.” He blocked most of it by vetoing those bills in September.

“I made it crystal clear that we are seeing economic headwinds,” Newsom said.

Assembly Speaker Anthony Rendon, a Democrat from Los Angeles, said lawmakers make proposals to benefit their districts and the people of California.

“What is remarkable is that the Senate and Assembly have managed to unite on the budget in recent years,” Rendon said. “We have worked with the Administration to make California’s budget stronger, more resilient and just plain better. We have more reserves and more cash on hand now than ever before. Our differences are minor compared to that achievement.”

Toni Atkins, the Democratic president pro tempore of the California Senate, said it's too early to know what the budget will look like next year. But she said “we're more prepared than ever to protect our progress and withstand a revenue downturn without harmful program cuts or middle class tax increases.”