Walters: How California’s budget morphed into a $45 billion deficit in two years

Wishful thinking and outdated forecasts assumed that a 2022 surge in tax revenue would keep flowing into state coffers.

The much-revised 2024-25 state budget that Gov. Gavin Newsom released last week contains hundreds of spending reductions and other actions to close what he says is a $44.9 billion deficit.

Exactly two years earlier, Newsom boasted as the state enjoyed a $97.5 billion budget surplus, thanks to surging revenues from the post-pandemic economic recovery.

“No other state in American history has ever experienced a surplus as large as this,” Newsom said as he unveiled a revised $300 billion 2022-23 budget, which was $14 billion higher than his original proposal.

The budget he signed a month later was even larger, $307 billion, with immense new commitments, including cash payments to poor families and expansions of health care and early childhood education.

So, one must wonder, how did a $97.5 billion surplus morph into a huge deficit and a budget that is pulling back much of the new spending Newsom and the Legislature had so eagerly approved?

The new budget takes a stab at answering the question, basically saying that revenues fell well short of projections.

“Due to the revenue spike from 2019-20 to 2021-22, the budget acts of 2021 and 2022 were based on forecasts that projected substantially greater revenues in the last two fiscal years than occurred,” the budget declares.

However it doesn’t reveal why those erroneous projections were made in the first place.

In 2022, Newsom’s budget staff evidently looked at a spike in tax revenue as the state’s economy recovered from the pandemic, mostly due to massive amounts of federal relief funds, and concluded that the cornucopia would continue indefinitely.

That conclusion — or wishful thinking — led to extrapolating that a $97.5 billion surplus would emerge in 2022-23 and future years. However that number never appears in budget documents and was merely a verbal boast from Newsom.

A chart in then newly revised 2024-25 budget contains the pertinent numbers of the miscalculations.

According to the chart, the 2022-23 budget projected that revenues from the state’s three biggest sources — personal and corporate income taxes and sales taxes — would top $200 billion through 2025-26. In fact, however, they have fallen well short of that level every year since, and are now expected to remain far below for the remainder of Newsom’s governorship.

“The total difference across the four fiscal years is a negative $165.1 billion,” the new budget declares.

That’s an enormous amount of money that Newsom thought the state would be receiving but didn’t — a phantom surplus that fueled unsustainable spending.

The administration was also not alone in assuming in 2022 that the state was on the verge of a big increase in budget revenues. The Legislature’s budget analyst, Gabe Petek, largely confirmed Newsom’s rosy 2022 projections, tabbing revenues from income and sales taxes to hit $214 billion by 2023-24, $36 billion more than the current revenues from those taxes.

Those who crunch numbers in the Department of Finance and Petek’s office are seasoned professionals who, we must assume, honestly believed that California’s treasury would overflow with cash.

Their error apparently reflected models for revenue forecasts that are outdated, particularly when judging how wealthy Californians fare in taxable earnings on investments — a major but very volatile aspect of the revenue stream.

Newsom is proposing a couple of budget process changes to adjust for the volatility in addition to the current practice of setting aside rainy-day reserves. He would not spend spike revenues until they are actually in hand, and write budgets that look ahead to future years.

Those are steps in the right direction. Spending money based on volatile revenue estimates is not only foolish but cruel because — as this year proves — it raises expectations that later turn to pixie dust.

Dan Walters is a CalMatters columnist.