key takeaway
California’s state budget reserves, including the “rainy day fund” and other reserve accounts, serve as a financial safety net for services like education, health care, and child care during economic downturns. The rules for depositing and withdrawing funds are complex, and policymakers should consider reforms, such as excluding reserve deposits from the Gann Limit spending cap, to strengthen the state budget’s resilience during a recession.
Introduction
California has several state budget reserves. These reserves help to maintain essential public services — like education, health care, and child care — when revenues fall short, such as during recessions. Reserves aren’t for everyday spending, but rather a financial safety net for the state.
This report describes California’s state budget reserves, explains how funds can be accessed and used, and discusses proposals to reshape these reserves that have been floated in recent years. For more information about California’s reserve accounts, see the Budget Center’s companion resources, including this video — California’s State Budget Reserves Explained — and this fact sheet — 5 Key Questions About California’s State Budget Reserves.
state budget Reserves in a nutshell
- The Budget Stabilization Account (BSA), or “rainy day fund,” holds revenues to support any program funded through the state budget.
- The Public School System Stabilization Account (PSSSA), or schools reserve, periodically holds revenues to support K-12 schools and community colleges.
- The Safety Net Reserve periodically holds revenues intended to support the CalWORKs and Medi-Cal programs.
- The Special Fund for Economic Uncertainties (SFEU) holds revenues to cover unexpected state budget costs during a fiscal year.
- The Projected Surplus Temporary Holding Account can be used to temporarily set aside some anticipated surplus revenues and avoid spending funds that may not materialize.
Budget Stabilization Account (BSA): California’s Largest Reserve
The BSA is California’s largest state budget reserve. Deposits into and withdrawals from this “rainy day fund” are based on complex rules that were added to the state Constitution by Proposition 2 of 2014. Key rules include the following:
An annual deposit is required. Prop. 2 requires that 1.5% of General Fund revenues be set aside every year. Until 2029-30 half of these revenues must be deposited into the BSA and the other half must be used to pay down certain state debts. Beginning in 2030-31, the entire amount must be deposited into the BSA, although state leaders will have the option of redirecting up to one-half of each year’s deposit to pay down debts.
In some years, the state must set aside additional General Fund revenues. This occurs in years when estimated General Fund revenues that come from personal income taxes on capital gains exceed 8% of total General Fund proceeds of taxes. The share of these “excess” capital gains revenues that is not owed to K-12 schools and community colleges under the state’s Prop. 98 funding guarantee must be used for BSA deposits and debt repayments, following the same requirements as the mandatory 1.5% deposit. Since Prop. 2 was enacted, capital gains tax revenues have exceeded the 8% threshold in most years, but could fall below the threshold in years when there are downturns in the stock market.
State leaders may also make discretionary deposits. In addition to the mandatory annual deposits required by Prop. 2, policymakers have the option of saving additional, discretionary revenue in the BSA.
The required annual deposit may be reduced or suspended in the event of a “budget emergency. If the governor declares a budget emergency, the state may reduce or suspend the required BSA deposit with a majority vote of each house of the Legislature. Prop. 2 defines a budget emergency as a situation where:
- Conditions of disaster or extreme peril are present; or
- The state has insufficient resources to maintain General Fund expenditures at the highest level of spending in the three most recent fiscal years, adjusted for state population growth and the change in the cost of living.
BSA funds may be withdrawn in the event of a budget emergency, but the entire balance cannot be removed at once. If the governor declares a budget emergency and the Legislature agrees with a majority vote of each house, funds may be taken out of the BSA. However, the entire balance cannot be removed immediately. Only the amount needed to address the budget emergency may be withdrawn, subject to the additional limitation that a withdrawal may not exceed 50% of the BSA balance in the first year of a budget emergency. In the second consecutive year of a budget emergency, all of the funds remaining in the BSA may be withdrawn.
Funds that are taken out of the BSA may go toward any purpose determined by the Legislature. For example, these dollars could be used for health care services, subsidized child care for working families, cash assistance for people with low incomes, K-12 schools, and any number of other public services and systems.
Funds in the BSA cannot exceed 10% of General Fund tax revenues. Prop. 2 caps the balance of the BSA. Once the balance — excluding any discretionary deposits — reaches 10% of General Fund tax revenues, any revenue that would otherwise have been required to go into the reserve must be instead spent on infrastructure, which includes housing. Prior to 2026, the BSA balance reached the cap twice — in 2022-23 and 2023-24 — but then dropped below the cap as state leaders withdrew funds in some years to address budget shortfalls.
Prop. 2 of 2014 also established the PSSSA, the state’s budget reserve for California’s K-12 schools and community colleges. Prop. 2 does not require an annual deposit into this reserve. Moreover, Prop. 2 restricts the circumstances under which transfers to the PSSSA can occur. For a PSSSA deposit to be required, all of the following conditions must be met:
- General Fund revenues that come from personal income taxes on capital gains are relatively strong;
- Growth in General Fund revenues leads to relatively strong growth in the state’s annual minimum funding guarantee for K-12 schools and community colleges; and
- The Legislature does not suspend the annual K-14 education minimum funding guarantee.
Even under these restricted circumstances, Prop. 2 limits the size of the deposit to the schools reserve when such a deposit is required.
Deposits to the PSSSA may be reduced or suspended in the event of a budget emergency under the same rules that govern reductions or suspensions of deposits to the BSA (see the prior section of this report). Similarly, funds may be withdrawn from the schools reserve if the governor declares a budget emergency and the Legislature agrees with a majority vote of each house.
In contrast to the rules governing the withdrawal of funds from the BSA, all of the PSSSA funds may be withdrawn in one year. Moreover, funds withdrawn from the PSSSA must be used to support K-12 schools and community colleges.
Safety Net Reserve: Funds to Protect the Medi-Cal and CalWORKs Programs
The Safety Net Reserve was created in 2018 to set aside funds to help cover the costs of two programs that often see increases in enrollment during recessions: Medi-Cal and California Work Opportunity and Responsibility to Kids (CalWORKs). Both of these programs serve Californians with low incomes — with Medi-Cal delivering health coverage, and CalWORKs providing modest cash assistance to families with children. During economic downturns, more people become unemployed and temporarily rely on these programs to cover their basic needs, increasing state costs.
The Safety Net Reserve is not a constitutional reserve, so there are no binding requirements governing deposits or withdrawals. This means that funds can be transferred into and withdrawn from the reserve at the discretion of the Legislature. In fact, state policymakers voluntarily deposited $900 million in the Safety Net Reserve before draining all of those funds in 2024 to help address a $55 billion state budget problem.
Moreover, while state law specifies that the funds are to be used only for Medi-Cal and CalWORKs costs during economic downturns, state policymakers could decide to modify this language and use the funds for other purposes. However, in establishing this reserve, policymakers clearly recognized the need to protect critical services for Californians with low incomes from budget cuts — cuts that would undermine Medi-Cal and CalWORKs at the very time that these programs are needed most.
Special Fund for Economic Uncertainties (SFEU): The Discretionary Reserve
The SFEU is the state’s discretionary General Fund budget reserve, meaning policymakers have a great deal of latitude in spending the funds in the reserve. The amount of money in the SFEU is equal to the difference between General Fund resources and General Fund spending in a given fiscal year.
The SFEU acts as a buffer against unanticipated revenue shortfalls or spending increases. Due to California’s constitutional balanced-budget requirement, which requires the state to enact a budget in which spending does not exceed available resources, the projected SFEU balance cannot be less than zero at the time the annual budget is adopted. However, if state revenues come in lower than projected and/or spending unexpectedly rises, the SFEU balance will decline, and may become negative as spending begins to exceed revenues.
The Legislature can appropriate funds from the SFEU at any time and for any purpose. Additionally, in the event of a disaster, the governor can allocate funds from the SFEU without the prior approval of the Legislature. Specifically, when the governor declares a state of emergency, the Department of Finance (DOF) can transfer funds from the SFEU into a subaccount called the Disaster Response-Emergency Operations Account (DREOA). These funds are allocated to state agencies for costs that are “immediate and necessary to deal with an ongoing or emerging crisis.”
Projected Surplus Temporary Holding Account: A Place to Set Aside Anticipated Surplus Revenues
State leaders created the Projected Surplus Temporary Holding Account in 2024. This account gives policymakers a place to temporarily set aside anticipated surplus revenues, “ensuring that funds are only spent once they are realized.”
State leaders have broad authority to determine whether or how to use this holding account. The only requirement is that revenues that go into the account cannot remain there for longer than one year. If state revenues materialize as projected, the revenues in the account may be spent for any purpose or transferred back to the General Fund for future use.
This holding account is a “pilot budgeting project” that expires at the end of 2030, although state leaders could approve an extension as well as potentially modify the rules.
What’s Next for California’s State Budget Reserves?
The rules that govern California’s budget reserves can be amended by voters or state policymakers. Changing the reserve rules established by Prop. 2 (2014) would require voters to approve a constitutional amendment. Other reserve rules can be changed by state policymakers without the need for voter approval.
In recent years, state policymakers and others have advanced proposals to revise California’s reserve policies, although none have moved beyond the conceptual stage. Common proposals for changing state reserve policies include the following:
Proposals to increase the share of state General Fund revenue deposited into the Budget Stabilization Account (BSA), or rainy day fund.
Proposals to require a substantially larger share of General Fund revenue to go into the BSA raise concerns. Such changes would reduce annual funding available to address Californians’ growing needs. While saving for a rainy day is important, it shouldn’t come at the cost of meeting people’s needs today.
If policymakers want to increase state reserves, they can do so without requiring more revenue to be deposited into the BSA. State leaders currently have the authority to make discretionary deposits into the rainy day fund and other reserves, like the Safety Net Reserve. Discretionary deposits can be made periodically and can be accessed more easily than the BSA’s mandatory deposits, which are subject to stricter withdrawal conditions.
State leaders also can build up the rainy day fund through policies that increase General Fund revenue. This is because higher revenue would automatically boost annual deposits into the BSA under current Prop. 2 rules.
Proposals to allow the balance of the BSA to grow beyond 10% of annual state General Fund revenue.
Increasing the maximum size of the BSA above the current 10% cap would be an acceptable change — but only if the proportion of General Fund revenue that must be deposited into the BSA does not also increase substantially. Raising the 10% cap while also shifting a larger share of revenue into the rainy day fund would leave less funding to support the critical services that Californians need.
Proposals to exclude reserve deposits from California’s spending cap, or “Gann Limit.”
Excluding reserve deposits from California’s spending cap would be a sensible change. Currently, deposits into the BSA and other state budget reserves are classified as “expenditures” under the Gann Limit, which voters created by passing Prop. 4 in 1979.
Counting reserve deposits as “spending” increases the likelihood that the state will exceed the spending cap in years when revenues are strong. When revenues go over the Gann Limit, state leaders lose the ability to spend those dollars in ways that address Californians’ most pressing needs. Therefore, excluding deposits from the limit would allow state policymakers to build up budget reserves in years when revenues are particularly strong — which is exactly when the state is most likely to exceed the spending cap.
Changes to the rainy day fund or the Gann Limit would require amending the state Constitution. This means that voters would have the last word on the most significant proposals to modify California’s state budget reserves.
