State Budget Update: Booming Revenues, Structural Deficits, and a Fiscal Future Written in Pencil

California’s fiscal outlook has taken on a familiar duality: encouraging bursts of revenue strength set against large, persistent deficits that threaten to dominate next year’s State Budget debate. This article takes CIPA members through the latest developments in Sacramento’s volatile budget environment, presenting the full picture in a long-form, magazine-style narrative without losing the details that matter most.

A Precarious Reality Sets the Stage

Before diving into the revenue upside, it is worth acknowledging the reality check delivered recently by the Assembly’s chief budget consultant. In a late-October analysis, he warned that ongoing annual State Budget deficits of roughly $20 billion for the next two to three fiscal years “seem likely.” His point was straightforward: California may be in the middle of a revenue upswing, but it is still standing on shaky financial ground.

He reminded readers that more than $154 billion in General Fund revenues remains uncollected for the 2025-26 fiscal year. Withholding, capital gains, and corporate income, all of them volatile revenue sources, could easily deviate from expectations. And with so much outstanding revenue yet to come in, the State’s budget trajectory could swing dramatically in either direction.

In short, while the numbers look better today, the underlying conditions remain fragile.

A Fall Revenue Surge Carries the Headlines

Despite the structural deficit looming overhead, October brought undeniably strong news: state revenues outperformed projections by $2 billion. That gain piled onto the $6.5 billion in revenue collected above expectations since the budget was enacted in June.

Driving the surge was the Personal Income Tax (PIT), the engine of California’s entire fiscal system.

• Estimated PIT payments for 2025 blew past expectations, coming in $3.1 billion (72 percent) above projection.

• Final PIT payments for 2024 beat estimates by $498 million (15 percent).

• And while PIT withholding essentially matched estimates, it still nudged slightly higher than projected by $122 million (1 percent).
  

Corporate tax receipts were a rare weak point, coming in $75 million below projections, but the overall story remains: the State’s revenue picture is significantly better than lawmakers expected only a few months ago.

The AI Wealth Wave: A Boon with an Expiration Date?

Much of the recent revenue strength appears linked to the ongoing investment surge surrounding artificial intelligence. Tech-driven capital gains, high-income estimated payments, and startup-related liquidity events are filling State coffers faster than budget writers anticipated.

If the trend continues, California could see many billions more in PIT-driven revenue through the remainder of the fiscal year. According to the Assembly’s consultant, half or more of this windfall would go directly to schools and budget reserves, while the rest would serve to shrink the deficit lawmakers must close in June.

But this boom is also showing signs of plateauing. Unlike prior months where withholding soared, October’s withholding barely budged above estimates. If the AI frenzy cools or even pauses, the State’s PIT gains may taper just as quickly.

For those tracking the month-to-month movements, the Legislative Analyst's Office (LAO) provides detailed trend data here.

Looking Ahead: January Budget Will Be Theater, May Will Be Reality

With markets shifting, federal policy changes still in flux, and billions in unpredictable PIT revenue lying ahead, the governor’s January Budget for FY 2026-27 will be little more than a placeholder. It is expected to sketch the broad outlines of the administration’s intentions but leave most serious decisions for the May Revise, when updated revenue figures and federal guidance will better indicate the size of the actual problem.

California has leaned heavily on one-time budget maneuvers in recent years, fund shifts, deferrals, and loans from special funds to close gaps. That pattern is almost guaranteed to continue in 2026.

The LAO’s Final Word on the Current Budget: One-Time Fixes Everywhere

The LAO has released its final, authoritative summary of the FY 2025-26 State Budget. For sectors that CIPA members follow closely, including Natural Resources and CalEPA, the LAO notes a dominant theme: the administration used one-time fund shifts to Proposition 4 to cover the majority of reductions.

The LAO cautions that these shifts “do not represent a dollar-for-dollar backfill in all cases.” This means that while agencies appear “whole” on paper, many programs are effectively underfunded going into FY 2026-27.

Full LAO summary can be viewed here.

Digging Into the Details: Natural Resources and CalEPA

The LAO’s budget breakdown for 2025 includes additional information on where and how dollars are being allocated across departments. For CIPA members tracking the regulatory environment, two items stand out:

Major Water Funding Still Moves Forward

The State Water Resources Control Board (SWRCB) retains large allocations this year, including:

• $153 million for water reuse and recycling, and

• $183 million dedicated to drinking water projects.
  

These are sizable commitments, especially given the broader fiscal climate.

Special Fund Borrowing Continues, and It Is Growing

The budget includes a $16.4 million General Fund loan from the Underground Storage Tank Cleanup Fund to support SGMA staff at the SWRCB. Repayment is to be determined, either from the General Fund or through future fee increases.

This is part of a repeated pattern: to avoid deeper cuts today, the administration is leaning on special funds to help close gaps. Such choices directly impact industries subject to these fees and programs.

For more on this year’s spending plans, please go here.

What About Proposition 4?

Because so much of Natural Resources and CalEPA’s “backfill” relied on Prop. 4, CIPA members may want to reference the LAO’s full analysis of how those funds were used: https://www.lao.ca.gov/Publications/Report/5076

This reliance raises important questions for next year: with Prop. 4 funds now used as a one-time plug, what tools will the administration turn to in FY 2026-27, when the deficit is projected to reappear at nearly the same magnitude?

The Bottom Line

California’s budget is experiencing a temporary lift, thanks largely to PIT overperformance and the AI-driven financial surge. But the underlying structural deficit, roughly $20 billion per year, remains untouched. One-time fixes, fund shifts, and special-fund borrowing are masking the real size of the problem, not solving it.

The State is, in many ways, floating, buoyed today by strong revenues but still in the path of fiscal storms. The May Revise will be the decisive moment for the 2026-27 budget, and all signs point to a challenging season ahead.