Gov. Gavin Newsom’s just lately proposed 2026-27 state finances included a pleasing shock: a deficit of about $3 billion — considerably lower than analysts had estimated. However in the case of California state budgets, excellent news hardly ever lasts. Newsom’s personal estimates warn that the deficit might attain $22 billion within the following fiscal 12 months.
It’s all too frequent for California’s finances to careen from 12 months to 12 months. Between 2022 and 2024 the state skilled a $175-billion swing from surplus to deficit. This time the crunch got here as a result of spending fueled by the post-pandemic financial restoration was not sustainable when income plummeted only a few years later — however the state finances has lengthy gone via comparable boom-and-bust cycles.
Though California’s leaders deserve their fair proportion of the blame for placing the state on this budgetary curler coaster, there are three underlying components that make efficient fiscal administration in California uniquely difficult: an overreliance on the state’s private revenue tax; obligatory spending commitments that restrict policymakers’ discretion to handle challenges; and a scarcity of accountability for the taxpayer cash that’s spent.
First, California has an outdated tax system. Within the 2025-26 finances, for instance, the non-public revenue tax made up almost 70% of basic fund income. By comparability, private revenue taxes account for 38% of complete state tax collections nationally. The Golden State’s excessive reliance on the non-public revenue tax implies that when incomes are excessive in California, income collections are robust, however when the economic system slows and incomes fall, state income weakens drastically too.
The outsize function that capital positive factors — revenue from sure investments — play in income makes the volatility worse. Excessive earners are inclined to earn a bigger share of their complete revenue this manner. In truth, the unexpectedly slim deficit in Newsom’s 2026 finances was because of what California’s Legislative Analyst Workplace recognized as a $42-billion tailwind created by a sturdy inventory market, which led extra Californians to earn extra capital positive factors and pay extra taxes on these earnings. However when fairness markets aren’t performing properly, collections take a serious hit. Contemplate this distinction: In 2021, capital positive factors accounted for nearly 1 / 4 of the non-public revenue tax legal responsibility within the state, in contrast with simply 10% in 2023.
The reliance on private revenue taxes implies that as the very best earners depart, so does California’s income. Within the 20 years main as much as 2023, the highest 1% of revenue earners within the state have been answerable for a mean of 45% of complete private revenue tax legal responsibility. That’s why insurance policies just like the just lately mentioned “billionaires tax” may result in capital flight from California, jeopardizing the state’s skill to fund fundamental companies.
The second complicating think about California’s finances course of is the amount of cash tied up in spending commitments over which policymakers have little discretion. Many of those restrictions have been imposed by voters over the past a number of a long time in poll initiatives which have handed with important margins. Collectively, these provisions — whereas well-meaning and politically widespread in lots of circumstances — create limitations that make budgeting a problem in California.
For instance, funding for the state’s public faculties is essentially assured by Proposition 98, a state constitutional modification accredited by voters in 1988 that establishes an annual minimal funding quantity for public Ok-12 faculties and group schools. About 40% of the overall fund finances in California, or almost $90 billion in 2026, is dedicated with out exception to Ok-14 faculties via Proposition 98.
California voters have additionally accredited tens of billions of {dollars} in borrowing over the past 20 years that the state’s structure requires be paid again from the overall fund. These bond authorizations create obligations to repay borrowing for priorities as wide-ranging as well being services, water infrastructure and wildfire prevention. Repaying these “IOUs” requires policymakers to trim spending in different areas. Additionally, the state’s rainy-day fund, which is designed to insulate the finances from financial downturns, requires an annual set-aside of 1.5% of estimated basic fund income.
Lastly, California has no systematic means of offering accountability for and assessing whether or not any of its spending is producing promised outcomes. Governments at each stage wrestle with the idea of detailing what the “return on funding” is for public spending. However the state of affairs in California is especially dire. Thus, taxpayers are sometimes caught financing underperforming authorities packages riddled with waste and outright fraud, as was the case within the latest $30-billion scandal that the state’s unemployment insurance coverage program.
Within the mid-2000s, California commissioned a unified monetary accounting and transparency system referred to as Fi$Cal that was supposed to switch a number of outdated programs. Over a billion {dollars} and a number of other blown deadlines later, the platform nonetheless isn’t full and received’t be totally operational till July 1, 2032. Whereas the state auditor, an official appointed by the governor, does a reputable job of analyzing state spending, suggestions for enhancements are sometimes not applied. And the state controller — the elected chief fiscal officer who’s accountable to voters for monetary oversight of state spending — hasn’t produced California’s annual monetary audit on time since 2017.
It’s arduous for a state to correctly handle its funds when there’s confusion over how a lot it’s actually spending, or whether or not that cash is attaining its supposed objective. However that’s grow to be enterprise as traditional right here.
Policymakers can have a troublesome time addressing California’s finances and financial challenges until every of those three underlying components is addressed. Our antiquated tax code needs to be reformed to scale back reliance on the non-public revenue tax and lift income in a extra predictable means. Californians should perceive that there are long-term implications of borrowing to handle challenges and warily strategy future bond measures and different initiatives that tie the palms of policymakers at this time. And voters ought to elect politicians prepared to supply them with the oversight that’s wanted for the taxpayer cash that Sacramento spends.
With out these adjustments, Californians are most likely headed for extra fiscal follies within the years forward.
Lanhee J. Chen is a fellow on the Hoover Establishment at Stanford College and was a candidate for California state controller in 2022.
