LAO Warns: California’s “Astonishing” Revenue Spike Masks Deep Structural Deficits

The Legislative Analyst’s Office (LAO) this week reported what it called “astonishing growth” in the state’s primary revenue engine, the Personal Income Tax (PIT), offering a brief moment of good fiscal news amid an increasingly fragile long-term outlook.

According to the LAO, September withholding came in $1.3 billion higher than projected, a remarkable 16% above budget expectations and 24% above the same month last year. Analysts attribute much of this surge to capital gains and investment activity linked to the so-called artificial intelligence (AI) boom, a sector that has supercharged Silicon Valley stock values and, by extension, California’s tax receipts.

However, as the LAO and Assembly Budget Chief Consultant Jacob Sisney both cautioned, this surge may prove fleeting. Sisney’s Monday blog post called the current moment “a bubble,” warning that AI-driven market exuberance could just as easily reverse, leading to “dramatic state tax revenue declines when [the bubble] bursts.”

“Despite the recent revenue strength, California’s budget condition remains fragile,” Sisney wrote. “There are many indications that an investment bubble from the ‘AI’ industry is fueling recent tax revenue gains.”

The underlying fiscal picture remains grim. The LAO’s multi-year forecast projects persistent annual deficits between $10 and $20 billion through 2028-29, a structural imbalance fueled by spending locked into automatic growth, especially in social, education, and environmental programs. Compounding matters, most of the state’s rainy-day reserves have already been tapped to balance recent budgets, and large cash balances are not accessible to patch recurring General Fund shortfalls.

Further pressure looms from policy and political crosscurrents:

• Expiration of the Prop 30 high-income tax rates in 2030 will erode revenue.

• AB 1207’s extension of the Cap-and-Trade program may alter previous fiscal assumptions tied to the Greenhouse Gas Reduction Fund’s $4 billion in annual receipts.

• H.R. 1, passed by federal Republicans earlier this year, is expected to constrain future state and local revenues.

• The Unemployment Insurance Fund debt to the U.S. Department of Labor now stands at $23 billion, making California the only state in the nation that has yet to repay its pandemic-related unemployment borrowing.

  
  

With only one sitting lawmaker having served during the Great Recession, Sacramento’s institutional experience with fiscal triage is alarmingly thin. Few expect a lame-duck governor and term-limited legislature to attempt the painful reforms required to rein in runaway program spending.

The next round of fiscal reality checks is due soon. The Legislative Analyst’s Office will issue its next Budget Outlook in mid-November, followed by the Governor’s 2026-27 Budget proposal in early January.

For California’s economy, and for industries that depend on fiscal stability, the message is clear: temporary windfalls don’t fix structural problems. The math, as the LAO dryly notes, “possibly adds up to a prolonged fiscal crisis.”