California facing projected $18B deficit as Newsom heads into his last year as governor

Newsom will release his own budget estimates in January as he lays out a spending proposal for the next fiscal year; sometimes his office disagrees with the LAO and paints a rosier financial picture. His second and final term as governor ends in January 2027, and this year's budget will be his last say on how money is spent in the nation's most populous state. Governors in California are limited to two terms.

New federal policies on tariffs and ongoing high borrowing costs are leading to weaker corporate and sales tax trends and sluggish job growth, Legislative Analyst Gabriel Petek said at a briefing Wednesday.

The only bright spot has come almost exclusively from strong investments in artificial intelligence, allowing the state to collect billions more in personal income tax than projected. But most of those revenue gains must go toward schools and paying down state debt. The report also warns that the AI investments might not be sustainable in the long run.

“It’s risky to assume that these trends will just continue unabated,” Petek said. He added: “The budget condition right now has become relative weak."

For Newsom, how he balances the budget without abandoning Democrats' priority programs will help shape his national image as he mulls a presidential run.

He already had to roll back a signature health care program last year in the face of a $12 billion deficit, dealing a major blow to state Democrats' priority of providing universal health care. The ambitious state-funded program started in 2024 to provide free health care to immigrants living in California regardless of their legal status. Those without legal status will no longer be eligible to enroll in the program starting next year, and some will have to start paying a premium in 2027.

State Democratic leaders in the past few years have avoided some of the deepest cuts to their priorities by borrowing from special funds and delaying payments to plug the budget hole. But they’re running out of most temporary and one-time solutions.

More cuts to health care programs could come next year, as they are among the biggest expense in the state budget. The governor in past years had rejected calls to raise taxes to fix budget problems. Lawmakers have until June to pass a balanced budget.

“While we’re still updating and refining our forecasts and projections for the Governor’s January budget, the LAO has again highlighted the challenges that we’ve underscored throughout the year – federal uncertainty, market volatility, and continued growth in both cost and caseload for major state programs,” H.D. Palmer, a spokesperson for the California Department of Finance, said in a statement.

California will likely see even a bigger deficit, up to $35 billion, the following year, the LAO report said.

Legislative Republicans said the budget challenges are a result of poor spending decisions.

“The state’s structural deficit continues to grow because of the majority party’s unstoppable spending problems," Republican state Sen. Roger Niello said in a statement.

Lawmakers passed a $321 billion spending plan last year following an agreement between Newsom and Democratic leaders.

Senate President pro Tempore Monique Limón, a Democrat, said lawmakers will work with the governor to craft “a responsible state budget that protects core programs, including education, childcare, safety net, health care, and public safety.”