California’s Governor Is Set to Unveil Budget Padded With Surplus

(Bloomberg) -- California Governor Gavin Newsom is set to unveil a budget that boasts another multi-billion dollar surplus as the world's fifth-largest economy continues to benefit from top earners amassing even more wealth during the lopsided recovery from the pandemic.

The first-term Democrat on Monday will release a spending plan for the fiscal year beginning in July that will show a sizable surplus coming on the heels of this year's $75.7 billion windfall. The state's nonpartisan fiscal adviser in November estimated it could be about $31 billion.

With a progressive tax system that rakes in more revenue when the income of the highest earners rises, California continues to collect more than it forecast. That group has reaped the benefits of rising stock prices and stable employment even as lower-income workers lost their jobs during the pandemic. The top 1% of earners pay nearly half of personal income-tax collections.

“California is one of the better performing” states, said Jennifer Johnston, director of research for Franklin Templeton Fixed Income's municipal bond team. “Part of that is because of the very progressive tax structure that we have and the strength of employment at the high wage earner level, we tend to outperform in good years, and underperform in bad years.”

The current budget spends approximately $196 billion, up 18% from the previous year.

Severe Problems

To be sure, California faces severe problems from extreme drought to wildfires exacerbated by climate change to a deepening homelessness and affordable housing crisis. Yet for Newsom, he will have more at his disposal to deal with them without significant political pitfalls.

Newsom easily prevailed in a rare recall election in September. While at one point polls were showing that he might lose, the entry of Larry Elder, a Donald Trump-supporting, conservative talk show host, as a replacement candidate helped galvanize voters to reject Newsom's removal. Newsom now faces a November re-election in a state where Democrats outnumber Republicans nearly two to one.

And despite departures of notable Californians and their companies to Texas such as Elon Musk, it would take major upheaval to disrupt the world's fifth-largest economy. The state's gross domestic product increased 21% during the past five years ending in December 2020, dwarfing No. 2 New York (14%) and No. 3 Texas (12%), according to the most recent data compiled by Bloomberg.

Bond Prices

The budget presentation is unlikely to affect prices of California bonds as the state regularly provides updates of its fiscal position, said Bernhard Fischer, senior analyst at Principal Global Fixed Income.

California's bonds are “from a credit standpoint, very attractive. From a relative value, perhaps a bit expensive,” Fischer said, adding, “but everything in the muni market right now is pretty expensive.”

Newsom's budget blueprint will undergo revisions, often significant, in May. The Democratic-led legislature must approve a spending plan by June 15 or forgo pay. Here are some items anticipated Monday:

Higher revenue than expected
- California has collected about $66.8 billion of revenue so far during the fiscal year that will end in June, about 25% more than was anticipated in the budget, according to the state's finance department last month. Personal income tax collections alone are 26% more than expected year to date.
Higher spending on education and social programs
- With revenue running ahead of projections, that means the state's spending on education will increase, per a constitutional amendment.
- Newsom has also said he would like to allocate more to early education and programs for dyslexia.
- Liberal priorities
  - An advisory group recommended that the state expand its ability to provide abortions to out-of-state residents, including potentially helping to cover their costs, if the landmark Roe v. Wade case is overturned. Some of the report's recommendations will appear in his budget proposal, Newsom told the Associated Press.
  - Possible rebates to taxpayers
    - Constitutional requirements constrain use of the surplus dollars falling over the appropriations limit. Lawmakers can cut taxes, spend more on specific items like infrastructure or education, or issue tax rebates. Newsom has suggested he could send checks to residents, as he did with this year's budget.
    - Addressing retail crime
      - Following a string of highly publicized break-ins, Newsom said in November that the upcoming budget “will be investing even more to aggressively curb retail crime.” He didn't specify the amount.
      - Newsom Vows Increased Spending to Fight Smash-and-Grab Thefts