[Video] State Budget Preview: Understanding the Process and What’s to Come in 2025

In late June, Governor Newsom and state leaders reached a deal on the 2024-25 California state budget. Confronted with a substantial shortfall, state leaders negotiated a budget package that presents a mixed bag for California families. Policymakers managed to protect many essential programs, but some financial maneuvers and the continued resistance to significantly raise revenues to help all Californians thrive may hinder progress in future years.

The June budget package rejects many harmful cuts to critical programs initially proposed by Governor Newsom in January and May. State leaders protected many essential programs that Californians rely on, including by drawing on the state’s reserves and delaying some program expansions. However, the budget also relies heavily on borrowing from future budgets, commits a higher percentage of future revenue growth to schools, and only temporarily increases revenues. These decisions could compromise the state’s ability to sustain core programs and stall much-needed investments in the coming years if revenue conditions do not improve.

This analysis highlights key components of the June budget package and examines how it protects — or misses opportunities to enhance — services that aim to improve the well-being of Californians with low incomes, Californians of color, women, immigrants, and others historically excluded from sharing in the state’s wealth.

How did state leaders close the budget shortfall?

State leaders closed a roughly $47 billion General Fund shortfall across the three-year “budget window” (fiscal years 2022-23 through 2024-25) using a broad array of budget tools. The “solutions” in the 2024-25 budget package include:

• $16 billion in spending reductions.
• $13.6 billion from a combination of additional revenue (which is mostly temporary) and internal borrowing from state special funds.
• $6 billion in fund shifts, which transfer certain costs from the General Fund to other state funds.
• Nearly $6 billion in withdrawals from two reserves: the Budget Stabilization Account (also known as the rainy day fund) and the Safety Net Reserve.
• $3.1 billion in funding delays and pauses. This includes delaying, for two years, an expansion of food assistance to undocumented Californians as well as postponing, for six months, a wage increase for people who provide services to Californians with intellectual and developmental disabilities.
• $2.1 billion in deferrals, which postpone certain payments to later years. This includes shifting one month of state employee payroll costs from June 2025 (the last month of the 2024-25 fiscal year) to July 2025 (the first month of the 2025-26 fiscal year).

What happened to Prop. 98? Was school funding protected?

The budget agreement protects funding for Transitional Kindergarten, K-12 schools, and community colleges (TK-14 education) despite revenue challenges. Estimates of the Proposition 98 minimum funding guarantee for TK-14 education are updated to reflect two major budget actions: 1) the adoption of a proposal to “accrue” some funding from 2022-23 to future years and 2) the suspension of the Prop. 98 guarantee in 2023-24. These actions increase the Prop. 98 minimum funding levels across the 2022-23 to 2024-25 “budget window” and also ensure funding growth beyond the three-year window.

Key details that further explain the Prop. 98-related budget actions are outlined below.

Overall, decisions on the minimum guarantee push large spending obligations to future budget years that add pressure to the non-Prop. 98 side of the budget. First, while the Prop. 98 suspension provides relief in 2023-24, TK-14 education will get a higher percentage of future revenue growth than normal until the maintenance factor is paid. In other words, a larger portion of General Fund revenue growth will go toward the maintenance factor obligation, leaving less funding for the non-Prop. 98 side of the budget.

Second, shifting $6.2 billion in TK-14 education spending to the non-Prop. 98 side of the budget starting in 2026-27 will reduce funding available for other critical needs, such as food security, child care, housing, and other programs that help families make ends meet.

What revenue solutions does the budget include?

One of the budget solutions is a temporary increase in state revenues, which helps to avoid more harmful service cuts, but will also lead to decreased revenues in later years. 

Specifically, for tax years 2024 through 2026, the budget agreement 1) limits the tax credits businesses can use to $5 million and 2) suspends tax deductions for prior-year losses (“net operating losses” or NOLs) for businesses with at least $1 million in profits.  These provisions are estimated to increase revenues by $5.95 billion in 2024-25, $5.5 billion in 2025-26, and $3.4 billion in 2026-27.

However, the budget agreement also includes provisions to allow businesses impacted by these limitations to fully recoup the lost tax benefits in later years, reducing state revenues for several years beginning in 2027-28 by as much as a few billion dollars in some years. Notably, businesses subject to tax credit limitations will be allowed to receive the credits above the $5 million annual limit as a refund — spread across five years — after the limitation period ends. In other words, if the excess credits claimed in future years exceed a business’ tax bill, it can receive the difference in cash. Historically, business tax credits have generally not been refundable.

Additionally, if the governor’s administration determines that the budget can be balanced in 2025-26 and/or 2026-27 without the additional revenue from the temporary business credit limitation and NOL suspension, policymakers can specify in the Budget Act that these provisions do not apply for that year.

Finally, the budget contains some smaller, ongoing tax policy changes impacting businesses and investors. These changes will increase revenues by a few hundred million dollars ongoing, including eliminating tax subsidies that specifically benefit oil and gas companies.

state budget terms defined

What’s the difference between a trailer bill and policy bill? A deficit and an operating deficit? And what exactly is a “Budget Bill Jr.?” Our Glossary of State Budget Terms answers that and more.

View Glossary

How did California’s Rainy Day Fund and other reserves help cover the shortfall?

California has several reserve accounts that set aside funds intended to be used when economic conditions worsen and state revenues decline. These include:

• The Budget Stabilization Account (BSA), commonly referred to as the Rainy Day Fund. This is the state’s largest reserve and its funds may be used for any purpose.
• The Public School System Stabilization Account (PSSSA), which is also known as the Prop. 98 reserve. Funds withdrawn from this account must be used to support K-12 schools and community colleges.
• The Safety Net Reserve Fund. Funds withdrawn from this account are intended to maintain existing CalWORKs and Medi-Cal benefits and services during an economic downturn.

The budget agreement rejects many harmful cuts to critical services in part by drawing on state reserves. However, the budget takes an imbalanced approach, taking around half the funds in the BSA, but draining all funds from the Safety Net Reserve, leaving no dedicated funds to help support CalWORKs and Medi-Cal in future years.

Specifically, the budget agreement withdraws $4.9 billion from the BSA in 2024-25, and assumes an additional BSA withdrawal of $7.1 billion in 2025-26, which would leave about $10.5 billion available for future years. In contrast, the budget withdraws all $900 million from the Safety Net Reserve in 2024-25. The budget also takes all $8.4 billion from the PSSSA in 2023-24, but makes a $1.1 billion discretionary deposit to that account in 2024-25.

As required by the state Constitution, the governor signed a proclamation on June 26 declaring a budget emergency in order to allow the withdrawal of funds from the BSA. The governor did not need to declare a budget emergency to withdraw funds from the PSSSA or the Safety Net Reserve.

The budget includes a big cut to “state operations” spending — what does this mean and is the cut achievable?

The budget agreement adopted the governor’s plan to permanently reduce “state operations” spending by around $3 billion starting in 2024-25. This funding supports the basic activities of state government. Savings are to be achieved through two actions implemented by the Department of Finance (DOF) in collaboration with state departments:

These reductions would equal roughly 10% of total General Fund state operations spending. However, it’s questionable whether $1 of every $10 in state operations costs could be permanently eliminated through efficiencies and other measures without eroding state services. Moreover, in some departments, most state operations spending supports employee salaries and benefits — which cannot be unilaterally cut to generate state savings. As a result, some departments may have relatively little state operations funding available to cut to help meet the $3 billion statewide reduction target.

Furthermore, the governor’s administration reported in budget hearings that 24-hour operations would be exempt from the reductions. This includes, for example, the state prison system, which is overseen by the California Department of Corrections and Rehabilitation (CDCR). The budget agreement assumes that CDCR will account for nearly $400 million of the $3 billion in state operations reductions. CDCR could easily achieve these savings by closing state prisons. However, the governor refuses to plan for more prison closures, and it’s uncertain whether CDCR will be able to cut roughly $400 million from its operating budget without downsizing the state prison system.

Overall, it’s highly unlikely that the projected $3 billion in statewide savings will fully materialize, according to the Legislative Analyst’s Office. Unrealized savings would need to be addressed during the 2025-26 budget process and would “add to any fiscal challenges” the state is facing that year. In the meantime, DOF will update the Legislature in October and again in January on any progress made toward reducing state operations spending as envisioned in the budget agreement.

What changes were proposed to the MCO tax, and how does it help support Medi-Cal services for Californians?

Managed Care Organizations (MCOs), also known as health insurance plans, are responsible for managing health care services as a way to manage cost, utilization, and quality. States, with federal approval, can impose a tax on MCOs to reduce — or offset — state Medicaid spending and draw down additional federal funds. The MCO tax is a charge based on enrollment in Medi-Cal managed care plans and private health insurance plans. 

In 2023, California renewed its MCO tax with federal approval, effective from April 1, 2023 to December 31, 2026. State leaders planned to use the roughly $19.4 billion in tax revenue to offset General Fund spending on Medi-Cal and support provider rate increases to improve access to health care services. Currently, many Californians face difficulties accessing Medi-Cal health care services because local providers oftentimes do not accept Medi-Cal patients.

This year, state leaders proposed amendments to increase the tax, generating a net fiscal benefit of $24.3 billion total, given the budget shortfall. These amendments require federal approval.

The 2024-25 budget agreement outlines a plan to use revenue from the MCO tax to support the Medi-Cal program as well as rate increases for health providers, with some investments delayed to 2026. Budget allocations include:

• $6.9 billion in 2024-25, $6.6 billion in 2025-26, and $5.0 billion in 2026-27 to help maintain existing services in the Medi-Cal program; and
• $133 million in 2024-25, $728 million in 2025-26, and $1.2 billion in 2026-27 for new targeted Medi-Cal provider rate increases and investments.

However, the MCO tax spending plan would be overturned if voters approve a ballot initiative this November that would make the tax permanent and require the state to use these dollars solely for certain provider rate increases.

What was the overall impact of the budget on critical programs and services?

The budget agreement rejects many harmful cuts to critical programs proposed by Governor Newsom in January and May. However, despite growing needs, the agreement includes considerable cuts to housing and safety net programs and makes no significant ongoing investments in critical programs and services.

Safety Net

Housing & Homelessness

Child Care

Health

Domestic Violence

What changes to the 2024-25 budget package might happen in August?

Budget decisions happen throughout the year, not just from January to June. In August, for example, the governor and legislative leaders will revisit the 2024-25 budget package and make changes by passing additional trailer bills and, potentially, amending the 2024 Budget Act.

In fact, the Legislature is expected to soon consider proposals that aim to smooth budget volatility by requiring the state to set aside more revenue in the future. State leaders have indicated that this plan includes two components:

• Require a portion of a projected budget surplus to be placed in a “temporary holding account” to be allocated in future years if anticipated revenues are actually realized; and
• Ask voters to 1) amend the state Constitution to increase the maximum size of the Budget Stabilization Account (“rainy day fund”) — which is currently capped at 10% of General Fund tax proceeds — and 2) exclude deposits to state reserve funds from the state spending limit created by Proposition 4 in 1979 (the “Gann Limit”).

These proposals involve trade-offs. Expanding reserves would provide more budget resilience during revenue downturns and help policymakers avoid making harmful cuts. But some critical needs of Californians may remain unmet if additional resources must be saved instead of being immediately invested in California’s communities.

What more should state leaders do next year and beyond to create an equitable California?

For every Californian — from different races, backgrounds, and places — to thrive and share in the state’s economic and social life, strategic policy choices must be made. To a large extent, these choices are made through the state budget process. State leaders should set funding and policy priorities that help all Californians share in the wealth that they help create while also ensuring that the state’s tax dollars are invested in the areas of greatest need.

To achieve these goals — and move toward a more equitable California — bold approaches are needed across a broad range of public services and systems. For example, state leaders should: