"Upside" and "downside" for May Revision estimates
California state revenues could end up many billions above or below new projections
The administration’s May Revision economic forecast assumes that the S&P 500 stock index remains just above the 7000 level for the rest of 2026 and about 7100 for 2027. As of Friday, May 15, the S&P 500 closed at 7409, or 5.6% above the May Revision assumption for this quarter.
“A combination of a strong corporate earnings season, optimism about AI spending, and a view that the Iran conflict will end soon has powered a hearty level of investor optimism,” writes one financial journalist today in a column entitled “The S&P 500 is blowing minds and defying the odds.”
The administration’s May Revision summary notes that its assumption of “a moderation in stock market growth” results in capital gains realizations—a key source of state personal income tax revenue—declining by approximately 13 percent in 2026.
“One upside risk” for the forecast, the administration summary notes, “is the potential revenue impact of large Initial Public Offerings (IPOs) that may occur with regard to SpaceX, Anthropic, and OpenAI, each of which has a large workforce in California.” “The May Revision does not make any explicit adjustments for the potential impacts of these IPOs given the uncertainty as to their timing, actual IPO valuation, and whether the employees at these companies have stock-based compensation that will become taxable at the IPO.” In recent years, the summary adds, “more private companies have allowed companies to sell their stock prior to an IPO, which means there is less of a backlog of stock-based compensation that would become taxable at the IPO.”
The Governor’s May Revision projects that personal income tax totals $146.8 billion in state fiscal year 2025-26 and $145.6 billion (down 0.8%) in 2026-27. Overall, the May Revision summary explains, the revised administration forecast upgrades projections of the Pass-Through Entity Elective (PTET) Tax forecast by $4.3 billion across 2024-25, 2025-26, and 2026-27. The PTET (corporate) tax allows business entities to pay state taxes on income so that qualified taxpayers who own a part of those companies receive a credit for their share of the business’s tax, thereby reducing their personal income tax payment. “Higher PTET payments related to tax year 2025 contribute a net revenue gain of $2.1 billion…due to credit use against the personal income tax lagging payments under the corporation tax,” so that there is “higher corporation tax revenue of $4.3 billion and lower personal income tax revenue of $2.2 billion due to the PTET.” Even after considering the effect of the PTET, the year-over-year growth of the personal income tax in 2026-27 under the May Revision forecast seems modest.
The May Revision notes that “it continues to project modest economic growth,” as the economy has “generally remained resilient in the face of multiple shocks, including the Iran war, frequently shifting tariff policy, and more restrictive immigration policy, all of which have increased uncertainty, raised costs, or constrained labor supply.” Discussing risks for the forecast, the administration’s summary notes that “if higher fuel prices and inflation persist, then recessionary risks increase as higher fuel prices would crowd out consumption.” Further, “if a (stock) market downturn of more than 20 percent—comparable to the decline in 2022—were to occur in 2026 and be sustained through the end of the year, revenue could be $15 billion to $20 billion below forecast…even if there were no economic recession.”
The administration’s economic forecast assumes that refiners’ cost to acquire crude oil climbs from $73.50 in the first quarter of 2026 to $103.70 in the current quarter, before falling back to $77.30 in the third quarter.
Distinct from the revenue forecast, the Legislative Analyst’s Office has noted recent years’ trends of state spending growth, focused on inflation of costs for services funded by the state prior to 2019 and moderated by last year’s health budget cuts.
Focused on downside risks for the budget, staff colleagues and I wrote in last week’s Assembly Budget May Revision Overview that the May Revision proposes “unprecedented layers of budget resiliency protections that, if approved, would put the budget on a somewhat more sustainable path.” In addition to the modest projections for the personal income tax noted above, the administration proposes:
A budget balanced with more than $14 billion to spare in 2026-27 and $2 billion to spare in 2027-28. In 2026-27, the Governor proposes to deposit the $14 billion extra in the state’s new Projected Surplus Temporary Holding Account ($9.7 billion) and the basic General Fund reserve, the Special Fund for Economic Uncertainties ($4.5 billion). These funds are then drawn down in the Governor’s plan to help balance next year’s state budget.
A budget benefiting from a projected $15.1 billion in the state’s main rainy day fund, the Budget Stabilization Account, in 2026-27—up from $11.2 billion in the 2025-26 budget package last June.
A record school budget that includes $10.3 billion in the Proposition 98 (school funding) rainy day fund—up from zero in the 2025-26 budget package last June. The proposed May Revision school budget reduces unfunded Proposition 98 obligations (called “settle up” by some) to $3.9 billion—down from $5.6 billion in the Governor’s January proposal: an obligation that the state would need to address in the future under the Governor’s plan.