Governor Newsom released his 2026-2027 budget proposal Friday morning. The budget shows a revenue of $248.3 billion. But not everyone agrees on the projection, especially when it comes to AI stocks.
The Legislative Analyst’s Office, a nonpartisan legislative advisory group in its November fiscal outlook, projected revenues about $36 billion lower than Governor’s revenue projections.
So, why is the LAO less optimistic?
“There are certain signs pointing to the fact that the stock market is overvalued at this point,” Gabriel Petek, head of the Legislative Analyst’s Office said. “Although we revised our revenue up… if you were to just kind of look at stock market trends, it would even be higher.”
Newsom reinforced the $248.3 billion number in his State of the State address, but he didn’t address the risk stated by the proposed budget and the California Director of Finance Joe Stephenshaw.
“The biggest difference in the kind of factors in the forecast, really, is the LAO incorporated a significant risk of a stock market downturn in their forecasts,” Stephenshaw said. “We did not do that. We don’t build in downturns, recessions into our forecast.”
Petek, however, said that his office is just advising the legislature to consider the market’s volatility.
“We’re not predicting [a downturn] necessarily,” Petek said. “It’s prudent to not assume the market will just remain the way it has in the last year.”
With the stock market booming on the heels of AI tech companies’ rise to prominence, the Governor’s revenue forecast hinges on continued growth in the tech sector.
“Even if there’s underlying value in these new technologies, what we’ve seen in the past is that the market can kind of get ahead of that and create sort of a bubble situation,” Petek said. “The internet is obviously a very useful tool. But at the moment when it was first emerging, there was some overexuberance in the markets.”
He said that his office also found evidence that the current market is overvalued.
“Investors out there are taking some riskier actions, doing things like borrowing on margin to buy stocks,” Petek said. “We’ve seen these kind of indicators line up like this before, and that’s tended to be right around the time of the stock market peaking.”
According to FINRA, a not-for-profit, self-regulatory investor protection agency, margin debts, or the amount of money investors have borrowed to buy stocks, is at an all-time high of $1.21 trillion.
At times in the past when this activity has peaked, the peak has preceded a major decline: in 2000 with the dot-com bubble, in 2008 with the housing crisis, and a more recent decline in 2022 preceded the popping of a massive cryptocurrency bubble as well.
This is the first time in history margin debts have surpassed $1 trillion.
“A downturn in the market is one of the top risks that we see out there to our revenue forecasts,” Stephenshaw said in his presentation. “We feel it’s important to wait and see how things develop over the next couple of months and then at the May revision, take appropriate action.”
When will the bubble pop?
Partnership on AI is a nonprofit partnership with representatives from companies like Open AI, Microsoft and Meta as well as media and education nonprofits like AP and the American Psychological Association.
Rebecca Finlay, the CEO of Partnership on AI, said that tech development can seem unending, but that may not always be the case.
“It’s called Amara’s Law… the idea is that we just tend to overestimate the short term impacts of technology development,” Finlay said. “But we underestimate the long-term impacts.”
She said that while we can be bad at making predictions, one of the most common examples of Amara’s Law’s is the birth of the internet with the dot-com bubble.
“We had the hype that led to the dot-com bubble and then, that was a bubble,” Finlay said. “Now, the internet is just integral to absolutely every business and all that we do… The long term has led to a lot of economic growth.”
The California Budget & Policy Center is a nonpartisan, non-profit research and analysis organization that helps guide policymakers in the California state government. Alissa Anderson, Policy Director at the Center, said that it’s common to see a difference between the Governor’s Office and the LAO.
“I think both the Legislative Analyst’s Office and the Governor’s Office acknowledge that there is a significant risk,” Anderson said. “This current surge in revenues that’s largely coming from tech is likely to reflect an AI bubble that could pop.”
Anderson said that this recent surge in revenues from the tech industry reflects deep and widening inequality in California.
“A small number of wealthy investors have been doing exceptionally well,” Anderson said. “While millions of Californians have been struggling with rising costs. Inequality in our state is stark.”
She said that corporate taxes in California have legal loopholes that allow nearly half the profitable companies to only pay the minimum $800 in state taxes.
“Collectively, they had almost $12 billion in state taxes,” Anderson said. “Closing these loopholes is a common sense way to … generate the long term revenue that California needs to strengthen economic security for all people in our state.”
Anderson also said that the federal HR 1 bill, also known as the “Big Beautiful Bill,” will have a significant impact on the budget that the Governor’s projection doesn’t take into account. According to the Center, cuts to Medi-Cal and food assistance included in the bill will affect millions of Californians.
“We think that the Governor really missed an opportunity to propose meaningful, progressive revenue solutions,” Anderson said.
Historically, according to the California Budget & Policy Center, the state has tended to adopt the Governor’s revenue projections. However, that could change by May, when the Governor will revise the budget to reflect economic forecasts.
“The other really important thing to understand is that the state’s fiscal picture is going to change,” Anderson said. “It will definitely change by the spring … we’ll have a much better sense of the revenue picture by then.”