In beginning its work on the state budget for 1989-90, the Legislature faces the most adverse set of fiscal circumstances it has faced since the recession of 1981-82. The state’s budget reserve has been completely depleted, and a deficit in the current-year's budget appears likely. At current levels of service, expenditure requirements for 1989-90 will exceed projected revenue growth by at least $500 million, and the full restoration of the state's reserve fund would require another $1.1 billion. This fiscal situation has come about despite the continued strength of the California economy. The state government faces a number of challenges. Here, we review the challenges facing the Legislature and the state; review the state's fiscal condition, the major areas where demand for state ser-vices is outstripping its ability to provide them, and the extent to which the state's exist-ing revenue base is capable of supporting the delivery of existing and additional state services; and provide an examination of the strategies proposed.