AI Boom Masks Pension Crisis, Real Estate Collapse, and Mounting Job Losses 2026

California Economy Fractures: 

"A Tale of two Cities" the best of times and the worst of times 

BLUF: California's economy splits into winners and losers as $405 billion in AI investment enriches Silicon Valley while three structural crises converge—over $265 billion in unfunded pension liabilities, a commercial real estate collapse with vacancy rates exceeding 30% in downtown Los Angeles, and a frozen residential market where only 1.15% of LA homes changed hands in 2025—all as unemployment heads toward 6% and tariffs, federal shutdowns, and immigration crackdowns squeeze traditional industries.

The Golden State faces not just a cyclical economic slowdown but a convergence of structural crises that threaten its fiscal foundation for decades.

Nearly 70% of all U.S. venture funding in early 2025 went to California, and seven of the 10 largest investment deals in the Americas this year occurred in-state, according to the UCLA Anderson Forecast released Wednesday. AI-related investment in 2025, originally estimated at $250 billion, has already surpassed $405 billion, fueling spectacular returns for investors and high earners concentrated in narrow geographic and industrial bands.

Yet that prosperity masks deepening problems across the broader economy. Payroll job losses through the first eight months of 2025 marked the first sustained decline since the pandemic, and California's unemployment rate has remained above 5% for more than 19 consecutive months. The forecast projects unemployment will peak at 5.9% in early 2026 before falling to 4.6% in 2027.

The Pension Time Bomb

Beneath these cyclical problems lies a fiscal crisis that threatens to overwhelm state and local budgets for decades. California's state and local governments have the most public pension debt in the country, with total unfunded pension liabilities of more than $265 billion—over $6,000 in pension debt for every state resident. CalPERS has $166 billion in debt, and CalSTRS has $39 billion in unfunded liabilities.

The pension burden already reshapes government spending and constrains economic activity. Government employer contributions to CalPERS increased from being equivalent to 19.5% of payroll in 2014 to 32.4% in 2023, squeezing funding for infrastructure, education, and public safety.

San Diego's pension board approved a record-setting $533-million pension payment, $44 million higher than last year, amid a $250-million budget shortfall. The pattern repeats across California: San Francisco faces a nearly $1 billion budget gap across the next two years, while San Diego faces a $258 million deficit and Sacramento confronts a $77 million shortfall.

Pension contributions in Stockton rose from $6.8 million in 2002 to $41.5 million in 2017, with estimates suggesting city pension costs will nearly double and reach up to 16% of general fund budgets by 2024–25. When cities devote 15-20% of budgets to pension obligations, they slash infrastructure investment, delay maintenance, and cut services—all of which weakens local economies and reduces tax revenues, making the pension burden even worse relative to available resources.

Making matters worse, pension funds have responded to funding shortfalls by taking on more investment risk. California's public pension plans are taking on more risk than other pension systems while generating relatively poor investment return results. CalPERS recently approved plans to increase investments in private equity and private credit to 40% of its portfolio—a strategy that exposes taxpayers to potentially overwhelming losses if markets turn.

Commercial Real Estate Collapse

California's commercial real estate market faces what industry analysts describe as an ongoing crisis, with cascading effects on property tax revenues that fund local governments.

In Downtown Los Angeles, the office vacancy rate topped 31 percent in the first quarter, while commercial footage under development in Silicon Valley fell to 4.5 million square feet, down 45% from the end of 2024 and down 79% from its most recent peak in 2021—the lowest level since 2013.

The crisis extends beyond offices. More than a third of developers (36 percent) are delaying or canceling projects, citing increased construction costs and global trade tensions among their key concerns, according to the summer 2025 Allen Matkins/UCLA Anderson Forecast survey. About half of total respondents reported delaying or canceling projects, with 85 percent expressing a more cautious outlook due to tariffs and supply chain disruptions.

Los Angeles County saw its 11th straight quarter of negative office absorption, with a 24.5 percent vacancy. Industrial vacancy rose to 4.9 percent—the highest in a decade. Orange County's office vacancy hit 19.2 percent, nearly doubling in five years.

Distress is climbing, rising 23% to more than $116 billion at the end of March from a year earlier—the highest in more than a decade, according to MSCI Real Capital Analytics.

The commercial real estate collapse threatens municipal finances through multiple channels. An estimated 98% of the $145 billion of assessed value under appeal in Santa Clara County is commercial property, as owners seek tax relief. An increasing number of office buildings are selling for less than assessed value, and foreclosures from delinquent loans are becoming more frequent.

This creates a vicious cycle: declining commercial property values reduce tax revenues for cities already struggling with rising pension costs, forcing service cuts that make cities less attractive for business investment, which further depresses commercial real estate values.

Residential Market Paralysis

California's residential real estate market has entered unprecedented stagnation, creating additional fiscal pressures for local governments while reducing economic dynamism.

Redfin's 2025 Home Turnover Report shows that only 11.5 out of every 1,000 homes in Los Angeles changed hands this year. That 1.15% rate is the second-lowest in the U.S. behind only New York City (1.03%), and is down 8.6% from the previous year.

New homes listed for sale fell by more than 17% in San Francisco compared to the same time last year. Of the 10 metros where new listings fell fastest, five were in California.

The mortgage rate "lock-in effect" combines with California's Proposition 13 to create powerful disincentives for homeowners to sell. A recent analysis by the Lincoln Institute of Land Policy estimated that new buyers can expect to pay more than twice as much in property taxes compared to a typical long-time homeowner in many of California's largest cities, including Los Angeles, San Diego, Long Beach, Oakland and Sacramento.

firsttuesday forecasts annual home sales volume will slip around 3.5% in 2025, and that the slipping will accelerate come 2026. The decline stems from the combination of high asking prices and elevated mortgage rates creating an affordability crisis that locks most Californians out of homeownership.

This residential market paralysis has profound economic consequences beyond individual buyers and sellers. Reduced home sales mean fewer property reassessments at current market values, which under Proposition 13 translates to slower growth in property tax revenues for local governments. The frozen housing market also reduces labor mobility—workers can't relocate for better jobs without triggering massive tax increases—which reduces economic efficiency.

Economic Bifurcation Deepens

"We continue to live in an era of elevated uncertainty," said UCLA Anderson Senior Economist Clement Bohr. The labor market shows "a state of paralysis and therefore gradual deterioration, marked by low levels of both hires and fires".

The record-setting 43-day federal government shutdown that ended November 12 amplified California's stress. At least 670,000 federal employees were furloughed, while roughly 730,000 continued to work without pay, creating cascading economic effects.

California's fiscal picture has deteriorated across multiple fronts. The Legislative Analyst's Office projects an $18 billion deficit for fiscal year 2025-26, potentially ballooning to $35 billion annually by 2027-28 as spending grows and debts come due.

U.S. consumer price inflation is projected to accelerate to 3.5% in 2025 and 3% in 2026, driven largely by tariffs. Governor Newsom's May budget revision acknowledged the damage: The administration revised down its projection for job growth to just 6,000 jobs per month in 2025 and 3,000 per month in 2026—a collapse from the pre-pandemic average of 30,000 monthly job gains.

The construction industry faces a perfect storm of workforce shortages linked to immigration enforcement, tariff-driven materials costs, and persistently high financing expenses. Despite urgent housing needs following devastating wildfires, building permits remain depressed.

Meanwhile, Silicon Valley's AI boom continues. In the first half of 2025, roughly 68% of all U.S. startup funding went to California-headquartered companies—penciling out to around $94.5 billion.

A surge in artificial intelligence stock prices has boosted California's tax collections by about $11 billion, yet the windfall gets consumed by constitutional spending requirements for schools and reserves—and does nothing to address the structural pension liabilities, declining commercial real estate tax revenues, or frozen residential market that continue draining public finances.

The Convergence Crisis

The simultaneous pressure from three structural crises creates compounding effects that simple economic growth cannot solve.

Since pension benefits promised to government workers are constitutionally protected, taxpayers are on the hook for that debt. Even as AI-driven tax revenues surge, they cannot overcome the combined drain of rising pension costs, declining commercial property tax revenues, and stagnant residential property assessments.

States tend to address their own fiscal challenges in part by limiting support for local governments. California's 2025-26 budget demonstrates this dynamic: The $321.1 billion spending plan does not fund the Homeless Housing, Assistance and Prevention (HHAP) program in 2025-26, and offers just $500 million in 2026-27, down from $1 billion in each of the last four budgets.

This fiscal squeeze at all government levels creates economic headwinds that compound the challenges identified in the UCLA forecast. Public sector employment faces constraints from budget pressures. Infrastructure investment gets delayed or canceled. Services deteriorate, making the state less attractive for business investment—which further depresses commercial real estate values and reduces the tax base needed to fund pension obligations.

The forecast offers a mixed outlook: economists expect the economy to "muddle through" early 2026 before experiencing stronger growth later in 2026 and 2027. But the state's alternative scenario projects real GDP contractions of 1.3% and 1.6% annualized in the last two quarters of 2025, with unemployment peaking at 6.7% in 2027.

For California policymakers, the challenge transcends managing a cyclical slowdown. The state faces structural problems—unfunded pension liabilities, commercial real estate collapse, and residential market paralysis—that will constrain government budgets and economic activity for decades. The two-track economy, with AI prosperity concentrated among the few and stagnation for the many, makes these structural problems even harder to solve, as the tax base narrows while obligations continue expanding.

The UCLA Anderson Forecast sees no immediate crisis. But the report's unspoken message is sobering: California's economic model, built on ever-rising property values and an expanding tax base to fund growing obligations, confronts its limits as three structural crises converge simultaneously.

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Sources

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UCLA Forecast: California economy to 'muddle through' early 2026