Overview of the 2010-11 May Revision

The 2010-11 Budget: Overview of the mac Taylor Legislative Analyst May Revision may 18, 2010 an LaO RepORt 2 LegisLative anaLyst’s Office an LaO RepORt Summary G P $19 B B s overnor roPoses illion of udGet olutions Large Budget Problem Little Changed Since January. In the May Revision, the administra- tion estimates that California must address a $17.9 billion gap between current-law resources and expenditures in the 2010-11 General Fund budget. In our view, the administration’s estimate is reasonable. While our tax revenue estimates are slightly higher than the Governor’s: $400 million in 2009-10 and $1 billion in 2010-11—overall, our view of the budget problem is similar. Governor’s Proposal Relies Heavily on Spending Reductions. The Governor’s May budget package proposes $19.1 billion of solutions—enough to close the $17.9 billion shortfall and leave the General Fund with a $1.2 billion reserve. Program spending reductions make up two-thirds of the solutions proposed by the Governor. Compared to his January proposal, the May Revision assumes a more reasonable level of increased federal aid ($3.4 billion), although receipt of even that amount remains uncertain. Borrowing and fund shifts total about 10 percent of the Gover- nor’s solutions. New revenues make up under 5 percent of the Governor’s package. Significant New Spending Reduction Proposals. The May Revision includes major spend- ing reduction proposals that were not included in the Governor’s base budget package in January. In particular, the Governor proposes eliminating the California Work Opportunity and Responsibility to Kids (CalWORKs) program, which provides cash grants and welfare-to-work services to over 1 million Californians in low-income families. He also would eliminate state funding for need-based, subsidized child care thereby eliminating slots for more than 200,000 children. The cuts mainly would be ongoing in nature. Still, even if the Legislature approved all these painful cuts and realized the savings assumed by their passage, a stubborn multibillion dollar operating deficit would persist in the years to come. K Q l ey uestions for the eGislature Alternative Proposals or Drastic Cuts in Some Core Programs? Throughout the spring, our office has offered alternative spending reduction proposals to the Legislature. In many areas, including health and social services programs, our alternatives reduce program spending by a lesser amount than the Governor in order to preserve core services for those most in need. In other cases, such as the universities, trial courts, and pub- lic safety local assistance grants, we believe there are opportunities for savings beyond those identified by the administration. We advise the Legislature to reject the Governor’s most drastic spending cuts, especially the elimination of CalWORKs and child care funding. Our alternative spending reductions—in conjunction with other budget actions—could help sustain critical components of these important programs. LegisLative anaLyst’s Office 3 an LaO RepORt More Revenues Could Ameliorate the Most Severe Cut Proposals. The Governor presents Californians with a clear vision of the types of severe program reductions that are necessary if the budget were balanced without some additional revenue increases this year. Alternatively, some of the most severe cuts proposed by the Governor could be avoided by adopting selected revenue increases—from fee increases and other nontax revenues, changes to tax expenditure programs, delays in previously scheduled tax reductions or expirations, and targeted tax in- creases. We urge the Legislature to put these types of solutions in the mix. How Much Education Spending Can the State Afford? Given the state budget situation, there is a real question whether California can afford to fund the current-law Proposition 98 minimum funding level. Rather than adopt strained legal interpretations of the funding guarantee, as presented by the Governor, the Legislature should forthrightly suspend Proposition 98 if the minimum guarantee is above the level of funding that the state can afford. How Will the State Prepare for the Longer Term? Even if the Legislature adopted all of the May Revision’s proposals and achieved the full es- timated savings, the state would be left with a multibillion dollar (between $4 billion and $7 bil- lion) annual operating shortfall. We believe that the Legislature should therefore adopt changes now that will help address the remaining problem. Major changes that would move the state in the right direction include a stronger state “rainy day fund,” realignment of certain state respon- sibilities and funding to local governments, changes to kindergarten and after school programs, and major pension and retiree health reform. lao B l ottom ine The last decade has provided some of the most challenging budget situations—including last year’s plan addressing roughly $60 billion in solutions. Yet this year’s budget situation may prove to be the most difficult. All of the major options available to the Legislature to close the budget gap will be difficult. The two basic avenues to balancing this budget—sharply lower spending in some programs and higher revenues—each result in negative consequences for the economy, jobs, and the Californians most directly affected. While much of the remainder of this budget process will focus on how to minimize the damage to taxpayers and program service levels, we urge elected leaders to use this crisis to better prepare the state to cope with future economic downturns and challenges. 4 LegisLative anaLyst’s Office an LaO RepORt adminiStration’S aSSeSSment of the Budget ProBlem Relatively Minor Changes Between Janu‑ which put in place the so-called “gas tax swap” ary and May. When he submitted the 2010‑11 (the elimination of the gasoline sales tax offset by Governor’s Budget to the Legislature on January an increase in the per gallon excise tax on gaso- 8 and called the Legislature into a fiscal emer- line)—reduced the 2010-11 budget problem by gency special session, the Governor identified an $1.4 billion according to administration estimates. $18.9 billion current-law budget shortfall in the (As described in the nearby box, enacted special General Fund in 2010-11. (At that time, he pro- session legislation also included laws to address posed $19.9 billion of budget solutions to close the state’s serious cash flow problems.) In addi- the shortfall and leave the state with a $1 billion tion, the federal government agreed to apply an reserve.) Enacted special session legislation— enhanced federal Medicaid match to the state’s C B i s f … ash ills an mPortant teP orward B s C r s l ut ummer ash isKs till oom Background. As we described in our January 2009 report, California’s Cash Flow Crisis, the state suffers from a basic cash flow problem, even in good years. Most revenues are received during the second half of the fiscal year (January to June), while most expenses are paid in the first half of the fiscal year (July to December). When the state is unable to borrow—as occurred in February 2009 and during the summer 2009 budget impasse—the Controller sometimes must refrain from making some payments or issue “IOUs” so that the state’s “priority pay- ments,” such as debt service and payroll, continue as scheduled. Issuing IOUs rattles investors and disrupts finances of state payment recipients. More flexibility to delay some payments helps prevent IOU issuance. More Flexibility for State Cash Flow Management in 2010‑11. As part of the special ses- sion, the Legislature passed two bills—ABX8 5 (Committee on Budget) and ABX8 14 (Com- mittee on Budget)—that give the executive branch more flexibility to manage cash in 2010-11. These measures allow the state to delay roughly $5 billion of scheduled payments to schools, universities, and local governments at almost any given time. Assuming the state meets previ- ously estimated revenue and expense targets in May and June 2010, it will enter 2010-11 with a $7 billion cash cushion (from available balances of special funds)—about the same as one year ago. The flexibility provided by the cash legislation, however, should help the state survive the first few weeks of the summer “cash drought” when expenses often far exceed receipts. Nev- ertheless, should a prolonged budget impasse or financial market disruptions delay the state’s routine annual cash borrowing past August or September, the Controller may again have to issue IOUs or implement unscheduled payment delays. LegisLative anaLyst’s Office 5 an LaO RepORt Medicare Part D “clawback payments,” which lowing a major oil spill in the Gulf of Mexico, the resulted in $680 million of General Fund relief. Governor dropped his support for drilling for oil Offsetting these positive developments were es- off the Santa Barbara coast (a $197 million solution timated cost increases of about $500 million and in January). The administration withdrew certain an estimated revenue decline of about $600 mil- criminal justice proposals, including a $317 million lion. Accordingly, the administration now esti- January solution that would have shifted specified mates that on net the size of the 2010-11 budget non-serious felons to a maximum sentence of 366 problem has declined $1 billion, to $17.9 billion. days in county jails instead of state prisons. The Administration Withdraws Some January Pro‑ Governor also backed off his proposal to suspend posals. In the May Revision, the Governor drops a new competitive CalGrant financial aid (a $46 mil- few proposals he made in January. Specifically, fol- lion January solution). major ProPoSalS in the may reviSion Figure 1 lists the Governor’s current budget elimination of need-based, subsidized child care proposals, including the changes made in his (not including preschool funding). The Governor’s May Revision. Many proposals remain from the proposed reductions in Proposition 98 spending Governor’s January budget package—such as the are described later in this report. $811 million January proposal to score savings Reduce State Employee Pay and Staffing, and in the Receiver’s inmate medical care operations Shift Pension Costs to Employees ($2.1 Billion). remains. (Estimated savings from some of these The Governor maintains his “5/5/5” employee proposals have been lowered due to assumed compensation proposal from January—reducing later enactment.) Major new or modified May state employee salaries by 5 percent, increasing Revision solutions are described below. state employee pension contributions by 5 per- cent for a like amount of state savings, and in- New or Modified creasing departmental “salary savings” by 5 per- Expenditure-Related Solutions cent to reduce state payrolls. In total, the Gover- As shown in Figure 1, the Governor’s budget nor’s January employee compensation package package includes $12.2 billion of expenditure- is scored as a $1.6 billion General Fund budget related solutions. Generally, these are budget solution by the administration, and its provisions solutions that would reduce program spending also generally apply to the state’s special funds. and result in a lower level of governmental ser- (Special funds generally are fee-driven accounts, vices for affected residents. New or substantially such as the Motor Vehicle Account [MVA].) In modified expenditure-related solutions in the the May Revision, on top of the 5/5/5 proposal, May Revision include the following. the Governor proposes a “mandatory personal Reduce Proposition 98 Spending ($4.3 Billion). leave program” (PLP), estimated to achieve A major change to the Governor’s Proposition 98 $795 million ($446 million General Fund) of state package in the May Revision is the proposed savings. Under PLP, state employees in the ex- 6 LegisLative anaLyst’s Office an LaO RepORt ecutive branch would have their take-home pay ployees would have discretion when to use their reduced by the equivalent of eight hours of PLP leave. In addition, furlough Fridays would pay each month in 2010-11, and they would be end in June 2010. credited with an equal number of PLP hours. Em- Figure 1 General Fund Budget Solutions Proposed by the Governor 2009‑10 and 2010‑11 Combined (In Billions) Reduced Costs or Increased Revenues Expenditure-Related Solutions Reduce Proposition 98 spending (including elimination of child care) $4.3 Reduce state employee pay and staffing, and shift pension costs to employees 2.1 Eliminate CalWORKs program 1.2 Implement various changes to Medi-Cal 0.9 Reduce inmate medical care costs 0.8 Reduce IHSS spending (excluding enhanced federal match) 0.8 Reduce county mental health realignment funds by 60 percent 0.6 Redirect county savings from social services reductions 0.4 Commit certain offenders to county jails, not state prisons 0.2 Suspend or defer certain mandate reimbursementsa 0.2 Reduce spending in various health programs 0.2 Reduce spending in various social services programs 0.2 Reduce SSI/SSP grants for individuals to the federal minimum 0.1 Reduce other spending 0.3 Subtotal ($12.2) Assumed Federal Funding and Flexibility Solutions Assume more federal money or flexibility in Medi-Cal and other programs $1.6 Assume extension of enhanced FMAP funding for Medi-Cal Program 1.4 Assume enhanced funding for other programs 0.4 Subtotal ($3.4) Loans, Loan Extensions, Transfers, and Funding Shifts Borrow from special funds $1.1 Extend due dates for existing special fund loans to General Fund 0.5 Use remaining authorized hospital fees for Medi-Cal children’s health coverage 0.2 Use temporary federal retiree reinsurance funds to reduce state retiree health costs 0.2 Transfer special fund monies to the General Fund 0.1 Use excess Student Loan Operating Fund monies for Cal Grant costs 0.1 Adopt other funding shifts 0.4 Subtotal ($2.6) Revenue Solutions Score additional revenues from previously authorized state asset sales $0.5 Authorize automated speed enforcement to offset trial court costs 0.2 Extend hospital fees 0.2 Levy 4.8 percent charge on all property insurance for emergency response activities 0.1 Subtotal ($0.9) Total, All Proposed Solutions $19.1 a Due to administration scoring, does not include $131 million for the proposed suspension of the AB 3632 mental health mandate. FMAP=Federal Medical Assistance Percentages. LegisLative anaLyst’s Office 7 an LaO RepORt Eliminate CalWORKs Program ($1.2 Billion). to achieve IHSS cost savings. While the full-year In the May Revision, the administration proposes General Fund savings proposed is $750 million the elimination of CalWORKs. Substantially beginning in 2011-12, the net General Fund ben- funded by the federal government, CalWORKs efit in 2010-11 would be $637 million because provides cash grants and welfare-to-work servic- of enhanced federal matching funds that resulted es to low-income families. Currently, enhanced from the federal economic stimulus legislation. federal funding included in last year’s federal This proposal would reduce General Fund sup- economic stimulus legislation (and assumed to port of this program by roughly half. be extended through 2010-11 in the Governor’s Reduce County Mental Health Realign‑ budget package) applies to CalWORKs. Accord- ment Funds ($602 Million). Counties use mental ingly, elimination of CalWORKs would result in a health realignment funds—totaling about $1 bil- substantial loss of federal funding for the state. lion under current law in 2010-11—to support Implement Various Changes to Medi‑Cal a range of mental health services for indigent (About $900 Million). The May Revision propos- persons as well as Medi-Cal enrollees. Under es a variety of additional changes to Medi-Cal, the administration proposal, counties would no including enrolling seniors and people with dis- longer have to provide more than the minimum abilities in managed care ($179 million); imposing range of mental health services required by the new copayment requirements for various ser- federal government for participation in Medicaid, vices ($ 152 million), hospital stays ($73 million), resulting in estimated savings of $602 million. and emergency room visits ($54 million); limiting (The remaining $435 million in mental health physician or clinic visits to ten per year ($90 mil- realignment dollars would be used to fund only lion); and freezing hospital rates ($85 million). these required services—such as early and The Governor’s budget assumes federal approval periodic screening, diagnosis, and treatment; in- of a state plan amendment or waiver to achieve patient hospital psychiatric services; and medi- the assumed savings. Enhanced federal fund- cation.) The county savings, however, would be ing approved as part of the economic stimulus offset by increased county funding shares for legislation is assumed to be extended through certain social services programs. The state would 2010-11. In addition to the types of proposals realize savings from the correspondingly lower described above for the Medi-Cal Program, the funding shares for these same social services Governor also proposes elimination of Drug programs. The Governor no longer proposes Medi-Cal (except for perinatal and youth services changes to Proposition 63—which provides programs). Drug Medi-Cal, funded in part by the about $1 billion per year for mental health ser- federal government as part of California’s Medic- vices from a personal income tax (PIT) surcharge aid program, pays for substance abuse treatment, on taxable income in excess of $1 million. including methadone. Place Certain Offenders in County Jails, Reduce IHSS Spending ($750 Million). With Not State Prisons ($244 Million). Under the May various prior In-Home Supportive Services (IHSS) Revision proposal beginning July 1, 2010, non- reductions blocked by the courts, the administra- serious, non-violent, non-sex offenders who are tion now proposes to consult with stakeholders convicted of specified felonies and sentenced to 8 LegisLative anaLyst’s Office an LaO RepORt three years or less would serve their sentence in federal aid: $3.4 billion. About half of this would a county jail instead of state prison. The admin- be provided through an assumed congressional istration estimates this would reduce the prison extension of enhanced Federal Medical As- population by 10,600 inmates in 2010-11 and sistance Percentage program and other funding generate $244 million of savings. Beginning in originally approved in last year’s economic stimu- 2011-12, the state would establish a public safety lus legislation. An additional $1.6 billion in the block grant program for counties to be funded May Revision relates to unspecified future fed- using about one-half of the state’s prior fiscal- eral funding or flexibility in Medi-Cal and other year savings from this shift. Also as part of the programs. The May Revision—with this much May Revision, the Governor proposes legislation smaller assumption of new federal funding—in- to continuously appropriate $503 million an- cludes no trigger list of alternative proposals. nually from the General Fund for various local Loans, Loan Extensions, Transfers, and public safety programs beginning in 2011-12. The Funding Shifts programs now are funded with revenues from the temporary vehicle license fee (VLF) increase The Governor’s budget proposals, as that is set to expire on June 30, 2011. (Taken amended by the May Revision proposals, include altogether, these proposals would help balance $2.6 billion of loans, loan extensions, transfers, the 2010-11 budget, but would result in a net and funding shifts. Major new proposals in this General Fund cost increase of nearly $300 mil- category are: lion beginning in 2011-12.) ➢ Loans, Transfers, and Loan Extensions Related to Special Funds ($1.6 Billion). Federal Funding and Flexibility Solutions As described in the next part of this More Reasonable—Though Still Uncertain— report on revenues, the budget includes Federal Funding Assumption ($3.4 Billion). $1.6 billion of one-time budget relief by In his January budget proposal, the Governor using special fund dollars for General proposed a budget based on the assumption that Fund purposes. the federal government would provide additional funding of about $6.9 billion in 2010-11, princi- ➢ Temporary Use of Federal Retiree Rein‑ pally for health and social services programs. In surance Funds to Reduce Retiree Health the event that the federal government was not Costs ($200 Million). The recent federal forthcoming with this aid, the administration health care reform legislation included proposed a “trigger” list of alternative revenue a temporary “early retiree” reinsurance and expenditure solutions. As described above, program designed to assist employers the federal government already has provided in preserving existing health coverage $680 million of additional funding to the state re- for pre-Medicare retirees age 55 to 64. lated to the Medicare Part D clawback, and these This program will be in place until the funds are already factored into health program establishment of health care “exchanges” budgets in the May Revision. The Governor now intended to provide more affordable assumes a much smaller amount of additional health care options. The budget reflects an expectation that costs for the Califor- LegisLative anaLyst’s Office 9 an LaO RepORt nia Public Employees’ Retirement Sys- eral Fund revenue and transfers in 2010-11 will tem’s state retiree health plans will be be $91.5 billion, while expenditures would be reduced $200 million in 2010-11 under $83.4 billion. This results in an $8 billion oper- this temporary program. (This is a prelim- ating surplus. That surplus would both address inary estimate that will be refined in the the $6.8 billion problem in 2009-10 and allow coming weeks. Final savings, we expect, the state to end the 2010-11 fiscal year with a will be less than $200 million.) $1.2 billion reserve. This is a $200 million larger reserve than the Governor proposed in his Janu- Revenue Solutions ary budget package. As shown in Figure 1, the May Revision Per Capita Real General Fund Spending includes about $900 million of new revenues Would Drop to Mid‑1990s Levels. As shown in to help balance the 2010-11 budget, principally Figure 3, the level of spending proposed by the from the Governor’s January budget proposals. administration would continue the recent drop in As described above, the Governor has aban- state spending, as adjusted for growth in popu- doned one of his January revenue proposals that lation and inflation. In 2010-11, the inflation- related to oil drilling at Tranquillon Ridge off the adjusted per capita spending level would be coast of Santa Barbara County. similar to that of 1993-94—also at a low point due to a recession. Since 2008-09, large tempo- $1.2 Billion Reserve Proposed for rary boosts in federal stimulus funds and shifts 2010-11—Up $200 Million From January of local government property taxes (lowering 2009‑10: Huge Year‑End Shortfall. As shown General Fund spending) have helped the state in Figure 2, the administration estimates that the balance its budget. Even accounting for these General Fund would end 2009-10 with a negative factors, adjusted General Fund spending under reserve balance of $6.8 billion. Despite spending the May Revision would be at its lowest level more than it took in, the state has continued op- since 1995-96. erations through a variety Figure 2 of cash management Governor’s May Revision General Fund Condition measures in 2009-10, (Dollars in Millions) including borrowing from Proposed for 2010-11 investors, loans from state Proposed Percent special funds, payment 2009-10 Amount Change delays, and (early in the Prior-year fund balances -$5,361 -$5,305 fiscal year) IOUs. Revenues and transfers 86,521 91,451 5.7% 2010‑11: $8 Billion Total resources available $81,160 $86,146 Estimated Operating Expenditures $86,465 $83,404 -3.5% Surplus. The administra- Ending fund balance -$5,305 $2,742 tion estimates that, under Encumbrances $1,537 $1,537 the Governor’s May Reservea -$6,842 $1,205 Revision policies, Gen- a Special fund for economic uncertainties. 10 LegisLative anaLyst’s Office an LaO RepORt Other Significant desalination, Delta sustainability, and May Revision Proposals other projects. In addition, $419 million of bond proceeds are proposed to be In addition to proposals to address the state’s appropriated for the Water Resources large General Fund deficit, the May Revision in- Control Board to fund water recycling cludes proposals affecting state special funds, the and wastewater projects. use of bond proceeds, and other accounts. Major non-General Fund proposals in the May Revision ➢ Decrease of Funds for Caltrans Capital include: Outlay Support Program. The May Revi- ➢ Initial Appropriations From the Water sion budgets a net decrease of $42 mil- Bond on the November 2010 Ballot. The lion for engineering workload in the May Revision proposes that the Legisla- Department of Transportation’s (Caltrans) ture appropriate $1.1 billion of proceeds capital outlay support program, including from the $11 billion water bond proposal a reduction of 750 engineering and other before voters on the November 2010 bal- positions and 102 overtime position- lot. The Governor proposes appropriating equivalents, as well as an increase of 69 about $700 million of these proceeds for contract staff. This will make more State the Departments of Water Resources, Highway Account funds available for Fish and Game, and Public Health for highway maintenance activities. drought relief, groundwater, conveyance, Figure 3 Inflation-Adjusted Per Capita General Fund Spending 2009-10 Base Year, State and Local Government Deflator $3,400 3,200 General Fund Expenditures Spending Absent Savings From Federal Stimulus 3,000 And 2009 Local Government Funding Shifts 2,800 2,600 2,400 2,200 2,000 80-81 85-86 90-91 95-96 00-01 05-06 10-11a a Reflects Governor’s May Revision proposed spending levels for 2009-10 and 2010-11. LegisLative anaLyst’s Office 11 an LaO RepORt adminiStration’S economic and revenue outlook Economic Forecast budget. These encouraging gains, however, were wiped out by April receipts, which fell more Forecast of Moderate Recovery. The eco- than $3 billion short of expectations. The sharp nomic forecast underlying the May Revision’s April decline—concentrated in PIT receipts—re- revenue estimates assumes that the state and flected a combination of (1) revenues coming in national economies will continue to recover at a on a different timeline than originally expected moderate pace from the deep recession of 2007 and (2) somewhat worse receipts attributable to through 2009. State personal income growth is the 2009 tax year. Consequently, as shown in projected at 3.2 percent in 2010 and 4.5 percent Figure 4, the May Revision estimates that current- in 2011—slightly lagging the forecast for the year revenues from the state’s “big three” taxes nation as a whole. The May Revision forecast will fall short of original expectations by more reflects some positive economic developments than $1.8 billion. For the budget year, the May since the release of the Governor’s budget, Revision’s forecast for these taxes is just slightly including the report that national gross domestic ($226 million) above the January outlook. In both product grew 5.9 percent in the fourth quarter years, strong sales tax receipts are helping to of 2009. As with its prior forecast, however, the offset expected PIT shortfalls. Taxable sales are administration expects that employment growth projected to jump 7.8 percent in 2010-11, reflect- will be slow in bouncing back. ing continued improved consumer spending after Revenue Forecast three straight years of decline. Budget Reflects New Loan Proposals. Modest Reduction in Tax Revenues Since The primary reason that the administration’s January. Tax revenue receipts from Decem- new 2010-11 revenue forecast is $2.1 billion ber to March this year were well above those higher than its January outlook is the addition amounts assumed in the Governor’s January Figure 4 May Revision Revenue Forecast Similar to January (In Millions) May Revision Change From January Budget 2009-10 2010-11 2009-10 2010-11 Personal income tax $44,021 $46,245 -$2,619 -$617 Sales and use tax 26,852 26,967 816 1,116 Corportation tax 9,386 9,779 -21 -273 Subtotals, “big three” revenues ($80,259) ($82,991) (-$1,824) ($226) Other revenues 5,815 7,347 243 261 Transfers/loans 447 1,116 19 1,642 Totals $86,521 $91,454 -$1,562 $2,129 12 LegisLative anaLyst’s Office an LaO RepORt of $1.6 billion in proposed one-time revenues state about $400 million better off. In 2010-11, related to the use of state special fund dollars for our expectation for the big three tax revenues is General Fund purposes. about $1 billion (1 percent) higher than the ad- ➢ New Loans. The Governor proposes ministration. The largest difference relates to the PIT and, specifically, capital gains. Our slightly $1.1 billion in new borrowing of special more positive view of capital gains’ rebound in fund balances, including $650 million 2010 accounts for most of the revenue differ- from fuel excise taxes and $250 million ence. Yet, our forecast still expects capital gains from the MVA. to be about one-half of their 2007 level. ➢ Delayed Repayment. The proposed loans June 2010 Will Be Key Month. Due to recent would be added to the state’s existing budget agreements to accelerate revenue collec- outstanding balance of $1.8 billion in tions, California taxpayers are now scheduled to similar loans previously authorized by the make 40 percent of their estimated annual pay- Legislature. The May Revision proposes ments in the month of June. This policy change, to delay the repayment of $494 million combined with April’s weak receipts, means that associated with these existing loans that June 2010 is now expected to be the state’s larg- otherwise would take place in 2010-11. est revenue collection month for 2009-10. How much the state will receive in June is difficult ➢ New Transfers. The Governor also to assess given the recent acceleration change proposes transferring $82 million from and uncertainty over the precise strength of the special funds, primarily the MVA, to the state’s economy. June’s actual receipts will help General Fund. Transferred funds would clarify the state’s revenue outlook for the upcom- not need to be repaid. ing year. Estate Tax Assumption Looks Shaky. Based LAO Assessment of May Revision on the provisions of current federal law, the May Revenue Forecast Revision assumes $892 million in revenues from LAO Forecast Similar, But Slightly Higher. the federal estate tax in 2010-11, and our fore- Our own updated economic and revenue fore- cast also includes a similar amount. It appears casts are quite similar to those of the adminis- increasingly unlikely, however, that the federal tration. They both reflect the consensus view government will allow the restoration of the state that the state is pulling out of the recession’s estate tax exemption in 2011 (known as the state doldrums—but slowly. Our economic outlook “pickup” tax) as provided for under current law. shows almost identical personal income growth Both the President’s budget and pending con- rates in California over the next two years. As gressional legislation would eliminate the state such, we believe the May Revision revenue pickup tax. Unless Congress fails to act on this is- forecast is reasonable and realistic. Under our sue (thus leaving current law in place), we would forecast, we expect revenues to be slightly higher expect that the state will not receive the estate in the final two months of 2009-10 and leave the tax revenues. LegisLative anaLyst’s Office 13 an LaO RepORt More Revenues Possible From Sale of State lars more than this assumption. If the Legislature Buildings. The May Revision continues the Janu- and the Governor finalize such a sale in the next ary budget estimate of about $600 million in few months, budget estimates could be adjusted revenues from the sale of state office buildings considerably upward to reflect the final sale authorized in the 2009-10 budget package. As amount. Given the poor long-term fiscal policy we described in our April 2010 report Evaluating of this proposal, however, we would encourage the Sale‑Leaseback Proposal: Should the State the Legislature to consider other alternatives for Sell Its Office Buildings?, we believe that the sale closing the budget gap. could net the state hundreds of millions of dol- ProPoSition 98—k-14 education Governor’s May Revision Proposal sion to use $877 million in one-time property tax revenues to support other parts of the state Figure 5 shows the Governor’s May Revision budget). Largely because of this increase in Gen- Proposition 98 spending levels. Relative to the eral Fund spending, the state would now meet Governor’s January budget, the May Revision the 2009-10 federal maintenance-of-effort (MOE) contains only a minor funding increase in the requirements for K-12 education. current year (due to various technical adjust- Budget‑Year Proposition 98 Changes. For ments) but a substantial funding reduction in the 2010-11, the May Revision reduces Proposi- budget year (due to the proposed elimination of tion 98 spending by $1.5 billion from the Janu- child care programs). We describe these adjust- ary level. Of the total reduction, $1.2 billion ments in more detail below. is achieved by eliminating all Proposition 98 Current‑Year Proposition 98 Changes. support for state-subsidized child care programs Although the drop in 2009-10 General Fund rev- (except state preschool programs). The Gover- enues resulted in a drop in the minimum guar- nor also proposes using $321 million in unspent antee, the Governor’s proposed Proposition 98 prior-year funds, thereby achieving the same spending level for 2009-10 remains virtually amount of ongoing Proposition 98 savings. The unchanged from January. As a result, the May Governor maintains his January proposals to re- Revision provides $503 million more than the duce K-12 revenue limits (by $1.5 billion) but no Governor’s estimate of the Proposition 98 mini- longer links these reductions to savings in con- mum guarantee. The Governor counts this over- tracting and administration. In 2010-11, the state appropriation as a payment towards an $11.2 bil- would not meet its federal MOE requirement for lion statutory obligation related to the 2009-10 K-12 education. Thus, it would continue to seek budget package (with subsequent payments to a waiver. (It appears to qualify for the waiver.) resume in 2011-12). Despite the small change To Achieve Budget‑Year Savings, Governor in Proposition 98 spending, the May Revision Proposes “Rebenching” Proposition 98. To includes $1.1 billion in additional General Fund achieve additional budget-year savings without spending to offset a decline in local property tax suspending the Proposition 98 minimum guaran- revenue (due primarily to the Governor’s deci- 14 LegisLative anaLyst’s Office an LaO RepORt tee, the May Revision “rebenches” the guarantee was tenuously held together. In particular, we to reflect the elimination of child care services. raised concern that the Governor’s Proposi- The rebenching essentially reduces the 2010-11 tion 98 approach was legally risky, as it assumed minimum guarantee by an amount equal to the state had no maintenance factor obligation Proposition 98 child care spending in 2009-10. (constitutionally required payments to restore By rebenching the guarantee, the Governor es- education spending over time) entering 2009-10. sentially redefines expenditures counted towards Not only does the May Revision retain this ques- Proposition 98 and the minimum percentage of tionable maintenance factor assumption, but it is General Fund revenues that the state must pro- further complicated by the proposed rebenching vide for Proposition 98 spending. This rebench- of the minimum guarantee due to the elimination ing results in 2010-11 savings of $1.5 billion. The of child care programs. Governor does not rebench for the gas tax swap Legality Uncertain. The legality of rebench- as required by the agreement enacted in March. ing for the elimination of state-subsidized child Instead, he proposes to override a statutory “hold care is uncertain. This uncertainty is heightened harmless” provision of that measure, thereby due to the Governor’s assumption that some avoiding $686 million in additional state costs. federally funded child care continues to be administered by existing providers. That is, under Already Questionable Proposition 98 the Governor’s plan, no functional responsibil- Plan Becomes Riskier Due to Rebenching ity has been eliminated entirely or clearly shifted In our February analysis, we noted that the to a different set of entities. Moreover, unlike Governor’s overall Proposition 98 funding plan rebenching for local property tax shifts, the state Figure 5 Governor’s Proposition 98 Funding Proposal (In Millions) 2009-10 2010-11 January May January May Budget Revision Change Budget Revision Change K-12 Education General Fund $30,844 $32,022 $1,178 $32,023 $30,927 -$1,096 Local property tax revenue 13,237 12,105 -1,133 11,950 11,529 -422 Subtotals ($44,082) ($44,127) ($45) ($43,974) ($42,456) (-$1,518) California Community Colleges General Fund $3,722 $3,722 — $3,981 $3,991 $9 Local property tax revenue 1,953 1,962 $8 1,913 1,907 -6 Subtotals ($5,675) ($5,683) ($8) ($5,895) ($5,898) ($3) Other Agencies $94 $93 -$1 $85 $89 $3 Totals $49,851 $49,903 $52 $49,954 $48,442 -$1,512 General Fund $34,660 $35,837 $1,177 $36,090 $35,007 -$1,083 Local property tax revenue 15,191 14,066 -1,124 13,864 13,435 -428 LegisLative anaLyst’s Office 15 an LaO RepORt has little experience with rebenching for the shift shows two budget-year Proposition 98 options or elimination of a program once funded within in addition to the Governor’s January and May Proposition 98. plans. Below, we discuss these budget alterna- tives in more detail. As discussed below, the key Potentially Unworkable Starting question for the Legislature in building its K-14 Point Calls for Different Approach education budget will be how much it can afford The Governor’s May plan does not reflect given its other budget pressures. a particularly useful architecture upon which to Two Options Require Suspension in build the state’s K-14 education budget. Absent 2009‑10. The two options identified in the figure the Governor’s legal interpretations, his proposed as alternatives to the Governor’s proposal would spending level would require suspension of the require suspension of the minimum guarantee Proposition 98 minimum guarantee. The May in 2009-10 to the current spending level (as al- plan also is based on the Governor’s question- lowed under the California Constitution). Despite able policy decision to eliminate all state-subsi- the suspension, schools would be funded at the dized child care immediately. (We discuss our same level as proposed by the Governor and recommended approach on child care in more would not be subject to additional programmatic detail later in this report.) reductions in 2009-10 (beyond the reductions Current‑Law Requirement Likely Unaf‑ already imposed in the enacted budget). The fordable. Under current law, the state would primary reason for suspending Proposition 98 need to provide sub- stantially more money Figure 6 than the Governor Options for 2010-11 Proposition 98 Spendinga proposes—$4.1 billion (In Billions) higher than the Gov- ernor’s May level and Current-Law Minimum Guarantee ($53.0) $2.9 billion higher than the Governor’s Janu- ary level. As such, we $50.8 believe the state cannot $50.1 $49.9 afford to support K-14 education at this level. $48.9 Take a Different Approach. Given these concerns, we recom- mend the Legislature 2009-10 January Flat May take a different ap- Suspension Onlyb Budget Fundingc Revision proach in building the aIncludes ongoing and one-time funds. K-14 budget. Figure 6 bAssumes Proposition 98 is suspended in 2009-10 to the current spending level. Meets minimum guarantee in 2010-11. cAssumes Proposition 98 is suspended in both 2009-10 and 2010-11 to the current spending level. 16 LegisLative anaLyst’s Office an LaO RepORt is to clarify that maintenance factor does exist they used their one-time federal stimulus upon entering 2009-10 (to the significant ben- monies in 2009-10 to support ongoing efit of education over the long run). As a result, programs.) suspension potentially could resolve the mainte- Make Targeted Reductions First. Whether nance factor issue in a straightforward manner. the state adopts the one-year suspension option, While signaling that maintenance factor exists, the flat-funding option, or some other funding suspension also acknowledges that the state can- level, some reductions to K-14 education will be not afford to make an immediate payment. (In needed. We recommend that the Legislature first 2009-10, under current law, the state would need make targeted cuts before resorting to across- to make an additional maintenance factor pay- the-board reductions. For example, we recom- ment of almost $1.3 billion absent suspension.) mend reducing funding for physical education Suspending in 2009-10 also provides benefit to courses offered by community colleges, aligning the state by lowering the minimum guarantee for special education funding with revised student 2010-11. counts, and reducing the number of times the After suspending in 2009-10, the Legislature state administers the high school exit exam. We then would have two options for 2010-11: have identified more than $650 million in these ➢ 2009‑10 Suspension Only. Under this targeted savings proposals. (We also have identi- option, the state would fund the mini- fied additional education-related savings outside mum guarantee in 2010-11 ($50.8 billion). of Proposition 98.) While this option would provide notably Make Other Cuts, As Needed, From Gen‑ less than required under current law, it eral Purpose Monies. Even if the state were is higher than the May Revision level by to take all our targeted reductions, it likely still $1.9 billion (or $700 million, excluding would need to make additional cuts. The Legisla- the effect of the child care elimination). ture could consider making these reductions, as needed, to K-12 revenue limits, California Com- ➢ Flat Funding. Another option would be munity College (CCC) apportionments, and the to suspend the guarantee to the current K-12 flex item (or some combination thereof). spending level in both years ($49.9 bil- For every 1 percent cut in these areas, the state lion). Though Proposition 98 funding would achieve about $435 million in savings would remain flat year over year, the ($310 million from K-12 revenue limits, $55 mil- state still would need to cut $1.9 billion lion from CCC apportionments, and $70 million in K-14 Proposition 98 program spending. from the K-12 flex item). As detailed in previous This is because the state used consider- reports, we continue to recommend combining able one-time state monies in 2009-10 to these additional cuts with additional flexibility for support its ongoing programs. (Similarly, districts (both from categorical program require- many school districts will experience ments and education mandates). additional program reductions because LegisLative anaLyst’s Office 17 an LaO RepORt lao’S overall aSSeSSment of the may reviSion Major Annual Budget Short- its proposals will achieve the desired level of falls Would Persist savings. Furthermore, consistent with current law, we generally assume no future cost-of-living ad- Reasonable Estimates, Reasonable Revenue justments for state programs or pay increases for Assumptions. We believe that the administra- state employees throughout the forecast period. tion’s estimate of the size of the state’s budget Given these assumptions, our out-year forecast problem in 2010-11 is sound. As noted earlier, should be viewed as a very best case scenario. our own updated economic and revenue fore- Under these assumptions, the ongoing gap casts are very close to those of the administra- between General Fund revenues and expen- tion. As such, we believe the May Revision ditures would be significantly reduced but not revenue forecast is quite reasonable and realistic. eliminated. As shown in Figure 7, shortfalls would Under our forecast, we expect revenues to be range between $4 billion and $7 billion through slightly higher in the final two months of 2009-10 2014-15. (The peak of the shortfall in 2012-13 and leave the state about $400 million better off. reflects the repayment of the state’s $2 billion In 2010-11, our expectation for the big three tax loan from local governments.) Given this ongoing revenues is about $1 billion (1 percent) higher shortfall even under the sharp spending reduc- than the administration. The largest difference tions proposed by the Governor, it is unrealistic relates to the PIT and, specifically, capital gains. for the Legislature to eliminate the long-term Stubborn Structural Deficit Would Persist. problem entirely this year. We, however, urge As we described in our November 2009 publica- the Legislature to consider the out-year implica- tion, California’s Fiscal Outlook, under then-cur- tions of its 2010-11 budget decisions and aim to rent law, the state faced a lingering General Fund achieve roughly the same level of progress as the budget gap around $20 billion through at least Governor in tackling the state’s structural deficit. 2014-15. Little has changed since then to shrink that amount. As part of our review of the May Legislature Should Take Actions to Revision, we have estimated how this persistent Mitigate Some Risky long-term problem would change under the Budget Assumptions Governor’s proposals. Specifically, our forecast Any Budget Adopted This Year Will Include combines our assessment of revenue and ex- Some Risks. As has been the case in several penditure trends with the assumption that all of recent budgets, the Governor’s budget proposals the May Revision’s proposals are adopted by include several billion dollars of assumptions— the Legislature. In addition, except in clear cases both on the revenue and expenditure sides of the when a proposal is unworkable (such as the ledger—that carry with them moderate or major Governor’s proposed increase in pension con- implementation risk. In fact, we cannot imagine tributions for current employees), we have given any balanced budget solution this year that could the administration the “benefit of the doubt” that 18 LegisLative anaLyst’s Office an LaO RepORt avoid some level of risky assumptions. Federal In enacting a credible, balanced budget for MOE and similar requirements in various pro- 2010-11, however, the Legislature can take ac- grams—including some related to provisions of tions to mitigate some budget risks. Careful, clearly last year’s economic stimulus legislation—limit the crafted trailer bills, particularly those relating to state’s budget options. In some other programs, reductions in health and social services programs, such as those requiring changes in eligibility or can ensure that budget-balancing actions have caseloads, significant savings cannot be achieved the strongest possible chance of withstanding quickly. It is clear that nearly all of the easy judicial scrutiny. Furthermore, if it assumes certain budget-balancing solutions for California are gone. expenditure reductions, the Legislature needs to Legislature Can Take Actions to Mitigate pass legislation to give departments a meaningful Some of the Risks. The Legislature cannot chance of actually achieving budgeted savings. control what Congress and the President do to For example, in our view, the prison medical care extend enhanced federal funding for health and Receiver will have little chance of achieving the social services programs, nor can it control what full $811 million of savings assumed in the Gover- the federal government does to affect the state’s nor’s budget package unless the Legislature passes estate tax revenues. It also cannot control what measures to assist him in doing so. In addition, the voters decide in the November election, as lawmakers should not assume that the administra- described in the box on the next page. tion can achieve hundreds of millions or billions of dollars of General Fund personnel savings on its own without prompt Figure 7 enactment of legislation May Revision Would Reduce, But Not Eliminate, that (1) facilitates major Future Operating Shortfallsa changes in operations, General Fund (In Billions) sentencing, or staffing in the prison system $0 (which is responsible for -1 about two-thirds of non- university General Fund -2 personnel costs), or (2) enacts reductions in state -3 employee pay or health -4 benefits. These pay and benefit reductions may -5 result either from col- -6 lective bargaining or the Legislature’s use of its -7 2011-12 2012-13 2013-14 2014-15 constitutional powers aLegislative Analyst’s Office estimates of the differences between annual General Fund expenditures and to appropriate funds for revenues under the Governor’s May Revision proposals. state personnel costs. LegisLative anaLyst’s Office 19 an LaO RepORt n 2010 i s ’ B P ovemBer nitiatives and the tate s udGet lanninG The Legislature has placed an $11 billion water bond proposal on the November 2010 ballot. In addition, although not all of them have officially qualified, it is now expected that the Novem- ber 2010 ballot will include about ten initiatives. If approved by the voters, a number of these measures could directly affect the Legislature’s budget plans. Some would improve the budget situation, even as others could reverse budget-balancing decisions. Historically, the state budget has not assumed the passage of voter initiatives at upcoming elections, but the Legislature may wish to have contingency plans in place depending on the outcome for several November ballot measures. While we are still reviewing the measures for our analyses in the November 2010 bal- lot pamphlet, we highlight some of the key measures with budget implications below. Two Proposed Initiatives Potentially Could Reverse Budget Decisions. A measure designed to protect local government revenues would apply its provisions to all legislative actions taken after October 20, 2009. As such, it might affect several major budget solutions provided in the gas tax swap package (Chapters 11 and 12, Statutes of 2009-10 Eighth Extraordinary Session [ABX8 6 and ABX8 9, Committee on Budget]) and the Governor’s May Revision proposals. These solutions total about $1.8 billion in General Fund relief in the current and budget years combined. The solutions include using revenues from fuel taxes to pay transportation debt service and to provide loans to the General Fund—uses that generally would not be permitted under the measure. The initiative also would limit the state’s authority to increase redevelop- ment payments to schools (beyond the $350 million required in 2010-11 under existing law) or make other changes in local finance. Another measure would amend the Constitution to broaden the definition of a state tax, local special tax, and state tax increase to include many measures that the Legislature and local governing bodies currently may approve by a majority vote. Under the measure, more revenue measures would require approval by a two-thirds vote of the Legislature or two-thirds of the lo- cal electorate. By expanding the scope of what is considered a tax or a tax increase, the mea- sure would make it more difficult for the state to enact a broad range of measures that generate revenues or modify existing taxes. The measure specifies that any state legislation enacted after January 1, 2010, that is inconsistent with its provisions would become inoperative 12 months after the state’s voters approve the initiative, unless the Legislature reenacts the legislation in compliance with the initiative’s provisions. (As such, any implications of the measure on en- acted measures would not be felt until 2011-12.) Other Initiatives Would Raise General Fund Resources. On the other hand, several pro- posed measures would improve the state’s fiscal condition by adding additional revenues. One measure would reverse recent budget actions that lower corporate tax revenues. If passed, the measure would increase corporate tax receipts by hundreds of millions of dollars in 2010-11, growing in subsequent years. In addition, a measure to impose a vehicle surcharge would allow a reduction in costs to operate state parks, and a measure to legalize marijuana-related activi- ties could increase state tax revenues. 20 LegisLative anaLyst’s Office an LaO RepORt Reject Elimination of CalWORKs and Temporary Assistance to Needy Families (TANF) Child Care block grant. Moreover, California would forego hundreds of millions of dollars in Emergency The Governor’s May Revision proposes to Contingency Funds (ECF) authorized by the 2009 eliminate the CalWORKs program effective federal stimulus package. (The ECF provides October 1, 2010, and state-funded child care 80 percent federal financial participation in costs programs effective July 1, 2010. Combined with for cash grants, nonrecurring short-term assis- savings assumed in January, these proposals tance, and subsidized employment which exceed would reduce General Fund spending by over their corresponding costs in 2007.) Although the $2.5 billion. These programs are core pieces of ECF is scheduled to expire on September 30, the state’s safety net, and we therefore recom- 2010, both the President’s budget and the Gover- mend that the Legislature reject these proposals. nor’s budget assume it will be extended for one Core Programs for State’s Neediest Fami‑ more year. lies. Since the 1930s, CalWORKs, or its federally Despite the elimination of all state child care authorized predecessor program, has provided funding, the Governor assumes the state would low-income families with children with cash continue to receive all anticipated federal fund- assistance to meet their basic needs. Following ing for child care and could thereby continue to enactment of the 1996 federal welfare reform leg- offer care to a small subset of currently served islation, the program added a substantial welfare- children. (Federal child care funds total about to-work component, whereby able-bodied adult $660 million in 2010-11, including $550 mil- recipients were provided with child care and/ lion in ongoing federal block grant funds and or other training and services so that they could $110 million in one-time stimulus funds.) It is enter the labor force. The cash grants, in combi- unclear, however, if California could continue to nation with food stamp benefits, provide families receive the same level of federal funding given with enough support to stay out of deep poverty the absence of state funding. While California (which is defined as 50 percent of the federal might be able to use state funding for preschool poverty level). Similarly, subsidized child care and applicable local funds to help meet some helps current and former CalWORKs recipients as federal match requirements, the state could lose well as other low-income families maintain em- at least some federal funding. ployment, serving as an important complement Proposal Would Shift Costs to Counties to adults’ efforts to obtain and keep jobs. Because and Elsewhere. Counties are responsible under existing eligibility criteria restricts services to state law for providing cash assistance to families families earning less than 75 percent of the state who are both unable to support themselves and median income, the child care program helps ineligible for other state and federal programs. some of the neediest families in California. The elimination of CalWORKs would make most Both Programs Provide Access to Large low-income families eligible for county general Federal Funding. By eliminating CalWORKs and assistance (GA) programs, potentially resulting child care, the state would be foregoing major in county costs exceeding $1 billion annually. amounts of federal funding. In CalWORKs, the It is not clear how counties would pay for this state would forego the annual $3.7 billion federal LegisLative anaLyst’s Office 21 an LaO RepORt obligation—particularly in the context of the Given the 80 percent federal funding stream recession’s hit on counties’ own revenues and which is likely to exist through October 2011, the Governor’s other proposals that would be we believe there is limited General Fund benefit financially detrimental to counties. Counties have from making substantial CalWORKs reductions no such obligation to provide welfare-to-work during 2010-11. However, once the ECF expires, services and child care. Absent these services, all savings from CalWORKs reductions accrue however, it will be difficult for many families to the state General Fund with no loss of federal to become self-sufficient and exit county GA funds (because the block grant is fixed). Accord- programs. ingly, given our projections of ongoing deficits, The administration’s proposal would also the Legislature may need to make substantial result in some eligibility determination costs reductions in CalWORKs in 2011-12. being shifted from CalWORKs to Medi-Cal. The Alternative Proposals Would budget plan does not take this into account. Help Preserve Core Programs We estimate these state costs to be roughly $200 million annually. Throughout the spring, our office has pro- Programs Can Still Contribute Savings. vided alternative spending reduction proposals While we recommend rejecting the complete to the Legislature. (Our web site—www.lao. elimination of these programs, we believe that ca.gov—contains an online list of our updated the state can generate substantial General Fund 2010-11 budget findings and recommenda- savings in these two program areas. For example, tions, as well as our published reports.) In many the state could make targeted child care reduc- areas, our alternatives reduce program spending tions while still providing subsidized care to the by a lesser amount than the Governor in order neediest families. Most notably, as outlined in to preserve services for those most in need. In our February report, The 2010‑11 Budget: Propo‑ some areas of the budget, we recommend that sition 98 and K‑12 Education, the state could the Legislature adopt more savings than imposed reduce eligibility ceilings and provider reimburse- by the Governor. In particular, we believe the ment rates. While this would achieve notably less Legislature should achieve substantially more savings than completely eliminating subsidized savings from the universities, trial courts, and child care, targeted reductions would allow the public safety local assistance programs. These state to preserve services for the lowest income spending reductions—in conjunction with other families. Moreover, by applying the same eligibil- budget actions—could facilitate maintenance of ity reforms across all child care programs, the the state’s core programs. state could address some existing inconsistencies More Revenues Could Ameliorate the Most between the state’s CalWORKs and non-Cal- Severe Cut Proposals. The Governor presents WORKs child care programs. (Currently, former Californians with a clear vision of the types of CalWORKs recipients who begin to earn more severe program reductions that are necessary if can continue to receive child care services even the budget were balanced without some addi- as children from lower income families linger on tional revenue increases this year. Alternatively, waiting lists.) some of the most severe cuts proposed by the 22 LegisLative anaLyst’s Office an LaO RepORt Governor could be avoided by adopting selected from a policy perspective. For example, revenue increases—from fee increases and other we have proposed the establishment of nontax revenues, changes to tax expenditure a wildland fire protection fee—an al- programs, delays in previously scheduled tax re- ternative to the Governor’s emergency ductions or expirations, and targeted tax increas- response initiative proposal—that would es. We urge the Legislature to put these types of place a charge on owners of structures solutions in the mix. in areas where the state has responsibil- We have previously presented the Legislature ity for wildland fire management. We with a menu of revenue options to consider from also have recommended community the following categories: college fee increases, which would not ➢ Delays in Previously Scheduled Tax affect financially needy students (because they are eligible to receive full fee waiv- Reductions or Expirations. In its Janu- ers) and would be fully offset for most ary trigger proposals (withdrawn as part middle-income students (who quality for of the May Revision), the administration federal tax credits). suggested delaying the implementation of recent tax changes (such as the op- ➢ Targeted Tax Rate Increases. Finally, tional single sales factor) by one year. we have suggested the Legislature could We recommend the Legislature consider consider targeted tax rate increases. delaying these provisions for two years Given the fragile state of the economy in recognition of the 2010-11 budget and the level of these taxes relative to challenges, as well as the loss of nearly other states, we discourage increasing $10 billion in other temporary taxes in the state’s broad-based big three taxes 2011-12. (personal income, sales and use, and ➢ Changes to Tax Expenditure Programs. corporation taxes) above their current levels. We have, however, suggested Tax expenditures are credits, exemptions, two proposals that would raise other tax and deductions intended to produce a rates while adhering to sound tax policy particular policy benefit through the tax principles. First, many economists believe code. Yet, some of these programs have that taxes on alcohol do not fully com- failed to prove their effectiveness—such pensate for the societal costs associated as enterprise zones—and others result in with drinking. Since alcohol tax rates a disparate treatment of income. As with have not been updated for inflation since programs on the spending side of the bud- 1991, such an adjustment could produce get, we recommend that the Legislature over $200 million of General Fund ben- eliminate those lower priority programs in efit. In addition, we suggest permanently order to preserve more critical ones. aligning the VLF—currently increased ➢ Fee Increases. Some fee increases ben- temporarily under provisions of the Feb- efit the General Fund and make sense ruary 2009 budget package—with local LegisLative anaLyst’s Office 23 an LaO RepORt property tax rates, as it represents a tax ➢ State‑Local Realignment. The Governor on property. has proposed to give local governments responsibility and funding for criminal Think Now About the Longer Term justice programs that they can better administer. Our office, legislative lead- The last decade has provided some of the ers, and others have suggested additional state’s most challenging budget situations—includ- shifts. For instance, the state-local rela- ing last year’s plan addressing roughly $60 billion tionship for the provision of some health in solutions. Yet this year’s budget situation may and social services should be reconsid- prove to be the most difficult in recent memory. ered, particularly within the context of All of the major options available to the Legislature federal health care reform. to close the budget gap will be difficult. The two basic avenues to balancing this budget—sharply ➢ Actions Now That Can Reduce the lower spending in some programs and higher Structural Deficit. With a continuing revenues—each result in negative consequences structural deficit, the state needs to adopt for the economy, jobs, and the Californians most actions that may require implementa- directly affected. While much of the budget pro- tion time but can save money later. For cess will focus on how to minimize the damage example, we recommend the state take to taxpayers and program service levels, we urge actions now relating to kindergarten and elected leaders to use this crisis to better prepare after school programs that could achieve the state’s budget and its government to cope with more than $900 million in savings in future economic downturns. By thinking now 2011-12. Similarly, sharply increasing about the longer term, the Legislature and the pension and retiree health costs should Governor can help bring the long-term structural prompt consideration of major changes deficit down. Among the actions that policy mak- in these benefits for future state and local ers could consider this year are: hires, which would save billions in future ➢ A Stronger State Rainy Day Fund. Along decades. with others, we have proposed improved Taking steps in these areas now would signifi- mechanisms for setting aside unexpected cantly improve the state’s future prospects. budget surpluses to build a stronger state rainy day fund. LAO Publications The Legislative Analyst’s Office (LAO) is a nonpartisan office which provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an E-mail subscription service, are available on the LAO’s Internet site at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 24 LegisLative anaLyst’s Office