Increased Capital Gains Revenue Improves California’s Budget Outlook

Governor Gavin Newsom released the “,” which incorporates state revenues collected through April and updated economic forecasts since his January proposal. This year's May Revise indicates an increase of $16.5 billion dollars in additional revenue of which $13.6 billion is primarily from capital gains collections.

The increase in revenue may allow the Governor to achieve his goal of signing a structurally balanced budget, without an increase in broad-based or personal income taxes, for the next two fiscal years as well as reduce future year deficits.

In addition to the increase in projected revenues, the Governor is proposing additional solutions as part of the May Revise to help balance the budget, including:

• Permanently limiting the use of business tax credits at $5 million or 50 percent of tax liability, whichever is greater starting in tax year 2027—which is projected to increase state revenues by $850 million in 2026–27, $1.7 billion in 2027–28 and similar ongoing revenue gains in subsequent years.
• Taxation of digital prewritten software and software as a service, effective January 1, 2027, which is projected to generate $450 million in 2026–27 and $900 million in 2027–28 and is projected to significantly increase local sales tax revenues.
• An updated 2027 Managed Care Organization Tax to comply with H.R. 1 limitations and to replace the existing tax, which expires at the end of this year.

The Governor also proposes several health care spending reductions to balance the budget, such as Medi-Cal asset test limits and increasing premiums for adults with unsatisfactory immigration status.

To help strengthen the budget over the next two fiscal years, the Governor is proposing a deposit of $9.7 billion into the Surplus Holding Account, an account established in 2024, that allows the state to set aside a portion of anticipated surplus funds and allocate the funds in a subsequent fiscal year. The Governor is also signaling his intention to seek constitutional reforms that will allow the state to build additional reserves and mitigate revenue volatility.

Although Governor Newsom is not proposing significantly new ongoing General Fund commitments, the May Revise includes a few notable investments:

• Covered California State Subsidy Program – $300 million ongoing Health Care Affordability Reserve Fund, for Covered California to expand the state premium subsidy program to enrollees at up to 200 percent of the Federal Poverty Level.
• Disaster Rebuilding Fund – $100 million investment, including $56 million General Fund and $44 million in existing National Mortgage Settlement funds to expand access to construction and renovation financing for disaster-impacted homeowners.
• Reducing the $800 Annual Tax for New Businesses by Half – reduction of the $800 annual tax paid by limited liability companies, limited partnerships and limited liability partnerships in their first year to $400 during the 2027, 2028 and 2029 tax years.

Given California’s notoriously volatile budget, the May Revise indicates that the fiscal future is uncertain, and the state will be particularly subject to macroeconomic trends. in their economic forecast “Despite the stronger-than-projected economic performance in 2025, the outlook has weakened in the near term reflecting broader global and national pressures, including higher global energy prices associated with geopolitical developments, most notably the Iran war, and the delayed impacts of tariffs.” As a result, the Administration projects increased inflation and reduced growth through 2026.

Next Steps

Both houses of the Legislature will begin public hearings on the Governor’s May Revise this month. The Senate and Assembly typically arrive at a joint budget agreement before negotiations with the Governor begin. The Legislature has a June 15 deadline to pass the budget.