Since 2020, California’s budget situation has been turbulent. Over the last six years, it has swung from a significant pandemic-era budget deficit that never materialized, to record-breaking surpluses, to large and persistent deficits. The state now faces an artificial intelligence (AI)-driven revenue surge that is masking—but not resolving—an underlying structural shortfall. In this post, we review this recent history of the state’s budget situation and assess where we are now.

2020: Pandemic Deficits That Never Arrived

Spring-Summer 2020: Economic Activity Froze and Massive Budget Problem Anticipated. In March 2020, the COVID-19 public health emergency brought large parts of the state economy to an abrupt halt. Nearly 3 million Californians lost jobs within weeks, and by most measures, declines in economic activity surpassed the worst of the Great Recession. In May 2020, our office estimated the state faced a 2020-21 budget problem of $18 billion under a “U-shaped” recovery and $31 billion under a slower “L-shaped” one. The administration, using a different methodology, estimated a $54 billion problem—and the 2020-21 budget, enacted that June, was built around that figure. These projections were reasonable at the time, given the track record from past recessions, when widespread job losses translated into revenue losses. This time, however, they did not.

Fall 2020: State Economy Experienced Rapid, but Uneven, Recovery. By November 2020, it was clear the anticipated revenue declines had not materialized. Instead, collections from the state’s three largest taxes were running 22 percent ($11 billion) ahead of budget act assumptions. Our office estimated the Legislature would have a $26 billion one-time “windfall” for 2021-22. This occurred because of the uneven nature of the recovery. Unemployment peaked at 16 percent, but job losses were concentrated among workers earning less than $20 per hour. Meanwhile, employment among workers earning more than $60 per hour was already back to pre-pandemic levels, and the S&P 500 was up 15 percent from February 2020 through the end of the year. Because the state’s income tax depends heavily on high earners and investment income, the budget remained strong.

2021-2022: Extraordinary Surplus Years

Late 2020 Through 2021: Rapid Rise in Revenue Collections. By 2021, it was not only clear that no drop in the state’s finances had occurred, but that state revenue was in fact surging. Between September 2020 and September 2021, state tax collections grew at an annual rate of 30 percent—the fastest in at least four decades. Stock prices doubled from their pandemic low, retail sales grew at double-digit rates, several major firms posted record earnings, and initial public offerings surged.

Federal Monetary and Fiscal Policy Resulted in Rapid Economic Growth… Increased economic activity in these years was largely a result of federal policy. The vast majority of federal money to the state during the pandemic bolstered economic activity and therefore indirectly improved the state budget by increasing Californians’ incomes. This included, for example, tens of billions of dollars in enhanced federal unemployment insurance benefits and loans and grants to small businesses. Federal monetary policy also fueled growth, mainly because the Federal Reserve kept interest rates at historically low levels throughout 2020 and 2021. This boosted incomes and asset prices, which directly improved revenues.

…While Some Federal Aid Directly Expanded the Budget Surpluses. Some federal programs directly improved the budget, increasing the size of the surplus by billions of dollars. For example, this included American Rescue Plan fiscal relief funds and an enhanced federal match for Medicaid.

2021-22 and 2022-23 Budgets Allocated Enormous Surpluses. As a result of the surge in revenues, the June 2021 and June 2022 budgets committed enormous surpluses: $47 billion and $55 billion, respectively, with tens of billions of dollars more available within the school and community college budget. Although the Legislature directed most of these funds to one-time and temporary purposes—nearly $39 billion in June 2021 and about $36 billion in June 2022—the budgets also made ongoing augmentations with growing costs over time. At the time of enactment, for example, new ongoing commitments in the 2021-22 package were expected to grow from $3.4 billion to $12.4 billion in a few years. Meanwhile, ongoing augmentations across recent budgets (including 2018-19 and 2019-20) were projected to reach about $25 billion by 2025-26.

Even at the High-Water Mark, the Budget Planned for Deficits. Despite enormous revenue upgrades and surpluses, the June 2022 budget package did not achieve multiyear balance. Under the budget act’s own assumptions, the state would have ended 2023-24 with a planned deficit of nearly $3 billion. The state therefore reached the peak of the revenue cycle already starting from a negative position. This meant that any revenue weakness, even a modest one, would translate directly into a budget problem.

Late 2022: Economic Conditions Weighed on Revenues and Multiyear Deficits Worsened. Aggressive monetary and fiscal policy at the federal level contributed to rising inflation. In response, the Federal Reserve raised interest rates repeatedly and aggressively. The unemployment rate rose modestly, from 3.8 percent to 4.8 percent, but higher interest rates hit precisely the income sources the state relies on most: stock prices, initial public offerings (the number of California companies going public in 2022 and 2023 fell more than 80 percent from 2021), and home sales (which fell by about half). By November 2022, the state’s budget situation had decidedly changed. Our office was projecting a $24 billion budget problem for 2023-24 with revenues across the budget window falling $41 billion short of budget act projections. Our forecast did not assume a recession, but we warned that if one occurred, revenues could fall an additional $30 billion to $50 billion.

Late 2022 Through 2023: Sharp Revenue Decline Obscured by Tax Delay

Early 2023: Storm-Related Deadline Postponements Delayed Key Information. After severe winter storms in early 2023, the Internal Revenue Service postponed tax filing and payment deadlines for most Californians, and the state’s Franchise Tax Board conformed. Payments on investment and business income that normally arrive in the spring were pushed into the fall of 2023. As a result, the state did not see actual payments (the data that typically reveal capital gains and business income) for the 2022 tax year until well after the 2023-24 budget was enacted. Without the benefit of real-time tax data, the 2023-24 budget plan assumed a relatively small revenue decline. The full magnitude of the real decline—and actual budget problem—was not yet known.

Late 2023: Tax Filings Reflected Even More Weakness Than Expected. When the postponed payments arrived in the fall, the full extent of the revenue weakness was finally understood. With the benefit of hindsight, it turned out total income tax collections fell 25 percent in 2022-23, a decline similar to those during the Great Recession and the dot-com bust. Meanwhile, total revenues across 2022-23 and 2023-24 ultimately fell $78 billion below June 2022 estimates. Because the 2022 budget had already planned on a deficit for 2023-24 and beyond, these revenue declines quickly made matters worse.

2024 Through 2026: Revenue Growth Coupled With Persistent Deficits

2024: AI Frenzy Fueled a Revenues Rebound… Increased enthusiasm around AI began building toward the end of 2022, in part driven by the release of the publicly available and popular ChatGPT platform. In 2023, stock prices for Nvidia—a manufacturer of chips broadly used to support AI models—tripled. They tripled again in 2024. As enthusiasm grew and investments in AI-related firms spread, revenues rebounded. By November 2024, despite a lackluster labor market and flat consumer spending, revenues were running about $7 billion above the June 2024 budget’s assumptions, driven by income tax gains tied to a stock market rally. That rally was unusually narrow: stock pay at four major technology companies made up nearly 10 percent of state income tax withholding in the first half of 2024, and a single company, Nvidia, accounted for about one-third of the S&P 500’s gains over the prior year.

…Then Surge in 2025. Beginning in late 2025, revenues grew dramatically, driven by stock market gains connected to investor enthusiasm around AI. Income tax payments in December 2025 and January 2026 were up more than 50 percent from a year earlier. Growth that strong has occurred only a few times, most notably during the 2000 and 2021 asset booms. The Governor’s January 2026 budget reflected a $42 billion upgrade relative to the 2025-26 Budget Act, driven almost entirely by higher revenue estimates, and the May Revision added roughly $16 billion more.

Despite This, the Budget Situation Did Not Seem Like a Surge Is Occurring. Even with this revenue growth, the state has faced a budget problem (or needed to adopt budget solutions) in every year since 2023. The Legislature addressed a $55 billion budget problem in June 2024, a $15 billion problem in June 2025; and a precariously balanced budget in June 2026 required about $14 billion in solutions. The state has also heavily relied on many tools for managing budget problems. By the end of 2026-27, outstanding budgetary borrowing incurred over these three years will total about $29 billion. The state’s rainy day fund, which stood at more than $23 billion in 2022-23, is expected to total about $15 billion by the end of 2026-27. Finally, even though the enacted budget is balanced, we estimate the state has a structural deficit of $18.5 billion in 2026-27. Three factors explain why.

  • Cost Growth in Major Programs Has Outstripped Revenue Growth. In recent forecasts, we have projected underlying growth in state spending commitments to grow faster than revenues, although this trend tempered somewhat. In November 2024, for example, we projected total spending growth of 5.8 percent per year through 2028-29, well above projected revenue growth of just above 4 percent. Our November 2025 outlook again projected spending growth of 5.6 percent per year. By contrast, in earlier years—for example, 2019-20 through 2023-24—forecasted growth averaged 3.5 percent. Increases in these growth rates reflect ongoing program expansions in recent years, notably in Medi-Cal, child care, and human services, and underlying cost growth, especially in programs like In-Home Supportive Services and developmental services.
  • Underlying Programs Grew Faster Than Expected. In a retrospective analysis conducted this spring, we found that General Fund spending grew about $100 billion between 2019-20 and 2026-27, from $146 billion to $248 billion. About 70 percent of that growth sustained services that already existed in 2019-20. About 30 percent expanded services or created new ones. As that analysis concluded, in retrospect, the state could not afford to sustain its existing services while funding the chosen suite of expansions.
  • One-Time Shock to Revenues Caused Structural Asymmetry. As we noted in November 2025, revenues dropped significantly in 2022-23, and the state has faced budget deficits since, but the state bridged budget gaps with reserves, borrowing, and other temporary tools. This means the underlying imbalance has been left in place and the level of ongoing services was not adjusted downward to reflect this more limited capacity, suggesting the expanded size of state government was unsustainable.

Where Are We Now and What’s Next?

Where Are We Now? California’s budget is structurally overextended despite booming and near-record revenues. This overextended budget reflects a higher ongoing spending base; diminished reserves; an already accumulated wall of debt; and annual, out-year operating deficits of $8 billion to $10 billion. As of September 2026, tax collections, propelled largely by an AI-driven stock market rally, are somewhat ahead of budget act assumptions. Market prices, however, appear increasingly overvalued, elevating the risk of a downturn that hits income tax collections. The state, therefore, is relying on evidently peaking market conditions just to maintain fragile budget balance.

What’s Next? There is an asymmetry to California’s future: elevated market valuations signal the heightened possibility of a market downturn with severe revenue implications, although revenues could also continue apace if asset prices stay higher for longer. Even then, however, revenue upgrades would not translate dollar for dollar to an improved budget condition due to the state’s constitutional spending requirements. In our forthcoming report, The 2027-28 Budget: California’s Fiscal Outlook, to be released later in November, we will provide our updated assessment of the economy and state revenues. This assessment will discuss how much the recent revenue surge depends on the stock market and what a reversal could mean for collections. As is typical, the report will lay out what that revenue outlook implies for the state’s budget condition over the coming years.