Why California Has a Budget Gap and New York Doesn’t

As Golden State lawmakers scramble to address a $22.5 billion shortfall, the Empire State has an $8.7 billion surplus.
California Gov. Gavin Newsom leaves the stage after delivering his budget proposal in Sacramento, Calif., Tuesday, Jan. 10, 2023. (AP Photo/José Luis Villegas)

California and New York’s budgets are both sensitive to the changing fortunes of high earners, raising over half their tax dollars from income taxes that are disproportionately paid by millionaires and billionaires.

But while California lawmakers this session will be scrambling to address a $22.5 billion shortfall, New York lawmakers will be debating how to spend an estimated $8.7 billion surplus.

Public finance experts say one of the several possible explanations for the states’ diverging fortunes stands out: California’s high earners have closer ties to the tech industry, which is struggling this year after booming in the early years of the Covid-19 pandemic.

“The one big difference … is each state’s reliance on the tech sector, which has been hit particularly hard by the Federal Reserve’s efforts to get this high inflation under control,” said Justin Theal, an officer with the Pew Charitable Trusts’ state fiscal health project.

Low interest rates helped spur record levels of tech industry initial public offerings in 2020 and 2021, Theal said. “The money that the state of California collected because of those IPOs really helped drive the historic budget surpluses in fiscal year 2021 and 2022.”

“Now that the Federal Reserve is raising those interest rates rapidly to get control over inflation, the conditions for those tech IPOs have evaporated,” Theal said. “And as a result a lot of the tax revenue that the state was benefiting from is no longer there.”

California Gov. Gavin Newsom (D) alluded to the tech sector’s struggles in his budget speech last month. “When we talk about a recession — tech has been in a recession for a year. You see growth stocks that have lost 80% of their value. If you ask, why California? What more evidence do you need than that,” he said.

California-based companies such as Alphabet, Meta and Salesforce have in recent months reported sluggish earnings and major layoffs. Crucially, tech executives are earning less from bonuses, stock options and IPOs, said Jerry Nickelsburg, director of the UCLA Anderson Forecast, an economic forecasting organization. “That is where you see an impact on the [California] state budget,” he said.

Nickelsburg said employment data suggests that many recently laid-off tech workers are finding new jobs. He said they tend to have skills prized by employers in many industries.

California raised almost 45% of its 2019 personal income tax dollars from the top 1% of earners, according to state budget documents. In New York, the share that year was 42%. That includes income taxes on capital gains such as investment earnings.

High earners in New York also have been hit by the bear market. New York budget analysts expect end-of-year bonuses received by Wall Street finance and insurance workers to drop 25.2% this year following a 14.6% surge last year.

Overall, New York’s tax collections are expected to rise by 11% to $115 billion this fiscal year, Acting Budget Director Sandra Beattie told reporters after Gov. Kathy Hochul’s (D) budget announcement this week.

Beattie said her team expects a “mild recession” to hit and tax collections to fall in fiscal 2024. They are expecting New York to face a $5.7 billion budget gap in fiscal 2025 and additional budget gaps in future years as the economy weakens, she said.

There may also be technical reasons for why New York’s tax collections are faring better than California’s this year. New York’s fiscal year starts on April 1, three months earlier than California’s, which is allowing New York in fiscal 2023 to capture taxes paid on 2021 stock market gains.

Budget analysts in each state may also have taken different approaches to estimating revenue for this fiscal year, public finance experts say. And there are nuances to each state’s tax code that could also be at play. Both states have a new income tax option for business owners with pass-through earnings that have complicated their revenue numbers, for instance.