In its initial assessment of the governor’s 2026-27 state budget this week, the Legislative Analyst’s Office chided Gov. Gavin Newsom for ignoring a likely stock market decline that could implode state revenues. It also warned that Newsom’s failure to confront a growing state deficit could compound the state’s fiscal challenges.
“These risks are severe enough that not incorporating them into this year’s budget, as the Governor proposes, would put the state on precarious footing,” wrote Legislative Analyst Gabriel Petek. The independent research office provides budget and policy advice to the Legislature.
TK-12 schools and community colleges would see significant funding reductions if the LAO’s pessimism is accurate, since their constitutionally guaranteed minimum annual funding is tied to the overall state budget.
In its budget forecast in November, the LAO projected an $18 billion budget deficit for 2026-27, assuming that income and capital gains tax receipts, generated primarily by AI entrepreneurs, would decline in the 2026-27 fiscal year. Newsom’s budget assumes the bonanza will continue after he leaves office at the end of the year.
Schools and community colleges receive a guaranteed minimum portion of the general fund, generally about 40%, through Proposition 98, which voters passed in 1988. The California State University and University of California systems compete with other state functions, social services, and entitlements over the remaining 60% of the budget.
Steadily rising Medi-Cal costs and pay raises for state workers are contributing to what Newsom and the LAO project will be $25 billion to $30 billion in annual state deficits in the next several years, despite record post-Covid revenues, the LAO said.
“Deficits have persisted even as the state’s economy and revenues have grown, underscoring that the problem is structural rather than cyclical,” the LAO wrote.
Lawsuit over Prop. 98 maneuver?
The budget picture will become clearer as more revenues are collected ahead of the May budget revision, but education advocates are furious about the one hedge against a revenue setback that Newsom included in his proposed budget.
Newsom projects that schools and community colleges will be entitled to $6.9 billion in revenues for 2025-26 beyond what the Legislature budgeted in June, but he wants to withhold $5.6 billion of it. He’d use that money to shore up the rest of the budget instead of giving it to schools and community colleges to fulfill the Prop. 98 obligation.
The state would be legally bound to repay the full amount, although it could defer the repayment until 2027-28. The state Department of Finance argues this wait-and-see set-aside is legal and appropriate to ensure the state neither shorts nor over-appropriates what schools are entitled to after the revenues are accounted for.
However, David Goldberg, president of the California Teachers Association, characterized the move as a “shell game” to fill holes elsewhere in the general fund. Districts, on the other hand, will use the lower Prop. 98 estimate with “devastating” results this spring when creating local budgets, Goldberg said in a statement. They will “issue unnecessary layoff notices, justify cutting programs and the closure of beloved neighborhood schools, and refuse to make investments to recruit and retain educators,” he said.
The California School Boards Association sued the state in September 2024, charging that it used a similar tactic in the 2024-25 budget. Newsom has included a $1.9 billion repayment in the 2025-26 budget but is continuing with the lawsuit to persuade a judge to strike down what CSBA regards as a bad precedent that violates a state mandate, said Troy Flint, chief spokesperson for CSBA.
Both CSBA and CTA are also threatening to file a new lawsuit over the proposed $5.6 billion withholding.
“The whole purpose of Prop. 98 is to establish funding stability, not to use it as a safety valve to solve volatile revenues,” Flint said. “The Department of Finance has been using it that way to normalize these maneuvers.”
Unlike CSBA, the LAO doesn’t object to withholding the $5.6 billion, but it suggests stashing the money in an education reserve account instead of backfilling a shortfall in the general fund. Doing so, it indicated, would add to the state’s growing deficit rather than solve an overspending problem.