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California’s revenue decline is reminiscent of the Great Recession, new report says

In a grim sign for the state, California is projected to see a $58 billion shortfall in revenue collection over the course of three fiscal years, from 2022-23 to 2024-25, according to a report released Friday by the nonpartisan Legislative Analyst’s Office.

The LAO said money from postponed tax payments came in far below projection.

“The impact of recent economic weakness and last year’s financial market distress on state revenues has become clearer. The postponed payments came in much weaker than anticipated,” the LAO report read.

The report cited a cooler California economy in part due to higher borrowing costs and reduced investment as a result of actions by the Federal Reserve.

“This has slowed economic activity in a number of ways. For example, home sales are down by about half, largely because the monthly mortgage to purchase a typical California home has gone from $3,500 to $5,400,” the LAO said.

Some of the Federal Reserve’s actions hit California particularly hard; investment in California-based startups and tech companies has dropped significantly, according to the report. The number of companies that went public in 2022 and 2023 dropped by 80% from 2021.

“As a result, California businesses have had much less funding available to expand operations or hire new workers,” the report said.

According to the LAO, California entered an economic downturn last year, with the number of unemployed workers jumping nearly 200,000 since the summer of 2022, raising the unemployment rate from 3.8% to 4.8%.

“Similarly, inflation-adjusted incomes posted five straight quarters of year-over-year declines from the first quarter of 2022 to the first quarter 2023,” the report said.

Storms delay tax receipts

When state lawmakers began crafting the 2023-24 budget earlier this year, they did so “without a clear picture of the impact of recent economic weakness on state revenues” due to postponed deadlines for tax payments on investment and business income. The IRS extended filing deadlines to provide more time for those affected by severe winter storms.

And then, the “full extent of revenue weakness” became clear with the arrival of those postponed payments.

“With the deadline passed, collections data now show a severe revenue decline, with total income tax collections down 25% in 2022-23. This decline is similar to those seen during the Great Recession and dot-com bust,” the report said.

While it’s unclear whether the state will encounter further financial distress, “the odds do not appear to be in the state’s favor,” according to the report.

“Past downturns similar to this recent episode have tended to be followed by additional weakness,” the report said.

The LAO projects that revenue collection will be nearly flat in 2023-24, after falling 20% the fiscal year prior.

“Our outlook then has revenue growth returning in 2024-25 and beyond,” the report said.

H.D. Palmer, a spokesman for the Department of Finance, emphasized the revenue shortfall is not the same as the projected budget gap, which the LAO will likely release next week.

Palmer said California has a unique concentration of high-income taxpayers who make their money from capital gains, stock options and bonuses tied to stock performance. Higher interest rates and stock market uncertainty particularly affect those earners, he said.

“We are still seeing economic growth in California,” Palmer said. “But because of the outsized role that the stock market plays in our revenues, there is somewhat of a disconnect between economic performance and revenue performance.”

Palmer also drew attention to the state’s $37.8 billion in reserves, which he called “an insurance policy against the risks of downturns.”

“I think it is important when you’re looking at the revenue decline that LAO talks about, it should also in the same breath, I think, be noted that the budget that was passed in June just set aside a substantial amount of money in budget reserves,” he said.

Lawmakers react to revenue decline

The report was met with concern by Democrats and Republicans alike.

Senate President Pro Tem Toni Atkins, a Democrat, said in a statement that the report is “not welcome news,” but that “California is more prepared than ever to withstand budget challenges.”

“We will have a clearer picture of our situation as we approach the budget deadline next June. But with our record reserves and other budgeting tools, we, along with our partners in the Assembly and the Administration, will work through these challenges while protecting middle class taxpayers and our progress on core programs that help all Californians,” Atkins said.

Meanwhile, Sen. Roger Niello, a Republican who vice-chairs the Senate Budget and Fiscal Review Committee, in a statement blamed the Democratic-controlled supermajority and the governor for increasing state spending.

“Hopefully, the majority will see it is time for a more realistic budget strategy, instead of throwing money at a laundry list of projects that sounds nice on the national television debate stage,” Niello said, in an apparent dig at California Gov. Gavin Newsom’s recent appearance at a Fox News debate with Florida Gov. Ron DeSantis.

Assembly Speaker Robert Rivas, D-Hollister, echoed Atkins’ reassurances that the state’s finances can handle fiscal challenges.

“I remain committed to working with my Assembly, Senate and administration colleagues on a 2024 budget that protects classroom funding and prioritizes support for core health care, safety net and public safety programs,” Rivas said in a statement.

Newsom’s office did not respond to The Bee’s request for comment by deadline.