Cash in the Bank

From time to time, we have noted that the state is sitting on a lot of cash. While some of that cash is in reserves associated with the General Fund, much is in "special funds" that are earmarked for various purposes (such as roads, transit, etc.). Here is what the Legislative Analyst's Office (LAO) has to say about state cash:

Executive Summary

California’s Cash Balance Reached Astonishing $100 Billion. The state’s cash balance—the internal borrowable resources the State Controller uses to ensure the state can pay its bills on time—is very strong. It now sits around $90 billion, only modestly below the peak of over $100 billion held in May 2024. As shown below, the state’s cash balance has been rising for some years, but it rose most dramatically after the pandemic in 2020. This is all the more remarkable given the situation less than two decades ago: during the Great Recession, California faced a cash crisis, with cash nearing administrative minimums while a frozen credit market nearly precluded emergency borrowing.

This Balance Results From Unplanned Cash in Special Funds, Not Necessarily an Inherent Sign of Fiscal Strength. The state’s cash balance has remained strong despite weakness in the state budget—double digit deficits in 2023‑24, and persistent structural shortfalls since. This is because the state’s cash balance and its General Fund budget condition can be related but are not directly linked. Rather, most of the balance increase reflects unplanned cash that built up in special funds: money that has been appropriated but not yet disbursed, now representing about half of all special fund balances. These balances accumulated for several reinforcing reasons—increased state and federal infrastructure funding occurred simultaneously with supply chain constraints and slowing project time lines, the pandemic‑era General Fund revenue surge spilled into special funds through transfers and loans, and federal funds surged such that departments rationally drew down those time‑limited funds before their own state fund balances. Beyond unplanned cash, reserves also built up during the surplus years—which does reflect genuine fiscal strength—and new funds and expanded services have added modestly to balances since 2020.

Having This Much Cash Has Been Useful to the State… A large cash balance confers genuine benefits. The state’s ability to manage daily cash flow without external borrowing saves interest costs and reduces bond market dependence. California has not needed to borrow for cash flow purposes in more than a decade and has not been at risk of a cash crisis, despite a sharp revenue decline in 2022‑23 and significant budget deficits since. Beyond routine cash flow management, the state has also used its cash balance to advance specific policy goals and has used indirect borrowing from cash resources to balance the General Fund budget. This latter borrowing occurred via two “maneuvers”—which essentially allow the state to make cash payments now while deferring their recognition in the budget to future years, effectively using the cash balance for an interest‑free loan.

…But Over Reliance on Cash Borrowing Carries Real Risks. Using the state’s cash balance in these ways is not without trade‑offs and risks. These maneuvers create real future obligations that are invisible in standard budget documents. Further, cash borrowing carries two structural risks that make it a poor substitute for more conventional budget solutions. First, the policymakers and taxpayers who benefit from deferring costs today will not always be the same ones who must repay them, creating an incentive to borrow and a disincentive to repay. And, second, repayment must be proactive: if repeatedly deferred, the obligation grows and the tool eventually disappears. As such, in this report, we recommend the Legislature treat cash borrowing as an option of last resort, maintain its planned repayment schedules, and avoid any further delays.

Maintaining Cash Vigilance Is Critical. The state’s cash balance has already declined somewhat from its May 2024 high, and we expect it to continue declining. In particular, this will occur as the backlog of infrastructure funds eventually works through the system, as pandemic‑era federal programs unwind, and if the state continues to use reserves to address deficits. This decline should be viewed as normal and expected—it reflects the unwinding of the dynamics described in this report, not fiscal deterioration. Nonetheless, we recommend the Legislature avoid actions that accelerate that decline unnecessarily. This would include further cash borrowing to balance the budget, or further delays in repaying existing maneuvers. The state has come a long way from the cash crisis of the Great Recession. We recommend the Legislature preserve that fiscal resilience, particularly given heightened economic and financial market uncertainty.

Full report at https://lao.ca.gov/Publications/Report/5198.

Bond. Prop 38

From the Sacramento Bee: Three former employees of the California Legislative Analyst’s Office came out in strong opposition against Proposition 38 Thursday, arguing that the ballot measure that seeks to support medical research lacked appropriate provisions for transparency and accountability. Instead, they said, it seemed to “steer public funds” to its billionaire backer’s “philanthropic project” and then “hide its tracks.” The proposition will ask voters in the November election to allow the state to borrow $8.4 billion to support medical research in immunology and immunotherapy conducted by California research institutes and universities.

...CalMatters reported only one research institute in California appeared to meet the criteria included in the measure for the nonprofit that would be awarded half the bond proceeds. That institute is the California Institute for Immunology and Immunotherapy [CIII], an independent medical research organization affiliated with UCLA. Gary Michelson, a billionaire philanthropist and medical inventor, is both the co-founder of that institute and the chief backer of Proposition 38...

First announced in 2024, the CIII is currently under construction and scheduled to open soon...

Full story at https://www.sacbee.com/news/politics-government/capitol-alert/article317199654.html.

Reminder - From the UCLA Newsroom (2024):

Key takeaways

The UCLA Research Park will occupy the former mall site, a 700,000-square-foot property 2 miles from the Westwood campus.

The research park will house the California Institute for Immunology and Immunotherapy at UCLA and the UCLA Center for Quantum Science and Engineering, as well as programs across the disciplines.

This acquisition was made possible in part by an intended $500 million investment from the state of California, with $200 million already allocated.

The California Institute for Immunology and Immunotherapy is also supported by a group of founding donors led by Meyer Luskin, Dr. Gary Michelson, Dr. Eric Esrailian, Dr. Arie Belldegrun, Sean Parker and Michael Milken...

Full news release at https://newsroom.ucla.edu/releases/ucla-to-transform-empty-mall-into-research-park.

Squeeze 'em harder, says LAO

Summary section from a recent LAO report:

[This] Brief Analyzes Nonresident Supplemental Tuition Rates at the University of California (UC). 

In addition to the tuition charges other undergraduates pay at UC, nonresident students pay nonresident supplemental tuition (NRST). UC charges the same NRST rate across all nine of its general campuses. In response to legislative interest, we analyzed whether opportunities exist to raise additional NRST revenue. In particular, we focused on opportunities for raising NRST revenue at UC’s three highest‑demand campuses—UC Berkeley, UC Los Angeles (UCLA), and UC San Diego (UCSD).

Several Findings Indicate Higher NRST Rates Could Be Warranted. 

As a university system, UC is unusual in charging the same NRST rate across all its campuses. Other major public university systems charge more at their flagship campus. For example, in 2025‑26, nonresident rates at the flagship University of Michigan, Ann Arbor campus are more than 4.5 times higher than at the Flint campus. Demand from nonresident students also is notably stronger at UC Berkeley, UCLA, and UCSD than at the other UC campuses. These three campuses receive more nonresident applications than the remaining six UC campuses combined, have the lowest admission rates, and enroll the highest shares of nonresident undergraduates. In addition, our UC‑specific research, together with national research on selective universities, indicates that aggregate nonresident enrollment does not decline as NRST rates increase. One reason this might be the case is that families could view a higher sticker price as an indicator of higher quality. Another reason could be that demand for selective universities is so strong and admission rates so low that many families are willing to pay higher NRST rates to secure a coveted enrollment spot.

Recommend Piloting Higher NRST Rates at Highest‑Demand Campuses.

If the Legislature wanted to pursue higher NRST rates, we recommend a four‑year pilot involving UC Berkeley, UCLA, and UCSD. We recommend beginning the pilot in 2027‑28, as UC already has published its NRST rates for 2026‑27. If UC were to raise the NRST rate for 2027‑28 by $6,000 at UC Berkeley, UCLA, and UCSD, compared to an increase of $2,000 at the other UC campuses, we estimate an additional $20 million in NRST revenue would be generated (ramping up to $80 million in year four). This additional revenue could be used to supplement core funds at UC or offset state General Fund in response to a state budget deficit or competing state budget priorities. While the pilot is in place, we recommend UC collect and report data on the impacts of the higher NRST rates at the three selected campuses, including impacts on the composition of the undergraduate nonresident student body.

Full brief at https://lao.ca.gov/reports/2026/5183/2026-27_Budget_Nonresident_Tuition_Rates_at_UC_051226.pdf.

The May Revise

As noted in prior postings, yours truly is traveling so our analysis of the governor's May Revise budget was delayed. However, last Thursday, May 14th, the governor presented his revised budget proposal for the coming fiscal year, 2026-27. He will be termed out in January 2027 when the budget year is a little over 50% over, and his successor will have to deal with the rest of the year and come up with a budget plan for 2027-28.

The governor spent about an hour going over his proposal of which about 13 minutes was more devoted to his non-campaign for president in 2028. He then took about an hour for Q&A. 

Usually, in our past reviews of such proposals, we start with the macro and then go to the micro, i.e., UC. But let's do it in reverse this time. What about UC?

SIGNIFICANT BUDGET ADJUSTMENTS

• Base Funding Augmentation—The May Revision maintains the proposed increase of $254.3 million ongoing General Fund, representing a 5-percent base increase for the fifth and final year payment of the Compact. The May Revision also maintains the proposed increase of $96.3 million ongoing General Fund to provide partial funding of the fourth year Compact payment as scheduled in the 2025 Budget Act.

• Compact Funding Deferral—The May Revision maintains the planned one-time deferral of the 2025-26 Compact investment of $240.8 million, representing a 5-percent base increase in the fourth year of the Compact, to 2027-28. The May Revision also maintains the planned one-time 2025-26 deferral of $31 million to offset revenue reductions associated with the replacement of 902 nonresident undergraduate students enrolled at three campuses with an equivalent number of California resident undergraduate students, from 2025-26 to 2027-28.

• One-Time Base Deferral—The May Revision maintains the proposed delay of a one-time repayment of $129.7 million, representing a deferral of a one-time 3-percent base increase from 2025-26, from 2026-27 to 2027-28.

• Foster Youth Support Services—An increase of $1.5 million one-time General Fund to support First Star Academy Youth Cohorts at UC campuses.

Source: https://ebudget.ca.gov/2026-27/pdf/Revised/BudgetSummary/HigherEducation.pdf.

Translation: We have a multi-year "compact" with UC but we won't actually pay what is due. Instead, we will keep deferring part of what is due to the future when there will be some new governor and a new legislature and they might or might not honor it. Compact is not the same as contract. The latter is enforceable. The former isn't.

Of course, everyone understands this point. But the game is played by UC thanking the governor and then seeking more from the legislature. From UC President Milliken:

I’m deeply grateful to Gov. Newsom for his thoughtful leadership and sustained support of the University of California over the years. The UC funding included in the May revision will help ensure that the university remains affordable and accessible to California students. As the University of California faces ongoing federal funding uncertainty and increasing operational and labor costs, state funding for UC is more important than ever.  

We will continue to advocate for the resources necessary to help our hundreds of thousands of students succeed, and to support the faculty and staff who deliver the teaching, research, and patient care that Californians expect and deserve. I look forward to working with Gov. Newsom and the Legislature in the coming weeks to achieve a state budget that fully funds UC and improves the lives of every Californian.

Source: https://www.universityofcalifornia.edu/press-room/uc-statement-gov-newsoms-2026-27-revised-budget-proposal.

How effective will the UC advocacy be? The governor's May Revise for UC is about what the proposal was in January, with some tidbits added.* So the governor wasn't much affected. We will have to see what the legislature does in the next few weeks.

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*See https://ebudget.ca.gov/budget/m/2026-27/Department/6440.

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What about the macro?

Enough extra revenue (revenue above projections) came in thanks to AI and stock market gains to lead to a modest surplus for the current fiscal year.** Next year, however, total reserves fall rather than rise, i.e., a deficit. That isn't what the governor said during his presentation. But that is what his numbers say.

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**There are various reserve accounts associated with the General Fund (GF). Yours truly had to estimate the changes in the Public School and Safety Net accounts using figures for 2024-25 as enacted to calculate the change in those accounts to 2025-26. LAO, which has more access to data, reports a slight deficit for the current year rather than a small surplus:

https://ebudget.ca.gov/reference/MultiYearProjection.pdf. 

LAO also reports projected deficits out to 2029-30:

https://lao.ca.gov/Publications/Report/5187.

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NOTE: The governor's May Revise news conference can be seen at:

https://ia601802.us.archive.org/14/items/newsom-may-june-2026/newsom%205-14-2026%20May%20revise.mp4.

Ex Officio: A Brief Look at the Governor's Proposal

An Ex Officio Brief

Most of the UC Regents are appointed by the governor and confirmed by the State Senate for 12-year terms. However, there are also alumni and student Regents who serve as voting members for one year. And finally, there are the ex officio Regents: the Governor, Lieutenant Governor, Speaker of the State Assembly, the Superintendent of Public Instruction, and the president of UC who serve as long as they are in office.

Except for the last, the other ex officio Regents are all elected, statewide officials whose positions are enshrined in the state constitution. The governor and the Speaker of the Assembly are generally busy with their main duties and - with the exception of former governor Jerry Brown - typically don't attend Regents meetings. The Lieutenant Governor - currently Eleni Kounalakis - doesn't have much to do under the constitution. She would become governor on the death or resignation of the governor. She also becomes acting governor whenever the governor is out of state. (That situation is becoming more frequent during the current governor's non-campaign for president.) So, without much else to do, she often does attend Regents meetings.* 

The Superintendent of Public Instruction primarily is involved in matters related to K-12 on a day-to-day basis. However, Governor Newsom recently proposed downgrading the responsibilities of Superintendent, essentially moving his responsibilities to the governor and his cabinet. Undoubtedly, he would have proposed eliminating the position entirely, but since it is enshrined in the constitution, that step would take a constitutional amendment. Depending on where you stand, the proposed downgrading of the Superintendent could be seen as a power grab or, alternatively, as a reform designed for good governance and efficiency. Either way, we would primarily be talking about governance of K-12 education.

As it happens, however, the Legislative Analyst's Office (LAO) has generally endorsed the governor's proposal. You can find the details at:

https://edsource.org/2026/newsom-education-restructuring-california/754254 and

https://lao.ca.gov/reports/2026/5165/2026-27_Re-Envisioning_State_Education_Governance_031826.pdf.

What is absent from the LAO's analysis of the plan is higher education. As noted, the Superintendent is an ex officio Regent. If the governor and LAO have their way, the role of the Superintendent would become some kind of external evaluator of K-12 operations. He would, however, continue as an ex officio Regent. So we would then have two ex officio Regents with day jobs that don't give them much else to do, as opposed to only the Lieutenant Governor now.

Is that a Good Thing for UC? Yours truly doesn't know. If you think of the Superintendent of Public Instruction as a link between UC and the K-12 system, a weakened Superintendent, as proposed by the governor, would mean a weakened link. Maybe that doesn't much matter; maybe it does. But now you know.

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*Lieutenant Governors often have gubernatorial ambitions. (Newsom was Lieutenant Governor for 8 long years before being elected governor.) But those ambitions don't always work out. Lieutenant Governor Kounalakis is currently running for State Treasurer after dropping a campaign for governor. (Tony Thurmond, the current Superintendent of Public Instruction, is running for governor.)

Want something to worry about?

The Legislative Analyst's Office has looked back at periods when the stock market dropped suddenly to see what happens to income tax revenue. There has been concern that the AI boom might turn into a bust, similar to the dot-com boom and then bust. When you look back at that period, income tax revenue dropped sharply, but with a lag. (Taxes are paid on past earnings.) Revenues did not recover for a prolonged period:

The adverse consequences of such an event on UC's budget are evident. So, if you want to worry about something, you can add this to your menu.

The LAO report is at https://lao.ca.gov/LAOEconTax/Article/Detail/852.

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And there's this:

https://www.nytimes.com/2026/03/16/opinion/financial-crisis-private-credit-ai-iran-taiwan.html

LAO on UC

The Legislative Analyst's Office (LAO) goes to work after the governor presents his January budget analyzing the key features of the proposal and suggesting alternatives. Basically, in broad terms, the LAO seems upset that UC spending in real terms is rising - which would seem to be the expected result of the legislature's insistence on increasing enrollment. The LAO has never been keen on multiyear "compacts" (even though these are often pushed aside in periods of budget stringency). To save money, it suggests less substitution of residents for out-of-state students (who pay higher tuition). But squeezing out-of-state enrollment to make more spaces for Californians seems to be a major legislative commitment. In any case, LAO seems to want to achieve lower state spending on UC by one means or another.

LAO acknowledges problems UC faces with regard to its conflict with the federal government, but seems to believe that maybe - in the end - the budgetary implication will turn out to be less dire than initially expected.

Excerpt from the LAO report on UC:

Over the Past Ten Years, UC Spending Has Outpaced Inflation. Over this period, core spending grew at an average annual rate of 4.3 percent, compared to inflation growing by 3.3 percent. This faster growth reflects increases both in student enrollment and underlying cost drivers. UC’s largest cost driver is employee compensation, accounting for about 75 percent of UC spending in 2024‑25. Growth in employee compensation has been mostly driven by the expansion of UC’s workforce.

Recommend Reducing or Eliminating Base General Fund Increase. The Governor proposes a $351 million (7 percent) base increase for UC in 2026‑27 and assumes UC generates $273 million in additional tuition revenue. Given the state’s fiscal outlook, the Legislature could provide a smaller base increase aligned with inflation. Alternatively, it could provide no base increase to help manage the structural deficit and reduce pressure for more significant reductions over the coming years. Even without a base increase, UC’s core funding would grow by 3.5 percent.

Recommend Using Available One‑Time Funding to Retire Payment Deferral. In 2025‑26, the state began deferring a $130 million General Fund payment from one fiscal year to the next. If one‑time funding becomes available, we recommend the Legislature make retiring this payment deferral a high priority. Retiring the deferral would return UC’s state payments to their regular schedule, eliminate the associated debt obligation, and reduce state budgetary pressures in the out‑years.

Recommend Removing Out‑Year Commitments. Under the Governor’s budget, the state commits to providing UC with a one‑time back payment of $241 million in 2027‑28, followed by a 3 percent ongoing base increase of $144 million in 2028‑29. We recommend removing these out‑year commitments. The Legislature could determine each year how much support to provide UC in light of overall fiscal conditions and its budget priorities.

Recommend Funding Enrollment in 2026‑27 at Original Target, Separately From Base Increase. The Governor’s budget maintains the original resident undergraduate enrollment target established in the 2025‑26 Budget Act for 2026‑27, a level that UC expects to exceed by more than 3,000 students. Given the projected budget deficits and moderating demographic pressures, we recommend the Legislature maintain the original target set for 2026‑27. We further recommend the Legislature fund enrollment growth separately from, and in addition to, any base increase to enhance transparency and accountability. For 2027‑28, we recommend holding enrollment flat to help UC avoid the potential negative programmatic impacts of adding students without associated funding.

Recommend Pausing the Nonresident Replacement Plan. The Governor’s budget provides $61 million ongoing General Fund to replace a certain number of nonresident students with resident students at three high‑demand campuses. We recommend an alternative that funds the same number of resident students while leaving the number of nonresidents flat. This alternative costs $36 million less than the Governor’s proposal. Given all three high‑demand campuses have added resident students beyond replacing nonresidents the past few years, they appear to have associated physical capacity.

Full LAO report: https://lao.ca.gov/Publications/Report/5143.

LAO Counsels Legislature to Save Added Revenue

As blog readers will know, Gov. Newsom's January budget proposal was based on more optimistic revenue forecasts than the Legislative Analyst Office was providing. But then current revenue seemed to be outpacing both the governor and the LAO forecast.

The LAO has not retreated from the idea that the outyears still contain a structural deficit, but it concedes that there is likely to be more revenue by the time of the May Revise than forecast. So it now is counseling the Legislature to put away the above-forecast revenue into reserves, i.e., save for a rainy day.* Note that some of the above-forecast revenue automatically ends up in K-14 due to Prop 98.

Whether saving for a rainy day will appeal to the legislature is another matter. As we have noted in prior postings on this blog, UC should be pushing to get its share.

One thing to note in that regard is that the LAO takes the view that paying down debt is an alternative to saving for a rainy day. And, in listing various debts the state has, it includes the deferral of a payment due under the "compact" with UC to 2027-28. Translated: The legislature could consider not deferring the payment and allocating the money now. That appears to be the position taken by UC President Milliken we noted yesterday.

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*https://lao.ca.gov/Publications/Report/5133.

Get It While You can

The state controller's cash report is out for the first seven months of fiscal 2025-26 and - guess what? - revenues are running ahead of the forecast made at the time the current state budget was passed to the tune of $15 billion. Indeed, revenues are running ahead of the updated forecast made last month when the governor made his budget proposal for next year to the tune of $6.9 billion.

Now, we all know that much of this overage seems to be fueled by AI spending, which filters into tax revenues by way of the stock market and capital gains. And we all know that it could be a bubble and that - if it is - revenues will slump when it bursts, i.e., we could have a repeat of the dot-com boom/dot-com bust. If that happens, revenues will drop and a crisis will occur. 

We know, in addition, that the Legislative Analyst's Office keeps warning of a "structural" budget problem in the years to come. And blog readers will know that even with the governor's optimistic forecast for the economy, we are currently running a deficit (total reserves of the general fund are being drawn down).* We know from the dot-com boom/bust episode that if the state is not socking away a lot of cash at the peak of the cycle, a downturn will be especially painful.

With all of that knowledge, however, it is unlikely that the legislature is going to accept austerity now when it sees extra revenue coming in. And the governor, who is running for president and is termed out, seems unlikely to want to play Dr. No. If he can just make it to next January without a fiscal mess developing, he can say it didn't happen on his watch, and leave whatever problems that follow to his successor. 

So, the best advice yours truly can give to UC lobbyists is "Get It While You Can" - because every other interest group will be seeing what I see.

Or direct to https://www.youtube.com/watch?v=mtj9w2gYzV4.

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*https://uclafacultyassociation.blogspot.com/2026/01/the-no-hassles-while-im-in-office-state.html.

Bubble Worries

As we have noted on this blog, state revenues have come in ahead of projections thanks - it appears - to capital gains tax receipts related to AI-related stock.

The governor based his January budget on good revenue news continuing and was criticized by the Legislative Analyst and others for not taking account of the possibility that an AI bubble will burst, or at least the good revenue news won't continue.

If you want to worry about all of that, and what it could mean for the UC budget, consider this from the Washington Post:

Big Tech is taking on record levels of debt, marking a new chapter in the artificial intelligence boom as names like Oracle, Alphabet and Meta pour big money into massive data centers and the energy systems needed to run them.

Technology companies issued a record $108.7 billion in corporate bonds in the last three months of 2025, according to data from Moody’s Analytics. That’s the largest total for any quarter and roughly double that of the previous three months. And the trend is extending into 2026: Some $15.5 billion in bonds were issued in the first two weeks alone.

For now, investors are assuaged by the eye-popping cash flow numbers from major tech companies. In the past 20 years, Big Tech companies including Google, Microsoft, Meta, Amazon and Apple have built what are arguably the most profitable business models in history. In the third quarter, Google brought in just over $100 billion, with a margin of over 30 percent. All five are trillion-dollar companies, as are such AI darlings as Nvidia, Broadcom and TSMC.

But some economists and business analysts say the massive new bonds are spreading risk throughout the economy, with hundreds of billions being spent on a technology whose profit-making potential is not yet clear.

“It’s a lot of debt, and a lot of it all of a sudden,” said Mark Zandi, chief economist for Moody’s. When companies are funding risky ventures with debt “it does put the broader financial system at risk. If the financial system is at risk, then the broader economy is.” ...

Full story at https://www.washingtonpost.com/business/2026/01/23/ai-corporate-debt-record/.

UC Should Cash the Check Quickly

The Legislative Analyst's Office - LAO - has provided a (critical) review of the governor's recent budget proposal for 2026-27 [excerpt]:

...In the budget summary and presentation, the Governor and administration officials have acknowledged the downside risk to the state’s revenue picture. For example, in the budget summary, the administration points out that:

(1) much of the revenue surge is attributable to investor enthusiasm around artificial intelligence,

(2) history suggests these gains are not sustainable, and 

(3) the dominant risk to the budget is the stock market and asset price declines. 

…But Governor Proposes No Material Actions to Address Downside Risk... 

Full review at https://lao.ca.gov/reports/2026/5101/2026-27_Budget_Overview_011226.pdf.

As we noted in our posting on the budget proposal, it is basically focused on avoiding problems for now and getting the governor to the end of his term without having to take drastic measures. His successor, whoever that turns out to be, will have to clean up, if that proves to be necessary, and the governor will be able to pursue his presidential ambitions and say it didn't happen on his watch.

Note that the governor deviated from his past practice and left it to his finance director to handle the news conference at which the budget proposal was unveiled. He thus avoided the kind of nasty questions that the LAO has asked. Reporters did ask the finance director questions about budget sustainability, but the answer was we plan to look at such unpleasant matters in the May Revise.

Yours truly would advise UC to cash the check as quickly as possible.

The No-Hassles-While-I'm-in-Office State Budget Proposal

As blog readers will know, Gov. Newsom decided his big final speech should be the State of the State address and left the budget presentation yesterday to his finance director Joe Stephenshaw.

You will read in news coverage that the budget is "balanced." That is California budget-speak. Budgets that pull down reserves are not balanced in common English usage and the proposal pulls down reserves. It essentially relies on the extra revenue (compared with estimates made when the current budget was enacted) that has accumulated as added reserves in the general fund (GF).

It pulls down that reserve in the general fund by around $21 billion and puts about $3 billion in the "rainy day" fund (Budget Stabilization Account or BSA). The Public School reserve is also largely drained. The bottom line is a deficit of about $18 billion. All of these estimates are based on underlying economic forecasts which verbally acknowledge that the added revenue is coming largely from capital gains in the stock market associated with the AI boom, but don't directly reflect what might happen if the boom becomes a bust. 

In addition, the current year - when you sum up all the reserves associated with the general fund - shows a deficit of over $5 billion. Total spending next year rises over 5%, i.e., more than inflation is likely to be. We show these results on the table below:

Source: https://ebudget.ca.gov/2026-27/pdf/BudgetSummary/SummaryCharts.pdf. To estimate surpluses and deficits in the Public School, Safety Net, and BSA, I used estimates from the enacted budget of the current year (2025-26) from https://ebudget.ca.gov/2025-26/pdf/Enacted/BudgetSummary/SummaryCharts.pdf. Those estimates may differ from what the Dept. of Finance now has by a bit, but not enough to matter for the general story.

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During the presentation news conference, Finance Director Stephenshaw repeatedly emphasized that the Legislative Analyst's Office (LAO) is using more cautious revenue estimates and that, if revenue problems arise from the stock market, the May Revise budget will take account of them.

What about UC's allocation? The official numbers show a general fund allocation this year of about $4.9 billion rising to $5.4 billion in the coming fiscal year. So it was unlikely there would be complaints from UC. There is a verbiage about the "loans" to UC that were made to avoid actual cuts and that the loans seem to roll over next year. It's hard to disentangle the details from the fuzzy description. But, again, UC was unlikely to squawk (as it did last year when cuts were on the agenda). Instead, there was the more usual thank-you for UC President Milliken:

UC statement on Gov. Newsom’s 2026–27 state budget proposal

UC Office of the President, January 9, 2026

I am deeply grateful to Governor Newsom and our legislative leaders for their steadfast support of the University of California. Despite ongoing financial challenges for the state, they have remained committed to California’s students. Working together, we’ve kept a UC education affordable and accessible, advancing opportunity across the state. We’ve enrolled a record-breaking 200,000 California undergraduates and provided the financial support that allows 64 percent of California students to graduate with no student debt. Our total student enrollment of 301,093 for fall 2025 is also a new record.

The budget introduced today by Governor Newsom continues to provide critical support for the University and our students. State support is more important than ever, as we face tremendous financial pressures stemming from rising costs and unprecedented federal actions. UC campuses rely on funding stability to serve students and maintain the academic and research excellence that has made UC the world’s greatest research university. An investment in UC is an investment in California’s future. I look forward to our ongoing partnership with Governor Newsom and the Legislature to ensure that our students have what they need to succeed at UC and beyond.

Source: https://www.universityofcalifornia.edu/press-room/uc-statement-gov-newsoms-2026-27-state-budget-proposal.

The bottom line on the budget proposal is that the governor does not want to deal with complaints and attacks from the legislature and the various state interest groups for the remainder of his term. How kind the gods of the stock market will turn out to be remains to be seen.

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You can see the budget presentation at:

https://ia800106.us.archive.org/0/items/newsom-1-1-2026-new-year/Finance%20Director%20Joe%20Stephenshaw%20presents%20Governor%27s%202026-27%20budget%20proposal%201-9-2026.mp4. (It starts at minute 2.)

Today Is Budget Day

The governor will be unveiling his constitutionally-required proposal for the 2026-27 state budget later today. Yours truly is otherwise occupied this morning but he will provide some analysis in due course. As blog readers will know, there will later be analysis of the proposal by the Legislative Analyst's Office, hearings at the legislature, and another revised gubernatorial proposal in mid-May. Typically, after the May Revise, the governor and Democratic legislative leaders work out a deal so that a new budget can be in place by July 1.

One question is whether the governor will actually orally present the budget or just send it to the legislature and leave it to his budget director to make the oral presentation. That format would be a break from past practice but is suggested by a news release from the governor's office:

SACRAMENTO — California Director of Finance Joe Stephenshaw will hold a media briefing to provide details of Governor Gavin Newsom’s 2026-27 state budget proposal, which will be transmitted to the Legislature on Friday.

WHEN: Friday, January 9 at approximately 10 a.m.

LOCATION: State Capitol Annex Swing Space

LIVESTREAM: The Governor’s YouTube page: https://www.youtube.com/@cagovernor

Full release at https://www.gov.ca.gov/2026/01/06/this-week-state-finance-director-to-hold-media-briefing-on-governor-newsoms-2026-27-budget/.

In the past, the governor has presented his budget in a (very) long presentation, then takes questions from reporters, and then turns the affair over to his budget director.

The coming state budget squeeze

From CalMatters: Gov. Gavin Newsom opened [2025] with a rosy forecast: Buoyed by $17 billion more in revenue than previously planned, the state would have a modest surplus... But life turns on a dime. The January wildfires that ripped through Los Angeles forced the state to spend billions in disaster aid and delay tax filings for LA residents. The cost of Medi-Cal, the state-run health insurance program for low-income residents, ballooned to $6 billion more than anticipated... 

California is facing $6 billion in extra spending next year, including at least $1.3 billion because the state must now pay more to cover Medi-Cal benefits under Trump’s budget bill. The state also stands to lose more housing and homelessness funding from the federal government... The LAO [Legislative Analyst's Office] notes that solving an ongoing structural budget problem requires either finding more sustainable revenue streams, or making serious cuts, or both.

Full story at https://calmatters.org/politics/2025/12/california-budget-primer/.

Under the state constitution, Gov. Newsom must propose a budget for 2026-27 sometime this week.

State Budget Outlook

The Legislative Analyst's Office (LAO) customarily produces a budget outlook publication around this time of the year and has done so.*

In general terms, the LAO sees a gloomy outlook. It acknowledges the better-than-forecast revenue numbers but attributes them to a potential AI bubble. Were that bubble to burst, the added revenues would disappear along with others.

Revenues from sales tax and corporate tax suggest a weakness in the economy.

The LAO makes a projection of a workload budget, i.e., what would happen if there are no policy changes. Of course, there will be changes (and the underlying economy may also deviate from what is projected).

We show the LAO numbers below including the estimates for this year and last year and the workload projections for next year:

What you see is a deficit last year, an estimated deficit for this year, and a larger deficit next year absent policy adjustments. Thus, it looks like continued state budget pressures on UC.

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*https://lao.ca.gov/reports/2025/5091/2026-27_Fiscal_Outlook_111925.pdf. Note: To calculate the BSA Surplus/Deficit for 2024-25, the BSA balance estimate that was needed for the end of 2023-24 was taken from historical data at:

https://ebudget.ca.gov/2025-26/pdf/Enacted/BudgetSummary/BS_SCH1.pdf.

Continued Receipts Above Estimate

The state controller has issued her monthly cash report for the current fiscal year through October. Receipts are running $6.3 billion above forecast levels. Almost all of the overage is coming from the personal income tax, suggesting it reflects the AI stock market boom and estimated capital gains. Sales tax receipts are in line with forecast levels suggesting the economy is performing at around projected levels.

Unused borrowable resources are down from a year ago indicating a drawdown of available reserves, but they are still at a very high level of $85.8 billion (down from $97.4 billion). So we are nowhere near the kind of budget crisis that hit the state during the Great Recession of 2008.

While the Legislative Analyst's Office continues to worry about structural budget problems in the outyears and what might happen if we have a bubble that bursts in the stock market, there will at least be members of the legislature who will observe the immediate happy results in formulating next year's budget.

The latest cash statement of the controller is at:

https://www.sco.ca.gov/Files-ARD/CASH/October2025StatementofGeneralFundCashReceiptsandDisbursements.pdf.

Ten Percent

According to the state controller, revenues for the first quarter of fiscal year 2025-26 ran ten percent above estimates made at the time the state budget was enacted.

Almost all of the overage came from the state's personal income tax. Sales tax came in more or less as anticipated.* So that suggests that the underlying economy was performing as expected, but that capital gains - and withholding reflecting those gains - was pushing up revenue.

The Legislative Analyst's Office (LAO) notes the discrepancy between forecast withholding and actual:

Source: https://lao.ca.gov/LAOEconTax/Article/Detail/756.

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Within that hypothesis is the possibility that AI enthusiasm is creating a financial boom reminiscent of the dot-com boom of the late 1990s (which also enhanced state revenue - until it suddenly didn't).**

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*https://sco.ca.gov/Files-ARD/CASH/September2025StatementofGeneralFundCashReceiptsandDisbursements.pdf.

**https://jasonsisney.substack.com/p/astonishing-september-tax-withholding.

Things are looking up - for now

Jason Sisney of the Legislative Analyst's Office notes the unexpected inflow of income tax revenue into the state treasury - likely due to AI-related stock market gains:

From a Sept. 24 email to his subscribers: 

August Revenues Up $1.7 Billion from Budget Projections. California’s General Fund revenue collections in August 2025 outpaced budget projections for the month by $1.7 billion (13%), according to data released by the state’s Department of Finance. Gains in personal income tax (PIT) withholding (likely “due to stock-based compensation,” according to Finance) made up more than half of this monthly gain. Corporation tax refunds and payments also were nearly $300 million above the monthly projection. Federal cost recoveries related to disasters in prior years also have been coming in better than projected.

Waiting for Los Angeles County Tax Payments Next Month.

The coming weeks will be important for revenue tracking due to the federal government’s decision to delay this year’s income tax deadlines to October 15 for all of Los Angeles County due to the January wildfires in parts of that jurisdiction.

AI Bubble Driving Big State Revenue Gains.

Recently, California’s Legislative’s Analyst Office (LAO) has noted the strong trend in PIT withholding, stating in one report that higher state “income tax collections are being driven higher by enthusiasm around artificial intelligence (AI), which has pushed the stock market to record highs and boosted compensation” of California’s tech industry workers. The LAO adds that the “rest of the economy appears fragile.” The apparent AI bubble led LAO in one recent report to project that General Fund revenues—principally PIT revenues—would exceed previous budget forecasts by more than $20 billion across the three fiscal years 2024-25, 2025-26, and 2026-27.

Short-Term Revenue Gains May Help Moderate Big Budget Deficits Ahead. 

These short-term revenue gains, a large part of which will be directed to reserves and TK-12 schools under the State Constitution, may moderate large projected General Fund deficits in the coming few years...

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Some of us remember the dot-com boom when state revenues surged - until they didn't:

Or direct to https://www.youtube.com/watch?v=e7xiIzcYRpA.

The LAO on the longer-term state budget outlook

From the Legislative Analyst's Office: 

...Federal Budget Changes Likely to Create Additional Fiscal and Policy Pressure. The House of Representatives recently passed H.R. 1: One Big Beautiful Bill Act. If passed by the Senate and signed by the President, the legislation would make a variety of changes to federal spending. The impacts on the state budget generally fall into two categories: (1) direct General Fund costs and (2) reductions in federal funding that create state budget pressure. Changes with direct General Fund costs include many changes to Medicaid and food assistance. These have the potential to directly increase state General Fund costs in Medi-Cal and CalFresh by billions of dollars annually. In addition, some of the changes included in the bill would create budget pressure to the extent the state considers creating “state-only” programs for individuals no longer eligible for federal-state partnership programs. Other areas that could create state budget pressure include reductions to federal support for drinking water projects, zero-emission vehicles, and flood protection. The May Revision appropriately excludes the potential fiscal impacts of pending federal actions, as these effects remain uncertain. We encourage the Legislature to keep these potential fiscal pressures in mind, however, as it crafts the final budget package.

Future Budget Problems Likely to Become More Difficult to Solve. This May Revision marks the third consecutive year the Legislature has needed to close a budget shortfall. While the Governor’s proposal makes some progress toward narrowing the state’s persistent multiyear gaps, both our office and DOF project continued multiyear deficits. These shortfalls will become increasingly difficult to resolve over time, as the state has already relied on the least disruptive solutions—such as reducing one-time and temporary spending, drawing down reserves, and increasing borrowing—although notably the state still has $11 billion in reserves under the May Revision proposals. To balance the budget going forward, the Legislature will likely need to adopt additional solutions that increase ongoing revenues or reduce ongoing spending—both of which involve the most difficult and consequential trade-offs for policymakers. Further, although there is a possibility that revenue growth could ease future deficits, it is equally likely that the budget problem will grow larger than our forecast suggests. In short, the Legislature faces a challenging budget landscape in the years ahead.

Full report at https://lao.ca.gov/Publications/Report/5052.

Lots of cash now but maybe not in the future - Part 2

We have been noting the paradox of the state having lots of cash on hand in various funds and yet also having a budget squeeze that notably is affecting UC.

Jason Sisney of the Legislative Analyst's Office (LAO) has a lengthy piece in his Substack blog on this paradox. In essence, despite the squeeze, we are not likely to have an experience similar to what occurred in the Great Recession of 2008 when the issue was whether the state could pay its bills. That kind of experience was the result of having little cash with which to adjust. That is not the case now: [Excerpts]

During the administration of Governor Gavin Newsom, California’s state treasury liquidity—loosely what one can think of as the state government’s “cash position” or “cash on hand”—has improved dramatically. On April 30, 2018, the year before he took office as chief executive, unused and available balances in state government funds totaled $35 billion. On April 30, 2025, these balances totaled more than $111 billion. (These state government balances do not include state and local pension fund holdings—for example, those of CalPERS and CalSTRS.) California’s current cash on hand is among the strongest for any subnational government’s operating funds ever...

...The 2008-2009 cash crisis precipitated some of the hardest decisions of the dreadful 2009 state budget cycle, such as the bond funding freeze. Without warning, these big funding streams counted on by contractors, local governments, and non-governmental organizations were abruptly cut off. There was no rainy day fund, and there was a dwindling supply of state cash that had to be preserved to make sure bond debt service and state payroll were paid each month.

Bond debt service is contractually obligated, but also essential to pay on time since borrowing from the bond markets can be a key tool for managing a period of public budget distress. Bond market trust is essential for public budgeting. Salaries have to be paid on time for most state workers to keep basic state services going and avoiding large late payment penalties under labor laws.

In the years after the cash and budget crises of the Schwarzenegger years, Governor Brown and the Legislature benefited from a growing economy and stock market. They worked diligently to improve the state’s financial health, advocated voter approval of Assembly Speaker John Pérez’s rainy day fund proposal (ACAX2 1 of 2014), and changed to a more conservative manner of state budgeting that emphasized multiyear forecasting and used portions of projected surpluses for one-time spending, not just ongoing commitments and restorations. In August 2019, Legislative Analyst Gabe Petek wrote about the “quiet transformation of California’s cash management” over the prior decade. In December 2018, marking the tenth anniversary of the state’s cash crisis, his office released a report noting “the state has made undeniable progress” that “few could have predicted” a decade before.

The COVID pandemic seemed to threaten that progress, but federal fiscal and monetary stimulus produced instead a boom of sorts for the economy and state budget that brought new opportunities and challenges. 

...Every time that the budget has a projected deficit, Governors and legislators agree to use balances from outside the General Fund—principally from the state’s “special funds”—to help balance the budget. This is one way to temporarily delay more difficult budget actions, such as program cuts or tax increases. It is a very important way that the state’s strong cash position helps address projected deficits.

California case law gives the Legislature broad authority to loan available special fund balances to the General Fund to help address projected deficits. Special funds typically receive money from fees, such as user fees or license charges, dedicated to a specific state department’s services to the public. Courts have given the Legislature significant flexibility to decide when special funds lend money to the General Fund and when and how the loans are paid back.

...So, if the state’s cash position is so strong, why are such difficult budget cuts and even some tax increases needed now? Basically, it comes down to this: an ongoing imbalance of revenues and expenditures eventually would consume all the cash. Cash cannot balance the budget over a long period.

...In the end, revenues and expenditures of the state will always differ from the projection, and the decision of how much or how little to balance the budget now from non-recurring sources like cash balances is a subjective one.

But, having big cash balances in the state treasury: it’s much better than having small cash balances. California has learned that lesson over the last two decades.

Full story at https://jasonsisney.substack.com/p/deficitsand-a-strong-cash-position.