By Shane LaVigne, LaVigne Strategies

Big Focus: California Budget 2025

On January 10, Department of Finance Director Joe Stephenshaw unveiled Governor Gavin Newsom’s proposed 2025-26 Budget. During a preview earlier in the week, Newsom highlighted California’s ability to sustain “forward momentum” with a balanced budget and preserved investments for the upcoming fiscal year.

Stephenshaw reported that the State had transitioned from a record deficit to a modest $363 million surplus, fueled by an unexpected $16.5 billion revenue increase. The proposed $322 billion Budget marks a rise from last year’s $298 billion, with General Fund spending climbing to $228.9 billion from $212 billion in the previous fiscal year. The Administration attributed this fiscal turnaround to cost-saving measures, strategic use of reserves, and a resurgence in capital gains taxes.

Despite the revenue boost, Newsom recommended withdrawing $7.1 billion from the State’s Rainy-Day Fund for the upcoming fiscal year. He also cautioned the Legislature against pursuing new spending initiatives.

The Budget proposal arrives amidst uncertainties regarding potential federal funding cuts under the Trump Administration. Such reductions could force California to scale back critical programs, as the State depends on over $100 billion in federal funding annually.

Newsom remained optimistic, emphasizing progress in education, infrastructure, mental health, and homelessness. However, concerns about long-term fiscal stability persist. While the Department of Finance (DOF) presented a balanced Budget, the Legislative Analyst’s Office (LAO) projected a $2 billion deficit. The LAO described this gap as relatively modest for California’s economy and characterized the Budget as “roughly balanced” in the short term.

Adding to fiscal concerns, the LAO noted in its report that nearly 10% of California’s income tax withholding during the first half of 2024 stemmed from stock compensation at four major tech companies, underscoring the State’s economic reliance on volatile tech sector revenues.

This Year’s Budget Balancing Factors

Revenue
The balanced Budget is partially attributed to stronger-than-expected economic performance, driven by notable growth in personal income, a thriving stock market, and higher-than-anticipated General Fund cash receipts. Key contributors include:

• A $12.6 billion upward revision in personal income tax revenues, stemming from increased wages in the technology sector and higher capital gains realizations.
• A $2.5 billion increase in corporate tax revenues, largely due to limits on corporate tax credits and net operating losses implemented in the 2024-25 Budget.
• An additional $2 billion from interest income generated by the Pooled Money Investment Account.

Collectively, these factors result in a General Fund revenue projection of $16.5 billion above the forecast set in the 2024 Budget Act over the three-year budget window.

However, the Budget highlights inherent risks tied to California’s dependence on volatile personal income tax revenues. High-income earners remain a significant yet unpredictable source, compounded by uncertainties around potential federal policy changes and global economic conditions. To mitigate this volatility, Proposition 2 requires a portion of excess capital gains revenue to be deposited into the Rainy-Day Fund. The Budget also includes tax policy measures such as extending the pass-through entity elective tax and transitioning financial institutions to a single sales factor apportionment, contributing an additional $186 million to General Fund revenues for 2025-26.

Reserves
To support fiscal stability, the Budget incorporates a planned $7.1 billion withdrawal from the Budget Stabilization Account (BSA), resulting in an overall reserve of $17 billion by the end of 2025-26. This includes:

• $10.9 billion in the BSA.
• $4.5 billion in the Special Fund for Economic Uncertainties (SFEU).
• $1.5 billion in the Public School System Stabilization Account.

Additionally, the Budget proposes raising the BSA’s mandatory deposit cap from 10% to 20% of General Fund revenues and introduces a statutory change to exempt these deposits from the State Appropriations Limit. These adjustments aim to strengthen the State’s resilience against revenue fluctuations driven by capital gains and other unpredictable sources.