However, a week after the Governor released his January Budget Proposal, the nonpartisan Legislative Analyst’s Office (LAO) released its assessment of the proposal — providing a very different take on the Governor’s vision for the 2026–27 budget. In contrast with the LAO’s November Fiscal Outlook, which projected an $18 billion deficit, the Governor only projects a $3 billion deficit. The difference is largely due to Gov. Newsom not including the risk of an economic downturn in his revenue estimates, assuming that revenues will be $42 billion more than what was projected in June 2025.
The LAO’s assessment is more critical of the Governor’s proposed budget than during past years, noting that while the Governor acknowledges the challenges that the state could face if the artificial intelligence (AI)-fueled stock market tumbles, he makes no proposals to address this risk and build budget stability. In fact, both Gov. Newsom and the LAO project multiyear deficits of between $20 and $35 billion a year, showing that the budget problems that the state has solved for in the past few years are no longer cyclical, but chronic.
Citing stock market volatility and the ongoing year-over-year projected operational budget deficit, the LAO states that “the state’s negative fiscal situation is now chronic.” This is in stark contrast to the optimistic perspective presented by the Governor. Citing concerns that Gov. Newsom’s proposed budget relies too heavily on higher projected revenues that are unlikely to materialize, the LAO urges caution and recommends that the state acknowledge the downside risk, use its estimates and work to shrink multiyear deficits.
The first is the growth in stock market, in large part due to the growth in AI. Citing a high risk that an economic downturn could have a significant impact on state revenues, the LAO is urging the Governor and Legislature to take this risk into account when adopting a state budget.
The second is the state’s structural deficit — the continued growth in state spending. Although revenues have increased, expenditures continue to grow. It should be noted, however, that state expenditure growth is not the only factor in the state’s operational budget deficit. Actions at the federal level over the past year have eroded advancements the state has made to reign in its operational costs. The unpredictability and spontaneity of the on-again, off-again approach to tariffs, cuts to the federal budget and reductions in federal funding for public education and health and human services are having an outsized impact on California’s budget stability.
“The state’s continued manipulation of Prop 98 is unacceptable,” CSBA CEO & Executive Director Vernon M. Billy said. “This is the third manipulation in as many years and is becoming an appalling precedent that is taking funds away from California’s students at a moment when they need it the most. Now is the time for the state to double down on protecting the integrity of Prop 98 rather than ’tripling down’ on a highly questionable accounting maneuver that deprives LEAs and students of much-needed funding.”
Opposed by CSBA last year and again this year, the withholding, according to the LAO, provides “one-time savings, giving the state more budget capacity.” However, it went on to say that the withholding would “add to a future deficit,” meaning that the state will owe this money to schools in the following year.
The threat to the integrity and reliability of Prop 98 is of great concern. If the withholding of Prop 98 funds continues in future years, it could mean that the amounts could grow and the repayment of that withholding could be reduced or fail to materialize. If this occurs, it could result in the long-term erosion of Prop 98, rendering it toothless.
CSBA is adamantly opposed to this withholding and considers it an ongoing and possibly precedent-setting practice that could undermine the integrity of Prop 98.