Governor Newsom released his 2026-2027 budget proposal Friday morning. The budget shows revenues of $248.3 billion. But not everyone agrees on this projection, especially when it comes to AI’s actions.
The Office of the Legislative Analyst, a nonpartisan legislative advisory group, in its November fiscal outlook projected revenues that were about $36 billion below the governor’s revenue projections.
So why is LAO less optimistic?
“There are some signs that the stock market is overvalued at this point,” said Gabriel Petek, head of the Legislative Analyst’s Office. “Even though we revised our revenue upwards…if you just looked at the stock market trends, it would be even higher. »
Newsom reinforced the $248.3 billion figure in his State of the State address, but he did not address the risk outlined in the proposed budget and by California Finance Director Joe Stephenshaw.
“The biggest difference in the type of factors in the forecast, actually, is that LAO has built a significant risk of a stock market downturn into its forecast,” Stephenshaw said. “We haven’t done that. We don’t factor slowdowns, recessions into our forecasts.”
Petek, however, said his office was simply advising lawmakers to take market volatility into account.
“We do not anticipate [a downturn] necessarily,” Petek said. “It is prudent not to assume that the market will remain as it was last year.”
While the stock market is booming on the rise of AI technology companies, the governor’s revenue forecast hinges on continued growth in the tech sector.
“Even though there is underlying value in these new technologies, what we’ve seen in the past is that the market can kind of get ahead of this and create kind of a bubble situation,” Petek said. “The Internet is obviously a very useful tool. But at the time it appeared, there was a certain exuberance in the markets.”
He said his office also found evidence that the current market was overvalued.
“Investors are taking riskier actions, like borrowing on margin to buy stocks,” Petek said. “We’ve seen these kinds of indicators line up like this before, and it tends to happen around the time the stock market is peaking.”
According to FINRA, by a nonprofit, self-regulated investor protection agency, margin debt, or the amount of money investors borrowed to buy stocks, reached a record high of $1.21 trillion.
In the past, when this activity peaked, this peak preceded a major decline: in 2000 with the dotcom bubble, in 2008 with the housing crisis, and a more recent decline in 2022 also preceded the bursting of a massive cryptocurrency bubble.
This is the first time in history that margin debt exceeds $1,000 billion.
“A market downturn is one of the key risks we see to our revenue forecast,” Stephenshaw said in his presentation. “We think it is important to wait and see how things develop over the next few months and then, at the May review, take appropriate action.”
When will the bubble burst?
Partnership on AI is a nonprofit partnership bringing together representatives from companies like Open AI, Microsoft, and Meta, as well as media and education nonprofits like AP and the American Psychological Association.
Rebecca Finlay, CEO of Partnership on AI, said technology development can seem endless, but that’s not always the case.
“It’s called Amara’s Law…the idea is that we just tend to overestimate the short-term impacts of technological development,” Finlay said. “But we underestimate the long-term impacts.”
She said that while we may be bad at making predictions, one of the most common examples of Amara’s Law is the birth of the internet with the dotcom bubble.
“We had the hype that led to the dotcom bubble and then it was a bubble,” Finlay said. “Now the Internet is an integral part of every business and everything we do… The long term has led to strong economic growth. »
The California Budget & Policy Center is a nonpartisan, nonprofit research and analysis organization that helps guide policymakers in California state government. Alissa Anderson, policy director at the Center, said it’s common to see a difference between the governor’s office and the LAO.
“I think the Legislative Analyst’s Office and the Governor’s Office recognize that there is a significant risk,” Anderson said. “This current increase in revenue, which is largely coming from technology, likely reflects an AI bubble that may burst.”
Anderson said this recent increase in tech industry revenue reflects deep and growing inequities in California.
“A small number of wealthy investors are doing exceptionally well,” Anderson said. “As millions of Californians struggle with rising costs, inequities in our state are stark.”
She said California’s corporate tax has legal loopholes that allow nearly half of profitable businesses to pay only the minimum $800 in state taxes.
“Collectively, they had almost $12 billion in state taxes,” Anderson said. “Closing these gaps is a common-sense way to…generate the long-term revenue California needs to strengthen the economic security of everyone in our state.”
Anderson also said the federal bill HR 1, also known as the “Big Beautiful Bill,” will have a significant impact on the budget that the governor’s projection does not take into account. The cuts to medical and food assistance included in the bill will affect millions of Californians, according to the Center.
“We think the governor really missed an opportunity to deliver meaningful, progressive revenue solutions,” Anderson said.
Historically, according to the California Budget & Policy Center, the state has tended to adopt the governor’s revenue projections. However, that could change by May, when the governor revises the budget to reflect economic forecasts.
“The other really important thing to understand is that the state’s financial situation is going to change,” Anderson said. “That will definitely change by spring…then we will have a much better idea of the revenue situation.”
