California, now the world’s fourth-largest economy, is once again navigating familiar territory—a large budget shortfall in an unpredictable economic environment. On Wednesday, Governor Gavin Newsom unveiled his 2025–26 May Revision, a revised $321.9 billion proposal aimed at closing a $12 billion deficit, driven in part by delayed tax filings following natural disasters, higher than anticipated costs for state programs and broader economic pressures.

While the shortfall for the upcoming budget year is significant, future challenges loom larger, as the Department of Finance anticipates additional economic headwinds stemming from federal policy changes, including new tariffs on foreign goods and potential reductions in programs like Medicaid.

“The Governor and his team have made hard and necessary decisions to bring this budget into balance, but significant risks remain as the federal government deliberates actions that could have further catastrophic impacts on state budgets.”

Keely Martin Bosler

Keely MB Strategies CEO
Former California Department of Finance Director

The May Revision identifies a $12 billion shortfall in the current year, which is significantly lower than the $73 billion multi-year budget problem projected by the Legislative Analyst’s Office late last year, which included deficits spanning multiple budget cycles. Newsom’s latest proposal includes the following  general fund solutions for the upcoming fiscal year on top of $27.3 billion in remedies the Governor and Legislature agreed to earlier this year.

Sector Pressures Amplify the Stakes

The biggest cuts to the state budget came in the Medi-Cal program, particularly in the extension of coverage to all Californians regardless of immigration status. The revise includes a proposal for undocumented adults to pay a co-pay, which is expected to reduce enrollment in the program and a freeze for full-scope Medi-Cal for undocumented adults aged 19 and older. To help address the state’s budget shortfall, the Administration proposes using MCO tax revenue to offset General Fund costs. Still, some planned enhancements, like provider rate increases and behavioral health investments, are delayed or scaled back.

Other key sectors continue to face strain:

• Energy: Investments in clean energy and grid resilience remain a priority, particularly those tied to decarbonization and modernization. However, wildfire risks and ongoing permitting complexities continue to pose implementation challenges.
• Infrastructure: Although funding constraints affect some clean energy and transportation efforts, the administration is advancing the Delta Conveyance Project as a key infrastructure priority. The proposal includes measures to streamline permitting, confirm funding authority, reduce litigation delays and expedite construction, positioning the water project within a broader effort to accelerate delivery of climate-resilient infrastructure.
• Jobs: Workforce programs connected to climate, health care and infrastructure are sustained, but broader expansion is likely to be tempered by fiscal constraints and compressed timelines.
• Local Government: Cities and counties are navigating rising service demands amid tight budget conditions. Programs addressing homelessness, behavioral health and public safety remain critical but face ongoing pressure due to limited flexibility.
• Tourism: While not a central focus of the budget, the ongoing recovery of the tourism sector remains uneven, with disaster recovery and broader economic uncertainty continuing to impact coastal and rural areas.
• Cap-and-Invest: The governor called for an extension of the cap-and-trade program. Revenues from the Greenhouse Gas Reduction Fund have benefited from recent strong auction performance, helping to support climate initiatives. Still, the volatility inherent in this funding source underscores the need for careful and adaptive long-term planning.
• Education: The budget proposes to appropriate Proposition 98 funding at $117.6 billion, which is below the currently calculated minimum guarantee of $119.2 billion in 24-25. Education advocates argue the budget unlawfully withholds $1.6 billion and reduces Local Control Funding Formula support by $400 million, raising concerns about funding stability and legal compliance.

“State budget politics carry consequences and change quickly. Advancing a sound communications strategy that is carefully calibrated to the political nuances of the budget debate and ripple effects those discussions can have across a wide range of policy issues is essential.”

Travis Taylor

Executive Vice President
Lucas Public Affairs

Breaking the Cycle: A History of Volatility

For decades, California has experienced fiscal whiplash driven by its income tax structure. Booming markets produce windfall revenues, but economic downturns expose deep vulnerabilities, particularly due to the state’s dependence on high-income earners and capital gains.

Reforms introduced by previous administrations, such as establishing a rainy-day reserve, have provided some insulation. However, the structural imbalance remains. Newsom’s May Revision seeks to go beyond temporary fixes and reflects a broader effort to rethink how California forecasts, commits to and disciplines its spending over time.

Newsom’s Structural Reform Pitch

Among the most consequential proposals in the May Revision is a structural shift in how California manages revenue volatility. The Governor is calling for a policy of avoiding spending projected revenue spikes until the money is actually received — an approach likened to not planning your mortgage around a raise you haven’t yet earned.

Additionally, the Governor is proposing to:

• Increase the cap on the Budget Stabilization Account (BSA) from 10 percent to 20 percent of General Fund revenues, and
• Exempt BSA deposits from the State Appropriations Limit (SAL) — a statutory change aimed at allowing the state to save more during economic booms.

These reforms signal an effort to introduce stronger fiscal discipline and enhance the state’s resilience to future downturns.

Forging Ahead

California’s economic scale may be global, but its budgeting remains vulnerable to local disruptions, climate-driven impacts, market fluctuations and federal policy shifts.

At the same time, interest groups and stakeholders reliant on state funding are weighing potential ballot measures that could significantly shape future budgets. These include a possible extension of the high-income tax rates first approved by voters in 2012. While these progressive taxes have generated substantial revenue, they have also contributed to heightened budget volatility.

The rainy-day fund was designed to bank surplus revenues during economic booms. But with total state reserves projected at $17 billion in 2025–26, including $10.9 billion in the BSA, some leaders contend that California’s fiscal cushion remains inadequate. Proposals to increase the state’s reserve capacity, including raising the BSA cap, are gaining momentum as part of broader long-term fiscal reform efforts.

Though discussions on broader reforms are active in the Legislature, much of the real strategizing is taking place behind the scenes, as key funders and campaign planners assess whether to pursue fiscal changes on the 2026 or 2028 ballot.

This broader context will shape budget deliberations in Sacramento in the lead-up to the June 15 constitutional deadline. While improved revenues ease short-term pressure, the enduring challenge remains: building a disciplined, resilient fiscal system that can endure the uncertainties of tomorrow.

Read the full May Revision summary.