AI-driven stock market boost sets California up for a balanced budget

The stock market surge propelled by artificial intelligence company gains has set California up for a balanced budget, but the state’s Legislative Analyst’s Office is also projecting outyear deficits hitting $30 billion by 2029.

Legislative Analyst Gabriel Petek and his staff provided their annual year-ahead outlook during a Wednesday press conference in which they define the state’s current economic situation and how revenues are shaping up ahead of the governor’s budget introduction in January.

California revenues are running ahead of the broader economy as the stock market earnings for high-net-worth residents have soared in recent months resulting in a similar bounce in income tax collections, according to the LAO report released Wednesday.

AI champ Nvidia and three other tech companies are driving a stock market surge resulting in California revenues coming out $7 billion above expectations set when the 2024-25 budget was approved in July.

The LAO report cautioned, however, that because the state’s revenue recovery is being driven by the stock market rally, it calls into question the sustainability of the growth in state coffers in the absence of improvements in the state’s larger economy.

“There is no capacity for new budget commitments,” according to the LAO report. “While the budget picture is fair for the upcoming year, our outlook suggests that the state faces double-digit operating deficits in years to come.”

In the near term, which Petek defined as the prior year, the current fiscal 2023-24 and the upcoming 2024-25 budgets, his office is projecting a $2 billion deficit, which could change after Gov. Gavin Newsom introduces his fiscal year 2025 budget in January.

“Revenues have been outperforming our state economy when you look at the budget window and for the upcoming budget year,” Petek said. “We describe the budget as being in fair shape. There is no new capacity for new budget commitments for the upcoming budget or in the out years” beyond the upcoming budget.

Though revenues have experienced a recent spike driven by stock market gains, the general California economy has been in a gradual slowdown for the past few years, Petek said.

“We have several pieces of evidence related to this, if you look across the state,” he said. 

Most of the new job creation can be attributed to growth in government jobs and unemployment has been ticking up, Petek said. 

“At this point, we have 25% more unemployed workers than we did during the strong labor markets of 2019 and 2022,” Petek said. “This is contributing to a lackluster broader economy.”

But increases in income at the higher level — largely through bonuses and capital gains — resulted in 17% growth in total pay at an annualized rate, among the sharpest growth rates on record, and income tax receipts followed suit, growing nearly 10% this year.

“Yet this pay bounce does not appear to be connected to the hourly wages and salaries that most workers receive,” according to the LAO report. “Estimates suggest pay from these traditional forms grew at an annualized rate of only a few percentage points in the first quarter.”

“Consumer spending (measured by inflation-adjusted retail sales and taxable sales) has continued to decline throughout 2024,” according to the LAO report.

The revenue gains are showing a disconnect with the broader state economy, said Petek, adding, the revenue forecast is now $7 billion higher for the 2024-25 budget than it was last year when the budget act was passed in July.

“The outlook ahead is a little more precarious, because revenues were driven up by the stock market and AI,” Petek said. “Nvidia accounts for a significant chunk of the improvement in the stock market.”

The LAO report attributes 10% of the state’s revenue growth to four companies: Google, Facebook, Apple and Nvidia.

“A potential pullback in Nvidia’s stock is part of the precariousness that Gabe mentioned,” said Brian Uhler, deputy legislative analyst. “If sentiment around Nvidia changes, we could see a reversal. It could be billions of dollars of revenue impact just from a stock market correction.”

The state is notoriously dependent on income tax revenue — particularly from high-net-worth taxpayers, who receive a significant portion of their income from capital gains. It creates a volatility where revenues surge and fall based on how the stock market is doing.

This year’s outlook is starkly different from a year ago when the state was projected to have a $45 billion deficit.

Lawmakers were able to close that deficit and pass a balanced budget, by implementing $15 billion in budget solutions, including $5.5 billion in temporary revenue increases and a $7 billion withdrawal from the state’s rainy-day fund.