Newsom celebrates as the AI boom bails out California

California is poised to see a spike in revenue in the next fiscal year. For a state that’s faced multibillion-dollar budget deficits the past three years, it’s potentially good news, but analysts warn it’s no time to celebrate.

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On Thursday, Gov. Gavin Newsom’s proposed budget revision touted a $16.5 billion projected increase in revenue, largely thanks to income tax gains from a booming stock market coasting on artificial intelligence enthusiasm. Three California AI giants are aiming to go public later this year, and while excitement alone has boosted the economy, the actual public offerings could send even more into the state’s wallet. Just one week ago, the Legislative Analyst’s Office predicted the windfall could be as high as $25 billion, but with a staunch warning — the gains won’t last forever.

“Several historically-reliable signals suggest the stock market currently is overheated and due for a correction,” the office wrote in a May 7 report. “… It is now hard to ignore that the stock market appears, on its face, to be in a speculative bubble, rivaled only by the dot-com boom and the Roaring Twenties.”

Though the increase in projected revenue was a bragging point in Newsom’s budget announcement — where economic “dominance” was a main theme — the governor recognized the need to address California’s volatile revenue stream. 

Newsom highlighted the expected initial public offerings of OpenAI, SpaceX and Anthropic as an opportunity to capture more revenue, and he called reforming California’s system for injecting revenue in the state’s reserve budget as “long overdue.” But the governor also warned that a drop in the stock market could send a shock to the state’s budget.

“When the nation gets a cold, we get the flu,” Newsom said. “The issue around volatility has to be fundamentally addressed.”

Newsom’s budget attempts to weather that volatility by adding $9.7 billion to the state’s Surplus Holding Account as a way to “avoid overcommitting revenues during uncertain economic conditions,” according to a Thursday news release.

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The Legislative Analyst’s Office’s concerns, published in the May 7 report, are not new. The office warned in November of a potential AI bubble burst in the current fiscal year. But with the fiscal year set to close on June 30 and the stock market still roaring, the expected collapse in stock values has yet to happen. 

The latest data from the Franchise Tax Board indicates that income taxes have continued to significantly trend upward. In December and April, income tax payments increased 50% compared with the year before, a rare jump largely attributed to the hype over AI, according to the May 7 report. 

But just because the state had a good past six months, that doesn’t mean the risk of a collapse has disappeared. The Legislative Analyst’s Office’s revised report reiterates that the AI bubble could still collapse and subsequently crash state tax revenues. Ahead of Newsom’s revised budget announcement, the office recommended the Legislature take precautionary measures to prevent a significant blow to the state budget if a crash were to occur, including avoiding taking on new debt or using more reserve funds.

“This was a pattern we saw in the dot-com bubble. It was a pattern we saw during the housing boom and subsequent great recession,” Legislative Analyst’s Office analyst Biran Uhler told SFGATE. “The sheer rate of growth and income tax revenue are signaling to us that we’re starting to reach points that are kind of similar to those high points in our past.”