A new state report warns that Gov. Gavin Newsom’s plan to close a projected $2.9 billion budget shortfall fails to confront what it calls “alarming” multibillion-dollar deficits looming in the years ahead.
“The Governor and administration officials have acknowledged the downside risk to the state’s revenue picture and the multi-year challenges facing the budget,” the state’s nonpartisan Legislative Analyst’s Office wrote in the report. “However, the Governor’s budget does not include material actions to address either challenge.”
The report published Monday warns of rising spending commitments in the proposed budget, which counts on a $42 billion windfall from high-income taxpayers’ stock market returns to balance the books this year — a volatile revenue source that could evaporate in a financial downturn.
Critics of Newsom, including San Jose Mayor Matt Mahan — now considering a run for governor as Newsom reaches his term limit in 2026 — were quick to pounce on the report.
“California needs to get its fiscal house in order if we want to protect the vulnerable and prosper economically, starting with addressing waste, inefficiency and even fraud,” Mahan said in a social media post Wednesday. “Kicking the can down the road just means higher taxes and reduced services in the years ahead.”
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“The Governor’s Budget is clear: a pullback in the financial markets is a real risk, which is why the proposal is built on modest, below-average revenue growth and a prudent fiscal posture,” H.D. Palmer, a spokesperson for the department, said in a statement.
Newsom’s $349 billion total budget, up from about $320 billion for the current budget year, is only an initial proposal. It will evolve as financial forecasts are updated and state lawmakers, who must work with the governor to finalize the budget by mid-June, negotiate changes. It’s the fourth consecutive year that the state has been forced to close a multibillion-dollar budget deficit, following an almost $100 billion surplus in 2022.
The governor’s plan includes multibillion-dollar increases to education and health spending. It also proposes more than $1 billion in reductions to housing and homelessness programs, a concern for local officials, including Mahan.
The plan does not include funding for the millions of low-income Californians who could lose their state health insurance through Medi-Cal due to new work requirements and other policy changes pushed by the Trump administration — a potential point of contention for state lawmakers. The state also faces billions of dollars in new costs as a result of the changes, including a potential increase in the share it must contribute to cover some Medi-Cal participants.
Initially, the LAO had projected an $18 billion deficit for the 2026-27 budget, about six times the Newsom administration’s $2.9 billion estimate. State officials attributed the smaller shortfall to an additional $42 billion in revenue expected for the current and next budget years, compared to projections made in 2025.
However, the LAO warned that an overheated stock market driven by Silicon Valley’s artificial intelligence boom is at “high risk of reversing course into a downturn in the next year or so,” which in turn would batter income tax revenue.
“These risks are severe enough that not incorporating them into this year’s budget, as the Governor proposes, would put the state on precarious footing,” the state’s fiscal and policy advisor wrote.
The finance department disputed that position, responding that “actual revenue receipts and the moderately improved economic conditions since last year’s budget” do not “support that level of pessimism.”
In addition to tax revenue, the LAO also raised concerns about ongoing spending commitments and other increased costs, contributing to multi-year deficit projections ranging from $20 billion to $35 billion annually starting in the 2027-28 budget year.
In a November report ahead of the governor’s budget proposal, the LAO identified a number of drivers of the “structural deficit” for the years ahead. They include an estimated $5 billion in new costs over the next five years related to the changes and cuts to federal healthcare and food assistance programs pushed by Trump in his “One Big Beautiful Bill Act.” The report also forecasted billions of dollars in increased spending to pay off “budgetary borrowing” used to cover Medi-Cal and education costs. Under two voter-approved measures, the state must increase school funding as tax revenues rise.
The LAO’s latest report encouraged the state to tackle the multi-year shortfalls through either spending cuts, new taxes, or a combination of both. The state finance department said it would review “any meaningful proposals” from the LAO on how to ensure California’s finances are sound.
Whatever the solution, the report stressed that the governor and state lawmakers should tackle the budget issues now, “before a crisis is at the state’s doorstep.”
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