The State’s Legislative Analyst (LAO) released a report this week, Economic Conditions Weigh on Revenuesthat reported on several economic factors California will face next year that could push the State back into a budget deficit. Facing rising inflation, the Federal Reserve—tasked with maintaining stable price growth—repeatedly has enacted large interest rate increases throughout 2022 with the aim of cooling the economy and, in turn, slowing inflation. The longer inflation persists and the higher the Federal Reserve increases interest rates in response, the greater the risk to the economy. The chances that the Federal Reserve can tame inflation without inducing a recession are narrow. Reflecting the threat of a recession, the LAO’s revenue estimates represent the weakest performance the state has experienced since the Great Recession.

Under this outlook, the Legislature would face a budget problem of $25 billion in 2023‑24. (A budget problem—also called a deficit—occurs when resources for the upcoming fiscal year are insufficient to cover the costs of currently authorized services.) The budget problem is mainly attributable to lower revenue estimates, which are lower than budget act projections from 2021‑22 through 2023‑24 by $41 billion. Revenue losses are offset by lower spending in certain areas. Over the subsequent years of the forecast, annual deficits would decline from $17 billion to $8 billion.

The Assembly Speaker and other legislative leaders have indicated they want to continue spending but the LAO cautions; “We conclude with a discussion of the state’s reserves, which are the key tool the state has available to address budget problems. We urge lawmakers to begin planning the 2023‑24 budget without using general purpose reserves and, instead, to save those reserves for when the state faces a recession.” Let’s hope the Legislature and Governor Newsom heed this recommendation!