Every year, our office publishes the Fiscal Outlook in anticipation of the upcoming budget season. This report gives the Legislature our independent estimates and analysis of the state’s budget condition with the goal of helping lawmakers prepare for the 2025-26 budget process. Our report has three key takeaways:

  • Revenues Running Ahead of Broader Economy. Despite softness in the state’s labor market and consumer spending, earnings of high-income Californians have surged in recent months. Income tax collections have seen a similar bounce. This recovery in income tax revenues is being driven by the recent stock market rally, which calls into question its sustainability in the absence of improvements to the state’s broader economy.
  • 2025-26 Budget Roughly Balanced. In the 2024-25 budget process, the Legislature not only addressed the budget problem for that fiscal year, but also made proactive decisions to address the anticipated budget problem for 2025-26. Although revenues are running ahead of budget act assumptions, those improvements are roughly offset by spending increases across the budget. This means the budget is roughly balanced this year.
  • No Capacity for New Commitments. While the budget picture is fair for the upcoming year, our outlook suggests that the state faces double-digit operating deficits in the years to come. While these out-year estimates are highly uncertain, this is an indication that the Legislature might need to address deficits in the future, for example, by reducing spending or increasing taxes. In our view, this year’s budget does not have capacity for new commitments, particularly ones that are ongoing.

Executive Summary

The Fiscal Outlook gives the Legislature our independent estimates and analysis of the state’s budget condition for the 2025‑26 budget process. We evaluate the budget condition based on current law and policy at both the state and federal level. This means we are assessing the state’s spending and revenues assuming no new laws or policies are enacted. This is not a prediction of what will happen—state and federal laws and policies will change in the coming years—but rather serves as a baseline to help the Legislature understand its starting place. Further, while changes in federal policy are being actively discussed, we cannot predict which changes may be enacted and therefore cannot estimate the effects on California’s budget.

Legislative Action Last Year Addressed Anticipated Budget Problem Proactively. In the 2024‑25 budget process, the Legislature not only addressed the budget problem for that fiscal year, but also made proactive decisions to address the anticipated budget problem for 2025‑26. These choices included about $11 billion in spending‑related solutions and $15 billion in all other solutions, including $5.5 billion in temporary revenue increases and a $7 billion withdrawal from the state’s rainy‑day fund. After these solutions, the spending plan assumed the 2025‑26 budget would be balanced.

Revenues Running Ahead of Broader Economy. Despite softness in the state’s labor market and consumer spending, earnings of high‑income Californians have surged in recent months. Income tax collections have seen a similar bounce. This recovery in income tax revenues is being driven by the recent stock market rally, which calls into question its sustainability in the absence of improvements to the state’s broader economy.

Revenue Improvement Offset by Higher Costs, 2025‑26 Budget Remains Roughly Balanced. Although revenues are running ahead of budget act assumptions, those improvements are roughly offset by spending increases across the budget. On net, our assessment finds the state has a small deficit of $2 billion. Given the size and unpredictability of the state budget, we view this to mean the budget is roughly balanced. If a budget problem of this magnitude were to materialize by the end of the budget process in June, relatively minor budget solutions would be needed.

Revenues Are Unlikely to Grow Fast Enough to Catch Up to Atypically High Spending Growth. While the budget picture is fair for the upcoming year, our outlook suggests that the state faces double‑digit operating deficits in the years to come. By historical standards, spending growth in this year’s outlook is high. Our estimate of annual, total spending growth across the forecast period—from 2025‑26 to 2028‑29—is 5.8 percent compared to an average of 3.5 percent in other recent outlooks. Meanwhile, revenue growth over the outlook window is just above 4 percent—lower than its historical average largely due to policy choices that end during the forecast window. Taken together, we view it as unlikely that revenue growth will be fast enough to catch up to ongoing spending.

No Capacity for New Commitments. While out‑year estimates are highly uncertain, we anticipate the Legislature likely will need to address deficits in the future, for example by reducing spending or increasing taxes. In our view, this year’s budget does not have capacity for new commitments, particularly ones that are ongoing.

This report is available using the following link: https://lao.ca.gov/Publications/Detail/4939