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What Caused California's $68B Budget Hole?

The state's projected $68 billion shortfall for the coming fiscal year represents a big challenge. Still, California’s deep reserves can reduce the burden.

a man with a microphone stands in front of a wall with sticky notes with questions on them
Greg Anglea, who runs a nonprofit in Escondido, Calif., reviews questions about serving the homeless population after the city council pulled funding for a shelter.
Ana Ramirez/TNS
In Brief:
  • Fiscal year 2022-23 marked significant revenue decreases in California due to stock market fluctuations and rising interest rates from the Federal Reserve.

  • The IRS’ decision to push back filing deadlines because of storms delayed the state from receiving the full picture of its lowered revenues from 2022-2023.

  • The state government can manage and mitigate major effects of the deficit by looking to reduce spending, scale back infrastructure investments, and even potentially on core services.

  • A shortfall of $68 billion seems like an insurmountable number. For California, this is the situation state lawmakers will have to deal with in the budget process next year, due to massive drops in revenue in the current fiscal year.

    The state is highly reliant on tax receipts from top earners, which has made its finances particularly volatile. As recently as May, California Democratic Gov. Gavin Newsom announced the state was running a surplus of $97.5 billion.

    “Lowered revenues for the state have to do with the fact that we have a revenue structure that's very progressive on the income tax,” says Chris Hoene, executive director of the California Budget and Policy Center. “When the stock market fluctuates, our tax system tends to go up and down very quickly."

    That's what led to the shortfall, which represents about 30 percent of the state's current general fund budget. Last year, rising interest rates contributed to stock market declines, which in turn led to a downturn in IPOs, or initial public offerings, in Silicon Valley and elsewhere. All that led to a decline in revenues across the state.

    You may have filed your taxes last April, but due to widespread storms in California, the IRS pushed back the deadlines for most state residents to file their 2022 returns — initially, until Oct. 16 and then until Nov. 16. The lack of returns left the state flying blind in terms of the looming shortfall.

    “[The deadline change] is one of the really big reasons that the state faces such a massive number for the deficit," says Ann Hollingshead, principal fiscal and policy analyst at California’s Legislative Analyst’s Office. "The deadline change did not result in lower revenues, but the deadline change did mean that the state didn't have the information last year. It forced it all into one year, instead of giving the state the information that it would have needed across two years."

    Newsom will be required by the state constitution to submit a balanced budget for the coming fiscal year this spring. Hoene doesn’t expect to see significant cuts to ongoing services, thanks to deep reserves of more than $30 billion. But he does note some key areas where the state may scale back, primarily infrastructure.

    Policymakers will have to look more broadly, Hollingshead suggests, including canceling some one-time spending programs included in recent budgets, or perhaps shifting revenues between fiscal years. They might also have to follow the politically perilous course of tinkering with the state's complicated method of setting funding levels for schools.

    "Given the scope of the budget problem, it's possible that the Legislature will also have to reduce spending of core services," she says. "Ultimately, what those decisions are, and how the Legislature makes them, it would be up to the elected officials.”
    Zina Hutton is a staff writer for Governing. She has been a freelance culture writer, researcher and copywriter since 2015. In 2021, she started writing for Teen Vogue. Now, at Governing, Zina focuses on state and local finance, workforce, education and management and administration news.
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