Newsom Touts Revenue Boom; LAO Warns of Bust Risk

Despite Gov. Gavin Newsom’s portrayal last week of a budget out of crisis for at least the next 18 months, the Legislative Analyst’s Office (LAO) is, once again, questioning the wisdom of his spending plan and urging a closer look at expenditure and long-term revenue projections.

When Newsom unveiled his $349.9 billion May Revise last week, the governor sarcastically quipped that his “friends” at the LAO undershot their projections by billions of dollars and that the revenues were strong enough to erase the deficit to the 2028 cycle.

While the revenues are strong at the moment, the LAO admits, so too is the state’s unquenchable thirst for spending money it should be more careful with.

“Despite booming revenues, the budget position is overextended, reflecting: a structurally higher spending base, diminished reserves, an already accumulated wall of debt and an operating deficit,” the office wrote in its budget response.

The state’s revenue boom, some $53.6 billion higher than the LAO’s $16.5 billion estimate, is largely attributed to income tax collection driven by the stock market’s love affair with artificial intelligence.

But these sorts of love affairs sometimes end abruptly (see the dot-com and housing overvaluation bubbles) and some economists speculate that we may already be seeing some of the warning signs with the AI boom.

“Alarmingly, given current market conditions, the dot‑com bust probably is a better parallel. If such a scenario were to repeat, the revenue hole could be $100 billion,” the report reads.

For the LAO, this overreliance on that volatile revenue stream, coupled with overspending and undersaving, is a recipe for bitter future discomfort. One area of particular concern for the government watchdog was the reduction in reserve funds typically used in times of fiscal crisis to achieve budgetary balance.

“Instead, the May Revision draws it down — relying on roughly $20 billion in reserve withdrawals and suspended deposits, as well as $4 billion in borrowing (on top tens of billions of dollars of existing borrowing), to achieve budget balance,” the report reads.

“These actions should be reserved for addressing revenue shortfalls in downturns, not to balance the budget during a revenue boom,” the report continues.

The LAO outlined several recommendations the Legislature could take to strengthen the state’s fiscal footing, including the maintenance of ongoing solutions (a.k.a. reductions) to reduce the deficit by at least half; add $20 billion to the state’s discretionary reserve; and stock $4 billion toward a "potential settle-up obligation."

“These conditions warrant a disciplined and cautious fiscal approach. In our view, this means recognizing that recent revenue performance may not represent a sustainable long-term baseline for the budget,” the report states. “It also means aligning ongoing spending commitments more closely with the state’s long-run revenue capacity, prioritizing rebuilding reserves — even at the expense of additional spending cuts or revenue increases — and planning explicitly for downside scenarios.”