DOF, LAO Issue Fiscal Outlooks Projecting Significant Budget Deficits

This week, both the Department of Finance (DOF) and the Legislative Analyst’s Office (LAO) issued fiscal updates detailing projected budget deficits amid the ongoing COVID-19 pandemic. The reports were released ahead of next week’s May Revise budget that is expected to be released by Governor Gavin Newsom on Thursday, May 14. Below, we highlight the two reports:

DOF Projects a $54.3 Billion Deficit, 18 Percent Unemployment

On Thursday, the Newsom Administration’s Department of Finance (DOF) issued a fiscal update detailing DOF’s May Revision forecast in light of the ongoing COVID-19 pandemic. The report assesses the pre-pandemic budget and economy which featured an unemployment rate (3.9 percent) one-third of its Great Recession peak (12.3 percent), a $5.6 billion surplus, and a record level of reserves ($21 billion in FY 2020-21, including $18 billion projected in the state’s Rainy Day Fund).

However, the rapid onset of the COVID-19 pandemic has exacted an immediate and severe impact on California’s budget and economy, including significant numbers of job losses and unemployment insurance claims. Notably, DOF projects the 2020 unemployment rate will be 18 percent, representing a much higher rate than during the Great Recession. DOF further projects that the state’s three main General Fund revenue sources are projected to drop in 2020-21; those drops include a 25.5 percent decline in personal income tax, a 27.2 percent decline in sales and use tax, and a 22.7 percent decline in corporation tax. General Fund revenues are expected to decline by $41.2 billion below January projections.

Given the projected General Fund declines, combined with $7.1 billion in caseload increases supporting health and human services programs and $6 billion in other expenditures (largely due to COVID-19 response activities), DOF projects an overall budget deficit of approximately $54.3 billion ($13.4 billion from the current year and $40.9 billion in the budget year). The overall projected deficit is equal to nearly 37 percent of General Fund spending authorized in the 2019 Budget Act and nearly three- and one-half times the revised balance of the Rainy Day Fund ($16 billion). Despite the unprecedented loss of jobs and income due to COVID-19, DOF’s projected deficit as a percent of General Fund spending is modestly smaller than budget deficits faced by the state in 2003 and 2009.

The full DOF fiscal update is available here.

LAO Predicts a $18 Billion to $31 Billion Budget Problem, Deficits for Years to Come

This morning, the Legislative Analyst’s Office (LAO) released its spring fiscal outlook providing the Legislature an overview of the significant budget implications as a result of the COVID-19 pandemic. The LAO’s report focuses on the potential size of the budget problem by assuming a baseline level of expenditures; the LAO indicates the May Revise budget that will be released next week will include different revenue estimates and expenditure proposals than what the LAO used in its assessment of the budget problem. As such, the LAO aims to provide the Legislature a sense of an estimated baseline budget problem going into the May Revision and to assist lawmakers “for the tremendous fiscal challenges ahead.”

In its projections, the LAO details two scenarios in which the state will face significant budget deficits. In a “somewhat optimistic” U-shaped recession assumption, the LAO projects California will have to address an $18 billion budget problem. In a “somewhat pessimistic” L-shaped recession assumption, the LAO projects California will face a $31 billion budget problem. The LAO indicates the Newsom Administration’s estimates are substantially larger than the higher range of its own estimate largely because the DOF focuses on gross changes to the budget’s bottom line while the LAO’s estimates include the net effects of current law.

Moreover, the LAO estimates the newly emergent fiscal challenges are likely to persist well beyond the COVID-19 pandemic emergency. Under both LAO projections, budget deficits continue into at least 2023-24. Over the entire multiyear projection period, deficits total $64 billion in the U-shaped recession and $126 billion in the L-shaped recession.

In responding to the projected budget deficits, the LAO indicates California’s budget reserves totaling approximately $16 billion are insufficient to cover the project deficit amounts. Even with budget reserves at around $16 billion, the LAO determines the Legislature could only have access to $10 billion of its reserves in 2020-21 due to constitutional rules governing use of the state’s main reserve account. Notably, the LAO discusses that unlike previous recessions when the state had virtually no reserves and had to make immediate deep budget cuts, California has now established a sizeable budget reserve which will provide some cushion in the upcoming budget crunch.

In rounding out its report, the LAO provides the Legislature a series of recommendations in addressing the projected budget shortfall. For the 2020-21 budget, the LAO recommends using reserves, reducing expenditures, increasing revenues, and shifting costs. While programmatic reductions will be necessary to address the budget problem, the LAO encourages the Legislature to mitigation actions that could worsen the current public health emergency or compound personal economic hardships facing Californians. Given the likelihood of a multiyear budget problem, the LAO further urges the Legislature to consider ongoing solutions to bring the budget into structural alignment and to begin making difficult budget decisions in June as opposed to waiting for future budgets.

The full LAO Spring Fiscal Outlook is available here.