In two years, California has gone from a record budget surplus of $97 billion to a massive deficit of $73 billion. Moreover, the nonpartisan Legislative Analyst’s Office forecasts continued deficits for years to come. Over the next four years, LAO estimates the cumulative deficit could reach $155 billion.
How did this happen? The first clue is the sheer amount of money California spends. Most states’ annual spending never approaches the near-$100 billion surplus California enjoyed in fiscal year 2022. According to National Association of State Budget Officers data, California spent $271 billion from non-federal sources in 2022. Other than New York, which spent $130 billion, no other state even spent $90 billion. For example, Texas spent $76 billion in 2022.
Even adjusted for population, California is a high spender. Using the Census Bureau’s population estimates for 2022, state-level spending in California amounted to $6,934 per resident. In other large states like Florida and Texas, those values were $2,739 and $2,528 per resident, respectively.
It’s also impossible to compare California’s actual spending with legislatively approved budgets because the state has gone delinquent in financial reporting. It hasn’t produced audited financial statements since 2021. Even then, Controller Malia Cohen pointed out that 2021 would “mark the fourth consecutive year that California has published its financial statements well beyond the regulatory deadline of nine months after fiscal year-end” because agencies were not submitting timely and accurate records to her office.
This mismanagement appears to be costing California taxpayers billions. In 2021, auditors discovered a $19.8 billion misstatement in reported liabilities—authorities understated what they owed and refused to make corrections as required by generally accepted accounting principles. Auditors further noted major weaknesses in internal controls over unemployment benefits that might lead to systemic fraud and refused to offer an opinion on the accuracy of California’s financial statements.
Spending and financial mismanagement may be the top two explanations for California’s fiscal woes, but the problems don’t stop there. Since state leaders won’t reduce spending, California also faces challenges on the revenue side because it is chasing taxpayers out of the state.
After implementing a new top tax bracket of 13.3% in 2012, California has increasingly saddled the cost of its government on a smaller number of people. Out of nearly 18 million personal income tax filers in 2021, 24.4% of state income taxes were paid by just 8,519 filers (0.05%). Roughly half of California’s income taxes were paid by 494,799 filers (2.5%). Households earning over $100,000 accounted for only 21.8% of the state’s tax filers but paid 93.5% of the income taxes.
In a country where we can move freely from state to state, it’s not hard to imagine how the highest-taxed Californians will react. Census data shows that people have been moving out of California at alarming rates. In 2022, 817,699 residents left California, while only 475,803 moved in. Californians are overwhelmingly fleeing to lower-tax jurisdictions like Texas, Florida, Arizona, and Nevada.
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To be sure, mobility isn’t the only factor explaining the loss of revenue. California has made itself highly susceptible to changes in the stock market because capital gains constitute a majority of earnings for top earners. The Legislative Analyst notes the number of California-based companies going public has declined 80 percent since 2021 as higher interest rates dampened markets, which means early investors have fewer opportunities to realize gains upon the resale of their stock holdings. LAO reports that home sales in the state are also down about 50% due to the higher interest rates, further reducing revenues.
No state can sustain the budget deficits projected for California. To restore long-term sustainability and deal with the short-term deficit, the state needs to reduce spending immediately, implement better financial controls, and flatten and broaden its tax burden.
Geoffrey Lawrence is research director at Reason Foundation and formerly served in the Nevada Controller’s Office.