HomeMy WebLinkAboutGovernor's Budget Summary 2025-262025-26
GOVERNOR’S BUDGET SUMMARY
Gavin Newsom, Governor
STATE OF CALIFORNIA
ECONOMIC OUTLOOK
S ince April 2024 when the May Revision economic forecast was finalized, the U.S.
economy has continued on a steady, stable growth path despite slowing job
growth and still-elevated interest rates. The outlook for the U.S. and California
economies has improved relative to the May Revision economic forecast as U.S. real
Gross Domestic Product (GDP) growth has been more robust than projected, inflation
has cooled more rapidly, and job growth has been stronger, leading to an overall
upgraded personal income forecast.
The Governor’s Budget forecast projects U.S. real GDP to grow at an annual rate of
1.5 percent to 2 percent in every quarter of the forecast window, starting with the fourth
quarter of 2024. This is upgraded from the May Revision forecast which projected
quarterly growth below 1.5 percent in the fourth quarter of 2024 and through the first
half of 2025. This upgrade is due to higher projected growth in most categories of GDP,
reflecting faster growth in 2024 that is expected to carry over into the near future.
Consumer price inflation slowed sharply from its most recent peaks in June 2022 of
9.1 percent year-over-year for the U.S. and 8.3 percent in California to 2.6 percent and
2.5 percent, respectively, in October of 2024, below the respective May Revision
forecast projections of 2.9 percent and 3.2 percent, due mainly to deflation in gasoline
prices. In response to slowing inflation, the Federal Reserve reduced its target interest
rate range by 0.5 percentage point in September after holding it steady for over a year,
by 0.25 percentage point in November and again in December to the range of
4.25 percent to 4.5 percent. Similar to the May Revision, the forecast projects U.S.
inflation to stabilize at 2.2 percent to 2.3 percent starting in 2025. Falling gasoline prices
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will lead projected inflation to decrease to 2.3 percent in 2025 before stabilizing at a
higher rate of 2.6 percent for California. The target federal funds rate is projected to be
in the range of 2.5 percent to 2.75 percent over the long term.
Since the beginning of 2024, California’s job market has rebounded from sluggish
growth in 2023 while nationwide jobs continued to grow at a slowing but healthy pace.
California gained about 56,000 jobs per quarter on average in the second and third
quarters of 2024, substantially higher than the 31,000 jobs projected in the May Revision
forecast. Through November 2024, California added 167,000 jobs (0.9 percent
year-to-date growth), significantly higher than during the same period in 2023 when the
state gained just 113,000 jobs, but still well below the 2015-19 pre-pandemic average of
about 326,000 jobs added for the comparable period. The nation added nearly
2 million jobs (1.3 percent year-to-date growth) in the first eleven months of 2024, down
from the 2.7 million jobs added during the same period in 2023. California’s share of U.S.
jobs averaged 11.4 percent year-to-date through November 2024, in line with the
2015-19 pre-pandemic average share of 11.5 percent.
The personal income forecast is upgraded from the May Revision due to
better-than-projected actual trends in the first half of 2024. Annualized income in both
quarters was over $100 billion, or 3.2 percent, higher than projected in the May Revision,
driven mainly by significant increases in wages and salaries, contributing about
1.8 percentage points of the overall increase, and in transfer payments in the first
quarter, contributing 1.3 percentage points. Thus, projections for the annualized level of
personal income were upgraded by an average of $68 billion (1.8 percent) per quarter
over the forecast window from the third quarter of 2024 to the end of 2028, driven
mainly by compensation (wages, salaries, and supplemental payments such as pension
contributions and health insurance).
With inflation cooling and seemingly in check following its recent highs, policy
uncertainty appears to present the biggest risk to the forecast stemming from
potentially disruptive trade and immigration policies proposed by the incoming federal
administration. The forecast is based on current law and does not incorporate any
assumptions of potential future policy changes. There also remains the risk that the
trajectory of monetary policy shifts, especially if inflation reverses course due to federal
policy changes. Finally, geopolitical risks remain, including possible further escalation in
the Middle East or the Russian invasion of Ukraine.
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U.S. AND CALIFORNIA FORECASTS
SLOW, STEADY, AND STABLE GDP GROWTH
Economic growth is expected to continue in the forecast, driven by strong but slowing
personal consumption, with U.S. real GDP growth projected to be on average
0.1 percentage point faster than expected in the May Revision forecast through the
end of the forecast period. While the annualized U.S. real GDP growth rate has been
2.4 percent or higher in all but one of the last nine quarters through the third quarter of
2024, the forecast projects GDP growth to gradually slow to 1.5 percent in the third
quarter of 2026 and stay in the steady-state range of 1.5 percent to 2 percent for the
entire forecast period. The projected slowdown stems from somewhat lower expected
growth in consumption and investment spending as interest rates are projected to
remain well above their pre-pandemic levels. The end of the temporary boost from
federal manufacturing incentives, such as the Creating Helpful Incentives to Produce
Semiconductors (CHIPS) Act, is also expected to hinder new business investment.
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INFLATION PROJECTED TO CONTINUE TO MODERATE
The forecast projects California headline inflation will continue to moderate. Inflation is
projected to slow to historical rates of between 2 percent and 2.5 percent for both the
nation and the state by early 2025, with the state having a slightly higher rate of inflation
in line with historical trends. The annual average state inflation rate in 2025 is projected
at 2.3 percent compared to 2.6 percent in the May Revision, with the downward
revision due mainly to base effects from declines in gasoline prices in late 2024. The
projected longer-term inflation path for the U.S. is similar to the May Revision while the
California projection is just 0.1 percentage point lower in steady state at 2.6 percent.
This slight reduction is due to lower projected inflation in a number of components such
as household fuels and medical care.
CONTINUED SLOWING JOB GROWTH
Nonfarm payroll job growth slumped in 2023, due mainly to disproportionate losses in
high-wage sectors even as outsized job gains in the low-wage sectors kept the state’s
labor market afloat. “Low-wage sectors” are sectors with an average wage that is
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lower than the state’s 2022 average wage of about $88,000 while “high-wage sectors”
have average wages above the state average. According to this definition, low-wage
sectors are comprised of construction, trade, transportation, and utilities, private
education and health services, leisure and hospitality, other services, and government
while high-wage sectors are comprised of mining and logging, manufacturing,
information, financial activities, and professional and business services. In 2023,
high-wage sectors averaged 15,000 job losses per month which were more than offset
by gains of 27,000 jobs per month in the low-wage sectors. In the first eleven months
of 2024, job losses in high-wage sectors slowed to around 4,000 jobs per month on
average. In contrast, low-wage sectors have again buoyed overall job growth,
averaging a solid 19,000 jobs added per month during that same period. In
comparison, the May Revision forecast projected low-wage sectors to add around
11,000 jobs per month in 2024 while high-wage sectors were projected to gain on
average around 2,000 jobs per month. Across all sectors, 15,000 jobs were added per
month in the first eleven months of 2024, slightly higher than the 13,000 jobs per month
projected in the May Revision forecast.
Projected job growth in the forecast is 0.1 percentage point higher on average
between 2024 and 2027 compared to the May Revision forecast due to
stronger-than-expected job growth and resilient labor market conditions. The forecast
projects job growth to slow to a low of 0.6 percent year-over-year in the second half
of 2026, a slightly delayed time frame but a less pronounced slowdown compared to
the May Revision forecast which projected the slowest growth of 0.4 percent
year-over-year to occur in mid-2025. This is due mainly to continued robust U.S. real
GDP growth in 2024, and relatively healthy nonfarm payroll employment growth
through the third quarter of 2024, particularly in low-wage sectors which account for
about 70 percent of the state’s payroll employment. Given the typical lag of about
18 months between overall economic activity and employment, California nonfarm
payroll employment is projected to slow, but remain positive, from late 2024 through
the second half of 2026 following the projected softening in U.S. real GDP growth.
Thereafter, the state’s nonfarm payroll employment is projected to rebound from
below-trend growth and return to a steady state average rate of 0.7 percent by 2027.
The California labor force increased by 54,000 persons or 0.3 percent in the first eleven
months of 2024, slightly lower than the 0.4-percent growth projected in the May
Revision. This was driven mainly by trends in the first half of 2024 as the third quarter
labor force annualized growth of 0.8 percent exceeded the May Revision projection of
0.5 percent. The slower pace of labor force growth in the first half of 2024 was due
mainly to the decline in labor force participation of prime-age Californians (those
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between the ages of 25 and 54), and particularly the 25-34 and 45-54 age groups
whose participation rates declined by 0.6 percentage point and 0.4 percentage point,
respectively, from December 2023 to June 2024.
California’s headline labor force participation rate has shown signs of stabilizing in
recent months, remaining unchanged at 62.1 percent from August through
November 2024 and staying between 62 percent and 62.2 percent since March 2023.
While headline participation remained 0.9 percentage point below its pre-pandemic
February 2020 level of 63 percent, participation amongst prime-age workers surpassed
its pre-pandemic February 2020 rate of 80.7 percent in September 2022, and was at
81.8 percent as of November 2024. The higher prime-age labor force participation rate
further emphasizes California’s slow but ongoing labor force recovery.
Due to lower-than-projected growth since finalizing the May Revision in April, projected
labor force growth in the forecast is slower by an average of 0.1 percentage point in
2024 and 2025. From 2026 to 2028, California’s labor force growth is projected to
average 0.4 percent, compared to 0.3 percent projected in the May Revision forecast,
in line with the state’s upwardly revised population projections in the out years,
particularly for working-age individuals.
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California’s unemployment rate averaged 5.3 percent in the first three quarters
of 2024, higher than the May Revision projection of 5.2 percent. The slightly higher
unemployment rate than projected was due to subdued civilian household
employment since the turn of the year, growing by an average of just 0.1 percent
(annualized rate) over the first three quarters of 2024 instead of the 0.4-percent growth
assumed in the May Revision. California’s unemployment rate was 5.4 percent as of
November 2024, 1.6 percentage points higher than its historic low of 3.8 percent in
August 2022 and higher than its 2015-19 pre-pandemic average of 5 percent. In
comparison, the U.S. unemployment rate fell to a 70-year low of 3.4 percent in January
and April 2023 and has since increased to 4.2 percent as of November 2024, slightly
lower than its 2015-19 average of 4.4 percent.
The projected California unemployment rate in the forecast is 0.1 percentage point
higher in 2024, compared to the May Revision forecast, due largely to civilian
employment contracting more than expected so far in 2024. Civilian employment
declined by an average of nearly a thousand persons a month in the first eleven
months of 2024, more than the projected decline of about 800 persons per month in the
May Revision. As civilian household employment is projected to increase only gradually,
the unemployment rate is projected to stay at around 5.3 percent through the first
quarter of 2025 before moderating thereafter. The Federal Reserve is expected to
continue to loosen its still-restrictive monetary policy, which, in turn, is expected to
stimulate economic activity and employment (including self-employment). California’s
unemployment rate is projected to gradually decline from averaging 5.3 percent in
2024 to 4.7 percent in 2028.
MODEST WAGE GROWTH PROJECTED FOLLOWING STRONG 2024
Projected average wage growth in the forecast is 0.5 percentage point faster on
average than in the May Revision, due to the significant wage growth in the first half
of 2024 in the information and professional and business services sectors. The overall
average wage for all sectors is projected at 6.4 percent in 2024. Average wages are
then projected to moderate growing between 3.4 percent and 4 percent from 2025 to
2028, similar to the 3.5 percent-to-3.9 percent growth projected in the May Revision.
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PERSONAL INCOME GROWTH REVISED LOWER, BUT LEVELS REMAIN HIGHER
California headline personal income captures the total amount of income received by
all persons who live in the state from all sources and is not adjusted for inflation. The
personal income forecast is upgraded from the May Revision due to new
higher-than-projected estimates for the first half of 2024. As the 2024 base is higher,
personal income is higher in each year of the forecast than in the May Revision despite
slower projected growth rates from 2025 on.
Personal income growth is projected to slow from 6.7 percent in 2024 to 4.2 percent in
2025 before settling at 4.6 percent to 4.7 percent over the rest of the forecast window
through 2028. In contrast, the May Revision projected just 4.6 percent growth in 2024
followed by higher growth of 5 percent in 2025 and beyond. This lower projected future
growth trajectory is due mainly to weaker projected growth in dividend and interest
income.
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HOUSING PERMITS TO GRADUALLY ACCELERATE AFTER SOME NEAR-TERM
WEAKNESS
High interest rates for mortgages and other loans continue to negatively impact
California’s residential construction sector as residential permitting has fallen
substantially in 2024, with total permit growth in the third quarter falling by 13.5 percent
from the previous year to an annualized rate of just around 102,000 permits per month.
Total residential permits have steadily declined since averaging nearly 120,000 in 2021,
when interest rates were near record lows. Multi-family permitting was weak in 2024,
declining by 23.9 percent on a year-to-date average annualized basis through
November 2024. In contrast, single-family permits have increased by 5.4 percent on a
year-to-date average annualized basis, as high interest rates have a smaller negative
effect on single-family construction due to lower capital borrowing requirements.
Actual annualized permits through November 2024 averaged 100,000, significantly less
than the 110,000 permits projected in the May Revision forecast for 2024 and well below
the 2018-19 annualized quarterly average of 113,000 units. Permits are one of several
ways to measure likely housing production and development and there is a variable
lag between permits issuance and housing building completion.
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Projected total permits in the forecast are lower than the May Revision by roughly
9,000 permits, or nearly 8 percent on average, through the forecast window due to
subdued permitting in 2024 moving the baseline much lower than the May Revision.
Residential permitting is projected to accelerate from around 106,000 in the second half
of 2025 to 125,000 in 2028 as the Federal Reserve decreases interest rates, making
construction inputs more affordable and lowering mortgage rates.
RISKS TO THE BASELINE FORECAST
Uncertainty about federal policy presents the most immediate risk to the forecast. The
forecast is based on current law, and thus does not reflect any future policy changes
that may be implemented by the new federal administration. In particular, the
incoming administration has proposed broad tariffs at very high rates that would lead
to price increases in many categories of consumer and producer goods that are
commonly imported. In addition, domestic producers that do not generally face
foreign competition—but that buy imported intermediate inputs or other goods they
use in the course of conducting business—would likely also raise their prices to pass on
the higher costs to their customers. Tariffs of the scale and scope proposed by the
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incoming administration would be highly inflationary and likely lead the Federal Reserve
to pause its interest rate cuts and possibly raise target rates again. California would also
be especially vulnerable to tariffs as the ports of Los Angeles, Long Beach, and Oakland
and the logistics industry that is concentrated in the Inland Empire are highly
dependent on foreign trade.
The incoming administration has also proposed to reduce legal immigration and to
deport millions of undocumented immigrants, many if not most of whom are workers.
To the extent that existing workers are deported and potential new workers banned or
discouraged from immigrating, many sectors of the U.S. and California economies
could face labor shortages, leading to price increases in the goods and services
produced by these sectors. These shortages will likely be most acute in construction,
manufacturing, agriculture, leisure and hospitality and other service-oriented sectors.
Generally, reductions in the size of the labor force are inflationary and reduce the
economy’s potential output.
The potential paths of inflation and interest rates also pose risks. If inflation is slow to
return to the Federal Reserve’s target rate of close to 2 percent or increases due to
federal policy or other reasons, the Federal Reserve could pause cutting rates or
reverse course and increase rates, which would result in additional drag on
interest-sensitive spending. The current high-interest rate environment could also
hamper economic activity more than projected, especially given more cautious
lending practices and if consumers curtail discretionary spending. Additionally, if
geopolitical conflicts persist, this will increase economic uncertainties despite any
potential economic boost from increased defense spending.
The Department of Finance has not modeled a recession scenario for the forecast.
However, in the case that inflation takes longer to cool to the Federal Reserve’s target
rate of 2 percent, the Federal Reserve’s monetary policy could result in tighter credit
conditions, which would likely dampen economic activity. This could deepen the
expected slowdown in U.S. real GDP growth and push the economy into a mild
recession, which would likely entail steeper declines in investment and interest-sensitive
consumption than assumed in the baseline forecast. GDP and nonfarm payroll
employment would likely contract and the unemployment rate would increase. This
would then likely result in lower total wage and personal income growth as well as lower
business and consumer spending on taxable goods negatively impacting revenues.
Other long-term structural downside risks to the state economy and budget also
remain, including climate change and its more frequent extreme weather events such
as wildfires, drought, and floods, the challenges of an aging cohort that is becoming an
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increasingly larger share of total state population, declining migration inflows, lower
fertility rates, stock market volatility, and persistently high housing and living costs.
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