Gov. Gavin Newsom and Democratic lawmakers agreed Saturday to make $16 billion in cuts to close California's $46.8 billion budget deficit, declare a statewide fiscal emergency and draw money from the state's reserve fund.

The agreement on the $297.7 billion spending plan comes after weeks of intense negotiations with labor unions and business interests after lower-than-expected revenues forced Newsom and lawmakers to scale back California's progressive agenda. The shortfall sparked a tug-of-war over much-needed state funding and drove a rift between the governor and some of his closest allies in the Legislature.

Among the more high-profile changes, the 2024-25 budget proposal delays a minimum wage increase for health care workers until at least October, cuts funding for affordable housing by $1.1 billion and slashes funding for the state prison system by $750 million.

California businesses were also hit hard when nearly $15 billion in tax cuts were suspended for three years, a year earlier than Governor Newsom had originally proposed.

“This agreement puts the state on a path to long-term fiscal stability by eliminating our current budget deficit and strengthening our budget resilience for the future,” Governor Newsom said in a statement. “We will ensure that we preserve the programs that serve millions of Californians, including expanding education, health care and behavioral health services and tackling homelessness.”

The deficit marks a dramatic reversal of California's fiscal position from a $100 billion surplus projected two years ago, creating a tough political argument for Governor Newsom, who often boasts that California is an essential economic engine for the nation.

The governor is required by law to declare a statewide budget emergency before drawing money from the reserve fund to close the deficit, but doing so would give ammunition to critics who accuse Democrats of mismanaging the state's finances and overspending.

Despite the budget deficit, California's economy remains strong and the state has more revenue to spend than when Governor took office.

“This isn't about revenue,” said David Klein, president of Governors for California, a nonprofit group that opposes union influence in state government. “The deficit is the result of spending.”

In April, Governor Newsom said California's economy Maintained fifth place in the worldHe said the state “continues to punch above its means.”

Part of the state's fiscal problems are the result of poor revenue forecasts that led Governor Newsom and lawmakers to allocate more money to programs than they could actually spend.

The state's progressive tax system means the government relies on income tax revenues paid by California's CEO and other high-income earners, which are subject to stock price fluctuations and are difficult to predict. The postponement of the 2022 tax filing deadline from April to November forced California leaders to craft the current budget without a full understanding of how much the state's tax revenues had fallen.

When Governor Newsom signed the budget last year, he expected California's budget deficit to widen and said most of the new funding in his spending plan was intended as temporary boosts that could be easily stopped if revenues fell. The cuts include $500 million to a loan program to pay for affordable housing for college students and $485 million to the Work Student Program for students.

But the governor and lawmakers have been criticized for choosing to pull money from the state's rainy day fund — set to be worth $5.1 billion in the 2024-25 fiscal year and $7.1 billion the following year — to avoid further cuts. Democrats also plan to pull $900 million from the Safety Net Reserve Account next year.

Putting money into the state's piggy bank has raised concerns about what will happen to state programs that help California's neediest people if the economy sinks into a recession and state revenues fall further.

Democrats on Capitol Hill have outlined several proposed cuts that state lawmakers will vote on next week before the budget takes effect July 1.

Newsom and lawmakers said the agreement includes measures that would require the state to set aside a surplus for the next budget year in future years as a way to prepare for revenue fluctuations, as well as amending the constitution in 2026 to increase the state's rainy day fund. No details were provided in the announcement.

Here's what we know so far about the agreement:

Postponement of increase in minimum wage for medical care

Newsom signed a bill last year raising the minimum wage for health care workers to $25 an hour, but waited weeks before explaining that he would not allow the law to go into effect if the state's fiscal crisis worsened.

At the time, the Treasury Department estimated the law could cost the state $2 billion, and the unions argued the cost would be closer to $300 million if the state had required hospitals to cover most of the costs.

Governor Newsom said he shared concerns with labor unions before signing the bill, which sparked months of closed-door negotiations over when wage increases would occur and how to cover the costs of the increases.

The talks ultimately ended with a budget agreement, with wage increases now being postponed until October 15th at the earliest, rather than this month as originally planned.

The start date for the pay hikes depends on one of two scenarios: state revenues in the first quarter of the fiscal year exceed projections by 3% or federal funding to hospitals increases through quality assurance fees. If neither happens, the pay hikes could be delayed until after October.

Lawmakers and the governor essentially use the quality assurance fee as a mechanism to help hospitals cover price increases: Hospitals pay the quality assurance fee, the federal government matches it, and then sends the money to the hospitals.

The federal increase requested by the state is expected to cover 30% of the cost of raising hospital wages.

The budget projects the program will cost the state $600 million in 2024-25.

No resolution to MCO tax dispute

The question of how to spend the revenues from the tax on managed care organizations (known as the MCO tax) has proven to be the hardest question to answer in the budget negotiations — so difficult, in fact, that it has led to the talks collapsing and Governor Newsom threatening to veto a ballot measure supported by some of his closest allies.

The tax would apply to health insurers that charge a flat monthly payment for services and serve as a mechanism to allow California to collect billions of dollars in additional federal funds for Medi-Cal, its health care plan for low-income people.

Newsom and lawmakers renewed the tax last June, agreeing to use some of the revenue to raise reimbursement rates for providers who see Medicare patients. Doctors have unsuccessfully campaigned for years to raise the fees, arguing that reimbursements are too low and result in a shortage of doctors to take patients, limiting access to care.

But Governor Newsom reversed course and proposed taking more than $6 billion in Medicare fee hikes over several years and using the money to avoid cuts to the program.

The change puts Newsom at odds with a coalition led by the California Medical Association and Planned Parenthood, two groups that have supported the governor's causes and supported his campaign.

The coalition called on the governor to honor the agreement to increase provider fees in 2023. It is also leading the push to pass legislation. Measures on the 2024 ballot This would result in the permanent implementation of the MCO tax to cover the higher reimbursement rates.

The governor wants the coalition to take the bill off the ballot because he wants the money to be flexible and allow the state to use it in the future if it is needed to support Medicare.

The coalition has so far refused to remove the bill from the vote, fearing Democrats will again divert the budget, and talks have ended in a stalemate.

The final state budget includes $6.9 billion to support the Medicare-Cal program next year.

Governor Newsom and lawmakers agreed to reduce funding from the MCO tax for “provider fee increases and investments,” but it's far less than what was previously set aside. The budget includes $133 million in 2024-25, with plans to increase that to $728 million in 2025-26 and $1.2 billion the following year.

Democrats said if the bill is approved for the 2024 ballot, MCO funding would become “non-operational” and essentially be eliminated.

As negotiations stalled, the governor has threatened to campaign against the bill, raising the possibility that Newsom could challenge his supporters in the November election.

Suspension of corporate tax cuts

The budget proposal would limit the total tax credits available to in-state businesses to $5 million per filer and suspend the net operating loss tax credit for businesses with revenues of $1 million or more in 2024, 2025 and 2026.

As a concession to the business community, Governor Newsom and lawmakers are allowing companies to get refunds on tax credits after the restrictions end.

Newsom had originally proposed halting and capping the tax cuts starting in 2025, but Democrats in the state Legislature insisted on making the change a year earlier to avoid cuts to other programs.

The administration said the tax cut changes would raise about $15 billion in revenue by 2026.

The early start could hurt businesses that had been scheduled to deduct losses from their taxes in 2024 but now have to scramble to reduce staff or inventory to make up for unexpectedly high bills. The limit also marks the second time in five years that the state has capped tax credits, potentially scaring away companies doing business in California.

Major prison cuts

Lawmakers previously proposed an additional $1 billion in cuts to the Department of Corrections and Rehabilitation, including at least $12 million in cuts to the Governor's plan to renovate San Quentin Prison. Newsom's proposed cuts included $80.6 million in savings from the newly announced elimination of 46 housing units at 13 state prisons.

The final agreement would result in a total of $750 million in cuts to correctional facilities funding, including savings from reduced operating costs and eliminating vacant positions.

Governor Newsom supports new homeless aid package

In late May, state Democrats in the Assembly proposed spending $1 billion more than the governor budgeted for a sixth round of homeless housing, assistance and prevention grants to local governments to address homelessness. At the same time, lawmakers proposed cutting $100 million in funding for homeless camp cleanups for the current budget year.

The final budget proposal appears to represent a compromise.

The deal includes $1 billion in additional grant funding for homeless assistance, which the governor and lawmakers said will be tied to new accountability measures to ensure local governments spend the money appropriately. The deal also provides $150 million for encampment grants next year.

Broadband Internet Access for All — Coming Soon

As the pandemic shifted K-12 education from classrooms to distance learning, it highlighted the need to improve access to broadband internet for homes across California, where low-income households and those living in rural areas often lack the same internet connections as more affluent areas.

Governor Newsom aims to make access to the internet more equitable through his “Broadband for All” initiative.

The spending plan defers $550 million in funding for “last mile” work to connect the network to the home until fiscal year 2027. The budget agreement also proposes dedicating $250 million next year to programs to expand and improve fiber optic networks under “middle mile” projects, giving Democrats a total of $2 billion to last-mile work over multiple years.

Delays in funding public schools

Under Proposition 98, approved by voters in 1988, California provides guaranteed minimum funding for schools and community colleges.

Earlier this year, Governor Newsom proposed the unusual step of restructuring the 2022-23 budget to reflect lower-than-projected state revenues.

The California Teachers Association said the changes would cut school funding by about $12 billion over two years. The union ran television ads criticizing Newsom's proposal and urging him to reverse course.

Governor Newsom and teachers finally agreed to a complicated solution late last month that would suspend minimum funding guarantees and defer $5.5 billion in funding until the future.