California’s Rainy Day Fund and Other Budget Reserves Overview

Introduction

California has several state budget reserves. These reserves help to maintain essential public services — like education, health care, and child care — when revenues fall short, such as during recessions. Reserves aren’t for everyday spending, but rather a financial safety net for the state.

This report describes California’s state budget reserves, explains how funds can be accessed and used, and discusses proposals to reshape these reserves that have been floated in recent years. For more information about California’s reserve accounts, see the Budget Center’s companion resources, including this video — California’s State Budget Reserves Explained — and this fact sheet — 5 Key Questions About California’s State Budget Reserves.

Budget Stabilization Account (BSA): California’s Largest Reserve

The BSA is California’s largest state budget reserve. Deposits into and withdrawals from this “rainy day fund” are based on complex rules that were added to the state Constitution by Proposition 2 of 2014.¹Prop. 2 was placed on the November 2014 statewide ballot by the Legislature; voters approved the measure by a more than 2-to-1 margin. Prop. 2’s rules are found in the California Constitution (Article XVI, Sections 20 to 22). Key rules include the following:

An annual deposit is required. Prop. 2 requires that 1.5% of General Fund revenues be set aside every year. Until 2029-30 half of these revenues must be deposited into the BSA and the other half must be used to pay down certain state debts.²Revenues that are set aside for paying down state debts may be used for several types of debt, including reducing unfunded liabilities associated with state-level pension plans and prefunding other retirement benefits, such as retiree health care. Beginning in 2030-31, the entire amount must be deposited into the BSA, although state leaders will have the option of redirecting up to one-half of each year’s deposit to pay down debts.

In some years, the state must set aside additional General Fund revenues. This occurs in years when estimated General Fund revenues that come from personal income taxes on capital gains exceed 8% of total General Fund proceeds of taxes.³A capital gain is the increase in the value of an asset — like stock market shares — between the date of purchase and the date of sale. This increase represents income to the asset holder and is subject to the personal income tax in California. The share of these “excess” capital gains revenues that is not owed to K-12 schools and community colleges under the state’s Prop. 98 funding guarantee must be used for BSA deposits and debt repayments, following the same requirements as the mandatory 1.5% deposit.  Since Prop. 2 was enacted, capital gains tax revenues have exceeded the 8% threshold in most years, but could fall below the threshold in years when there are downturns in the stock market.

State leaders may also make discretionary deposits. In addition to the mandatory annual deposits required by Prop. 2, policymakers have the option of saving additional, discretionary revenue in the BSA.

The required annual deposit may be reduced or suspended in the event of a “budget emergency. If the governor declares a budget emergency, the state may reduce or suspend the required BSA deposit with a majority vote of each house of the Legislature.⁴In contrast, the portion of General Fund revenues that is required to be used for debt payments cannot be reduced or suspended under any circumstances. Prop. 2 defines a budget emergency as a situation where:

• Conditions of disaster or extreme peril are present⁵A budget emergency that is declared in response to a disaster or extreme peril must meet the definition provided in Article XIII B, Section 3(c)(2) of the state Constitution. This section refers to the existence of “conditions of disaster or of extreme peril to the safety of persons and property within the State, or parts thereof” and defines these conditions as being “caused by such conditions as attack or probable or imminent attack by an enemy of the United States, fire, flood, drought, storm, civil disorder, earthquake, or volcanic eruption.”; or
• The state has insufficient resources to maintain General Fund expenditures at the highest level of spending in the three most recent fiscal years, adjusted for state population growth and the change in the cost of living.⁶General Fund expenditures for the prior three fiscal years would be based on the level of spending “estimated at the time of enactment” of the budget bill for each fiscal year. The change in the “cost of living” would be measured using the California Consumer Price Index.

BSA funds may be withdrawn in the event of a budget emergency, but the entire balance cannot be removed at once. If the governor declares a budget emergency and the Legislature agrees with a majority vote of each house, funds may be taken out of the BSA.⁷The BSA balance may be reduced for another reason unrelated to a budget emergency. Specifically, Prop. 2 requires revisions to prior calculations of “excess” capital gains revenues — once in each of the two subsequent years — as updated revenue estimates become available. If a revision of “excess” capital gains revenues determines that a prior-year deposit to the BSA was greater than required, then the amount of funds equal to the over-deposit must be withdrawn from the reserve and returned to the General Fund. Alternatively, if a prior-year deposit was smaller than required, then funds must be added to the BSA to make up the difference. This after-the-fact “true-up” process  does not apply to the portion of “excess” capital gains revenues that is used to pay down state debts each year. The true-up process also does not apply to the 1.5% of General Fund revenues that are required to be set aside each year. However, the entire balance cannot be removed immediately. Only the amount needed to address the budget emergency may be withdrawn, subject to the additional limitation that a withdrawal may not exceed 50% of the BSA balance in the first year of a budget emergency. In the second consecutive year of a budget emergency, all of the funds remaining in the BSA may be withdrawn.

Funds that are taken out of the BSA may go toward any purpose determined by the Legislature. For example, these dollars could be used for health care services, subsidized child care for working families, cash assistance for people with low incomes, K-12 schools, and any number of other public services and systems.

Funds in the BSA cannot exceed 10% of General Fund tax revenues. Prop. 2 caps the balance of the BSA. Once the balance — excluding any discretionary deposits — reaches 10% of General Fund tax revenues, any revenue that would otherwise have been required to go into the reserve must be instead spent on infrastructure, which includes housing. Prior to 2026, the BSA balance reached the cap twice — in 2022-23 and 2023-24 — but then dropped below the cap as state leaders withdrew funds in some years to address budget shortfalls.

Public School System Stabilization Account (PSSSA): The Reserve for K-12 Schools & Community Colleges

Prop. 2 of 2014 also established the PSSSA, the state’s budget reserve for California’s K-12 schools and community colleges. Prop. 2 does not require an annual deposit into this reserve. Moreover, Prop. 2 restricts the circumstances under which transfers to the PSSSA can occur. For a PSSSA deposit to be required, all of the following conditions must be met:

• General Fund revenues that come from personal income taxes on capital gains are relatively strong;⁸Specifically, capital gains revenues must exceed 8% of total General Fund proceeds of taxes.
• Growth in General Fund revenues leads to relatively strong growth in the state’s annual minimum funding guarantee for K-12 schools and community colleges;⁹A PSSSA deposit can only occur in so-called “Test 1” years under the state’s Prop. 98 minimum funding guarantee for K-12 schools and community colleges. Test 1, which guarantees K-14 education a percentage of General Fund revenues. However, even in certain Test 1 years, the amount of growth in state per capita personal income from the prior year can prevent a deposit to the PSSSA. and
• The Legislature does not suspend the annual K-14 education minimum funding guarantee.

Even under these restricted circumstances, Prop. 2 limits the size of the deposit to the schools reserve when such a deposit is required.¹⁰For example, Prop. 2 specifies that transfers to the PSSSA may not exceed the difference between the Test 1 funding level under Prop. 98 and the “Test 2” funding level, which is determined by year-to-year growth in state per capita personal income. Prop. 2 also limits the size of the deposits to the PSSSA by prioritizing funding for K-14 education cost-of-living adjustments over deposits to the PSSSA.

Deposits to the PSSSA may be reduced or suspended in the event of a budget emergency under the same rules that govern reductions or suspensions of deposits to the BSA (see the prior section of this report). Similarly, funds may be withdrawn from the schools reserve if the governor declares a budget emergency and the Legislature agrees with a majority vote of each house.¹¹Prop. 2 requires funds to be withdrawn from the PSSSA, even without a declaration of a budget emergency, when prior-year PSSSA deposits were greater than required. Prop. 2 also requires a withdrawal of funds from the PSSSA in any year when the Prop. 98 minimum funding guarantee is less than the prior-year Prop. 98 funding level, adjusted for changes in student attendance and the cost of living. In this case, the required withdrawal would be limited to the amount needed to reach the prior year’s funding level. Prop. 2 defines change in “cost of living” as the higher of 1) the percent change in California per capita personal income from the preceding year or 2) the cost-of-living adjustment applied to school district and community college district general purpose apportionments.

In contrast to the rules governing the withdrawal of funds from the BSA, all of the PSSSA funds may be withdrawn in one year. Moreover, funds withdrawn from the PSSSA must be used to support K-12 schools and community colleges.

Safety Net Reserve: Funds to Protect the Medi-Cal and CalWORKs Programs

The Safety Net Reserve was created in 2018 to set aside funds to help cover the costs of two programs that often see increases in enrollment during recessions: Medi-Cal and California Work Opportunity and Responsibility to Kids (CalWORKs).¹²The Safety Net Fund is authorized in California Welfare and Institutions Code, Section 11011. Both of these programs serve Californians with low incomes — with Medi-Cal delivering health coverage, and CalWORKs providing modest cash assistance to families with children. During economic downturns, more people become unemployed and temporarily rely on these programs to cover their basic needs, increasing state costs.

The Safety Net Reserve is not a constitutional reserve, so there are no binding requirements governing deposits or withdrawals. This means that funds can be transferred into and withdrawn from the reserve at the discretion of the Legislature. In fact, state policymakers voluntarily deposited $900 million in the Safety Net Reserve before draining all of those funds in 2024 to help address a $55 billion state budget problem.

Moreover, while state law specifies that the funds are to be used only for Medi-Cal and CalWORKs costs during economic downturns, state policymakers could decide to modify this language and use the funds for other purposes. However, in establishing this reserve, policymakers clearly recognized the need to protect critical services for Californians with low incomes from budget cuts — cuts that would undermine Medi-Cal and CalWORKs at the very time that these programs are needed most.

Special Fund for Economic Uncertainties (SFEU): The Discretionary Reserve

The SFEU is the state’s discretionary General Fund budget reserve, meaning policymakers have a great deal of latitude in spending the funds in the reserve.¹³The SFEU (originally called the “Reserve for Economic Uncertainties”) was created through the 1980-81 Budget Act and is authorized in California Government Code, Section 16418. The amount of money in the SFEU is equal to the difference between General Fund resources and General Fund spending in a given fiscal year.¹⁴Specifically, the SFEU balance is equal to the General Fund balance carried over from the prior year, plus revenues and transfers, minus expenditures and encumbrances. Legislative Analyst’s Office, The 2020-21 Budget: Structuring the Budget (February 10, 2020), p. 11.

The SFEU acts as a buffer against unanticipated revenue shortfalls or spending increases. Due to California’s constitutional balanced-budget requirement, which requires the state to enact a budget in which spending does not exceed available resources, the projected SFEU balance cannot be less than zero at the time the annual budget is adopted. However, if state revenues come in lower than projected and/or spending unexpectedly rises, the SFEU balance will decline, and may become negative as spending begins to exceed revenues.

The Legislature can appropriate funds from the SFEU at any time and for any purpose. Additionally, in the event of a disaster, the governor can allocate funds from the SFEU without the prior approval of the Legislature. Specifically, when the governor declares a state of emergency, the Department of Finance (DOF) can transfer funds from the SFEU into a subaccount called the Disaster Response-Emergency Operations Account (DREOA).¹⁵The amount that may be transferred to the DREOA is limited to the amount necessary to cover disaster-related claims that exceed the available balance in the account. California Government Code, Section 8690.6(d). These funds are allocated to state agencies for costs that are “immediate and necessary to deal with an ongoing or emerging crisis.”¹⁶The DOF is required to notify the Joint Legislative Budget Committee as well as the fiscal committees in each house before any funds may be allocated from the SFEU in response to a disaster. Funds in the DREOA can be spent for disaster response costs that occur within 120 days of the Governor’s emergency proclamation. The DOF can extend this time period in up to 120-day increments upon notifying the Legislature, subject to certain limitations. California Government Code, Section 8690.6.

Projected Surplus Temporary Holding Account: A Place to Set Aside Anticipated Surplus Revenues

State leaders created the Projected Surplus Temporary Holding Account in 2024. This account gives policymakers a place to temporarily set aside anticipated surplus revenues, “ensuring that funds are only spent once they are realized.”¹⁷Office of Governor Gavin Newsom, press release (September 30, 2024).

State leaders have broad authority to determine whether or how to use this holding account. The only requirement is that revenues that go into the account cannot remain there for longer than one year. If state revenues materialize as projected, the revenues in the account may be spent for any purpose or transferred back to the General Fund for future use.¹⁸California Government Code, Section 16418.7.

This holding account is a “pilot budgeting project” that expires at the end of 2030, although state leaders could approve an extension as well as potentially modify the rules.

What’s Next for California’s State Budget Reserves?

The rules that govern California’s budget reserves can be amended by voters or state policymakers. Changing the reserve rules established by Prop. 2 (2014) would require voters to approve a constitutional amendment.¹⁹Amendments can be placed on a statewide ballot through a citizens initiative or by the Legislature. Other reserve rules can be changed by state policymakers without the need for voter approval.

In recent years, state policymakers and others have advanced proposals to revise California’s reserve policies, although none have moved beyond the conceptual stage. Common proposals for changing state reserve policies include the following:

Changes to the rainy day fund or the Gann Limit would require amending the state Constitution. This means that voters would have the last word on the most significant proposals to modify California’s state budget reserves.