California faces a looming $18 billion budget gap, even as AI-powered tax gains mask deeper budget pressures.
The impartial one Legislative Analyst’s Office warns that AI-driven tax windfalls could mask serious fiscal risks.
In its November 2025 budget outlook, the agency said the state’s economy remains under pressure and recent revenue strength may not last.
Also read: Trump’s peace plan for Ukraine receives support from Moscow, skepticism across Europe and the US
Economy and tax collections
The agency noted that both the California and U.S. economies are facing major headwinds.
Borrowing costs remain high and new import tariffs are putting pressure on the budgets of companies and consumers.
Despite weak hiring and flat sales tax growth, the state’s income tax collections have soared in recent months.
The LAO attributes that strength to the exuberance around artificial intelligence, which has pushed tech sector compensation and stock market gains to new highs.
Revenue prospects and risk
The report explains that while the revenue forecast includes a modest upgrade based on strong income tax trends, it also includes caution.
The LAO assumes that some of the gains are related to a potentially overheated stock market and is therefore dialing back the momentum from 2026-2027. That hedge, the report says, gives the state some protection if markets turn.
The budget gap is widening
According to current LAO estimates, California now faces a budget deficit of nearly $18 billion in 2026-2027 – about $5 billion more than previously expected.
The increase results in part from mandated spending growth under Proposition 98 (1988) and Proposition 2 (2014), which absorb nearly all of the revenue improvements, as well as $6 billion in unexpected cost growth in other programs.
Structural shortage threat
The outlook warns that the state could face annual structural deficits of about $35 billion from 2027-28 if spending continues to exceed revenue.
The LAO urges lawmakers to implement continued spending cuts and/or revenue increases now, as the state has already used many of its emergency tools and built-in resilience is low.
Read next:
Image: Shutterstock/esfera
#California #faces #billion #budget #gap #tax #windfall #California #faces #billion #budget #gap #tax #windfalls