Gavin Newsom’s guess on tax collections was off by $26 billion, and now California faces a record $68 billion budget deficit

The nation’s most populous state — with an economy that is the fifth largest in the world — has been struggling since last year because of the rising prices of most goods and services and how the U.S. government has been trying to control it.

It is now much more expensive for people and businesses to borrow money, meaning fewer people are buying homes and fewer businesses are hiring workers. That is leading to fewer tax collections for the state.

A series of damaging storms last winter have made the problem worse. The storms were so bad that state officials decided to give people and businesses more time to pay their taxes this year. Californians did not have to pay their 2022 taxes until November of this year. That meant Newsom and the Legislature had to come up with a budget over the summer without knowing how much money the state had to spend.

It turns out that they badly misjudged how much taxes people and businesses would pay. The nonpartisan Legislative Analyst Office said tax collections were off by $26 billion, a major driver of the deficit. When combined with the economic slowdown California has been facing since last year, it leads to a predicted deficit of $68 billion, Legislative Analyst Gabriel Petek announced Thursday.

That is the biggest deficit by dollars in state history, but previous deficits have been larger as a percentage of state spending. California’s current budget tops $300 billion, the largest by far of any state.

Newsom and the state Legislature now must come up with a plan to cover this deficit. Newsom will present his plan in January and then negotiate with state lawmakers through June. The next budget year begins July 1.

Newsom’s first term in office was buoyed by record-smashing surpluses of more than $100 billion in some years. The money allowed him and his Democratic allies in the state Legislature to greatly expand government, including paying for guaranteed health insurance for all low-income adults regardless of their immigration status and free lunches for all public school students.

Now in his second term, growing budget deficits could threaten some of Newsom’s accomplishments at a time when he is building his national profile that could lead to a run for president beyond 2024. The Legislative Analyst Office says their projections, from 2022-2023 through 2027-2028, show a cumulative deficit of $155 billion.

Still, even in the face of deficits, Newsom and the state Legislature last year gave a lucrative tax break to the state’s film and television industry while also agreeing to gradually raise the minimum wage for health care workers to $25 per hour. That wage increase will cost the state about $20 billion this year in increased labor costs and Medicaid payments to hospitals.

“Republicans cautioned that this level of spending would lead to greater deficits, and it would be more prudent to show restraint. Unfortunately, the majority party ignored those warnings,” said state Sen. Roger Niello, a Republican from Fair Oaks and vice chair of the committee that oversees the state budget.

California is still in a strong position to weather the deficit compared with previous years, including the Great Recession more than a decade ago when the state struggled to have enough cash to pay its bills.

For one thing, the state has more than $37 billion in various savings accounts. Petek, the legislative analyst, suggested Newsom and lawmakers could use some — but not all — of that money to help balance the budget. In particular, Newsom could use the reserves to protect public schools from painful spending cuts.

Petek also said lawmakers could cancel about $11 billion of planned one-time spending. But even if they do all of that, it likely still wouldn’t be enough to cover the deficit.

“The state remains in a good cash position,” Petek said. “I would stop short of calling it a crisis.”

Assembly Speaker Robert Rivas, a Democrat from Salinas, pledged to craft a budget that “protects classroom funding and prioritizes support for core programs.” Toni Atkins, the Democratic president pro tempore of the state Senate, vowed to pass a budget “protecting middle class taxpayers and the programs and resources that help Californians and families.”

A spokesperson for Newsom said the governor will propose a budget that “protects vital services and public safety.”

The economic downturn has had a greater impact in California than other states, mostly because of its size and that it relies heavily on taxes paid by the wealthy. The number of unemployed workers has risen by nearly 200,000 since last year, enough to increase the state’s unemployment rate to 4.8% from 3.8%. The national unemployment rate is 3.9%.

Layoffs have hit the tech sector particularly hard, which has been the backbone of the state’s economic growth and revenue, said Sung Won Sohn, an economics professor at Loyola Marymount University.

“They expanded greatly during the pandemic and now they are finding that they have too many people and they need to cut back expenses,” Sohn said.

Home sales in California have been cut in half compared with two years ago as average monthly mortgage payments have jumped to more than $5,500 from $3,700, said Oscar Wei, deputy chief economist for the California Association of Realtors.

Wei said he expects interest rates to fall slightly in 2024 to around 6.5% — still well above the 3% rates seen during the pandemic.

“We’re still going to have higher mortgage payments for many of the homebuyers,” he said.