September 15, 2023
Bottom Line. While our most recent forecast indicates revenues could improve by about $9.5 billion, a roughly $10 billion deficit would remain for 2024-25.
This post provides an update to our formal May revenue outlook. This update reruns our May outlook forecasting models using newer revenue and economic data that has become available in recent months. We then compare those new estimates to 2023 Budget Act projections.
Latest Forecast Suggest Revenue Upside. Our latest forecast suggests there is upside potential for state revenues relative to the 2023 Budget Act projections. Specifically, our forecast is about $9.5 billion above the Budget Act across 2022-23 to 2024-25. That being said, this early in the fiscal year there is significant uncertainty about how much revenue the state ultimately will collect. It is entirely possible that revenues could end up $15 billion higher or lower than our estimate for 2023-24 and $30 billion higher or lower for 2024-25.
Less Revenue Deterioration Than Expected. The Budget Act assumed revenues would decline 8 percent in 2022-23 and an additional 2 percent in 2023-24. At the time of our May outlook, we warned that even more revenue deterioration was likely. As our latest forecast shows, however, recent data suggests the chances of further weakening have declined. This is due to improvement in some key indicators. Over the last few months, income tax withholding pulled out of the downward trend we had observed for the last year. Similarly, stock prices are up about 10 percent from where they were when we made our May outlook.
Risks Still Remain. Our May warning of downside risk to revenues stemmed, in part, from the observation that several historical indicators of forthcoming economic and revenue slowdowns were giving a warning signal. Those indicators continue to offer a warning today. The historical accuracy of these indicators, however, is not a guarantee they will be right this time. But it is too soon to write them off as inapplicable to our current situation. Our recession indicator, which combines data on unemployment, inflation, home sales, and bond markets, has been giving a warning signal for a little over a year. In comparison, in previous episodes downturns have come anywhere between 6 months and 2 years after the warning signal. Relatedly, another commonly cited indicator, the treasury bond yield curve, has offered a warning signal for about a year. This signal also has tended to precede downturns by anywhere between 6 months and 2 years.
$6 Billion Budget Bottom Line Impact. Higher revenue estimates usually result in higher spending (and vice versa). That’s because the state budget has two constitutional spending requirements that tend to increase when revenues are higher—these include spending on schools and community colleges (under Proposition 98) and reserve deposits and debt payments (under Proposition 2). Under these formulas, state spending requirements would be higher by nearly $4 billion across the three year budget window. This means that, on net, the revenue estimates reflected here would result in about a $6 billion improvement in the state budget bottom line.
Even with Revenue Improvement, State Still Faces a Deficit for 2024-25. The 2023-24 budget planned for a $14 billion deficit in 2024-25. Revenues will need to exceed expectations by well more than this amount for the budget to breakeven in that year. While the improvement in revenues estimated here result in a smaller deficit in 2024-25, even after accounting for this improvement, the state would still face a nearly $10 billion deficit in 2024-25 under current law.