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California Governor, Legislature Approve $351.7 Billion State Budget Amidst Revenue Surge and Long-Term Deficit Concerns

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California Governor Signs $351.7 Billion State Budget

"The spending plan relies on a surge in income tax revenue tied to stock market gains and the artificial intelligence sector."

California Governor Gavin Newsom has signed a $351.7 billion state budget for the fiscal year beginning July 1, following an agreement with legislative leaders. The spending plan represents a nearly $30 billion increase over the current year's budget.

The budget increases spending on education, healthcare, and childcare while projecting a smaller-than-anticipated shortfall for the upcoming year. However, it also includes cuts to some programs and faces warnings about long-term structural deficits and the sustainability of its revenue sources.

Budget Overview and Revenue

The budget allocates approximately $248.3 billion to the general fund. Projections indicate a $2.9 billion shortfall for the 2026-27 fiscal year—a figure significantly lower than the Legislative Analyst's Office (LAO) November estimate of an $18 billion deficit.

The improved outlook is based on an expected $9 billion increase in revenue, driven by a strong stock market and the AI-driven technology sector, with an additional $16.5 billion expected over a three-year window.

Despite the current revenue surge, Governor Newsom's proposal projects deficits of $10.3 billion in fiscal year 2028-29 and $9.6 billion in fiscal year 2029-30. The LAO has warned that the stock market may be in "bubble territory" and that revenues could fall tens of billions lower within one to two years. State Department of Finance Director Joe Stephenshaw identified a market downturn as a primary risk to the budget's assumptions.

Key Spending and Reserve Allocations

Education

  • $2.2 billion increase in the Local Control Funding Formula for K-12 schools and community colleges, reaching a historic general fund per-pupil spending of $21,148
  • Special education funding increased by $1.8 billion
  • $1 billion for high-needs community schools
  • Maintained funding for free school meals
  • Added 22,770 new slots for free or reduced childcare, reversing a proposed decrease
  • Per-pupil spending projected to increase to $27,400 in the upcoming year

Higher Education

  • University of California system: $350 million additional in 2026-27
  • California State University system: $365 million additional in 2026-27

Reserves

  • $6.4 billion placed in a temporary holding account to balance the budget through 2027-28
  • $3 billion deposited into the Budget Stabilization Account (Rainy Day Fund)
  • $8.6 billion into other reserve accounts
  • $3.6 billion transferred to the Rainy Day Fund for the next fiscal year

Both Governor Newsom and legislative Democrats support a ballot measure to increase the Rainy Day Fund cap to 20% of general fund tax revenues, which would require voter approval.

Pensions

The budget proposes $11.8 billion over four years, including $3 billion in the upcoming year, to pay down state pension liabilities.

Areas of Reduced Funding and Program Changes

Healthcare (Medi-Cal)

Medi-Cal continues as the largest state program. The budget rejects Governor Newsom's proposal to lower the asset limit to $2,000, instead lowering it to $21,000 in 2027-28.

However, the budget includes $1.8 billion in general fund spending cuts, primarily through reductions to Medi-Cal:

  • Raising monthly premiums for undocumented immigrant adults from $30 to $50 starting July 2027
  • Moving approximately 1.3 million undocumented immigrants in Medi-Cal to a separate fee-for-service program
  • Maintaining previously approved cuts, including freezing new enrollment and eliminating dental coverage (though some dental coverage cuts have been delayed)

Housing and Homelessness

The budget proposes a $1.3 billion reduction in spending for housing and homelessness—a more than 56% cut. This includes:

  • Eliminating a $500 million annual state contribution to the Low Income Housing Tax Credit
  • Reducing funding for local housing and homelessness services from $1 billion to $500 million, subject to new accountability requirements requiring a local match

Behavioral Health

The budget proposes redirecting $1 billion annually from Proposition 1 mental health funds towards housing and homelessness subsidies.

Controversial Tax Proposals

The budget includes a cap on corporate tax credits at $5 million or 50% of tax liability, estimated to raise $850 million next year and $1.7 billion the following year.

The California Chamber of Commerce opposed the cap, stating it would burden entrepreneurs and likely be passed to consumers.

Governor Newsom opposes major tax increases, putting him at odds with progressive legislators who advocate for corporate tax increases and new taxes on wealthy Californians to address potential federal healthcare cuts.

Background and Context

Governor Newsom attributed budget uncertainty to federal policies, including potential cuts to Medicaid. The state has a Democratic supermajority in the legislature.

The LAO reported that state spending from the main operating fund grew by over $100 billion (70%) since Newsom's first budget in 2019-20, with about 30% of that growth attributed to new programs or expansions.

California has also seen a 9% reduction in unsheltered homelessness, a figure that follows years of increases that brought the number of unsheltered individuals in the state to a record high of 123,974 in 2024, despite over $24 billion allocated to the issue during Newsom's two terms.

Reactions

"The proposal does not cut spending enough and leaves a structural deficit beyond 2027-28." — Senator Roger Niello, Senate Budget Committee Vice Chair

Senate Budget Committee Chair John Laird expressed caution regarding the sustainability of the AI-driven revenue boom, suggesting the Legislature address the long-term structural deficit proactively.

Healthcare advocate Kiran Savage-Sangwan of the California Pan-Ethnic Health Network expressed disappointment, hoping the Legislature would support immigrants.

Graham Knaus of the California State Association of Counties said the proposal leaves counties without adequate support.

Assemblymember David Tangipa (R-Fresno) called the budget "compassionate" but expressed concern that it continues a pattern of spending without a clear long-term plan.

Senate President pro Tempore Monique Limón and Assembly Speaker Robert Rivas stated the agreement reflects a commitment to protect core programs, build reserves, and ensure large corporations pay their fair share.