LAO revenue outlook brightens a bit
State still faces significant projected deficits and major federal uncertainty
The Legislative Analyst’s Office (LAO) notes today (here) that, in light of 2024-25 tax collections to date (especially withholding), “there is upside potential relative to the revenues assumed in the Governor’s Budget.” A graphic in LAO’s update suggests the possibility of revenues being $4.4 billion above Governor’s Budget projections for 2024-25 and $2.4 billion above for 2025-26, with possible personal income tax gains offsetting weakness in corporation and sales taxes, relative to the administration’s most recent forecasts.
These higher revenues will improve the near-term “bottom line” of the state budget by a much smaller net amount, if any. This is for several reasons. In most years, 40 percent or more of increased revenues must go to school spending, and other funds must go to reserves. For the 2025-26 budget, in particular, higher revenues may allow lower planned withdrawals from the state’s rainy day fund, especially in light of future projected deficits and threats of major federal cuts. In addition, pursuant to SB 175 of 2024, certain temporary tax increases in the 2024 budget plan may not apply for taxable years in which the Director of Finance determines that General Fund money over the multiyear forecast is sufficient without those increases and there is language in the annual budget act not applying those provisions.
The LAO says “the surge appears linked to the strength of the stock market,” which “has boosted the earnings of high-income Californians and, in turn, income tax collections.” The office again questions whether the recent stock market really is sustainable, but notes that “similar observations could have been made in 1998, but the stock market and the state continued to experience a boom for two more years.” “Stubbornly elevated inflation further complicates this picture,” LAO analysts write, adding this “also poses a risk for the continued strength of the stock market.”
LAO also has released new “guidelines for using revenue forecasts” here. These guidelines note:
Expect state revenue collections to differ from budget forecasts by billions of dollars in most years. “Revenue forecast errors are an unavoidable feature of the state budget. They also are ubiquitous. Every state in the country experiences meaningful forecast errors,” LAO analysts note, “often of a magnitude similar to California.”
Do not focus too much on smaller differences. “When [the administration’s] forecast for the [three-year] budget window is within $10 billion of ours at May Revision (or $15 billion at the January budget release), decision makers should tend to view it as reasonable.”
Policy makers should “weigh the chances that revenues end up higher than assumed against the chances they end up lower.” Comparing different forecasts is one way to go about that.
Interpret real-time tax collections with caution. “Monthly tax collections are noisy,” LAO analysts say. Patterns early in the year “are not guaranteed to persist.”
“Do not equate revenues and the economy.” Revenue trends “can diverge considerably from trends in the state’s economy.”