LAO upgrades state revenue estimates a lot
My opinion: California state tax revenues likely will be even higher in the near term
LAO Revenue Estimates Upgraded. The Legislative Analyst’s Office (LAO) upgraded its near-term state revenue outlook significantly today (online here). While noting the broad uncertainty inherent in California state revenue forecasting, the LAO said it anticipated state General Fund tax revenues might be $8.1 billion higher than the Governor’s January 9 estimates for 2025-26 and $3.4 billion lower than those January 9 estimates for 2026-27, for a net revenue gain of about $5 billion over those two fiscal years (known as the “budget window”). As LAO describes in an accompanying post, that $5 billion net revenue gain would reduce projected near-term deficits by about $2.5 billion.
My Opinion: Revenues Likely Will Be Much Higher in Near Term. I think the LAO’s revenue estimates likely are too low for 2025-26 and 2026-27. No one counsels humility about revenue projections more than me, but I think the odds are that General Fund revenues for the budget window will be somewhere between $15 billion and $40 billion above the Governor’s January 9 projections. (Those outcomes are roughly within the range of possible outcomes identified by LAO and colored in green in the figure of its online post.)
Strong Recent Tax Collections. LAO notes that major General Fund tax revenues came in about $6 billion ahead of the Governor’s projections for just the two months of December and January, as I noted on February 4. LAO also notes that “given the recent forecasting differences between our office and the administration, there is a good chance the administration’s revenue upgrade at May Revision will be larger than our current estimate.”
“Should Be Viewed As a One-Time Windfall.” The LAO prudently notes that these additional resources—of whatever amount—”should be viewed as a one-time windfall.” LAO recommends using this windfall to “reduce reliance on reserves and borrowing.”
Big Caveats About Any Near-Term Revenue Gains. In earlier posts, I noted the following about any near-term revenue overages, which I am happy to reiterate:
A large chunk of any tax revenue overage, relative to the Governor’s forecast, would be obligated to fund schools and reserves pursuant to constitutional requirements. That’s why LAO notes that a $5 billion near-term revenue gain would improve the “bottom line” of this year’s state budget picture by around $2.5 billion, with the rest required to be spent on schools and reserves.
Outyear deficit projections likely would persist to some degree due to troubling state cost trends and declining federal support, which collectively are likely to cause spending to outpace future revenue growth.
Neither administration nor LAO revenue forecasts account for the likelihood of a major drop in revenue accompanying any future bursting or subsidence of the possible investment bubble related to the so-called artificial intelligence industry. As LAO notes today, “We continue to think the risk of a revenue downturn starting in the next year or so is too great to ignore.”
Neither administration nor LAO revenue forecasts seem to account for a recent reported increase in high-income taxpayers shielding wealth and, likely, income from California state taxation due to the proposed “billionaire tax.” Increased taxpayer migration to other states is one method reportedly being used to reduce California state taxation. These reports raise the possibility that the base of the existing state income tax will be impaired somewhat in the coming years.
Tax increases passed under current constitutional guidelines may go to reduce future deficits and fund schools and reserves, leaving little or none available to restore programs above levels funded in the Governor’s budget plan.