A surge in artificial intelligence stock prices has boosted California’s tax collections by about $11 billion, yet the state’s deficit is still on track to swell to about $18 billion next fiscal year, officials said.
The state Legislative Analyst’s Office said Wednesday that despite sluggish job growth and flat consumer spending, California’s general-fund revenue has climbed well above expectations as a run-up in AI-related stocks delivered outsize capital gains to the Golden State’s wealthiest. That additional revenue, however, is almost entirely offset by higher constitutional spending requirements for public schools and reserve deposits, the office said in a report.
“Quite frankly, the budget condition right now has become relatively weak,” Legislative Analyst Gabriel Petek told reporters.
A gauge of the so-called Magnificent Seven megacap tech companies — Alphabet Inc., Amazon.com Inc., Apple Inc., Meta Platforms Inc., Microsoft Corp., Nvidia Corp. and Tesla Inc. — is up almost 19% so far this year, beating the 13% advance on the Standard & Poor’s 500 index. Nvidia is set to report its earnings after the bell Wednesday. In the first half of last year, stock compensation for high‑income workers at four major technology companies accounted for almost 10% of the state’s total income tax withholdings, according to the Legislative Analyst’s Office.
But California’s reliance on its richest people makes its budget highly sensitive to extreme booms and busts. The top 1% of California earners pay nearly half of personal income-tax collections. That worries Petek, who said he’s concerned the AI stock surge is being driven less by real economic activity than by investor excitement over AI and high-tech spending on chips and data centers.
“With so much exuberance surrounding AI, it now appears time to take seriously the notion that the stock market has become overheated,” the Legislative Analyst’s Office said in its report. “History suggests that the stock market is prone to overreact to major technological advances, even if the technology itself turns out to be revolutionary.”
With investors growing increasingly skittish about AI spending — plunging Nvidia shares nearly 13% since hitting a peak on Oct. 29 — the company’s results are likely to shape tech stock performance for the rest of the year given that Nvidia accounts for the biggest weight in the S&P 500 index.
The recent boom in high-income tax payments contrast sharply with weaker signals in the broader economy. The state has been losing jobs in the tech sector as AI continues to replace labor through automation, while unemployment spells stretch longer and consumer activity flattens, according to the Legislative Analyst’s Office.
Fueled in part by uncertainty surrounding recent federal policy shifts, California is also projected to face persistent deficits in coming years, with estimates from the Legislative Analyst’s Office showing deficits growing to about $35 billion annually in 2027-28. The office said higher constitutional spending requirements will consume roughly $10 billion of the revenue increase.
A multitrillion-dollar tax and spending bill that passed in July to help secure President Trump’s domestic policy agenda will affect the state’s healthcare coverage, food assistance, higher education and certain personal and corporate taxation provisions, according to the Legislative Analyst’s Office. Many of these provisions, however, are not going into effect until 2026 or later, muting their immediate effect on the budget.
The state’s ability to address the deficit is limited after years of short-term fixes, Petek said. California has already used most of the temporary tools at its disposal including one-time spending cuts, borrowing maneuvers, and reserve withdrawals. Reserves stand at about half their prior peak and the Legislative Analyst’s Office warns the state is “undeniably less prepared” for a downturn than in recent years.
Petek noted that the state’s budget has weakened even as the economy has avoided recession and the stock market has climbed, underscoring that the problem is structural. Given the weak budget position, the Legislative Analyst’s Office urged lawmakers to use ongoing spending reductions and revenue increases to structurally balance its budget.
The latest budget projections follow Gov. Gavin Newsom’s June approval of a $321-billion budget for the current fiscal year, which closed an estimated $12-billion deficit.
In order to close the projected $18-billion deficit for fiscal year 2026-2027, the state would need revenue for the current year to beat expectations by more than $30 billion, Petek said, citing constitutional school-funding and reserve requirements.
Adler writes for Bloomberg.
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