The Public Policy Institute of California (PPIC) estimates there is a 75 percent probability that the state’s next recession will result in a severe financial crisis.  

PPIC was established 25 years ago by William Hewlett, co-founder of Hewlett-Packard, to provide nonpartisan research regarding the state’s population, economy, governance and public finance issue. Responding to Gov. Gavin Newsome’s May Revised $147 billion “California for All” General Fund Budget, PPIC’s independent analysis warns:

“We estimate that a relatively mild recession would produce a drop in total General Fund revenue between $28 billion and $36 billion spread over three years. Should the state experience a moderate recession, revenue declines would range between $69 billion and $100 billion over four years. And finally, in a severe recession declines would be even deeper, between $173 billion and $185 billion over five years”

California has a very volatile revenue stream as evidenced by the severe last recession that began in 2008 and persisted for five years saw state revenues fall by an average of 26 percent, or about $37 billion annually. Revenues in the mild three year “Dot-Com Bust” suffered a 6 percent annual decline. The two prior recessions are considered moderate, with the 5-year early 1990s “Slump” experiencing a 14 percent annual revenue declines and the early 1980s “Oil Shock” seeing 12 percent annual declines.

PPIC highlights that as California General Fund spending grew at over twice the rate of inflation, the source of state budget revenue “shifted dramatically over the past 60 years.” In 1960, state revenues were broadly distributed with sales and use taxes accounting for 55 percent of revenue and PIT adding about 20 percent. But the 2019-2020 General Fund relies on personal income tax for over 70 percent of revenues.

California’s dependence on PIT is the result of regularly steepening the progressive income tax rate structure that increases as taxpayer’s income rises. In 2016, the top 1 percent of California income earners accounted for just 23 percent of reported state adjusted gross incomes but paid 46 percent of all California personal income taxes.

Any upward spikes or downward plunges in income experienced by this wealthy subsection of Californians population is directly magnifies surpluses and deficits in the state’s total revenue. The biggest annual income variability for the 1 percent comes from U.S. stock market capital gains or losses, especially from Silicon Valley tech stocks. In the last recession, capital gains taxes fell by 80 percent.

California has reserve funds, but state law mandates the legislature and the governor must produce a balanced budget. Although spending cuts were enacted during the past four recessions, a variety of constitutional constraints, federal regulations, and court decisions have increasingly restricted the number of items that can legally be cut.

As a result of California slashing and deferring spending in prior recessions, voter initiatives increased the share of spending supported by special funds, such as gasoline and diesel taxes that goes into a lockbox to only pay for road building and maintenance.

California has also been able to balance its budgets during recessions by engaging in short-term borrowing from certain special funds and convincing voters in 2004 to pass Proposition 57 that approved borrowing $15 billion in Economic Recovery Bonds from investors. But PPIC revealed it “took $19 billion and 11 years to pay off the debt.”

PPIC states that California engaged in highly questionable small dollar actions in the last recession that included shifting state employee pay dates, accelerated taxpayer withholding dates, and moved a quarterly public pension payment from June to July.

The U.S. federal government’s share of California state spending spiked during the last recession from under 30 percent in 2009 to about 45 percent in 2010 and continues to hover at about 35 percent. But with the national debt more than doubling over the last decade, California is at risk from efforts to cut unsustainable federal spending. 

PPIC predicts that “California is likely to experience a recession in the near future -- and given the state’s volatile tax structure, even a mild economic downturn will have a significant fiscal impact.” With only one of the last four recession considered “mild,” there is a high probability the next California recession will cause a financial crisis.