With a potential recession looming, the state estimates a deficit of $25 billion next year

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Driven by high inflation and the threat of recession, the state faces a potential budget deficit of $25 billion next year, which could curb at least some recent spending increases for essential safety net programs that help California’s neediest.

The state’s Legislative Analysts Office, which advises lawmakers on California’s fiscal outlook, released the sobering news Wednesday. It comes months after an estimated historic budget surplus provided Governor Gavin Newsom and the Democratic-led legislature with an abundance of wealth to expand government aid.

The previous projection — a $97 billion surplus — led to the expansion of Medi-Cal eligibility for all immigrants by 2024, paid family leave, free kindergarten for 4-year-olds, and an increase in the tax credit for earned income.

Newsom and lawmakers also approved a $17 billion aid package in June to help families, seniors, low-income Californians and small businesses — including $9.5 billion in stimulus payments to Californians struggling with high gasoline prices and increased inflation.

According to the LAO forecast, a significant portion of the projected revenue shortfall could be offset by spending cuts, including on transportation and housing. With lower enrollment in public schools, education spending may fall as well.

However, the forecast also warned that the fall in state revenues – and the need to cut spending – could be significantly worse if the country is hit by a significant recession.

Together with government spending, the outlook is largely determined by economic undercurrents hitting the country, namely the surge in inflation and the subsequent rise in interest rates.

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“The longer inflation persists and the higher the Federal Reserve raises interest rates in response, the greater the risk to the economy,” the legislative analyst firm said in its forecast. “The chances of the Federal Reserve being able to contain inflation without triggering a recession are slim.

“Reflecting the threat of a recession, our revenue estimates represent the weakest performance the state has seen since the Great Recession” in 2008 and 2009.

HD Palmer, a Treasury Department spokesperson, called the estimated shortfall a “realistic and reasonable estimate of the work ahead.” He said the Newsom administration anticipated the economic slowdown and planned accordingly, putting California in a good position to weather the impact.

“This is exactly why the governor made it clear that the state had to be smart with the surplus — which we did,” Palmer said. “Using it to build our fiscal reserves, pay down debt and focus the balance on one-time expenses — like the $9.5 billion in inflation support payments that are still being delivered to millions of Californians — and not to drive higher current spending on to build those that can’ cannot sustain.”

The governor and legislature could still face tough decisions to close the budget gap, especially if economic conditions worsen, he said. All of that is being considered as Newsom prepares his budget proposal, likely to be released in January.

Republican Assembly Leader James Gallagher of Yuba City blamed the state’s financial plight on Democratic leaders, who he said “overburdened Californians and allowed the government to grow while limiting investments in critical infrastructure such as new water storage ignored”.

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He said the legislature should focus on policies that will help the economy grow and lower costs for Californians.

The state is expected to have $22 billion in general reserves by the end of fiscal year 2023-24 to address budget deficits, and legislative leaders stressed on Wednesday that the state has spent most of its excess revenue in recent years on one-time expenses. instead of creating or expanding expensive programs that require annual funding.

“Thanks to our responsible approach, we are confident that we can protect our progress and make a state budget without continuing cuts in schools and other core programs or putting a burden on middle class families,” said Senate President Pro Tem Toni Atkins (D-San Diego) in a written statement. “The bottom line is simple: we are willing to hold on to the gains we made and pick up where we left off once our economy and revenues recover.”

Still, under state law, education funding is automatically tied to state budget revenue, meaning Wednesday’s report put public schools and community colleges on high alert.

Just months after celebrating a record high in education funding, the LAO’s latest analysis includes a plan for the governor and legislature to work with potentially billions of dollars less.

Despite an estimated drop of more than $2 billion in needed funding, the state could still fully fund schools by making some adjustments, according to the LAO, and schools are better off than other programs when a recession hits. The state constitution guarantees that they typically receive about 40% of the total budget.

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Maintaining normalcy will be possible in part by cutting some spending to reflect slumps in student attendance and withdrawing money from a rainy day fund created specifically for education – reserves that have grown due to required deposits thanks to luck of the state in recent years.

Any shortfalls in school funding may be small and short-lived, according to the LAO, and “by historical standards, the school funding picture remains strong.”

But the report also warns of an “uncertain” balance between school budgets in years to come, depending on economic health.

The report comes a week after voters overwhelmingly approved Proposition 28, which will allocate nearly $1 billion to music and arts education starting next year.

Expect teacher unions and school advocates to fight for more than just the required minimum for schools, even in a recession, said Kevin Gordon, an education lobbyist in Sacramento.

“The idea, after a year of spectacular new investment in education, to see conditions that could undermine some of those really important investments is disappointing, but a reality that we have to grapple with,” Gordon said.

The California Teachers Assn. said in a statement that it is optimistic, thanks to “collaborative budgeting and healthy reserves”.

“The state remains in a strong position to continue to prioritize equitable teaching and learning conditions and address the critical teacher shortage,” said union spokesperson Lisa Gardiner.

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