Tariffs reduce California revenues, complicating budget choices

Bloomberg News

While the Los Angeles wildfires overshadowed the release of California Gov. Gavin Newsom's proposed budget in January, international tariffs and potential cuts to Medi-Cal took center stage as he announced May revisions.

The revisions included lowered revenue expectations as a result of tariffs and stock market losses, changes to coverage in the state's Medi-Cal program, annual funding for high-speed rail and plans to fast track the state's Delta Tunnel project.

The release of the revised budget launches intensive talks between the governor and lawmakers leading to the budget signing ahead of the fiscal year on July 1.

The state has gone from a $363 million surplus when Newsom released his proposed spending plan in January to a $12 billion deficit, which the governor partly blamed on the economic slowdown caused by President Donald Trump's rapid shifts in tariffs and the resultant stock market spikes.

The state holds Aa2, AA-minus and AA ratings from Moody's Ratings, S&P Global Ratings and Fitch Ratings, respectively. All assign stable outlooks.

During his budget presentation Wednesday, the Democratic governor attributed a $16 billion decline in tax revenues in his revised $321.9 billion budget to what he called the "Trump slump."

"California is under assault, the United States of America in many respects is under assault, because we have a president that's been reckless in terms of assaulting the growth engines and has created a climate of deep uncertainty," Newsom said. "The impacts are being felt disproportionately in the fourth-largest economy in the world."

The state's projected revenue losses from tariffs and stock market declines include $10 billion from capital gains, $2 billion from lower wages and personal income tax withholdings, $2.5 billion due to weaker corporate taxes and $1.5 billion from personal income taxes, according to Newsom's presentation.

"The U.S. has gone from 145% tariffs to discussions of 80% and now 30%," Newsom said. "It's chilled investments, caused a $10 trillion swing in the markets between Liberation Day and his 90-day pause on tariffs — and that uncertainty is leading to uncertainty in business investments and decisions."

On Monday, Treasury Secretary Scott Bessent said the U.S. agreed to lower the 145% tax imposed on China last month to 30% and China agreed to reduce its tariff on U.S. goods to 10% from 125%. The agreement has a 90-day shelf life while negotiations continue.

Newsom and state Attorney General Rob Bonta said Tuesday they planned to file a motion seeking a preliminary injunction to block the tariffs. The pair claimed in a lawsuit filed in April Trump's use of an emergency power to raise tariffs was illegal and changes needed to be approved by Congress.

"Trump's chaotic tariff war is threatening to skyrocket the cost of living for families, lower wages, slash jobs and throw business owners and innovators into a spiral of uncertainty," Bonta said. "California is set to experience an outsized share of losses due to our larger economy, workforce and exposure to trade."

The president's actions are having an outsized impact on California, which engaged in nearly $675 billion in two-way trade in 2024 and has experienced a decline in international tourism, Newsom said.

"We are as a consequence pushing back," he said, referring to the $25 million included in his proposed budget in January to fund lawsuits, originally to challenge threatened clawbacks of federal funding.

"We had an estimated surplus of $363 million in the January budget," Newsom said. "Revenues for January through April exceeded expectations by $7.9 billion. Our economy was humming along. That has significantly changed based on actions by this administration."

Though revenues were up, the state was already experiencing challenges from overspending on programs like the expansion of Medi-Cal, the state's medical insurance for low-income residents.

Ahead of last year's budget passage, the governor and lawmakers made $16 billion in cuts to state agencies, reduced anticipated funding increases to healthcare providers, delayed money for schools and withdrew $7 billion from the state's rainy-day funds to close an estimated $40 billion to $70 billion deficit.

The state already tapped $5.1 billion from the rainy-day fund in 2024-25 and planned to take $7.1 billion in 2025-26. The governor's budget doesn't include plans to take more out of the fund. That would leave $15.7 billion in reserves at the end of fiscal 2025-26.

The budget also shifts the $1.7 billion proposed for wildfire resilience programs to be funded by cap-and-trade, rather than the general fund.

His proposal extends cap-and-trade from its current 2030 end date to 2045 and allocates $1 billion annually to high-speed rail, so it has a stable and reliable funding stream.

The governor said he's committed to the high-speed rail. It has cleared most of the major environmental hurdles and acquired needed land. "Let's get it done," he said.

While the state allocated $2.5 billion in wildfire-related aid to help Los Angeles recover, the governor did not include funding requested by Los Angeles Mayor Karen Bass and the city council to help with its budget woes.

"The money we have allocated is based on what has been reimbursed by the federal government," Newsom said. "When you are requesting funds not related to wildfire recovery, the state is not in a position to cover those."

Likely the most controversial change in the budget was Newsom's decision to freeze enrollment in the Medi-Cal expansion for undocumented immigrants over 19 years old and charge undocumented workers included in the plan $100 monthly premiums. The shift would save $5 billion in fiscal 2025-26, he said.

The state's move to cover undocumented immigrants under Medi-Cal began in 2016 during former Gov. Jerry Brown's tenure. Newsom expanded the program to add new age groups, beginning with senior citizens.

The state had to pump an additional $6.2 billion into the program, including $2.8 billion in emergency aid from the general fund approved in April by lawmakers as a supplemental budget item, and a $3.4 billion cash-flow loan to the program.

Newsom balked at laying the blame for the increased costs solely at the feet of undocumented immigrants, noting the Medi-Cal budget is $179 billion, and only 5.3% of that cost is from undocumented immigrants. He and lawmakers are also bracing themselves for threatened federal cuts to Medicaid, which has been listed as a potential target in order to extend corporate tax cuts enacted in 2017 and would shrink funding for the state's Medi-Cal program.

"Other states who don't have policies like California are also facing unprecedented increases in medical costs," Newsom said.

The May revision summary notes significant contributing factors to recent years' Medi-Cal cost growth "are the COVID-19 continuous coverage requirement and the implementation of major policy changes, such as the full elimination of the asset test for older adults and the full-scope expansion to all income-eligible Californians, regardless of immigration status." 

Without the May revision's proposals to trim cost growth, the administration estimates Medi-Cal costs would be roughly $10 billion higher across 2024-25 and 2025-26 and contribute significantly to future structural budget deficits.

Republicans, who are in the minority in the Senate and Assembly, and had opposed the expansion of Medi-Cal to undocumented immigrants began pushing for cuts early last year.

"We warned him," Sen. Minority Leader Brian Jones, R-San Diego said. "I urged the governor to immediately freeze his reckless Medi-Cal expansion for illegal immigrants a year and a half ago, before it buried our healthcare system and bankrupted the state. Had he listened, we wouldn't be in this crisis — breaking promises, scrambling for loans, and cutting services for legal Californians just to keep this broken program afloat."

Newsom's plan to fast-track the proposed $20 billion water tunnel project in the Sacramento-San Joaquin River Delta also drew fire, but this time from an East Bay Democrat, Sen Jerry McNerney, who co-chairs the Delta Caucus.

"Newsom's proposal to fast-track the costly and destructive Delta Tunnel Project in the state budget is a poorly conceived plan that the Legislature should reject," McNerney said in a statement. "The delta water project is expected to cost at least $20 billion — and likely much more — and will destroy nearly 4,000 acres of prime farmland in the fragile delta, along with salmon fisheries and tribal resources."

The tunnel's costs would be borne by "ratepayers who are already overburdened by skyrocketing utility bills," McNerney said.

McNerney supports fortifying delta levees and increasing water recycling and groundwater storage.

The concept has faced opposition from environmental groups, but support from most water agencies.

The tunnel would create a second route to transport water to the state's pumping facilities on the south side of the delta, where supplies enter the aqueducts of the State Water Project, delivering water to 27 million people and 750,000 acres of farmland.

The governor said his plan would simplify permitting by eliminating certain permit deadlines; narrow legal review to avoid delays; confirm the state's Department of Water Resources has authority to issue bonds to fund the project, which would be repaid by water agencies; and accelerate efforts to acquire land for construction.

"For too long, attempts to modernize our critical water infrastructure have stalled in endless red tape, burdened with unnecessary delay," Newsom said. "We're done with barriers — our state needs to complete this project as soon as possible, so that we can better store and manage water to prepare for a hotter, drier future."