Tax revenues have exceeded estimates in California, but Gov. Gavin Newsom’s spending proposals and other state costs could quickly swallow up any extra funds.
An extra $420-million tax break for Hollywood film studios. Twenty-five million dollars to wage legal battles against President-elect Donald Trump. Unanticipated costs for providing healthcare to seniors and undocumented immigrants.
As analysts warn about the need for California to restrain spending, Gov. Gavin Newsom’s wish list and other new costs are threatening to unwind progress toward balancing the state budget.
To solve a $78.5-billion deficit over the last two years, the Democratic governor and lawmakers took savings from the state’s rainy day fund, delayed programs, cut spending and relied on the occasional accounting gimmick. Those moves, combined with higher than expected tax revenues in recent months, suggest the state could face a relatively mild $2-billion shortfall in the coming year.
But the deficit could grow with the proposals Newsom unveiled in recent months, cost overruns on existing programs and the potential loss of billions in federal funding as analysts predict more significant budget problems in the years ahead.
“There are many different reasons for us to be cautious and prudent going forward, and we should be very clear-eyed about the tough choices that lie ahead,” said Assemblymember Jesse Gabriel (D-Encino), who leads the budget committee.
Gabriel said the Assembly will “carefully consider and vet” the governor’s proposals, which lawmakers will get a better look at when Newsom unveils his budget plan in January.
Newsom’s new spending proposals
With Hollywood experiencing a massive production downturn, Newsom recently proposed a “historic expansion” of California’s program for providing tax breaks to studios that produce movies and TV shows here. The program currently offers $330 million in credits annually, and the governor wants to more than double that to $750 million next year.
The boost would make California the most film-friendly state in the country. The tax credits will also become refundable for the first time in the upcoming budget year, which begins on July 1, meaning the state will pay companies cash for any credits that exceed their tax liability.
The governor said the expansion will help keep more projects in the state and increase economic activity at a time when Hollywood studios are struggling to bounce back from pandemic losses and strikes.
The film tax credit is popular among lawmakers from Los Angeles, where a majority of the 125,000 film industry jobs are based. But it could face objections from advocates for education because the credits will result in reduced school funding.
Chris Hoene, the executive director of the California Budget & Policy Center, said the state loses more than $70 billion a year in tax credits and deductions. He said giving away more tax credits to compete against other states “just becomes a race to the bottom.”
“One state moves their credit up, and all the other states feel like they have to and pretty soon everybody’s basically giving away free cash to film companies,” Hoene said. “So that’s a losing battle in the long run.”
The governor’s litigation fund against the incoming Trump administration is another new expense that wasn’t calculated in the $2-billion deficit projection from the Legislative Analyst’s Office in late November.
Anticipating a need for more legal firepower during the Trump administration, the governor is asking lawmakers to approve an additional $25 million for litigation with the federal government.
The amount is relatively small, and the governor’s office says it has the potential for significant returns. The state spent $42 million to file 122 lawsuits against the Trump administration from 2017 to 2021, according to the governor’s office. In just one case where the federal government sought to link police grants to immigration enforcement, the state prevailed and was reimbursed $57 million.
California’s healthcare program for low-income residents is also costing more than expected as the state expands eligibility to all income-eligible adults, regardless of immigration status, and experiences an increase in the number of seniors seeking services.
As of November, financial advisors to the Legislature reported that the program will cost the state $2.7 billion more than budgeted for in the current year and $1.2 billion more than forecast next year.
After a news conference at a rice farm in Colusa on Tuesday, Newsom said he will continue to fulfill the commitment he made to provide coverage for immigrants when he presents his spending plan for the year ahead in January.
“As it relates to future years, we’ll have conversations across the spectrum of issues,” Newsom said. “I can give you seven or eight categories in the budget that we have to consider soberly, and that’s one of them.”
Newsom said Trump’s threat to deport immigrants could also affect the cost of Medi-Cal services. The governor said he recently met a young immigrant woman who stopped chemotherapy treatment out of fear of being deported.
“That’s the new world reality, and Trump has not even been sworn in. That’s how scared she was to get treatment,” Newsom said. “So I think that’s going to have an impact as well on a lot of these programs.”
The governor declined to detail any cuts he will propose to pay for his new proposals or other unanticipated policy costs.
“We will put it up Jan. 10, and it will be balanced, and it will answer that question,” he said of his budget plan.
How voters and lawmakers add costs for the state
Newsom’s proposals aren’t the only squeeze on the state budget. Voters are calling for more spending too.
In November, voters adopted a permanent tax on managed healthcare organizations with the approval of Proposition 35. California uses the tax to draw down more federal money for Medi-Cal, the state’s healthcare program for low-income residents.
Proposition 35 effectively requires some of the money to be allocated to providers that serve Medi-Cal patients. The California Department of Finance estimates the measure will result in the loss of $4.9 billion in funding that the state planned to use in 2025-26.
Estimates suggest Proposition 36, another measure voters passed, could cost the state up to hundreds of millions of dollars each year. By requiring tougher punishment for some theft and drug crimes, it’s expected to increase spending on jails and prisons.
Voters also approved two bond measures on the November ballot that involve borrowing a combined $20 billion and repaying the loans with interest. Proposition 2 to improve school buildings and Proposition 4 to build environmental projects are expected to cost the state a combined $900 million a year.
Lawmakers’ priorities also create pressure on the budget. In its November report, the Legislative Analyst’s Office said “the timing and magnitude of the costs” associated with a pay hike approved last year for healthcare workers were still uncertain, with estimates ranging from the low hundreds of millions of dollars to the low billions of dollars.
A journalism fund that lawmakers and the governor agreed to support in August will cost the state $30 million in next year’s budget as part of a new public-private partnership with Google to research artificial intelligence and bolster local journalism. Google is expected to match the state investment next year, with each side spending an additional $10 million annually for the next four years.
Trump’s effect on state finances
On the campaign trail, Trump threatened to withhold federal wildfire funding if Newsom doesn’t go along with his plan to send water to southern farmlands from Northern California.
Although vague, the threat could have serious consequences for California, where major wildfires can cause billions of dollars in damage, much of which is typically covered by the federal government.
Newsom has said he’s considering setting aside state funding in a disaster account in the event that Trump declines to provide federal support. But it’s challenging for lawmakers and the governor to budget for a change in policy without knowing how much funding they could ultimately lose.
Trump also threatened to end federal consumer subsidies for clean cars.
Despite the state budget crunch, Newsom announced in November that California will offer its own rebates for those who purchase zero-emission vehicles if Trump follows through.
The governor has not quantified the amount of funding the state would make available for rebates and said the money would come from the cap-and-trade program, the state’s market for pollution credits to reduce greenhouse gas emissions.
Hoene pointed out that Trump’s promise to expand tax breaks for businesses that were approved in his first term will take significant revenue out of the federal budget. Threats to cut federal funding for social programs, such as healthcare and food assistance, he said, “could potentially blow a sizable hole in the state budget.”
Hoene said the state should consider raising taxes on the corporations and wealthy households that receive federal tax breaks to mitigate California’s losses if that happens.
“I’m not hearing state leaders talk about that yet, and I think that’s something they’re going to have to start taking seriously if they want to really protect the state’s budget situation, and the ability to provide services,” Hoene said.
H.D. Palmer, a spokesperson for the California Department of Finance, said the state is starting off 2025 in a better position than last year because of how Newsom and lawmakers reduced the current deficit and adopted solutions for next year’s budget problem.
That said, the transition to the Trump administration leaves “a known unknown” lingering over state budget discussions.
“We know there is a potential threat out there for upcoming policy decisions, but we don’t know the specific shape and form of those yet,” Palmer said. “And we don’t know what the price tag will be.”
