How Did California Find Itself with a $75 Billion “Surplus?”
June 28, 2021
By Chris Hoene, Executive Director, California Budget and Policy Center and External Advisory Panel Member, GFRC
Any time now – perhaps today – California’s governor and legislature could be finalizing a deal on the state’s budget. It’s not like anything anyone would have predicted twelve months ago. Here’s the story.
In mid-May, California Governor Gavin Newsom introduced a revised proposal for the state’s 2021-22 state budget, announcing a new $100 billion-plus “California Comeback Plan.” The plan included $75 billion in revenues state leaders had not anticipated when they enacted this year’s budget back in June 2020 and $27 billion in direct aid from the federal government via the American Rescue Plan. This surprisingly sunny fiscal outlook for the Golden State runs in stark comparison to a year ago, when the governor was predicting a $54 billion shortfall.
That $75 billion is a huge amount of money – even in California. The revised budget proposal called for a $196 billion General Fund, so the scale of the unexpected revenue meant state leaders have had a lot more fiscal policy space than they thought they would a year ago.
What changed and how did California find itself with $75 billion more to allocate than was expected? The answer comes in two parts.
The Pandemic Economy and a Progressive Tax System
A year ago, California, like the rest of the country, was in the throes of the early stages of the pandemic. Unemployment was increasing at unprecedented levels as state shelter-in-place orders shut down huge parts of regular economic activity in the face of a burgeoning and unpredictable public health crisis.
Many economic observers were predicting a macroeconomic downturn that would affect all parts of the economy. State leaders found themselves crafting a budget amid scenarios suggesting they would be facing Great Recession-level fiscal shortfalls in months. This would have been particularly likely in California, because the state’s tax system – a combination of a progressive income tax, corporation tax, and sales tax – was expected to see rapid declines in revenues across its three major tax sources.
However, the dire predictions of a macroeconomic meltdown did not come to pass. Many larger corporations have been profiting at unprecedented levels during the pandemic. Higher-wealth households have also been thriving and watching their wealth rise relative to the rest of the country. Federal and state policy interventions and investments have helped many low- and middle-income households avoid some of the economic outcomes predicted a year ago. As a result, the state’s revenues have performed surprisingly well.
Ironically, California’s fiscal outlook reflects not only its extreme wealth but also widespread income inequality. Home to an array of the globe’s most successful companies and most wealthy individuals, and with a tax system designed to ensure it extracts revenue from that wealth, the irony is that the state’s financial health is much stronger than the economic security of most Californians, many of whom live at or near poverty levels or struggle to manage the state’s high cost of living.
Fiscal Forecasting in a Pandemic
The other part of this story has to do with the challenges of forecasting a state’s finances during a pandemic. A year ago, state leaders were expecting the state’s fiscal fortunes to fall off a cliff. One of the realities of having a relatively progressive tax system is that California’s revenues can increase and decrease dramatically based on changes in economic conditions – so-called “revenue volatility.” That volatility appeared to be working against the state a year ago. In a matter of months in early 2020, the state went from a projected $154 billion General Fund to a $134 billion General Fund with projections of further decline mid-year. Yet, just a few months later, it became clear the state’s revenues were performing far better than expected, culminating ultimately in the $75 billion in unexpected revenues the Governor announced in May.
How to Allocate $75 Billion?
First, state leaders do not actually have the luxury of allocating the full amount. Only about half of the revenue is discretionary and available to be allocated. The other half is constitutionally obligated to go to funding for K-12 schools and community colleges and to the state’s reserves – one of the ways that the state buffers against its revenue volatility. The final 2021-22 state budget act will likely include $24-25 billion in state reserves.
As for the discretionary portion of the funds, the deal state leaders are finalizing as of this writing will seek to balance one-time uses of the funds with a desire to devote more to ongoing expenses to rebuild systems decimated by a combination of the Great Recession and the pandemic. The deal should ultimately result in Californians seeing a massive influx of public sector funding to combat the effects of the pandemic and position the state’s economy for recovery. State leaders, for instance, have already agreed upon $8 billion in one-time stimulus checks for households making less than $75,000 annually and $1.5 billion in grants for small businesses and nonprofits. And that is a far better path than we thought the state would be on just one short year ago.
For more on the final 2021-22 state budget agreement, click here to find an analysis of the final agreement in early July 2021.