Trump's volatile trade policy creates new problems for California state budget
As the stock market plummeted last week, California Assembly Speaker Robert Rivas sat at his desk in the state Capitol and predicted that President Trump's tariffs would 'squeeze our economy at every level.'
'This is certainly going to be the most challenging of years when it comes to our budget that I've had in my time in the Legislature. There will be some tough choices ahead,' the Democrat from Hollister forewarned. 'But again, it's so difficult to navigate this issue at the moment because of so much uncertainty. Every day is different.'
Less than 48 hours later, Trump paused most of the tariffs he imposed on imported goods. The financial markets that California's progressive tax structure is dependent on shot up in response before bouncing up and down the rest of the week.
The whiplash underscores the challenge before lawmakers and Gov. Gavin Newsom this spring as they attempt to develop a state budget plan for the year ahead that funds schools, healthcare, roadways and other essential services.
Every state budget is built on forecasts of state and federal economic conditions that will affect tax revenues over the next 12 months. California's oversized reliance on income tax from the top 1% of its earners, whose fortunes are often tied to the rewards they reap from the stock market, leaves the state particularly vulnerable to the booms and busts of Wall Street.
Trump's erratic trade policies and threats to withhold federal funds from California, from public health funding to support for schools, have made predicting revenues even more precarious than usual.
The tariffs and in-kind retaliation from other countries would undoubtedly hurt California, from new surcharges on almond exports to deflating Silicon Valley tech stocks.
Predicting if, or when, the additional tariffs could take effect and the potential fallout relies less on an understanding of U.S. economic policy and more on the psyche of the president.
Read more: China to reduce the number of Hollywood films allowed amid trade war
That poses a challenge for the Newsom administration, which is currently trying to develop economic forecasts for the budget year that begins in July. The estimates will serve as the bedrock of a revised state budget plan the governor presents to the Democratic-led legislature next month.
Before negotiations over the final spending plan even begin, Rivas is already cautioning the budget passed before the June deadline may need to be altered significantly before the Legislature adjourns in the late summer, or sometime in the fall.
'We have not seen the kind of changes in economic policy in Washington, either in intensity or rapidity, before,' said Jerry Nickelsburg, a senior economist for the UCLA Anderson Forecast.
'It is difficult to predict, but predict the executive and the legislative branch must do, and so the appropriate way to approach this is to be more conservative than the objective data would tell you.'
Trump imposed 10% worldwide tariffs and 25% tariffs on autos and auto parts. Locked in a trade war with China, he increased the tax rate on Chinese imports to 145%, while China raised tariffs on U.S. goods to 84%. Trump paused additional tariffs on goods imported from other nations for 90 days, citing his desire to negotiate.
H.D. Palmer, a spokesperson for the California Department of Finance, said the effects of tariffs that remain in place for international countries and China, a large trading partner for California, will be considered in the state's updated economic forecast for 2025-26, at least as of today.
But it's harder to build revenue projections around tariffs that may or may not be negotiated away.
'We're trying to wait as long as we can because things change every day,' said Somjita Mitra, chief economist for the Department of Finance. 'So we're trying, you know, to see as much information as possible.'
In Newsom's initial budget proposal announced in January, the governor flagged "uncertainty about federal policy" as the "most immediate risk to the forecast." The state stands to lose revenue from sales and use taxes, personal income taxes and corporate taxes.
The budget said Trump's tariffs proposal increases prices for consumers and businesses for everyday and essential goods, which could potentially lead to higher inflation, less spending and reduced sales tax revenue for California.
Read more: Another victim of Trump's tariffs: California's electric vehicle ambitions
Palmer noted that the state also is particularly vulnerable to stock market declines because the top 1% of income tax filers typically generated around 40% of all personal income tax paid in California. Their income is largely derived from capital gains and stock market options, or bonuses paid out based on stock performance.
"When the markets are doing well, they're doing well, and as a result, our revenue picture is doing well," Palmer said. "Conversely, when the markets tank and they're not doing so well, we don't do so well."
The "Magnificent Seven" tech stocks in the U.S. belong to companies largely based in California, such as Apple and Nvidia. The role those companies play in California's revenues from capital gains is greater than in other parts of the country, which leaves the state more susceptible to stock market declines.
Mitra noted that California's agricultural industry, particularly almond and pistachio producers that supply a large percent of the world market, could be hurt if other countries raise taxes on goods exported from the U.S. in response to Trump's tariffs. Ports in Los Angeles, Long Beach and Oakland stand to lose logistical jobs if global trade declines.
Tensions with other countries could also reduce travel and tourism to California, affecting hotels, theme parks and restaurants, Palmer said. China's decision this week to reduce the number of U.S. films released in the country will hurt major Hollywood studios.
Even before sweeping tariffs are imposed, Nickelsburg said the uncertainty from Washington will already affect California revenues.
Stock market volatility tends to depress initial public offerings and exercises of stock options, which are two important sources of capital gains that boost state revenues. The housing market, another origin of capital gains, is also likely to take a hit because people will be hesitant to buy homes if they don't feel confident in the economy, he said.
The effects of tariffs are only one source of potential financial problems for California from the Trump administration.
Since Trump took office his administration has made threats to cut billions in federal funding from California, punishing the state for its policies on parental notification of student gender changes and for offering diversity, equity and inclusion programs in schools.
Many of the attempts to slash funding, such as the administration's effort to rescind $200 million in federal funds for academic recovery after the pandemic, continue to be litigated in court. That leaves California with another big budget uncertainty.
Read more: California, other states sue Trump administration over clawback of COVID school funds
"California has had to step up because the federal government has pulled the rug out from all of our programs, all of our social safety nets," said Assemblymember Isaac Bryan (D-Los Angeles) during a floor debate this week.
Republicans at the state Capitol were quick to remind Democrats that not all fiscal challenges in California are Trump made.
The Legislature passed a bill Thursday to appropriate an extra $11.1 billion in state and federal funding to cover cost overruns for Medi-Cal, the healthcare program for low-income Californians, through the end of the current fiscal year.
A large share of the unexpected costs are from the state's expansion of healthcare coverage to all immigrants, regardless of legal residency status. While Newsom has committed to maintaining the program this year, cuts could be on the table in negotiations over next year's budget.
Before the effects of the cuts and tariffs were taken into account, the governor's January budget proposal had already relied on taking $7.1 billion from the rainy day fund to pay for state programs.
"Only in politics do you do a poor job and then try to blame someone else," said state Sen. Tony Strickland (R-Huntington Beach).
As the threat of tariffs hangs over California's budget and economy, the state should consider adopting policies to increase manufacturing and production to be less reliant on foreign suppliers, Strickland said. He called out the state's reliance on timber from Canada and oil and gas from overseas.
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This story originally appeared in Los Angeles Times.
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