In summary

The nonpartisan Legislative Analyst’s Office projects a relatively small $2 billion shortfall for 2025-26, but says the state can’t afford new programs. Gov. Newsom has complained about attention on the office’s deficit estimates.

With tax revenues from high-earning Californians rebounding in recent months, the Legislature’s nonpartisan fiscal adviser projects that the state budget remains “roughly balanced,” but spending growth is expected to drive increasing deficits in the years ahead.

That could make it difficult for Gov. Gavin Newsom to pursue ideas that he has proposed in recent months to fight back against a second Trump administration and reboot California’s sluggish economy during his final two years in office.

In its annual fiscal outlook, issued today to prepare lawmakers for the upcoming budget process, the Legislative Analyst’s Office estimated that California will face a $2 billion deficit next year, a potential gap that could be resolved with minor solutions — and one that Legislative Analyst Gabriel Petek repeatedly warned leaves no room for new programs.

“The revenues are up, but the outlook ahead on that is a little more precarious,” he told reporters during a briefing. “There’s really no capacity for new commitments, because we do estimate there to be these pretty significant operating deficits in the subsequent years.”

Those shortfalls will reach about $30 billion annually by the 2028-29 fiscal year, according to the office’s projections, and there are additional uncertainties related to President-elect Donald Trump’s agenda. California’s economy is particularly vulnerable to plans he has floated to raise tariffs and limit immigration, while Trump has threatened further recriminations to the state on disaster aid and other funding if it bucks him.

Assembly Speaker Robert Rivas, a Salinas Democrat who will negotiate California’s next budget with Newsom and his counterpart in the state Senate, endorsed a cautious approach.

“We need to show restraint with this year’s budget, because California must be prepared for any challenges, including ones from Washington,” Rivas said in a statement. “It’s not a moment for expanding programs, but for protecting and preserving services that truly benefit all Californians.”

Newsom has already called a special session starting in December to appropriate potentially tens of millions of dollars to the state Department of Justice for expected litigation against the Trump administration. He is also developing a proposal for a backup disaster relief fund and wants to double to $750 million annually the tax credit program for the state’s struggling film and television industry, a critical economic sector in Southern California.

H.D. Palmer, a spokesperson for the governor’s Department of Finance, said the state is in far better fiscal condition than it was a year ago even with challenges ahead. He declined to discuss how Newsom would offset proposed new spending in his budget plan, which is expected in early January.

“It reflects his policies and his priorities,” Palmer said, which will be “will be accommodated within the overall framework of a balanced budget proposal.”

Newsom and the Legislature passed a $298 billion budget this summer that aimed to address a major deficit, estimated to be tens of billions of dollars over the next two years, by dipping into reserves, pausing some business tax credits and making widespread cuts to state government operations, prisons, housing programs and health care workforce development in order to maintain California’s social safety net.

Now tax collections are forecast to beat expectations by $7 billion for the year, largely driven by stock market gains, according to the Legislative Analyst’s Office fiscal outlook. Stock compensation for employees of major tech companies such as Nvidia has provided an outsized portion of the income tax windfall.

But that money is projected to be offset by spending more than $10 billion higher than the current state budget assumed, including more guaranteed funding for schools and community colleges from the additional revenue. Other large unexpected costs include for fighting wildfires and an expanding caseload for state health programs for seniors, as well as a November ballot measure approved by voters that raises reimbursement rates for doctors who treat poor residents.

That leaves a “small deficit” of $2 billion for the state to address before the start of the next fiscal year in July, the Legislative Analyst’s Office concluded. “Given the size and unpredictability of the state budget, we view this to mean the budget is roughly balanced.”

Yet there are warning signs in California’s economy, such as soft consumer spending, an uptick in unemployment and hardly any job creation outside of the government and health care. The office questioned the sustainability of the recovery in state income tax revenue.

The annual fiscal outlook by the Legislative Analyst’s Office is merely a forecast and can vary greatly from the projection by the Department of Finance that the governor uses for his budget proposal in January.

Last December, the Legislative Analyst’s Office estimated a $68 billion deficit for the next fiscal year — frustrating Newsom, whose spending plan relied on a smaller $38 billion expected revenue gap. He repeatedly criticized the media for its widespread reporting on the Legislative Analyst’s Office figure.

Seemingly recalling those criticisms, Petek published an essay last week defending his office and “the value of independence” as it helps the Legislature understand the choices it may face.

“Our independent fiscal assessment underlies the Legislature’s ability to assert an informed check on the executive branch, making any added complexity from diverging estimates a worthwhile trade-off,” Petek wrote.