(The Center Square) - California’s nonpartisan state analysis agency warned the state has “no capacity for new commitments,” and faces annual deficits of $20 billion or more starting in 2026 as spending growth outpaces weak sales tax revenue.

For the 2025-2026 fiscal year, the Legislative Analyst’s Office said the state faces a $2 billion shortfall — assuming the Trump administration does not withhold any federal funding in response to California’s sanctuary state policies regarding undocumented immigrants.

About half the $161 billion budget for Medi-Cal, the state’s taxpayer-funded healthcare system that covers one-third of Californians, comes from the federal government. This spending includes about $5 billion for covering undocumented immigrants, according to the California Department of Health and Human Services.

“​​Today’s announcement is no surprise given that Governor Newsom and his Democratic allies in the Legislature have thrown caution to the wind and expanded California's state budget by over 63 percent—including expanding coverage and services for undocumented immigrants,” said State Sen. Brian Dahle, R-Bieber, to The Center Square.

Though the LAO did not assess possible federal spending cuts or withholdings, losses or withholding of federal funding would significantly impact California’s bottom line.

“While changes in federal policy are being actively discussed, we cannot predict which changes may be enacted and therefore cannot estimate the effects on California’s budget,” wrote the LAO in its fiscal assessment.

California Assembly Speaker Robert Rivas, D-Salinas, signaled he would be cautious with the state’s budget this year.

“We need to show restraint with this year’s budget, because California must be prepared for any challenges, including ones from Washington,” said Rivas in a statement. “It’s not a moment for expanding programs, but for protecting and preserving services that truly benefit all Californians.”

The LAO’s fiscal report also included comparisons of current indicators compared to their historical growth averages. Pay growth and unemployment are above average, possibly reflecting the state’s recent fast food minimum wage increase to $20 per hour, while business owner income, jobs, and taxable sales are below average.

“California’s economy has been in an extended slowdown for the better part of two years, characterized by a soft labor market and weak consumer spending,” said the LAO. “Outside of government and health care, the state has added no jobs in a year and a half … Consumer spending (measured by inflation‑adjusted retail sales and taxable sales) has continued to decline throughout 2024.”

However, stock market growth is expected to deliver higher than expected revenues, as the state relies on income from the highest earners to fund its operations.

“A recovery built on a stock market rally is especially precarious,” warned the LAO. “Current stock prices relative to companies’ past earnings (a common measure of how 'expensive' stocks are) are at levels rivaled only by the transitory booms of 1999 and 2021.”

The LAO also said that higher than expected state healthcare spending growth is a major driver of rapidly rising state spending; the LAO estimates Medi-Cal spending will rise by 8.6% per year through the 2028-2029 fiscal year due to a $25 per hour healthcare minimum wage, a surge in seniors after eliminating asset limits for the elderly to enroll in the system.