Governor Newsom and Legislative Leaders Reach Major Budget Agreement
In a significant move, Gov. Gavin Newsom has reached an agreement with legislative leaders on a $351.7-billion state budget for his final year as governor. This spending plan leverages a tax windfall to avoid major cuts and reduce California’s long-standing deficit in the coming years. The deal includes nearly $2 billion in additional state revenue next year through tax hikes on corporations, new levies on software sales, and a revised tax on managed healthcare organizations.
The budget continues to prioritize investments in education, healthcare, and expands funding for subsidized childcare and affordable housing. Newsom emphasized that the goal is to leave the next governor with a balanced and structurally sound budget. “We want to leave the next governor not only a balanced budget, but a budget that is substantially structurally sound,” he stated in an interview. He also noted that the state was cautious in terms of new spending.
The agreement ends weeks of lobbying by outside interests and negotiations among lawmakers and the governor at the state Capitol regarding how to handle a surge of income tax collected from stock market gains related to artificial intelligence.
Revised Financial Projections and Long-Term Implications
Early forecasts from June 2024 projected a $12.6-billion deficit for the 2026-27 fiscal year. However, updated predictions now suggest the state will end the year with a surplus of $4.5 billion. Democrats, following Newsom’s lead, have allocated $6.4 billion for future years, which helps eliminate a previously projected deficit through 2027-28 and addresses concerns about the governor's spending habits.
Despite these efforts, economists warn that the current financial adjustments may be temporary. Spending in California has generally exceeded revenue growth during Newsom’s tenure, creating a chronic shortfall. Even with the extra funding, the budget continues a trend of relying on reserves, shifting funds, borrowing, and suspending debt payments to balance state spending.
The Legislative Analyst’s Office (LAO), a nonpartisan fiscal advisor for lawmakers, has warned of a roughly $10-billion gap between the amount of money the state brings in and spends. This gap could worsen if the stock market declines. The LAO has indicated that any operating deficit during a revenue boom is a red flag, and the state is “ill-prepared” for even a modest decline.
Christopher Thornberg, an economist and founder of Beacon Economics, remarked that this pattern is typical in Sacramento. “They love increasing spending. But it seems politically impossible to go the other way,” he said. “We’ve seen this play out over and over again.”
Addressing Future Fiscal Challenges
Lawmakers and the governor argue that their decision to allocate $6.4 billion into a short-term reserve, called the Projected Surplus Temporary Holding Account, and to seek voter approval to store more money in the rainy day fund are examples of prudent budgeting. Senate President Pro Tem Monique Limón (D-Goleta) emphasized the importance of addressing both immediate needs and long-term structural budget issues.
“YOU see us save more and you see try to address the immediate needs of our community, but also the structural budget that potentially awaits us,” she said. “We are forecasting a moment where we will need to address these issues and we want to start now to think about the future as well.”
California’s budget is heavily dependent on income taxes paid by the ultra-rich on earnings largely from capital gains. This structure leaves the state vulnerable to the unpredictable nature of the stock market, dramatic swings in revenue, and recent reliance on poor projections.
Constitutional Amendment and Political Controversy
Negotiations at the state Capitol included an agreement on a constitutional amendment aimed at offsetting revenue highs and lows. If approved by voters in November, the amendment would raise the cap on mandatory deposits into the rainy day fund from 10% to 20% of general fund revenue. It would also allow lawmakers to exempt money they put into the rainy day fund and the temporary holding account from state spending limits.
Under the existing Gann Limit, lawmakers cannot spend more than an amount determined by a formula that takes annual tax proceeds, population changes, and cost of living into consideration. Tax revenue above the limit must be divided between schools and refunds to taxpayers.
Newsom believes the change will better prepare the state to weather volatility. While calls for tax reform remain in California, the governor says being able to place more money into reserves could ultimately solve the state’s budget challenges.
“The one thing missing is the one thing that I think we finally landed, which is the change in the reserves,” Newsom said. “It changes the political dynamic, where now you’re not exchanging general fund priorities.”
However, Republicans criticized the proposed constitutional amendment for failing to require that excess revenue pays down the state’s $22 billion in unemployment insurance debt. State Sen. Tony Strickland (R-Huntington Beach) called it a missed opportunity, stating it facilitates more spending and exempts reserve deposits from state spending limits.
Additional Provisions and Future Considerations
As part of the negotiations, lawmakers agreed to delay some healthcare cuts that would have required monthly premiums for immigrants and eliminated dental care. The deal adopts a Medi-Cal asset test of $21,000 on July 1, 2027, instead of a $2,000.
The budget agreement also includes a provision requiring California’s next governor to develop options to reduce taxpayer subsidies for corporations whose employees receive state-sponsored healthcare through Medi-Cal instead of the company’s health plan. This plan aims to raise revenue to offset federal cuts that are expected to leave millions of Californians without access to healthcare.
According to the California Department of Finance, state reserves are expected to total $28.8 billion under the 2026-27 budget.
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