California’s $68 Billion Deficit Looms as Newsom Unveils Budget

California Gov. Gavin Newsom’s proposed budget to be released on Wednesday will cast uncertainty on some of the legislature’s more ambitious policy priorities in areas such as labor, health care, and the environment as the state faces a $68 billion deficit.

The Democratic governor has already cited cost concerns as a reason for changing plans to raise the minimum wage for health care workers in the state that was enacted by a 2023 law, and his administration has ordered a spending freeze across government agencies.

Crafting a balanced budget by the state’s mid-June deadline will fall not just to the governor, though, but also to new leaders in the legislature presiding over chambers where most members have only known better fiscal times.

“Our budget deficit is staggering. So, this body must commit to serious fiscal restraint,” Assembly Speaker Robert Rivas (D), who assumed the role at the end of June, told lawmakers on Thursday.

Still, the current budget deficit differs from the financial downturns of the Great Recessions as state lawmakers can draw on billions of dollars in reserves. Some observers also remain optimistic that California may not be facing successive years of lower-than-expected tax revenues given upturns in the markets during 2023 as well as expectations that the Federal Reserve will cut interest rates in the coming months.

Policy Changes

The governor’s budget could also reveal new details about the implementation of several recently passed laws.

Newsom raised concerns in signing a law (S.B. 54) last year requiring diversity reporting from venture capital firms that the measure contained “unrealistic timelines” and suggested the state’s Civil Rights Department is not situated to implement the new requirements.

The governor said he would propose changes through the state budget.

Backers of the state’s first-in-the-nation emissions reporting law are closely watching to see how the California Air Resources Board—the agency responsible for implementing the measure—will proceed with hiring staff and drafting regulations for the program.

The board faces a deadline at the end of the year to set rules for companies that will be required to begin reporting emissions in 2026.

State Sen. Scott Wiener (D), the law’s author, said that while the board will need to take steps to ensure the law’s smooth rollout, the budget should not be a major factor.

The law was designed to let the board recoup the costs of implementing the program through fees that will be paid by companies required to report emissions, he said.

“I don’t see the budget being a hindrance to implementation,” Wiener said.

Reserves In Spotlight

With its progressive tax structure, the state’s revenues are particularly sensitive to declines in income tax filings from wealthier households, which fell short of expectations amid a slowdown in investment in California companies and broader economic weakness, the Legislative Analyst’s Office said in a December report.

The state’s $68 billion deficit stems largely from a decline in revenue during 2022 and 2023 that did not become clear until later last year due to delayed tax filing deadlines, the office said.

Chris Hoene, executive director of the California Budget and Policy Center, said lawmakers are likely to try avoiding cuts to areas of ongoing spending, such as education. The center says about 25% of the state’s current budget is dedicated to K-12 education. While it remains unclear how much lawmakers might instead draw down reserves—which the LAO estimated at around $24 billion—the legislature also has options for delaying spending on long-term projects, like infrastructure and climate adaptation efforts, he added.

“In the years where there were large budget surpluses, they made a lot of allocations to one-time investments they knew they could pull back if they needed to if financial conditions changed,” Hoene said.

Policymakers have also signaled areas they are likely to prioritize in drafting a budget for the fiscal year that begins in July.

Rivas listed housing, criminal justice, and climate change as top priorities.

Newsom told reporters in Los Angeles on Wednesday he stands by the state’s efforts to expand Medicaid to cover eligible undocumented immigrants, starting this year. The move is funded with more than $800 million from the state’s budget this year and is expected to cost about $2.6 billion annually once fully implemented.

Labor Funding

Meanwhile, labor unions that are particularly influential with the legislature’s Democratic supermajorities are likely to oppose substantial cuts to government agencies responsible for enforcing employment laws. The state labor commissioner has faced substantial backlogs in wage theft complaints, for example. Lawmakers set aside funding in the current budget to boost hiring at the agency and create a grant program to cover the costs of local prosecutors pursuing labor law enforcement.

“I don’t think there’s any room to cut when it comes to keeping workers safe and whole,” said Lorena Gonzalez Fletcher, executive secretary-treasurer of the California Labor Federation.

Still, the budget deficit may stifle plans for big new projects or initiatives. A new law will increase the minimum wage for health care workers to as much as $23 an hour at some facilities starting in June. But the governor has hinted at changing the union-backed measure due to the cost, which his administration has estimated will require about $2 billion from the state’s general fund. Legislators say they expect to see proposed changes but no agreement on such changes has been announced.

“For state legislators, this is for many of them the first time they’ll be going through a budget cycle where they’re facing a downturn, which means the realm of the possible is smaller,” Hoene said.

Policymakers are somewhat optimistic that the state’s financial situation will improve as revenue reflects the upturn in markets during 2023, which may be better reflected in updated data expected in May.

“I am, for the moment, somewhat more optimistic than the LAO about state revenues and the California economy,” Jason Sisney, budget adviser to the Assembly speaker, wrote in a newsletter last month.

Sisney cited an increase in stock prices, continued recovery in international tourism, as well as California’s position in the artificial intelligence and defense industries.