The state faces a 2026-27 budget deficit of $18 billion, the Legislative Analyst’s Office (LAO) projected November 19, even though revenue is running nearly $9 billion ahead of the expectations in the current budget. This gap is roughly $5 billion larger than the analyst’s June estimate.
“This is because constitutional spending requirements under Proposition 98 (1988) and Proposition 2 (2014) almost entirely offset revenue gains,” the report explained. “Moreover, we estimate costs in other programs to be about $6 billion higher than anticipated.”
Looking further ahead, the state’s structural deficit – the difference between projected revenue and spending if no changes in law are made – is expected to reach approximately $35 billion annually starting in 2027-28.
The analyst warned that “as it stands – with larger forecasted deficits and many fewer tools available to address them – California’s budget is undeniably less prepared for downturns.” Many of the tools used to manage previous shortfalls, including withdrawing billions from reserves and using temporary solutions, are largely depleted, leaving fewer options to address future gaps, the analyst stated.
CalTax President Robert Gutierrez said the Legislature should heed the analyst’s warning and take early action to address the budget problem.
“We urge the Legislature to curb spending increases well ahead of the budget deadline, so the budget problem will not continue to grow,” Gutierrez said. “Affordability should be the top priority. Since individuals and business taxpayers already are paying billions more than anticipated – and will be hit with increases next year in the gas tax, SDI payroll tax, UI tax, property tax, and local sales taxes – any additional tax increases should be completely off the table.”
The Department of Finance’s latest Finance Bulletin, released November 18, reported that for the month of October, general fund revenue was $2.2 billion (12.7 percent) higher than estimated, bringing the total to $8.6 billion above projections for the past seven months.
The revenue increase was driven primarily by personal income tax collections, which exceeded expectations by $2.1 billion in October and $6.7 billion since April. Corporate tax receipts were slightly weaker for the month, falling $75 million below the forecast, though they remain $174 million ahead since April. Sales and use tax revenue showed a modest monthly gain of $26 million but continued to lag overall, $187 million below the projection since April. Other sources of revenue were $110 million above the forecast for October and $1.8 billion above the seven-month projection, largely due to federal reimbursements for prior-year disaster costs.
“These strong income tax collections are being driven by enthusiasm around AI, which has pushed the stock market to record highs and boosted compensation among the state’s tech workers,” the LAO reported. “The stock market (S&P 500) has risen 50 percent in the last two years. Most of these gains come from the meteoric rise in the value of a handful of tech companies that investors believe will be major beneficiaries of recent advances in AI. These companies have made big bets on AI, spending hundreds of billions of dollars on data centers and offering extraordinary pay packages to recruit AI researchers. This spending, coupled with sizable gains to investors and tech company employees via stock options, is boosting state income tax receipts.”
These conditions raise concerns, the LAO warned.
“With so much enthusiasm surrounding AI, it now appears time to take seriously the notion that the stock market has become overheated,” the analyst wrote. “History suggests that the stock market is prone to overreact to major technological advances, even if the technology itself turns out to be revolutionary. For California, the dot-com era – when stocks rose and then fell precipitously in response to widespread adoption of the internet – offers the most salient example.”
While there is no certainty that a major downturn is coming, the LAO opined that “the risk appears strong enough – and the potential consequences for the state budget dire enough – that we think it should be incorporated in the state’s revenue outlook.”
The Department of Finance is in the process of preparing Governor Gavin Newsom’s final budget proposal. The governor has a January 10 deadline to submit a 2026-27 budget to the Legislature.
During this year’s budget process, the governor and Democratic leaders frequently said the president’s policies, especially tariffs and reductions in federal funding for various programs, are having a major economic impact on the state.
The LAO estimated that the federal budget will increase state costs by approximately $5 billion by 2029-30, attributed to a $3 billion net increase in Medi-Cal costs and a $2 billion increase in costs for the state’s implementation of the federal food assistance program. The analyst added that these figures “are limited to only those costs the state must pay due to changes in cost-sharing ratios and other changes in law,” and don’t include any costs attributed to changes in policy that are under the Legislature’s discretion.