A surge in artificial intelligence stocks has boosted California’s tax collections by about $11 billion, but the state’s deficit is expected to grow to about $18 billion next fiscal year, officials said.
The state’s Office of Legislative Analysts said Wednesday that the state’s general fund receipts were much higher than expected, as rising AI stocks generated huge capital gains for wealthy Californians, despite sluggish job growth and flat consumer spending. But that additional revenue would be almost completely offset by increased constitutional spending requirements for public schools and reserve funds, the LAO said in its report.
“Frankly, the current budget situation is relatively weak,” said legislative analyst Gabriel Petek. he told reporters.
Shares of the so-called “Magnificent Seven” tech giants, including Alphabet Inc., Amazon.com Inc., Apple Inc., Meta Platforms Inc., Microsoft Inc., Nvidia Inc. and Tesla Inc., are up nearly 19% since the beginning of the year, outpacing the S&P 500’s 13% rise. Nvidia is scheduled to report earnings after the bell on Wednesday. In the first half of last year, stock compensation for high-income workers at four major technology companies accounted for nearly 10% of the state’s total withheld income taxes, according to LAO.
But California’s dependence on its wealthiest people makes its budget highly sensitive to extreme booms and busts. The top 1% of California earners pay nearly half of all personal income tax collections. Mr. Petek is concerned about this, saying he worries that the rally in AI stocks is being driven more by investor excitement about high-tech spending on AI, chips and data centers than by real economic activity.
“With so much excitement surrounding AI, it seems time to take seriously the idea that the stock market is overheated,” LAO said in a report. “History suggests that stock markets tend to overreact to major technological advances, even if the technology itself turns out to be revolutionary.”
Nvidia’s stock has plunged nearly 13% since hitting an all-time high on Oct. 29 as investors become increasingly wary of AI spending, but its performance is likely to determine the performance of tech stocks for the rest of the year, given that it has the largest weight in the S&P 500 index.
The recent boom in high income tax payments stands in sharp contrast to weaker signs in the broader economy. According to the LAO, the state is losing high-tech jobs as automation replaces the workforce, while unemployment persists and consumer activity remains flat.
Spurred in part by uncertainty surrounding recent shifts in federal policy, California is also projected to face persistent budget deficits in the coming years, with LAO estimates showing the deficit will increase to about $35 billion annually from 2027 to 2028. LAO said the increase in constitutional spending requirements would consume about $10 billion of the increased revenue.
The multitrillion-dollar tax and spending bill passed in July to secure President Donald Trump’s domestic policies will affect state health care, food assistance, higher education and some personal and corporate tax provisions, LAO said. However, many of these provisions will not take effect until after 2026, so their immediate budget impact will be small.
Petek said the state’s ability to address its budget deficit is limited after years of short-term solutions. California has already used most of the temporary tools at its disposal, including temporary spending cuts, borrowing measures and reserve draws. Reserves remain at about half their previous peak, and the LAO warns that the state is “clearly less prepared” for an economic downturn than in recent years.
Petek emphasized that the problem is structural, noting that the state’s budget is weak even though the economy has avoided recession and the stock market has risen. Given the fragile fiscal situation, LAO urged lawmakers to leverage continued spending cuts and revenue increases to structurally balance the budget.
The latest budget forecast comes after Gov. Gavin Newsom approved a $321 billion budget for the current fiscal year in June, eliminating an estimated $12 billion deficit.
Petek said the state would need to raise more than $30 billion more than expected in revenue this fiscal year to close an expected $18 billion deficit in the 2026-2027 fiscal year, citing constitutional school funding and reserve requirements.
Adler writes for Bloomberg.
