Updated "Big Three" Revenue Outlook

Strong Growth This Year, Muted Expectations Moving Forward. Our updated forecast anticipates revenues from the state’s three largest taxes (income, corporation, and sales) will post strong growth in the current fiscal year. Moving into the budget year, however, our revenue forecast is essentially flat, reflecting mounting risks and headwinds. Total collections across the budget window (2023-24 and 2025-26) roughly match the assumptions in the January Governor’s Budget. The timing of those collections, however, is somewhat different, with more revenue attributed to the prior and current years and less revenue expected in the budget year. 

Strong Income Tax Collections Have Driven Recent Revenue Growth. Our forecast has revenues ending the current year (2024-25) up almost 20 percent from two years ago, considerably above the average two-year growth rate of 13 percent. Surging income tax collections underlie this growth. In just the last twelve months, total income tax collections have grown over 15 percent. More real-time measures of income tax collections show that growth has downshifted somewhat but remains solid. April estimated payments, which reflect how much taxpayers expect to owe for 2025, were up more than 10 percent from last year. Similarly, April income tax withholding grew 5 percent from a year ago.

Path to Continued Growth Appears Narrow. Typically, income tax collections like we have seen recently would suggest a positive revenue outlook. Our current forecast, however, is dampened by several factors. Some of these factors, such as the state’s stagnant economy and the stock market’s questionable sustainability, are issues we have raised previously but about which we remain concerned. Other factors, such as potential impacts of expanded tariffs, are new developments that add strain to an already tenuous situation. Taken together, these issues suggest the path to future growth could be narrow.

California Economy Has Been Stagnant for Some Time. The state’s economy has been in an extended slowdown for over two years. The labor market has struggled, marked by a growing number of unemployed workers and slowed hiring. The state has added no jobs so far in 2025. Similarly, consumer spending (measured by inflation‑adjusted retail sales and taxable sales) has consistently declined. These conditions have weighed on sales tax collections in particular, which have moved sideways for multiple years. Should these conditions persist, they also could increasingly weigh down income and corporation tax collections.

Stock Market Propping Up Income Tax Collections. Income tax collections have surged over the last two years despite a weak labor market. Collections instead have been driven by the stock market, which, despite the recent volatility, is up almost 40 percent from two years ago. This is a precarious basis for revenue growth, however. As recent weeks have shown, stock markets gains can come and go quickly and unpredictably. And despite some declines, there are still reasons to be worried gains of the last two years may not be sustainable. Measures of how “expensive” stocks are remain at historically high levels. Additionally, investors have taken on increased amounts of debt to buy stocks. While these observations are far from conclusive, they point to a significant risk to the state’s revenue outlook.

Federal Policy Turbulence Puts Fragile Economy at Risk. The risks posed by California’s stagnant economy and a potentially overheated stock market have been magnified by recent federal policy actions. Over the last few months, the Trump administration has taken numerous actions to expand and modify tariffs charged on imports from other countries. These tariffs will create new costs for consumers and businesses and likely place some drag on the economy. The extent of these impacts, however, is uncertain. To inform our forecast, we looked to some imperfect signals of potential impacts:

• Declining Consumer Sentiment. Escalating tariffs appear to have created significant unease among consumers, who report being worried about potential impacts on prices. Since the beginning of the year, a commonly-cited measure of consumer sentiment has dropped 30 percent, to historic lows. Similar drops in sentiment have occurred nine times in the last three decades. These drops have not universally signaled a coming downturn. On average, however, the state’s labor market and revenues have been weaker than normal following such episodes.
• Downgraded Expectations Among Economic Forecasters. Confidence in the economy also appears to have soured among economic forecasters. According to a long-standing survey of forecasters (Blue Chip Economic Indicators), expectations for gross domestic product growth over the next few quarters are among the lowest in the survey’s history. Survey readings have only been this low three times. Two of these episodes aligned with recessions. The third was in 2023, when economists consistently anticipated a near-term slowdown in the U.S. economy that did not materialize.