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Q&A: What Does the Projected Budget Shortfall Mean for California?

A guide for state leaders and advocates navigating the 2023-24 state budget

April 2023 | By Scott Graves, Jonathan Kaplan, and Kayla Kitson

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Building a just and equitable California for every person no matter their race, ethnicity, gender, age, or zip code requires investments to create health, housing, economic, and educational opportunities. The foundation for these investments is the state budget, through which policymakers can commit the funding needed to build a California where everyone can be healthy and thrive. But sustaining and expanding the state’s investments in individuals and communities becomes more challenging when revenues fall short of projections and lead to a state budget shortfall — as is the case this year.

“Advocates can continue to make the case for new state investments to help Californians be healthy and thrive.”

This Q&A explains why California faces a budget problem, highlights the challenges with estimating revenues this year, outlines state leaders’ options for addressing the budget gap — including using reserves — and describes how advocates can advance their policy priorities and lay the groundwork for building a more equitable California even in a tough budget year.

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Why is California facing a budget problem this year?

While California experienced extremely strong revenue growth in recent years, state forecasters are now estimating that revenues will come in significantly below expectations for the three-year “budget window” ending in fiscal year 2023-24. Specifically, the governor’s budget proposal assumes that revenues over this budget window will be $29.5 billion lower than estimated in the 2022 Budget Act, before accounting for required transfers into the state’s rainy day fund.

The Legislative Analyst’s Office (LAO) has projected a larger shortfall, noting that the governor’s revenue estimate is $13.6 billion higher than the LAO’s estimate. Revenues are expected to fall short primarily due to lower current-year personal income tax withholding and estimated payments, a weaker stock market, and the risk of an economic slowdown resulting from high inflation and interest rate hikes intended to combat inflation.

Looking at the current fiscal year (2022-23), actual General Fund tax collections for the first eight months are around $4.7 billion lower than estimated in the governor’s January budget proposal.

Under these lower revenue estimates, the state would not have enough resources to support currently authorized services. The governor’s proposed spending plan assumes the state will face a $22.5 billion budget shortfall, or deficit, without taking actions to balance the budget. Because the state Constitution requires the budget to be balanced, the governor proposes a combination of solutions to address the budget shortfall, including delays or reductions in previously planned spending, and cost shifts, but not the use of the state’s substantial reserves.

Could state revenues come in higher — or lower — than current projections?

The estimated budget shortfall is just that — an estimate. In May, the governor’s Department of Finance and the Legislative Analyst’s Office will release updated projections of the size of the budget gap. These new numbers will take into account the most recent information available on the economy, spending, revenues, and other factors.

The governor’s updated estimates will be unveiled in his revised budget (the “May Revision”), which must be released by May 14. The May Revision will set the stage for negotiations between the governor and legislative leaders in June over the key outlines of the 2023-24 budget package.

This year, however, there will be significant uncertainty regarding the May revenue estimates. The governor has extended income tax payment deadlines for individuals and businesses in counties that were affected by the storms that battered much of the state this winter. The filing deadline for personal income taxes — the state’s largest revenue source — as well as the quarterly estimated tax payment deadlines for individuals and businesses have been pushed to October 16 this year for filers in counties that were declared as disaster areas.

The counties where the tax-filing extension applies account for the vast majority of the state’s population. Moreover, January, April, and June are among the most important tax collection months. With a large share of tax revenue expected to arrive as late as October, the revenue forecast underlying the 2023-24 budget will be highly uncertain and balancing the budget will be much more difficult for policymakers.

What options do policymakers have to balance the state budget?

Policymakers have several tools to close the budget shortfall in a way that minimizes the impact on public services — particularly those that reduce poverty and help Californians with low incomes make ends meet. One option is to use the state’s General Fund reserves to address a budget shortfall. In fact, the state has built up substantial reserves precisely to help support critical services when revenues fall short.

State leaders especially should use reserve funds to help Californians meet basic needs like food, health care, housing, and child care. However, reserves should be used prudently. Reserve funds may be needed over multiple fiscal years, particularly if the economy slides into a recession and revenues decline over an extended period. (See below for more on the state’s General Fund reserves and how they may be used.)

Policymakers also could shift costs from the General Fund to state special funds that have the capacity to support additional services. For example, some of the state’s 500+ special funds may have large balances that aren’t immediately needed. The state could borrow these excess revenues and use them to temporarily support services typically paid for with General Fund dollars.

Any money borrowed from special funds would later be repaid with interest when General Fund revenues rebound. Shifting costs across funds is a reasonable budgeting practice. This approach can help to close a state budget gap in a way that minimizes the need for cuts to critical public services without compromising the state’s fiscal health.

Another option for balancing the budget while protecting core services is to raise revenues from corporations and the wealthy, the beneficiaries of windfall gains and profits in recent years. Corporations contribute a smaller share of their profits toward state taxes than they did a generation ago, partly due to tax cuts approved by state policymakers. More broadly, the state loses around $70 billion each year to corporate and individual tax breaks, many of which largely benefit profitable corporations and high-income households. These include wasteful tax breaks like the film tax credit.

Carefully targeted tax increases are a compelling option for closing a budget shortfall. Boosting the corporate tax rate, for example, would only affect businesses that report profits. Moreover, raising taxes on higher-income households would minimize the impact on the economy because the wealthy are more likely to reduce their savings rather than their spending in response to a tax increase.

Policymakers also can delay or reduce spending to help close a budget gap. Delaying an expenditure moves it to a later period when revenues may be more robust. In contrast, a reduction eliminates a previously approved expenditure. Spending reductions should be used with caution. In particular, any cuts should avoid eroding services that help families and individuals make ends meet and support their health — things like cash aid, food assistance, and child care. Instead, policymakers should eliminate ineffective expenditures, such as poorly targeted tax breaks as well as the billions of dollars that annually fund the state’s bloated, costly, and inequitable prison system.

How big are the state’s budget reserves, and when can those funds be used?

California policymakers’ prudent decisions to set aside funds for a rainy day mean the state is well prepared to address a potential budget shortfall. At the end of February 2023, California held a total of $37.2 billion in four state budget reserves:

Budget Stabilization Account (BSA)$23.3 billion
Public School System Stabilization Account (PSSSA)$9.5 billion
Special Fund for Economic Uncertainties (SFEU)$3.5 billion
Safety Net Reserve$900 million

California’s Constitution and state law govern when funds may be withdrawn from these reserves, the amount that can be withdrawn, and how funds may be used. For example, the state Constitution only allows withdrawals from the BSA and PSSSA if the governor declares a budget emergency and the Legislature passes a bill, by majority vote, that approves the withdrawal. In contrast, state law allows the Legislature to withdraw funds from the Safety Net Reserve or the SFEU at any time by majority vote.

All of the funds in the PSSSA, SFEU, and Safety Net Reserve may be withdrawn in one year. However, a withdrawal from the BSA is limited to the lower of the amount needed to address the budget emergency or 50% of the BSA balance, unless funds had been withdrawn in the previous fiscal year in which case all of the funds remaining in the BSA may be accessed.

The PSSSA is the only reserve with strict limits on the use of its funds, which must be provided to support K-12 schools and community colleges. On the other hand, the Legislature may use funds from the BSA and the SFEU for any purpose. In addition, while Safety Net Reserve funds are intended to support CalWORKs and Medi-Cal benefits and services during an economic downturn, the Legislature may allocate these funds for other purposes if the governor signs a bill to do so.

understanding California’s State Budget reserves

Want to learn more about each of California’s budget reserve accounts? View our latest report California’s State Budget Reserves Explained.

What should advocates keep in mind when advancing their policy priorities this year?

Advocating for policies and the funding to support them is clearly more challenging when the state faces a budget shortfall, like it does this year. In particular, proposals that call for new spending will face greater scrutiny — and higher hurdles — compared to years when state revenues are stronger.

One option for advocates in a tough budget year is to focus on protecting recent policy gains and funding commitments. These include investments in child care, housing, health care, assistance for older adults and people with disabilities, and many other critical services — any of which could be at risk if the budget gap grows. State leaders also have prioritized several policies for implementation in 2024-25 — if revenues are sufficient to support them. These policies include boosting CalWORKs grants and cutting red tape in the Medi-Cal program so that young kids can be continuously enrolled in health coverage. These pending policies could be threatened if revenues further weaken over the coming months.

Furthermore, advocates can continue to make the case for new state investments to help Californians be healthy and thrive. Advocates should educate state leaders about Californians’ ongoing needs, highlight policy solutions, and seek allies to help advance their proposals — using both the policy bill process and the budget process. These actions can lay the groundwork for policy wins and expanded funding when revenues rebound.

Faster progress also is possible. For example, state leaders may be open to adopting an ambitious policy change, but may also delay implementation until funding is provided in a future budget. This approach keeps the issue on the state’s “front burner” and puts advocates in a good position to argue for the needed resources in a future state budget cycle.

Finally, advocates should keep in mind that the major uncertainty surrounding revenue estimates this year (discussed above) means that the June budget package will likely be much more unsettled than usual. And because tax-filing deadlines have been pushed to October for most Californians, the revenue situation is unlikely to be much clearer by August when state leaders typically make significant revisions to the budget.

It’s not clear how the protracted revenue uncertainty may impact late-breaking budget proposals this year, but unexpected opportunities could emerge — so advocates should be prepared, as always, to advance their priorities through the budget process during the summer.

California Budget

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How Much Money Is in the State’s Budget Reserves?

At the end of February 2023, California held a total of $37.2 billion in four state budget reserves:

Budget Stabilization Account (BSA)$23.3 billion
Public School System Stabilization Account (PSSSA)$9.5 billion
Special Fund for Economic Uncertainties (SFEU)$3.5 billion
Safety Net Reserve$900 million

California’s Budget Reserves

California’s Constitution and state law govern when funds may be withdrawn from these reserves, the amount that can be withdrawn, and how funds may be used. 

  • Established in the state Constitution: Budget Stabilization Account, Public School System Stabilization Account
  • Established in state law: Safety Net Reserve, Special Fund for Economic Uncertainties 
Budget Stabilization Account (BSA)Public School System Stabilization Account (PSSSA)Safety Net ReserveSpecial Fund for Economic Uncertainties (SFEU)
Is the state required to make an annual deposit?YesNo
However, a deposit is required under a restricted set of circumstances.1For example, these circumstances include requirements that deposits only occur when capital gains tax revenues exceed a specific level of total General Fund proceeds of taxes and when growth in the state’s minimum funding guarantee for K-12 schools and community colleges is relatively strong.		NoNo
Can a required deposit be reduced or suspended — and by who?Yes
A required deposit can be reduced or suspended if the governor declares a budget emergency and the Legislature approves the reduction or suspension by a majority vote.		Yes
A required deposit can be reduced or suspended if the governor declares a budget emergency and the Legislature approves the reduction or suspension by a majority vote.		Not applicableNot applicable
When can funds be withdrawn?Funds may be withdrawn if the governor declares a budget emergency and the Legislature passes a bill, by majority vote, to withdraw funds.2 The withdrawal rules governing the BSA may not apply to some of the funds in the BSA. Specifically, of the $23.3 billion in the account as of December 31, 2022, $1.8 billion was not deposited in accordance with the current constitutional rules. The Legislative Analyst’s Office suggests that the Legislature may be able to appropriate this $1.8 billion “optional” balance without a declaration of a budget emergency by the governor. In contrast, under this interpretation, the various withdrawal rules would apply to the remaining BSA balance. Separate and apart from this issue, funds must be withdrawn from the BSA — without the need for a declaration of a budget emergency — when updated revenue estimates indicate that a prior-year deposit was greater than required.Funds may be withdrawn if the governor declares a budget emergency and the Legislature passes a bill, by majority vote, to withdraw funds.3Funds must be withdrawn from the PSSSA — without the need for a declaration of a budget emergency — when the state’s minimum funding guarantee for K-12 schools and community colleges is less than the prior year’s funding level, adjusted for changes in student attendance and the cost of living, or when updated revenue estimates indicate that a prior-year deposit was greater than required.The Legislature may withdraw the funds at any time by majority vote.The Legislature may withdraw the funds at any time by majority vote.4Additionally, the Department of Finance may withdraw funds from the SFEU without legislative approval to cover the cost of state disaster response efforts upon an emergency proclamation by the governor.
Is there a limit on the amount of funds that can be withdrawn?Yes
The amount that can be
withdrawn is limited to the lower
of 1) the amount needed to
address the budget emergency
or 2) half of the funds in the BSA,
unless funds had been withdrawn
in the previous fiscal year, in
which case all of the funds
remaining in the BSA may be
withdrawn.		No5However, in any year when funds must be withdrawn from the PSSSA because the state’s minimum funding guarantee for K-12 schools and community colleges is less than the prior year’s funding level — adjusted for changes in student attendance and the cost of living — the required withdrawal is limited to the amount of that shortfall.NoNo
How can the funds be used by the state?Funds may be used for any purpose.Funds must be used to support K-12 schools and community colleges.Funds are intended to maintain existing CalWORKs and Medi-Cal benefits and services during an economic downturn, but may be used for any purpose if the Legislature so chooses.Funds may be used for any purpose.
California Budget
  • 1
    For example, these circumstances include requirements that deposits only occur when capital gains tax revenues exceed a specific level of total General Fund proceeds of taxes and when growth in the state’s minimum funding guarantee for K-12 schools and community colleges is relatively strong.
  • 2
    The withdrawal rules governing the BSA may not apply to some of the funds in the BSA. Specifically, of the $23.3 billion in the account as of December 31, 2022, $1.8 billion was not deposited in accordance with the current constitutional rules. The Legislative Analyst’s Office suggests that the Legislature may be able to appropriate this $1.8 billion “optional” balance without a declaration of a budget emergency by the governor. In contrast, under this interpretation, the various withdrawal rules would apply to the remaining BSA balance. Separate and apart from this issue, funds must be withdrawn from the BSA — without the need for a declaration of a budget emergency — when updated revenue estimates indicate that a prior-year deposit was greater than required.
  • 3
    Funds must be withdrawn from the PSSSA — without the need for a declaration of a budget emergency — when the state’s minimum funding guarantee for K-12 schools and community colleges is less than the prior year’s funding level, adjusted for changes in student attendance and the cost of living, or when updated revenue estimates indicate that a prior-year deposit was greater than required.
  • 4
    Additionally, the Department of Finance may withdraw funds from the SFEU without legislative approval to cover the cost of state disaster response efforts upon an emergency proclamation by the governor.
  • 5
    However, in any year when funds must be withdrawn from the PSSSA because the state’s minimum funding guarantee for K-12 schools and community colleges is less than the prior year’s funding level — adjusted for changes in student attendance and the cost of living — the required withdrawal is limited to the amount of that shortfall.

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Californians from all corners of the state — of all races and ethnicities, genders, ages, and abilities — deserve to be able to afford the basics and thrive in their communities, and a more equitable tax and revenue system would help make that a reality. All Californians share in the responsibility of paying taxes to support public services that keep the state running and help families to be financially secure. This responsibility also extends to the corporations earning profits in the state. These corporations benefit from the fruits of the state’s public investments, which provide them with an educated workforce; a transportation infrastructure to transport goods; a functional legal system, and much more.

“Increasing corporate tax revenues would provide more resources to support solutions to the most significant challenges facing Californians.”

As millions of people struggle with the high costs of living and recovery from the health and economic effects of the pandemic, corporate profits have surged to historic new highs in recent years. However, corporations now pay just about half of what they did in the early 1980s in California taxes as a share of their income. This decline is a result of cuts to the corporate tax rate and the creation and expansion of corporate tax breaks. In addition, corporations were granted significant federal tax cuts as part of the “Tax Cuts and Jobs Act” of 2017, and some corporations even manage to pay nothing in federal taxes.

Policymakers have many options to ensure that profitable corporations are adequately contributing to California’s tax revenues and supporting the services that we all benefit from. These options include — but are not limited to — increasing tax rates for the most profitable corporations, ensuring that all profitable corporations pay a minimum level of taxes, and combating corporate tax avoidance. Increasing tax rates and limiting tax breaks for corporations only affects those corporations that make profits in California, so these actions will not harm struggling businesses that are operating in the red.

Increasing corporate tax revenues would provide more resources to support solutions to the most significant challenges facing Californians, such as unaffordable housing, child care, and health care costs.

1. Raise Corporate Tax Rates for the Most Profitable Corporations

When individuals and families pay their taxes, higher levels of income are subject to higher tax rates. This is not the case for corporations, which generally pay the same official tax rate regardless of the size of their profits.1Some types of corporations are subject to different rates, such as banks and other financial institutions, which pay an additional 2% in state tax because they are exempt from local taxes that other businesses pay. Corporations that are organized under Subchapter S pay only a 1.5% rate, but their shareholders pay personal income taxes on their shares of the business’ income. Additionally, the effective tax rate — the share of overall income paid in tax — varies from corporation to corporation based on the extent to which they are able to take advantage of corporate tax breaks. Just as a small share of households receive an outsized share of total income in the state, a small share of corporations earn the majority of profits in California. Corporations with California profits of more than $10 million represented 0.3% of corporations operating in the state but made 62% of all statewide corporate profits in 2019, according to Franchise Tax Board data.2Franchise Tax Board, Corporation Tax Annual Report, Tax Year 2019, Table C-8, https://data.ftb.ca.gov/California-Corporation-Tax/CORP-Annual-Report-2020/6mcf-cr69 Adding a surtax — a higher tax rate — on just these corporations could raise substantial revenues without affecting the vast majority of businesses.3Jonathan Kaplan, Why Aren’t Large Corporations Paying Their Fair Share of Taxes and What Can California Policymakers Do About It?, (California Budget & Policy Center, April 2021), 6, https://staging.calbudgetcenter.org/app/uploads/2021/03/IB-FP-Corporate-Taxes.pdf.

Of course, policymakers could set the threshold for a surtax lower than $10 million, or move to a graduated corporate tax structure where higher increments of profits are subject to higher rates. Several states already have graduated corporate tax structures and a few states have enacted temporary surtaxes on highly profitable corporations. Asking those corporations that are immensely profitable to contribute more to support state services would improve tax fairness and protect small and struggling businesses.

2. Ensure That Corporations Pay an Adequate Minimum Level of State Taxes

Based on the premise that corporations that take advantage of certain tax preferences should still pay a minimum level of taxes, the state put into place different rules to compute tax liability for these corporations.4This alternative minimum tax system is in addition to the $800 “minimum franchise tax” that must be paid by all corporations incorporated in, registered in, or doing business in California. However, state law still allows corporations to use many tax credits to reduce the minimum tax they would owe under these rules. This includes the research and development credit — the state’s largest credit, representing about 4 in 5 dollars of the total cost of California’s corporate tax credits.5Franchise Tax Board, Corporation Tax Annual Report, Tax Year 2019, Table C-7. As a result, California does not actually ensure that profitable corporations pay an adequate minimum level of tax. Policymakers could strengthen the minimum tax by not allowing credits to reduce a corporation’s tax liability below the minimum tax.6Specifically, credits could not be allowed to reduce taxes owed below the “tentative minimum tax,” which is the amount resulting by applying a 6.65% tax rate (or 8.65% for financial institutions) to an alternative income calculation which removes certain tax preferences. Credits could also not be allowed to reduce the “alternative minimum tax,” which is the additional amount that a corporation generally must pay when their tentative minimum tax exceeds their regular tax liability.

Another approach would be to simply limit the extent to which a corporation can use tax credits to reduce their tax bill in any given year. For example, California temporarily prohibited businesses from using more than $5 million in tax credits — excluding the low-income housing credit — to reduce their tax liability in 2020 after the COVID-19 pandemic hit when the state’s finances were expected to suffer. Policymakers could institute such a limit on a permanent basis, or limit the credits that can be claimed in a given year to a specific percentage of the tax that a corporation would otherwise owe. For example, credits could be limited to one-half of a corporation’s pre-credit tax liability in any given tax year.

3. Limit the Ability of Corporations to Avoid State Taxes by Using Tax Havens

Corporations doing business in multiple countries can minimize or even eliminate the taxes they owe to the US federal and state governments by shifting their profits into subsidiaries in jurisdictions with low or zero tax rates, known as tax havens. One recent estimate suggests that about one-quarter of the profits of US multinational corporations are booked abroad, and that about half of these foreign profits are booked in tax havens.7The authors also estimate that around 13-15% of the total worldwide profits of US corporations were booked in tax havens across 2015-2020, which they note represents a historically high level. Javier Garcia-Bernardo, Petr Janský, and Gabriel Zucman, Did The Tax Cuts And Jobs Act Reduce Profit Shifting By US Multinational Companies? (National Bureau of Economic Research, Working Paper 30086, May 2022), 3, https://www.nber.org/system/files/working_papers/w30086/w30086.pdf. Much of these shifted profits are not actually earned in these foreign jurisdictions, but have been artificially shifted out of the United States using creative accounting techniques.8One such technique is transferring intellectual property rights — such as patents and trademarks — to their foreign subsidiaries, which can then charge the US parent company for the use of that intellectual property. See, for example, Ana Maria Santacreu and Jesse LaBelle, “Profit Shifting Through Intellectual Property,” Federal Reserve Bank of St. Louis, Economic Synopses, no. 22 (July 2022), https://doi.org/10.20955/es.2022.22.

California and many other states allow corporations to take advantage of a loophole known as the water’s edge election, which enables this type of tax avoidance. This provision allows corporations to choose whether or not to include the income held by their foreign subsidiaries in their overall income when calculating the share that is taxable in California.9Generally, corporations determine the share of their total income that is taxable in California based on the share of their total sales that are made to California customers. This gives these corporations an incentive to shift profits abroad to avoid state taxes, and also gives them the option of choosing whichever of the two methods will result in the lowest tax liability. The water’s edge election is projected to cost the state an estimated $4.4 billion in 2022-23.10Department of Finance, Tax Expenditure Report 2022-23, 11, https://dof.ca.gov/wp-content/uploads/sites/352/Forecasting/Revenue_and_Taxation/TaxExpenditureReport.pdf.

The most comprehensive option to address this type of tax avoidance would be to eliminate the water’s edge election and require corporations to include their worldwide income as a starting point when calculating the share of their income subject to California taxes. This approach is known as “worldwide combined reporting,” and was used by California and other states in the past.11See, for example, Darien Shanske, White Paper on Eliminating the Water’s Edge Election and Moving to Mandatory Worldwide Combined Reporting (August 2, 2018), https://dx.doi.org/10.2139/ssrn.3225310. There are also less comprehensive measures that policymakers could consider. One approach that some other states have taken is requiring corporations to just include the profits they have booked in known tax havens for the purpose of computing their state taxes.12See Richard Phillips and Nathan Proctor, A Simple Fix for a $17 Billion Loophole How States Can Reclaim Revenue Lost to Tax Havens (Institution on Taxation and Economic Policy, U.S. PIRG Education Fund, SalesFactor, and American Sustainable Business Council, January 17, 2019), 7-8 and 11-13, https://itep.org/a-simple-fix-for-a-17-billion-loophole/. Another is to explore following the approach that the federal government adopted in 2017 of taxing  “global intangible low-taxed income” or “GILTI.”13See Darien Shanske and David Gamage, “Why States Should Tax the GILTI,” State Tax Notes (March 4, 2019), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3374987; and Darien Shanske and David Gamage, “Why States Can Tax the GILTI,” State Tax Notes (March 18, 2019), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3374991. The GILTI regime is, however, complex and imperfect, so this option requires careful consideration and potential modifications to ensure the policy is effective and legally permissible.

Corporate Tax Transparency, Corporate Tax Breaks, and Barriers to Raising Revenues

Beyond the three options discussed here, policymakers should also increase corporate tax transparency, scale back corporate tax breaks, and address barriers to raising revenues. These steps would help make the state’s corporate tax system — and the state’s revenue system as a whole — more fair and effective.

First, greater transparency is needed to shed light on the extent to which corporations are engaging in questionable tactics to minimize or wipe out their state liability. This includes stronger data reporting requirements, which can be structured to avoid jeopardizing taxpayer privacy. 

Policymakers should also examine the specific corporate tax breaks that already exist in the state’s tax code. These tax breaks should be regularly reviewed and subject to nonpartisan evaluation to determine if and how well they are achieving their policy goals, what types of corporations receive the most benefits, and whether they should be retained, reformed, or eliminated.

Finally, the state’s constitutional spending cap (the Gann Limit) poses challenges to any policy change that raises significant revenues, since substantial new revenues will push the state closer to or above the spending cap, and revenues above the cap are restricted to being spent in specific ways. This limits the ability of state leaders to use revenues to address the most pressing challenges faced by Californians. Policymakers could raise significant revenues and avoid this limitation by using the new revenues for tax benefits that improve the economic and social well-being of Californians with low and middle incomes — such as expanding the California Earned Income Tax Credit and Young Child Tax Credit. With this approach, revenues would not increase on net, allowing the state to avoid going over the spending cap and facing a restriction on how those revenues could be used. For policymakers to have more flexibility in spending significant new revenues — beyond investing them in tax benefits for people with low or moderate incomes — it will be necessary to reform the Gann Limit.

California Budget
  • 1
    Some types of corporations are subject to different rates, such as banks and other financial institutions, which pay an additional 2% in state tax because they are exempt from local taxes that other businesses pay. Corporations that are organized under Subchapter S pay only a 1.5% rate, but their shareholders pay personal income taxes on their shares of the business’ income. Additionally, the effective tax rate — the share of overall income paid in tax — varies from corporation to corporation based on the extent to which they are able to take advantage of corporate tax breaks.
  • 2
    Franchise Tax Board, Corporation Tax Annual Report, Tax Year 2019, Table C-8, https://data.ftb.ca.gov/California-Corporation-Tax/CORP-Annual-Report-2020/6mcf-cr69
  • 3
    Jonathan Kaplan, Why Aren’t Large Corporations Paying Their Fair Share of Taxes and What Can California Policymakers Do About It?, (California Budget & Policy Center, April 2021), 6, https://staging.calbudgetcenter.org/app/uploads/2021/03/IB-FP-Corporate-Taxes.pdf.
  • 4
    This alternative minimum tax system is in addition to the $800 “minimum franchise tax” that must be paid by all corporations incorporated in, registered in, or doing business in California.
  • 5
    Franchise Tax Board, Corporation Tax Annual Report, Tax Year 2019, Table C-7.
  • 6
    Specifically, credits could not be allowed to reduce taxes owed below the “tentative minimum tax,” which is the amount resulting by applying a 6.65% tax rate (or 8.65% for financial institutions) to an alternative income calculation which removes certain tax preferences. Credits could also not be allowed to reduce the “alternative minimum tax,” which is the additional amount that a corporation generally must pay when their tentative minimum tax exceeds their regular tax liability.
  • 7
    The authors also estimate that around 13-15% of the total worldwide profits of US corporations were booked in tax havens across 2015-2020, which they note represents a historically high level. Javier Garcia-Bernardo, Petr Janský, and Gabriel Zucman, Did The Tax Cuts And Jobs Act Reduce Profit Shifting By US Multinational Companies? (National Bureau of Economic Research, Working Paper 30086, May 2022), 3, https://www.nber.org/system/files/working_papers/w30086/w30086.pdf.
  • 8
    One such technique is transferring intellectual property rights — such as patents and trademarks — to their foreign subsidiaries, which can then charge the US parent company for the use of that intellectual property. See, for example, Ana Maria Santacreu and Jesse LaBelle, “Profit Shifting Through Intellectual Property,” Federal Reserve Bank of St. Louis, Economic Synopses, no. 22 (July 2022), https://doi.org/10.20955/es.2022.22.
  • 9
    Generally, corporations determine the share of their total income that is taxable in California based on the share of their total sales that are made to California customers.
  • 10
  • 11
    See, for example, Darien Shanske, White Paper on Eliminating the Water’s Edge Election and Moving to Mandatory Worldwide Combined Reporting (August 2, 2018), https://dx.doi.org/10.2139/ssrn.3225310.
  • 12
    See Richard Phillips and Nathan Proctor, A Simple Fix for a $17 Billion Loophole How States Can Reclaim Revenue Lost to Tax Havens (Institution on Taxation and Economic Policy, U.S. PIRG Education Fund, SalesFactor, and American Sustainable Business Council, January 17, 2019), 7-8 and 11-13, https://itep.org/a-simple-fix-for-a-17-billion-loophole/.
  • 13
    See Darien Shanske and David Gamage, “Why States Should Tax the GILTI,” State Tax Notes (March 4, 2019), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3374987; and Darien Shanske and David Gamage, “Why States Can Tax the GILTI,” State Tax Notes (March 18, 2019), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3374991.

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Having a place to call home is the most basic foundation for health and well-being no matter one’s age, gender, race, or zip code. But many thousands of individuals in California each year experience homelessness and its destructive effects. Polling shows that Californians continue to rank homelessness as one of the most serious challenges facing the state, and policymakers have paid increasing attention to this issue in recent years. Understanding the scale, impact, and drivers of homelessness in California can help guide effective policy solutions and action to end this crisis.

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How does homelessness affect the people who experience it?

Homelessness has devastating effects on the individuals who experience it because having a home is a basic necessity to maintain health, work, school, and dignified living conditions. Lack of stable housing seriously disrupts individuals’ ability to obtain or keep a job or to make sure that children are able to attend and focus on school. Homelessness exposes individuals to serious health risks and makes it difficult to take care of one’s health and access health care, and therefore homelessness can exacerbate chronic or acute health conditions. In fact, adults experiencing homelessness often have health problems and difficulty with daily living activities that are more typical of people 20 years older. Unhoused individuals have also faced serious health risks throughout the COVID-19 pandemic.

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This devastation to people’s lives is why homelessness in California is a crisis that requires urgent attention by federal, state, and local leaders.
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The stress of homelessness can also seriously harm individuals’ mental well-being. Research shows that the trauma of experiencing homelessness can cause people to develop mental health problems for the first time and can worsen existing behavioral health challenges. Longer time spent without a home is linked to higher levels of mental distress and more damage from coping behaviors like substance use.

This devastation to people’s lives is why homelessness in California is a crisis that requires urgent attention by federal, state, and local leaders.

How many people in California experience homelessness?

When Californians experience homelessness, urgent action is needed, because no one should be without a home. According to the most recent point-in-time data, as of January 2020 there were 161,548 people in California experiencing homelessness on a given night. The majority of these individuals – about 70% – were unsheltered, meaning that they were living on the street, in their vehicle, or in other places not meant to serve as homes. 

Another way to understand how many Californians experience homelessness is to consider how many people received homelessness services (like shelter or outreach) over the course of a full year. More than 270,000 homeless individuals across the state received some kind of services during calendar year 2021, and the total number receiving services likely increased the following year. This number is larger than the point-in-time number because many people who fall into homelessness at some time during the year return to stable housing relatively quickly, and the point-in-time count only captures the number of individuals experiencing homelessness on one night of the year.

Who experiences homelessness in California?

People of all ages and backgrounds fall into homelessness, and Californians experience homelessness in every county of the state. The majority of unhoused individuals are single adults, but an important share are also families with children and unaccompanied and parenting youth. A substantial share of single adults experiencing homelessness in California are older adults.

There are deep racial inequities in who experiences homelessness in California, with individuals who are Black facing a greatly disproportionate risk of homelessness, as well as American Indian or Alaska Native and Pacific Islander individuals. The number of Latinx Californians experiencing homelessness also increased substantially in the most recent point-in-time count. These disparities reflect the effects of structural racism and inequitable treatment and access to opportunities in education, employment, health, the justice system, and other domains.

In addition, there are disparities in experiences of homelessness by gender identity and sexual orientation. In terms of gender, the majority of unhoused Californians are male. Individuals who identify as transgender or gender-nonconforming are more likely than cisgender individuals to be unsheltered when they experience homelessness. Among youth, those who identify as LGBTQ+ are especially likely to experience homelessness, in many cases as a direct result of family rejection of their gender identity or sexual orientation.

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See our 5 Facts: Who is Experiencing Homelessness in California? to learn more about California’s diverse unhoused population.

What are the key drivers of homelessness in California?

Many systemic challenges rooted in classism, racism, and sexism that harm individuals and families put people at greater risk of becoming homeless at some point in their lifetime.

The severe shortage of affordable housing — particularly housing that is affordable to people with the lowest incomes — is the number-one driver of California’s homelessness crisis. For Californians with the very lowest incomes — those categorized as “extremely low-income” under the definition used for most state and federal housing policies — there were only 23 housing units that were affordable and available for every 100 renter households as of 2020. Statewide, an estimated 1.2 million new affordable homes are needed by 2030 to meet the housing needs of Californians with low incomes.

Because affordable housing is in such short supply in California, many renters with low incomes must pay much more than they can afford for housing, so that even a minor financial emergency can cause them to be unable to cover the rent and face the risk of eviction and homelessness. Black and Latinx renters are especially likely to face unaffordable housing costs, reflecting the effects of explicitly and implicitly racist policies and practices in housing, employment, and other arenas.

Other factors have also contributed to California’s homelessness crisis, including the decades-long trend of stagnant wages for lower-wage workers and past failure to fund adequate mental and behavioral health services to meet needs in the community. The shortage of deeply affordable housing, however, is a fundamental driver of the crisis.

What public systems and supports can address the needs of people experiencing homelessness or play a role in preventing homelessness?

Many different local, state and federal public systems and services intersect with homelessness in important ways. 

Nearly 1 in 8 Californians did not have enough resources to meet their basic needs, according to the most recent California Poverty Measure data. This reflects the high cost of living in many parts of the state. In addition, the share in poverty is expected to increase for 2022, as pandemic-era public supports like the expanded federal Child Tax Credit expired. For all individuals experiencing homelessness, public supports that help people meet basic needs are important both to prevent and exit homelessness. These supports include but are not limited to: cash supports like SSI/SSP and CalWORKs, refundable tax credits like earned income tax credits (EITCs) and child tax credits, nutrition assistance programs like CalFresh and WIC, and Medi-Cal health coverage.

While only a minority of unhoused individuals struggle with serious mental health or substance use disorders, behavioral health services are vital supports for maintaining stable housing over the long term for those individuals.

Among youth, abusive or neglectful family situations can cause young people to leave their homes and become homeless, pointing to a role for the child welfare system in preventing and addressing youth homelessness.

Domestic violence can also be the trigger that pushes individuals into homelessness, especially women and mothers with children. Services that directly address the experiences and needs of domestic violence survivors are important to prevent and address homelessness for these individuals.

The justice system has an impact on many unhoused individuals as well. This is both because of laws that criminalize homelessness (e.g., laws that make public camping punishable by citation or arrest) and because individuals who have a conviction record or are reentering the community after incarceration face daunting barriers to securing and maintaining stable housing. These factors compound challenges in helping individuals find safe, affordable housing.

What are effective, evidence-based ways to address homelessness? 

Extensive research shows there are several evidence-based approaches that are effective in helping people successfully exit homelessness and maintain stable housing. 

For all individuals experiencing homelessness, interventions that use a “housing first” approach have a strong track record of success. Housing first — as its name suggests — focuses on moving people into permanent housing as the first priority, before focusing on meeting other needs or connecting with other services.

For the minority of individuals who are chronically homeless and have serious physical or mental health challenges, supportive housing — or permanent housing paired with case management and support services — is an approach that research shows is effective in enabling individuals to exit homelessness and achieve housing stability. About one-third of Californians experiencing homelessness on a given night are chronically homeless with serious health challenges.

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Having a place to call home is the most basic foundation for health and well-being no matter one’s age, gender, race, or zip code.
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Housing vouchers, shallow rental subsidies, and targeted programs for specific subpopulations  — such as veterans, homeless youth, or domestic violence survivors — are additional tools to help individuals successfully return to stable housing.

Interim housing, like motel stays, emergency shelters, and tiny homes, can also be necessary short-term strategies to get people off the street so that they are not unsheltered. These options can contribute to solving homelessness if coupled with services that focus on moving individuals into permanent housing as quickly as possible.

State funding to address homelessness has recently increased, but the number of people experiencing homelessness did not decrease. Why is that the case?

Effectively addressing homelessness requires a system of housing and services with enough capacity and investment to meet the needs of all Californians who are experiencing homelessness in every region of the state. Building that capacity requires investing in proven effective approaches at a scale that meets the need — and then providing reliable ongoing funding so that effective efforts can be sustained. Partnership between the state, federal, and local governments is important to mobilize the resources needed for impact at scale.

California first dedicated significant state dollars to address homelessness only a few years ago, and state investments have primarily consisted of one-time funding. The 2021-22 state budget first included a multi-year commitment of $1 billion annually to support local homelessness efforts, with intent to continue “based on performance and need.” In addition, there were significant investments in housing supports for special populations, such as families with children, and support to acquire and develop housing specifically to meet the needs of individuals experiencing homelessness. The 2022-23 state budget further built on these investments, including maintaining the $1 billion support for local homelessness efforts and incorporating $1 billion to expand bridge housing for individuals experiencing homelessness with serious mental illness.

These recent increases in state funding have not been accompanied by a drop in the number of Californians experiencing homelessness. Why? The COVID-19 pandemic is a key factor. Both health and economic effects of the pandemic have directly affected homelessness services and put more individuals at risk of homelessness.

At the start of the pandemic, to protect the health of vulnerable individuals experiencing homelessness — and public health more broadly — policymakers and service providers pivoted remarkably quickly to implement new models of non-congregate shelter, with California leading the way in developing innovative new approaches. Launching these new models required significant up-front investment of time and funding, which was necessary in the short-term to protect the health of individuals, and is expected to produce sustained payoff by building a safer and more effective long-term model for interim housing.

At the same time, the economic effects of the pandemic have put more Californians at risk of falling into homelessness. Since the start of the pandemic, rents have increased significantly. Record-high inflation more generally has pinched household budgets, and Californians with the lowest incomes have been hit the hardest.

Given these significant pandemic headwinds, the recent increases in state funding to address homelessness have likely played several vital roles. These include preventing many unhoused Californians from experiencing severe health effects or dying from COVID-19; preventing a substantially larger increase in the number of Californians experiencing homelessness; and building California’s long-term capacity to address homelessness more effectively.

When addressing a complex challenge like homelessness — particularly in the shadow of a global pandemic — progress takes time, and sustained commitment by policymakers is critical. Maintaining and building on recent state budget investments to address homelessness, to meet the full scale of need, can enable California to achieve a functional end to homelessness. The experience of homelessness for Californians would then be rare, brief, and non-recurring for individuals and across communities.

At the same time, the widespread shortage of affordable permanent housing continues to drive Californians into homelessness. As a result, it is also critical to invest in expanding the state’s supply of affordable housing, especially rental housing affordable to households with the lowest incomes. Both housing development and tenant-based rent subsidies can play a role in making more housing available that is deeply affordable.

Bottom line: Ending homelessness is possible, but persistence is required. There are many opportunities for the state to leverage its resources to ensure all Californians have a home.

Support for this report was provided by the Conrad N. Hilton Foundation.

California Budget

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