California: A Financial Audit

The 60 Second Read

In June 2026, Governor Gavin Newsom signed a $351.7B state budget and said California will run a $0 deficit for the next two years. The plan spends roughly $23.2B more than the state expects to collect, a difference closed with reserve withdrawals and carried-over balances, and the annual math leaves out $302.4B in long-term obligations as of 2026. This Deep Dive audits how that position was built. California runs one of the worst operating balances of any large state because its largest revenue line moves with markets: personal income tax supplies about two-thirds of the $226.7B General Fund, the state's main operating account, and the top 1% of earners, roughly 176,000 returns, paid 37% of it in 2023. Their income rides capital gains, which hit a record $349B in 2021 and fell to $156B a year later. The rules that spend the money accumulated across nine decades and have never been reversed, so most of the budget is locked before a downturn starts and cuts land on the small unprotected share. The state's own analyst projects recurring shortfalls near $35B a year starting in 2027-28, and the $35.2B held in reserves covers roughly one of those years.

Key Takeaways

• Takeaway 01

  California is losing its tax base

  Out of 18M tax filers, 176,000 returns, under 1%, paid 37% of 2023 personal income tax, and that base is shrinking: about 103,000 millionaires have left since 2018, and in 2023 alone California lost a net 200,547 people and $11.9B in adjusted gross income to other states, with filers reporting $200,000 or more taking 58% of the income lost.

• Takeaway 02

  Revenue rides the market

  California taxes capital gains as ordinary income at rates up to 13.3%, the highest in the nation, so its tax take swings with asset prices. Realizations climbed 72% from 2020 to 2021, then fell 55% in 2022, and the top 1%'s tax liability fell 40% with them in a year when the state economy was flat.

• Takeaway 03

  Every crisis added a lock

  A lock is a budget rule written in a crisis and never undone. The Depression brought the sales tax in 1933 and the income tax in 1935. Proposition 13 capped property tax at 1% in 1978 and pushed school funding onto the state, and Proposition 98 made that funding a constitutional minimum, roughly 40% of the General Fund, in 1988. Proposition 2 followed in 2014, requiring annual rainy-day reserve deposits.

• Takeaway 04

  Spending rose as outcomes worsened

  California spent about $24B across more than 30 homelessness and housing affordability programs from 2019 to 2023, and the homeless count rose 20% to 181,399. In the schools, per-student spending rose from about $14,500 in 2003 to roughly $25,900 in 2024, inflation adjusted, while scores on the National Assessment of Educational Progress stayed below the U.S. average throughout.

• Takeaway 05

  Protected spending narrows the options

  California cannot file for bankruptcy, because federal law has no chapter for states. Much of the budget is also hard to cut: the constitution guarantees minimum funding for schools and community colleges, and debt service, under 4 cents of every General Fund dollar, sits next in line, so stress lands on what remains. From 2008 to 2011 the state furloughed workers and covered bills with $2.6B in IOUs while paying every bondholder in full.

• Takeaway 06

  A billionaire tax and a wildfire backstop

  Proposition 40 would levy a one-time 5% tax on the net worth of roughly 200 billionaire residents. Revenue models disagree, from $40B to $100B, and Polymarket prices passage at 26%. The base can move first: Alphabet's founders left California ahead of the tax's January 1, 2026 residency date.

  The FAIR Plan, the state's insurer of last resort, holds $768.4B in wildfire exposure across approximately 684,000 policies, a count up 152% since 2022. Its losses are billed to the state's insurers, which can recover part through temporary fees on their policyholders, and that concentration affects property values and local property tax revenue.

Why This Matters

California's output ranks fifth in the world, but its budget flexibility is narrowing. Four claims the state cannot easily cut, schools and community colleges, Medi-Cal, pensions, and debt service, take roughly $150B of the $226.7B General Fund, and only Medi-Cal grows faster than revenue. Versions of this problem are emerging worldwide as governments confront rising healthcare costs, pension promises, mobile wealth, and pressure to maintain public services. California reaches the tension sooner because its wealth and its commitments are unusually concentrated: a small group of taxpayers funds the budget, and their income rises and falls with asset markets. A market downturn can reduce revenue long before the state can reduce its commitments. California tests how long volatile revenue can carry obligations that cannot adjust at the same speed, and the vote on Proposition 40 on November 3, 2026 is the first reading for governments beyond Sacramento.

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