The 2012-13 Budget: Overview of the Governor's Budget

The 2012-13 Budget: Overview of the mac Taylor Legislative Analyst Governor’s Budget January 11, 2012 2012-13 BUDGET 2 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET ExEcutivE Summary Governor’s Proposal Proposed Tax Initiative Is Cornerstone of Governor’s Budget Proposal. The administration estimates that the Legislature and the Governor must address a budget problem of $9.2 billion between now and the start of the 2012-13 fiscal year. The cornerstone of the Governor’s 2012-13 budget plan is its assumption that voters will approve a temporary increase in income and sales taxes through an initiative that the Governor has proposed be on the November 2012 ballot. The administration estimates the initiative would increase state revenues by $6.9 billion by the end of 2012-13, and generate billions of dollars per year until its taxes expire at the end of 2016. The taxes would be deposited to the General Fund to pay for the state’s Proposition 98 school funding obligations, as increased by the initiative, and to help balance the budget by paying for other state programs. The Governor also proposes significant reductions to social services and child care programs and additional state borrowing. Administration Estimates Plan Would Return State Budget to Balance. The administration estimates the Governor’s plan would leave the state with a $1.1 billion reserve at the end of 2012-13 and balanced annual budgets for the next few years. The Governor also proposes that the state take steps to reduce outstanding state budgetary obligations (which he calls a “wall of debt”) during the next several years. Proposed Trigger Cuts if Voters Reject Governor’s Tax Initiative. The Governor’s proposal requests that the Legislature approve $5.4 billion of “trigger cuts” to take effect on January 1, 2013, if voters do not approve the Governor’s tax initiative. Proposition 98 funding for schools and community colleges would bear the brunt of these trigger cuts: $4.8 billion (90 percent) of the total. LaO comments Governor’s Plan Would Continue State’s Efforts to Restore Budgetary Balance. In 2011, the Legislature and the Governor took significant steps—through ongoing budgetary actions—to begin to restore the state budget to balance. To finish this job, the Legislature still faces a very difficult task for 2012, as the Governor’s proposal shows. The Governor’s plan envisions multiyear tax increases and significant reductions in social services and subsidized child care programs. As an alternative, if his tax plan is rejected he proposes much larger cuts, aimed largely at schools. If the state chooses either of the Governor’s two paths, the state budget would be moved much closer to balance over the next several years. Revenue Estimates Bigger Question Mark Than Usual. Our revenue estimates—including estimates of state revenue gains from the Governor’s proposed initiative—currently are lower than the administration’s. Already, California’s budget is dependent on volatile income tax payments by the state’s wealthiest individuals, and the Governor proposes that these Californians pay more for the next few years. As has become evident in recent years, differing fortunes for these upper-income taxpayers can create or eliminate billions of dollars of projected state revenues. If our current www.lao.ca.gov Legislative Analyst’s Office 3 2012-13 BUDGET revenue estimates are closer to the target than the administration’s, the Legislature will have to pursue billions of dollars more in budget-balancing solutions. Restructuring Proposals in Education Merit Serious Consideration. The Governor’s plan contains major restructuring of the school finance system, community college categorical funding, and education mandates. We think the Governor’s restructuring proposals in all these areas would overcome most widely recognized shortcomings of these current systems and institute lasting improvements. Social Services and Child Care Proposals Have Merit, But Involve Drawbacks. The Governor proposes to reduce General Fund support for California Work Opportunity and Responsibility to Kids (CalWORKs) and subsidized child care—the state’s primary sources of cash assistance and work support for low-income families—by a total of about $1.4 billion. His proposal would focus reforms in the CalWORKs program on achieving the goal of emphasizing work. The Legislature may wish to consider whether the proposed reductions to families most in need of support to achieve self-sufficiency are too severe, as well as the Governor’s proposal to restrict eligibility criteria and time lines for subsidized child care. Focusing these programs on a different set of objectives and priorities than the Governor would not necessarily eliminate opportunities for budgetary savings, but the savings potential under such alternatives could be less. Trigger Cut Framework Needs to Be Considered Carefully. Though the Governor’s tax initiative would improve the financial outlook of public education over the next several years, his trigger plan would create significant uncertainty for schools, community colleges, and universities in 2012-13. This uncertainty is likely to be particularly problematic for schools, as most will feel compelled to build their 2012-13 budgets assuming the trigger cuts will be implemented. This means schools in 2012-13 likely will implement most, if not all, of the reductions that many hope to avoid. Given this possibility, the Legislature needs to be very deliberate in structuring a workable trigger package. In particular, the Legislature will need to be careful in setting the size of the trigger reduction; deter- mining the specific education reductions to impose; and designing tools to help schools, community colleges, and universities respond to the trigger cuts. 4 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET OvErviEw T he G overnor ’ s B udGeT P roPosal called the baseline, or workload, budget forecast. For 2012-13, the administration projects that On January 5, 2012, the Governor proposed baseline General Fund revenues are $89.2 billion, a 2012-13 state spending plan with $92.6 billion while baseline General Fund spending is of General Fund expenditures, $39.8 billion of $94.3 billion. In addition to this prospective annual spending from state special funds, and $5.0 billion budget shortfall of over $5 billion for 2012-13, the of bond fund expenditures. In addition, the budget administration estimates that 2011-12 will end assumes that $73 billion of federal funds flow with a General Fund deficit of over $4.1 billion. through state accounts in 2012-13. Combined, the state faces an estimated budget The cornerstone of the plan is its assumption problem of $9.2 billion to address between now and that voters will approve the Governor’s proposed the start of the new fiscal year. tax initiative in November 2012. These taxes would Several Major Differences From LAO’s be deposited to the General Fund to pay for the November 2011 Forecast. In our November 2011 state’s Proposition 98 school funding obligations, publication, California’s Fiscal Outlook, our office as increased by the initiative, and to help balance estimated that the baseline budget problem for the the budget by paying for other state programs. state’s General Fund would total $12.8 billion for Under the administration’s estimates, as shown 2012-13. This is about $3.6 billion more than the in Figure 1, the state would end 2012-13 with a estimated budget problem reflected in the 2012-13 $1.1 billion General Fund reserve. The budget plan Governor’s Budget. The administration’s definition also contains trigger cuts that would take effect if of the 2012-13 budget problem differs from ours in voters reject the Governor’s tax proposal. several ways: $9.2 Billion Budget Problem Projected Figure 1 for 2012-13 Governor’s Budget Consists of General Fund Condition $4 Billion 2011-12 (Dollars in Millions) Deficit, Plus $5 Billion Proposed for 2012-13 Shortfall for 2012-13. Actual Proposed Percent Each year, in assem- 2010-11 2011-12 Amount Change bling the Governor’s Prior-year fund balance -$5,019 -$3,079 -$986 Revenues and transfers 93,489 88,606 95,389 7.7% proposed budget, Total resources available $88,470 $85,527 $94,404 the administration Expenditures $91,549 $86,513 $92,553 7.0% estimates what Ending fund balance -$3,079 -$986 $1,850 revenues and expendi- Encumbrances $719 $719 $719 tures would be under Reservea -$3,797 -$1,704 $1,132 current tax and expen- a Reflects the administration’s projection of the balance in the special fund for economic uncertainties. diture policies. This is (The 2012-13 Governor’s Budget proposes to continue suspending transfers to the Budget Stabilization Account.) www.lao.ca.gov Legislative Analyst’s Office 5 2012-13 BUDGET • Administration’s Revenue Forecast. The for some health and social services administration forecasts that baseline programs and debt service. Contrary to General Fund revenues and transfers will our past practices in developing workload be $4.7 billion higher over 2011-12 and budgets, the administration also includes 2012-13 combined than indicated in our over $700 million of General Fund November 2011 forecast. This is partially expenses to reimburse local governments offset by the administration’s estimate for the prior-year costs of currently inactive of $803 million less in revenues and mandates. In addition, we understand transfers than we estimated for the prior that budget proposals to augment some year, 2010-11. For the three fiscal years programs are included in the administra- combined, therefore, the Governor’s budget tion’s workload budget estimates, such forecasts baseline revenues that are over as a proposed $90 million increase to the $3.9 billion higher than those forecast by University of California (UC) budget. our office in November. The vast majority Finally, the administration also assumes of our differences during this period in its workload budget $500 million of are related to our respective forecasts of savings from using revenues from the personal income tax (PIT) revenues. Air Resources Board’s (ARB’s) auction of “cap-and-trade” greenhouse gas emission • Proposition 98 Estimates. The administra- allowances to offset unspecified General tion’s baseline figures are different from Fund costs. The Legislature, however, has those in our November forecast for state never explicitly adopted such a policy for General Fund spending for Proposition 98. the use of cap-and-trade auction revenues, Specifically, for the 2011-12 and 2012-13 and accordingly, we regard the revenues as fiscal years combined, the administration’s a budgetary solution (not as a change in the baseline General Fund Proposition 98 definition of the problem). estimates are about $1.1 billion lower than our estimates. A number of reasons Governor’s Budget Proposals account for these differences, including Proposes Over $10 Billion of Budget- the treatment of the realignment revenues, Balancing Actions. The Governor proposes over redevelopment revenues, the gas tax swap, $10 billion of budget-balancing actions to address and 2011-12 trigger cuts. the administration’s estimated $9.2 billion budget • Non-Proposition 98 Spending. Compared problem—leaving the state with a reserve of to our November forecast, the adminis- $1.1 billion at the end of 2012-13. Figure 2 summa- tration’s workload budget estimates for rizes the administration’s estimates of savings or 2011-12 and 2012-13 include a net amount revenue related to the Governor’s major proposals. of about $1.4 billion more in non-Propo- (We list the administration’s estimates in every case sition 98 General Fund spending. There but two—the cap-and-trade and mandate issues appear to be a variety of reasons for these noted above.) differences, such as the administration’s Key Proposals. The budget plan rests predomi- estimates of several hundred million nantly on proposals in three areas, all of which are dollars of higher General Fund expenses discussed in greater detail in the sections that follow: 6 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET • Plan Assumes Voters Approve Governor’s community colleges is the single largest Tax Initiative. The centerpiece of the spending priority in the proposed budget. Governor’s budget plan is its assumption For 2012-13, the Governor proposes that voters approve his initiative proposal state and local Proposition 98 funding to temporarily increase PIT on upper- of $52.5 billion—the administration’s income filers and sales and use taxes (SUT) estimate of the Proposition 98 minimum for the next several years. The admin- guarantee. The guarantee reflects the istration estimates that this plan would additional revenue assumed to be raised generate $6.9 billion of revenues to benefit by the Governor’s tax initiative. The the 2012-13 General Fund budget plan. year-to-year funding increase under the Governor’s budget proposal is dedicated • Proposition 98 Proposals. As always, largely to reducing the size of existing Proposition 98 funding for schools and K-14 payment deferrals. The budget also Figure 2 Budget-Balancing Actions Proposed by the Governor 2011-12 and 2012-13 General Fund Benefit (In Millions) Revenue Actions Increase personal income and sales and use taxes through voter initiative $6,935 Make permanent the existing tax on Medi-Cal managed care plans 162 Implement changes to unclaimed property program 70 Implement other revenue actions (net) 19 Subtotal ($7,186) Increased Proposition 98 Costs Due to Proposed Tax Increases -$2,534 Expenditure Actions Restructure and reduce CalWORKs and subsidized child care program costs $1,393 Defer payments to Medi-Cal providers and other related actions 682 Make various Proposition 98 adjustments 544 Use part of cap-and-trade program auction revenues to offset unspecified General Fund costsa 500 Change Cal Grant awards and eligibility requirements 302 Eliminate domestic and related services for certain In-Home Supportive Services recipients 164 Reduce Medi-Cal costs through program efficiencies and other changes 160 Defer payment on pre-2004 local mandate obligationsb 100 Reduce Healthy Families Program managed care rates 64 Reduce various other program costs 49 Implement other fund shifts 28 Subtotalc ($3,987) Other Actions Delay loan payments to special funds $631 Borrow from disability insurance fund to pay costs of federal unemployment insurance loans 417 Use weight fee revenues to offset General Fund costs 350 Suspend county share of child support collections on one-time basis 35 Subtotal ($1,432) Total $10,070 a Although the administration’s workload budget includes those funds, we characterize those funds as a budget-balancing proposal. b Contrary to the Governor’s approach, does not include as a solution $729 million related to past-year costs of suspended mandates. c The administration characterizes the Governor’s proposed expenditure actions as totaling $4.2 billion. Our estimate is $229 million lower due to the differences described in footnotes a and b above. www.lao.ca.gov Legislative Analyst’s Office 7 2012-13 BUDGET includes proposals that would dramatically trigger cuts change how the state provides general Over $5 Billion of Additional Cuts if Voters purpose, categorical, and mandate funding Reject Tax Measure. The Governor proposes to schools. $5.4 billion of trigger cuts to take effect in January 2013 if voters reject his proposed tax measure • Significant Changes for CalWORKs this November. These trigger cut proposals are and Child Care Funding. The Governor summarized in Figure 3. Proposition 98 funding proposes to reduce General Fund support for schools and community colleges would bear the for the CalWORKs program and subsi- brunt of such reductions: $4.8 billion (90 percent) dized child care, the state’s primary sources of the $5.4 billion in total trigger cuts. University of cash assistance and work support for and judicial branch appropriations, among others, low-income families, for total savings would see significant reductions in this scenario of about $1.4 billion. The savings would under the Governor’s plan. be achieved primarily by reducing cash grants to a significant portion of current impact on Future years CalWORKs recipients, further limiting Smaller Shortfalls Projected. Using its eligibility for subsidized child care and estimates of workload revenues and expendi- CalWORKs employment services, and tures, the administration estimates that the state reducing payments to child care providers. currently faces a future annual budget shortfall of Borrowing From State Special Funds. Typical $4.7 billion in 2013-14, $2.9 billion in 2014-15, and of budgets in recent years, the administration $1.9 billion in 2015-16—much reduced from the proposes further delays to specified General Fund outyear budget shortfalls projected one year ago. loan repayments to state special funds. Many Higher revenue collections and the results of last special funds are fee-driven accounts eligible to year’s ongoing budgetary actions are responsible for be used for specific public programs. The budget this improvement in the state’s fiscal health. plan assumes $631 million of such loan repayment Shortfalls Estimated to Be Eliminated. The delays. Examples of these delays include deferrals of administration estimates that the Governor’s General Fund repayments to the Off-Highway Vehicle Figure 3 Trust Fund ($90 million) Proposed “Trigger” Reductions and the Electronic Waste If Voters Reject Proposed Tax Initiative Recovery and Recycling 2012-13 General Fund Benefit (In Millions) Fund ($80 million). The budget also proposes to Proposition 98 funding for schools and community colleges $4,837 University of California 200 borrow again from the California State University 200 disability insurance fund Judicial branch 125 ($417 million) to pay the CalFire 15 Department of Water Resources flood control programs 7 state’s interest costs to the Department of Fish and Game 4 federal government on its Department of Parks and Recreation 2 unemployment insurance Department of Justice law enforcement programs 1 Total $5,390 loan. 8 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET 2012-13 budget plan would continue last year’s Revenue Estimates Are a Bigger Question progress in returning the state budget to balance. Mark Than Usual. As we discuss later in this Specifically, the administration’s calculations report, our revenue estimates for 2011-12, 2012-13, indicate the Governor’s plan would “eliminate and subsequent years currently are lower than the future budget problems throughout the forecast administration’s, and we estimate the revenue gain period under current projections.” (The adminis- from the Governor’s proposed tax initiative would tration’s forecast period runs through 2015-16.) also be significantly lower. The administration Reducing State Budgetary Obligations. In has made a good-faith effort in its revenue and addition to providing funding for support of economic forecasting despite the huge uncertainties existing General Fund program commitments, involved in projecting the state’s recovery from an the Governor proposes to use tax revenues over unprecedented economic downturn. Nevertheless, the next several years to pay down what the our differences with the administration’s estimates administration characterizes as a $33 billion wall for high-income tax filers mean we now project of debt. This consists of budgetary obligations such billions of dollars less in state revenues. We will as deferred payments to schools and community continue to review incoming revenue and economic colleges, the Economic Recovery Bonds that were data and update the Legislature during the next few used to refinance the state’s early-2000s deficit, months. unpaid local government mandate reimbursements, Already, California’s budget is dependent and loans from state special funds. The 2012-13 on volatile income tax payments by the state’s Governor’s Budget Summary states the Governor’s wealthiest individuals. The top 1 percent of PIT plan would “pay off” this $33 billion by 2015-16. filers pay around 40 percent of state income taxes, the General Fund’s dominant funding source. lao C ommenTs Because the Governor’s budget proposal is centered Governor’s Plan Would Continue State’s on his idea for these wealthy tax filers to pay more, Efforts to Restore Budgetary Balance. In 2011, the state would become more dependent on this the Legislature and the Governor took significant uncertain revenue source. For this reason, revenue steps—through ongoing budgetary actions—to estimates are an even bigger question mark than begin to restore California’s state budget to balance. usual for the Legislature this year. As we have To finish this job, the Legislature still faces a very learned in past years, differing fortunes for upper- difficult task in 2012, as the Governor’s proposal income taxpayers can quickly create or eliminate shows. The administration’s major proposed billions of dollars of projected state revenues. If our budgetary actions this year are significant— current revenue estimates are closer to the target multiyear income and sales tax increases coupled than the administration’s, the Legislature will with significant reductions in social services and have to pursue billions of dollars more in budget- subsidized child care. As an alternative, if the balancing solutions. voters choose not to approve the proposed tax Restructuring Proposals in Education Merit increases, the Governor proposes much larger cuts, Serious Consideration. The Governor’s package aimed largely at schools. If the state chooses either also contains major restructuring of the K-12 of the Governor’s two paths, the state budget would finance system, community college categorical be moved much closer to balance over the next funding model, and education mandate system. several years. In all three cases, the state’s existing systems www.lao.ca.gov Legislative Analyst’s Office 9 2012-13 BUDGET are widely recognized as having longstanding, would focus reforms in the CalWORKs program on fundamental shortcomings. We think the achieving the goal of emphasizing work. Governor’s restructuring proposals in all three Although we find the Governor’s CalWORKs areas would overcome most of these shortcomings and child care proposals have some advantages, and institute lasting improvements. As such, we they also involve potential trade-offs. Most recommend the Legislature adopt the Governor’s clearly, the reductions proposed by the Governor basic restructuring approaches. The Legislature, would have significant negative impacts on many however, might want to make some modifications of California’s low-income families. Regarding to specific proposals. For example, the Legislature CalWORKs, the Legislature may wish to consider might want to change the amount of mandate whether reductions made to families most in need block grant funding provided or the specific mix of support to achieve self-sufficiency would be of mandated programs that are eliminated versus too severe. Similarly, the Legislature may want made discretionary. to consider whether the Governor’s proposal Now Not the Time for Major New Programs or too severely restricts eligibility criteria and time Program Expansions. We agree with the Governor’s lines for subsidized child care. More generally, assessment that now is not the time to initiate major the Legislature should consider whether focusing new programs or authorizing program expan- CalWORKs and subsidized child care primarily sions. The Governor’s plan contains associated on supporting efforts of low-income families to proposals that together would help lower costs by obtain employment is consistent with its priorities $300 million. Of greatest magnitude, we recommend or whether other objectives are also important. the Legislature adopt the Governor’s proposal not Focusing these programs on a different set of objec- to initiate the transitional kindergarten program set tives and priorities than the Governor would not to go into effect beginning in 2012-13. Not initiating necessarily eliminate opportunities for budgetary this program yields $224 million in associated savings; however, the potential for savings could be revenue limit savings. We also recommend the less and there could be trade-offs in other areas of Legislature adopt the Governor’s proposals to halt the budget. the Cal Grant expansions that would otherwise Legislature Needs to Carefully Consider Any come about through loosened transfer entitlement Trigger Framework. Though the Governor’s tax rules and cohort default rate limits beginning in initiative would improve the financial outlook of 2012-13. These two proposals would result in state public education over the next several years, his savings of more than $70 million. trigger plan would create significant uncertainty Social Services and Child Care Proposals Have for schools, community colleges, and universities in Merit, But Involve Trade-Offs. The Governor’s 2012-13. This uncertainty is likely to be particularly budget proposes to reduce General Fund support problematic for schools, with most schools feeling for CalWORKs and subsidized child care—the compelled to build their 2012-13 budgets assuming state’s primary sources of cash assistance and work the trigger cuts are implemented (that is, assuming support for California’s low-income families—by a only the state revenue that they are assured of total of about $1.4 billion. The Governor’s proposal receiving). This means schools in 2012-13 out of recognizes that, given current funding constraints, necessity likely will be implementing most, if not it is difficult to fully achieve existing goals of the all, of the reductions that many would be hoping CalWORKs program. Accordingly, his proposal to avoid. Given this is the case, the Legislature 10 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET needs to be very deliberate in structuring a trigger the triggers. The Legislature also needs to assess package. In particular, the Legislature should be whether specific trigger plans are workable. One careful in setting the size of the trigger reduction; major consideration, for example, is how the state determining the specific education reductions treats realignment sales tax revenues in calculating to impose; and designing tools to help schools, the Proposition 98 minimum guarantee. community colleges, and universities respond to EcOnOmicS and rEvEnuES Economic Forecast foreclosure activity and continued price declines in the California housing market, as well as relatively Summer’s Economic Slowdown Apparently weak growth in real incomes. The administration, Temporary. The administration’s 2012 forecast however, expects the economy to begin expanding reflects an economy that has rebounded from its more rapidly in 2013, which is consistent with our generally disappointing performance this past recent forecast. summer. Economic weakness during the summer The administration observes that the California months was primarily due to the reaction of economy is being pulled along, in part, by healthy financial markets to the European debt crisis wage and salary growth in high-income labor and congressional deadlock over the federal debt markets—most notably the technology sector ceiling. Employment and other economic news in the Silicon Valley and other areas of the improved during the fall and early winter months. state. Consumer spending also has picked up in We agree with the administration that a return California, as individuals and firms return to of the U.S. economy to recession is unlikely now. more normal consumption behavior fueled, in The U.S. and California economies are poised to part, by pent-up demand. The Governor’s forecast continue slow recoveries. of taxable sales aligns closely with our November Administration’s Forecast for 2012. As shown forecast. Although we do not project consumption in Figure 4 (see next page), the administration’s to weaken, there is some risk to the administra- new economic forecast is similar to, but slightly tion’s and our office’s taxable sales forecasts because more pessimistic than, our November 2011 consumers and businesses are contending with economic forecast. Both forecasts are based on low credit availability and weak, albeit improving, the assumption that Congress extends the partial consumer confidence. employee payroll tax holiday and emergency Uncertainty About Federal Policies in 2012 unemployment insurance benefits beyond their and Beyond. A number of federal policy changes current expiration dates next month. Absent scheduled—or assumed—to take place in 2012 and these extensions, economic performance in the 2013 could alter the trajectory of economic growth immediate future probably would be weaker than projected by the administration and our office. As shown in Figure 4. noted above, the administration’s forecast assumes Modest Strengthening in 2013 Expected. Congress will extend the payroll tax holiday and The administration’s economic forecast projects unemployment benefits through 2012. In addition, cautious, but steadily expanding, growth in 2013. various tax reductions enacted under the prior More robust growth is being held back by lingering federal administration (and extended under the www.lao.ca.gov Legislative Analyst’s Office 11 2012-13 BUDGET current administration) are scheduled to expire Economic and Fiscal Forecasting Especially at the end of 2012, and both of our economic Challenging Now. There is considerable uncertainty forecasts now anticipate these tax cuts will be in the administration’s forecast—as well as our extended. Automatic congressional spending cuts, November 2011 forecast—regarding the short- and known as sequestration, also are set to occur in medium-term path for the economy. In addition to early 2013, and the President recently announced a the difficulty in predicting federal policies, there broad proposal to shrink the size of the Army, the is also significant uncertainty due to the nature Marine Corps, and other parts of the U.S. military, of the historically deep recession from which which could ripple through the national economy. California and the nation are recovering. There The U.S. Postal Service—a major governmental is limited precedent with which to make sound employer—also must implement large spending judgments about how the economy will proceed reductions in the coming years. in the coming years. Particularly significant in Most economic forecasts—including our own the context of California budgetary forecasting is and the administration’s—assume that Congress and the difficulty in projecting the income prospects the executive branch agree to compromises in the of high-income tax filers, who experienced a coming months to mitigate some of the near-term disproportionately large drop in income—relative negative economic effects of these changes. Failure of to other groups of taxpayers—during the recession. Congress and the President to agree to such policies These Californians are in the state’s top marginal could, therefore, negatively affect the economy income tax brackets and pay a very large share of during the next few years. Over the longer term, the state tax revenues. Largely because their income— federal government’s deep fiscal imbalances will dominated by sales of stocks, bond, and other require significant changes to federal programs and assets—is volatile, state income tax collections are taxation that could affect large segments of both the volatile too. U.S. and California economies. Figure 4 Comparing the Administration’s Economic Projections With LAO’s November 2011 Forecast 2012 2013 Governor’s Budget Governor’s Budget LAO Forecast— Forecast— LAO Forecast— Forecast— November 2011 January 2012 November 2011 January 2012 United States Percent change in: Real gross domestic product 2.1% 1.7% 2.8% 2.5% Wage and salary employment 1.0 0.9 1.7 1.4 California Percent change in: Personal income 4.1% 3.8% 4.5% 4.1% Wage and salary employment 1.3 1.3 2.1 1.8 Housing permits (thousands) 61 52 77 80 Taxable sales (billions) $537 $538 $579 $573 12 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET revenue Forecast higher baseline revenues than we did two months ago. In 2011-12, the administration’s baseline As shown in Figure 5, the administration’s new forecast is higher than ours by $1.5 billion, and revenue forecast projects that the General Fund in 2012-13, its forecast is higher than ours by will record $88.6 billion of revenues in 2011-12 and $3.2 billion. Over the three fiscal years combined, $95.4 billion in 2012-13, including revenue from the administration forecasts $3.9 billion more in the Governor’s tax initiative proposal. The admin- baseline General Fund revenues than we did. istration expects that the Governor’s tax proposal, Sizable PIT Forecasting Differences, if approved by voters, would generate $2.2 billion of Particularly for High-Income Taxpayers. Of the revenues attributable to 2011-12 and $4.7 billion in $3.9 billion difference in our baseline revenue 2012-13. Most of those revenues result from the PIT part of the Governor’s tax proposal. Figure 5 Administration Forecasts Higher Revenues Governor’s Budget Than Our Office Did in November. Figure 6 General Fund Revenue Forecast compares the administration’s baseline revenue (Including Revenue Proposals) forecast (that is, the current-law revenue forecast (In Billions) excluding revenue from the Governor’s tax and 2011-12 2012-13 other revenue proposals) with our November 2011 Personal income tax $54,186 $59,552 current-law forecast. For 2010-11, the administra- Sales and use tax 18,777 20,769 tion’s more up-to-date information on revenue Corporation tax 9,479 9,342 accruals and transfers and loans shows that the Subtotals, “Big Three” Taxes ($82,442) ($89,663) General Fund received $803 million less than we Other revenues $4,751 $4,885 assumed in November. For 2011-12 and 2012-13, Net transfers and loans 1,413 841 Total Revenues and $88,606 $95,389 however, the administration forecasts significantly Transfers Figure 6 Administration’s Baseline Revenue Forecasts Differ From LAO’sa General Fund (In Billions) 2010-11 2011-12 2012-13 LAO Governor’s LAO Governor’s LAO Governor’s November Budget November Budget November Budget Forecast Forecast Forecast Forecast Forecast Forecast Personal income taxb $49,779 $49,491 $50,812 $51,937 $53,134 $56,025 Sales and use tax 26,983 26,983 18,531 18,777 19,980 19,595 Corporation tax 9,838 9,614 9,483 9,479 9,432 9,342 Subtotals, “Big Three” Taxes ($86,600) ($86,088) ($78,826) ($80,193) ($82,546) ($84,962) Other revenues $5,795 $5,913 $4,486 $4,730 $4,540 $4,788 Net transfers and loans 1,897 1,488 1,451 1,386 -1,048 -529 Total Revenues and Transfers $94,292 $93,489 $84,764 $86,309 $86,038 $89,221 Difference—Governor’s Budget -$803 $1,545 $3,183 Minus LAO November Forecast a Baseline revenues are revenues excluding the effect of any proposed law or policy changes. For example, revenues that would result from the Governor’s proposed November 2012 tax initiative are excluded from these figures. b Differences in federal tax policy assumptions explain a portion of the administration’s higher personal income tax estimates. www.lao.ca.gov Legislative Analyst’s Office 13 2012-13 BUDGET projections, $3.7 billion can be attributed to our forecast assumes that the 2001 cuts in federal tax different PIT forecasts. In recent weeks, since rates will be allowed to expire as scheduled at the the Department of Finance (DOF) announced end of 2012. This expiration then is assumed to its updated 2011-12 “trigger” forecast, we have cause investors to accelerate realization of capital devoted significant time to analyzing these differ- gains that they otherwise would take in 2013, ences. While our respective forecasting models thereby “shifting” a portion of capital gains income differ—making it difficult to assess the reasons forward from 2013 to 2012. In this forecast, for the for all of our differences—it seems clear that our first time, DOF also has shifted an additional part office’s forecasting models currently assume that of 2013 capital gains to 2012 based on assumed high-income tax filers will receive significantly less investor behavior to shield income from higher income than that assumed in DOF’s models. Our Medicare taxes scheduled to take effect next year. differences seem particularly significant beginning These various shifts tend to reduce projected state in tax year 2012, which affects General Fund PIT revenues for 2013-14 and increase them in earlier revenue forecasts for both 2011-12 and 2012-13. It years. appears that our differences most likely include We are concerned that the administration’s those in various categories of income for wealthier current method of forecasting high-income filers, including wages and salaries, business-related filers’ income—especially capital gains—tends income, retirement income, and the exceptionally to overestimate state revenue growth from the volatile income category of capital gains. PIT over the next few years, including revenue Concerns About the Administration’s Capital growth that would result from the Governor’s tax Gains Forecast. In its new forecast, DOF projects initiative. Figure 7 shows historical net capital gains capital gains realized by California tax filers Figure 7 to rise to $96 billion Administration Forecasts Much Higher Capital Gains in 2012. By contrast, Net Capital Gains (In Billions) our office’s November forecast assumed $140 $62 billion of 2012 capital 120 gains. This $34 billion difference accounts for 100 Governor’s Budget about $3 billion of our organizations’ differing 80 PIT baseline forecasts 60 in 2011-12 and 2012-13 LAO (November 2011) combined. A part of 40 this $3 billion revenue 20 difference results from our differing assumptions concerning federal tax 1995 2000 2005 2010 2015 policy. In contrast to our Note: Figures are adjusted to eliminate assumed accelerations of capital gains realizations due to changes in federal tax policy. The figures are not adjusted for inflation. forecast, DOF’s revenue 14 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET of California resident tax filers, as well as both annual variation in the major categories of capital our office’s November 2011 estimates and DOF’s gains over the last two decades. We will continue current estimates. In this figure, we have adjusted to examine economic and tax collection data in the both sets of estimates to eliminate the federal coming months to try to reconcile our forecasting tax-related shifts described above in order to show differences with DOF. our underlying forecasting differences. With these December 2011 Income Taxes Lagged adjustments, DOF forecasts roughly $20 billion Estimates. Using data from FTB and the more of capital gains than our office in each year Employment Development Department (EDD), beginning in 2012. This results in DOF forecasting which administers PIT withholding, our office and roughly $2 billion more in annual baseline DOF track PIT and corporation tax (CT) agency revenues than we do going forward. Over time, cash receipts daily. December and January are DOF assumes capital gains begin to approach levels significant months for collections of PIT estimated only experienced during previous stock market and payments, which are paid largely by high-income real estate “bubbles.” We advise the Legislature to filers. December 2011 was a disappointing month regard these estimates with some caution. for PIT collections (as well as CT collections). As we discussed in our November report, Preliminary FTB data show that estimated PIT California’s Fiscal Outlook, Franchise Tax Board payments and PIT withholding lagged prior-year (FTB) data on the state income tax base lags by one collections for the same month. They also lagged to two years, such that preliminary data on 2010 the amount of expected revenues for December income tax returns only recently has emerged. 2011 assumed in DOF’s June 2011 budget forecast Since publication of our report, FTB preliminary of monthly receipts. (The DOF’s new revenue data for 2010 suggests that our November 2011 forecast has the effect of increasing the average forecast of capital gains for that tax year was projected PIT and CT receipts for the rest of too high. This, in turn, may have resulted in our 2011-12 above the levels in the June 2011 forecast. forecast of capital gains for subsequent years This makes it all the more notable that December being somewhat too high. We expect to adjust for PIT and CT revenues were over $900 million lower these differences—as well as other differences that than the June forecast.) may offset the downwardly revised capital gains It is too early to make definitive judgments estimates—in our next revenue forecast (slated for about what these most recent PIT collection release in late February). trends mean. In particular, receipts over the next Forecasting capital gains and other income of two weeks will be an important early indication wealthier Californians is extremely difficult. These as to whether our office’s or DOF’s high-income forecasts can change rapidly during the course taxpayer forecast is closer to target. Additional data of any given year due to abrupt changes in asset will emerge in the coming months, particularly markets and the overall economy, which, as we have during the all-important revenue collection month seen in recent years, are not all that rare. Yet, both of April. Negative trends like those we have seen DOF and our office utilize similar assumptions for recently can reverse themselves quickly. future stock market and home price growth in our The Facebook Effect. Facebook Inc., a privately models, and our office has found that movements held company headquartered in Palo Alto, may in these asset prices, combined with simple time proceed with an initial public offering (IPO) of its trends, have explained more than 80 percent of the stock in 2012. Facebook reportedly is considering www.lao.ca.gov Legislative Analyst’s Office 15 2012-13 BUDGET issuing $10 billion of stock in an IPO that would his initiative proposal for temporary PIT and SUT value the company at over $100 billion. Other increases. Specifically, the Governor proposes to companies also are considering IPOs in the coming increase PIT rates for upper-income Californians years. for five years (2012 through 2016) and a 0.5 percent In the coming months, the state’s revenue increase in the statewide SUT for four years (2013 forecasts will need to be adjusted somewhat to through 2016). The administration forecasts that this account for the possibility of hundreds of millions measure would generate $6.9 billion that would be of dollars of additional revenues related to the available for the Legislature’s consideration during Facebook IPO. These revenues could affect the the 2012-13 budget process—$2.2 billion in 2011-12 budgetary outlook beginning in 2012-13. We revenues and $4.7 billion of 2012-13 revenues. All of caution that it will be impossible to forecast the 2011-12 revenue and $3.5 billion of the 2012-13 IPO-related state revenues with any precision, revenue would result from the higher PIT rates. and it is likely that little information about the As we discussed in our recent analysis of the state revenue gain from the Facebook IPO will be Governor’s initiative proposal, our current estimates available before investors file tax returns in April of the revenue impact of his initiative proposal 2013. (Even then, due to the confidentiality of are lower than the administration’s. Currently, we individual taxpayer information, we are unlikely to forecast that the proposal would generate $4.8 billion know precisely how much state revenues increased for the 2012-13 budget process, or $2.1 billion less due to Facebook’s IPO.) than the administration’s estimate. Our estimates of In considering the size of the Facebook IPO the initiative’s revenue increases in later years also effect in the coming months, revenue forecasters are lower than the administration’s. The reasons will have a difficult task. Our office’s income for our lower estimates are essentially the same as models are based on historical trends and, the reasons for our differences in baseline revenues therefore, already assume that some level of IPO described above. activity occurs for California companies each year. Both our office and the administration agree Moreover, in our recent forecasts, our office has that the initiative revenues will likely prove to be deliberately built in “extra” capital gains (above volatile, given that a large portion of them will relate those generated by our model) in 2010, 2011, and to upper-income tax filers’ capital gains and other 2012 to try to account for a variety of factors, nonwage income. including the surprisingly strong PIT receipts in Accrual Proposal. The administration proposes some recent months. Finally, Facebook-related that the budget include a control section authorizing capital gains likely will prove to be a relatively a new method of accruing revenues for tax policy small percentage of California’s overall capital changes enacted in 2012. This proposed change, gains in 2012. If the stock market as a whole has similar to the administration’s rejected accrual an unusually strong or weak year, that fact could change proposal from last year, would apply to the change forecasted capital gains up or down by Governor’s tax initiative proposals but not other tax much more than the positive Facebook effect. revenues. We discussed last year’s proposal in our revenue Proposals January 2011 publication, The 2011-12 Budget: Governor’s Tax Initiative Proposal. The The Administration’s Revenue Accrual Approach. Governor’s 2012-13 budget plan assumes passage of Similar to what we described in that report, 16 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET the accrual of a portion of the initiative tax having a single tax administration entity, our office revenues to 2011-12 would tend to decrease has long advocated some sort of tax agency merger. In the state’s 2012-13 Proposition 98 minimum our view, a successful merger would require detailed school funding guarantee. While we find some preparatory work by the tax agencies involved and merit in the administration’s proposed accrual a significant amount of time to implement merger- approach, we continue to have concerns that it is related efficiencies gradually. not being applied uniformly across all revenues. In addition to merging FTB and the tax admin- We recommend that the Legislature pass a law istration sections of EDD, we urge the Legislature requiring DOF to develop and regularly update a to consider merging the bulk of the State Board of clear, transparent summary of the state’s accrual Equalization’s (BOE) tax administration efforts into methodologies, and we recommend that the state the proposed DOR. The State Constitution mandates move toward consistent application of accepted that certain limited tax administration functions accrual techniques across all tax revenues and remain with the elected BOE, but legislative action spending. could allow most of BOE’s functions to be transferred to the proposed DOR. We believe that long-term tax administration efficiencies are possible from a carefully planned Proposed Department of Revenue. The 2012-13 merger of this type. In addition, taxpayers could Governor’s Budget Summary mentions that the benefit from having one, coordinated tax agency with Governor will propose merging FTB and the tax which to interact. Other departments with revenue administration components of EDD into a new collection functions also could be considered for Department of Revenue (DOR). Based on the inclusion in DOR in the future. potential benefits for the state and taxpayers from PrOPOSitiOn 98 Proposition 98 funds K-12 education, the Makes Various Adjustments to Minimum California Community Colleges (CCC), preschool, Guarantee. For 2012-13, the Governor funds at and various other state education programs. The the minimum guarantee ($52.5 billion) assuming Governor’s budget increases total Proposition 98 approval of his tax measure (which accounts funding by $4.9 billion, or 10 percent between the for more than $2 billion of the increase in the current year and the budget year. As shown in guarantee). To arrive at this guarantee, the Figure 8 (see next page), the year-over-year increases Governor adjusts or “rebenches” the guarantee in Proposition 98 General Fund for schools and in three notable ways. Of greatest magnitude, the community colleges are larger—15 percent and Governor permanently rebenches the minimum 14 percent, respectively, with local property tax guarantee to account for a shift in property tax revenues estimated to be virtually flat. The funding revenues (of approximately $1 billion annually) levels reflected in Figure 8 assume voters approve from redevelopment agencies to school districts and the Governor’s November 2012 ballot measure to community colleges. By rebenching the guarantee raise sales and income tax rates temporarily, with a for this shift, the state achieves associated General portion of the associated revenue increase benefiting Fund savings. In addition, the Governor proposes K-14 education. to eliminate existing provisions that require the www.lao.ca.gov Legislative Analyst’s Office 17 2012-13 BUDGET state to rebench for the “gas tax swap” adopted by within the Proposition 98 minimum guarantee. the Legislature in 2011. The gas tax swap eliminated To account for this shift, the Governor proposes a the sales tax on gasoline (previously included rebenching of the minimum guarantee, resulting in the Proposition 98 calculation) and replaced in an increase of $200 million. Since the cost of it with an increase in the excise tax on gasoline debt-service payments ($2.6 billion) far exceeds (excluded from the Proposition 98 calculation). the increase in the minimum guarantee from the With the rebenching, the minimum guarantee rebenching, the Governor proposes $2.4 billion was unaffected by the gas tax swap. Without the in programmatic Proposition 98 reductions to rebenching, the minimum guarantee drops by maintain spending at the guarantee. His estimate of $544 million. Thirdly, the Governor proposes the guarantee also excludes the realignment-related to recalculate last year’s rebenchings using the sales tax revenue. How the state should treat these “1986-87 methodology.” This change (which revenues is currently being litigated. applies to child care, student mental health, and major Proposals redevelopment revenues) increases the 2012-13 guarantee by $217 million. As shown in Figure 9, the year-to-year funding Makes Two Additional Adjustments to increase under the Governor’s basic plan would Minimum Guarantee Under Back-Up Plan. If the be dedicated primarily to backfilling one-time Governor’s tax measure is not adopted, the Governor solutions from last year, covering a slight increase has a back-up plan that contains $4.8 billion in in the K-12 student population (estimated to be spending reductions to schools and community 0.35 percent) for a few select K-12 programs, and colleges, including $2.4 billion in programmatic paying down existing K-14 deferrals. The plan reductions. These programmatic reductions are provides no cost-of-living adjustment for any linked with the Governor’s proposal to include K-14 education program. (Providing the projected K-14 general obligation bond debt-service payments 3.17 percent COLA for K-14 programs would cost Figure 8 Proposition 98 Funding (Dollars in Millions) Change From 2011-12 2011-12 2012-13 Revised Proposed Amount Percent K-12 Education General Fund $29,329 $33,755 $4,426 15% Local property tax revenue 12,891 12,908 17 — Subtotals ($42,220) ($46,663) ($4,443) (11%) California Community Colleges General Fund $3,217 $3,683 $465 14% Local property tax revenue 2,107 2,101 -6 — Subtotals ($5,324) ($5,784) ($459) (9%) Other Agencies $83 $80 -$2 -3% Totals, Proposition 98 $47,627 $52,527 $4,900 10% General Fund $32,629 $37,518 $4,889 15% Local property tax revenue 14,998 15,009 11 — 18 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET $1.8 billion.) It also provides no enrollment growth In Weighted Student Formula Over Five Years. funding for CCC. Moreover, it contains essentially To assist with local budget constraints, the state no programmatic augmentations while containing has temporarily suspended requirements for about a few notable programmatic reductions. The 40 categorical programs. The Governor proposes Governor’s plan also contains a set of proposals to suspend requirements for up to ten additional to restructure the state’s K-12 and CCC funding programs—essentially phasing out most existing models. Below, we highlight the Governor’s major categorical programs beginning in 2012-13. (A few Proposition 98 spending proposals as well as his categorical programs—including special education, major restructuring proposals. (The Governor also child nutrition, and the After School Education proposes significant reductions for the California and Safety program—would remain.) In lieu of Department of Education [CDE]-administered the current revenue limit and categorical program child care programs, described in the next section model, the Governor proposes that all districts of this report.) and charter schools receive an equal base per-pupil Dedicates Funding Increase to Paying Down amount, plus additional general purpose funding Deferrals. The largest component of the Governor’s intended to serve their disadvantaged students. plan is to pay down $2.4 billion in existing K-14 Specifically, for every dollar districts/charter deferrals ($2.2 billion for school districts and schools receive for a student, they would get an $218 million for CCC apportionments). This additional 37 cents if the student were poor and/or funding would reduce the need for school districts an English Learner. Districts/charter schools with and community colleges to borrow to support large proportions of these disadvantaged student operations while awaiting the state’s late payments. populations also would receive supplemental From both a state and a Figure 9 local perspective, paying 2012-13 Proposition 98 Spending Changes down deferrals helps to realign funding with (In Millions) expenses. The proposal would reduce the state’s Technical outstanding deferrals Backfill one-time actions $2,440 Make revenue limit technical adjustments 162 from $10.4 billion to Fund revenue limit growth 158 $8 billion. Because Backfill Proposition 63 mental health funding 99 this funding would Backfill CCC fee revenue decline 97 Make other technical adjustments -182 not be intended to Subtotal ($2,775) increase programmatic Policy activities, K-12 per-pupil Pay down K-12 deferrals $2,151 Pay down CCC deferrals 218 programmatic funding Create K-12 mandate block grant 98 under the Governor’s Create CCC mandate block grant 12 basic plan is roughly flat Do not initiate Transitional Kindergarten program -224 Reduce preschool funding -58 year over year. Swap one-time funds -57 Suspends K-12 Eliminate Early Mental Health Initiative -15 Categorical Program Subtotal ($2,125) Total $4,900 Requirements, Phases www.lao.ca.gov Legislative Analyst’s Office 19 2012-13 BUDGET “concentration” funding. Perhaps as soon as • Suspends Remaining Mandates. The 2013-14, the administration plans to add a remaining 26 education mandates would performance component to the weighted student be suspended. (Though suspended, school formula, which would provide fiscal incentives districts and community colleges still for districts to improve or sustain high academic would need to undertake these activities performance. Districts would have local discretion if they wanted to access the block grant as to how to spend weighted student formula funding described below.) funding. The Governor proposes to transition • Creates Block Grant. The Governor to the new formula over a five year period, with proposes to create a new, discretionary implementation beginning in 2012-13. “mandate block grant.” His budget Proposes More Flexibility for CCC Categorical provides $200 million ($178 million for Programs. Under current law, 11 of community school districts, $22 million for community colleges’ 21 categorical programs are included colleges) for the block grant. School in a “flex item.” Through 2014-15, districts are districts and community colleges that permitted to transfer funds from categorical choose to receive block grant funding programs in the flex item to any other categorical would receive a per-student allocation. As a purpose. As part of his emphasis on flexibility, condition of receiving block grant funding, the Governor adds seven currently protected recipients would be required to complete categorical programs to the flex item. Under the the 26 sets of activities still deemed to Governor’s proposal, funding for the remaining be high priorities. The administration three CCC categorical programs (Disabled Students indicates it will establish some auditing Program, Foster Care Education Program, and and/or compliance monitoring process Telecommunications and Technology Services) to ensure grant recipients undertake the would remain restricted. required activities. Replaces Existing K-14 Mandate System With New Block Grant. The Governor proposes a Does Not Initiate Transitional Kindergarten number of K-14 mandate-related changes. Under Program. In response to concerns that California the Governor’s package of changes, the existing was encouraging children to start attending mandate system essentially would be replaced with school before they were developmentally ready, the a discretionary block grant. Legislature recently passed legislation prohibiting • Eliminates More Than Half of Existing children under five years of age from enrolling Mandates. The Governor proposes to in kindergarten (unless a parental waiver was obtained). The change is phased in, moving eliminate 31 of 57 existing education the birthday cutoff back from December 1 to mandates. The mandates proposed for September 1, by one month at a time over three elimination include two of the costliest years, beginning with the shift to November 1 in mandates—one relating to high school 2012-13. This change reduces the kindergarten science graduation requirements and one population by about 125,000 students and yields relating to behavioral intervention plans for estimated revenue limit savings of $224 million in special education students. 20 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET 2012-13. The Legislature, however, redirected these Proposition 98 obligations, we also recommend savings to fund a new Transitional Kindergarten the Legislature adopt the Governor’s proposal to program, which is to offer an additional year of avoid initiating a major new program beginning in public school to the children who will just miss 2012-13. We discuss these particular aspects of the the new kindergarten cutoff. This program also Governor’s plan in more detail below. is phased in over three years, beginning 2012-13 More K-12 Categorical Flexibility, New for those children turning age five between Funding Model Moving in Right Direction. Most November 1 and December 1. By proposing not to experts and advocates at both the state and local initiate this new program, the Governor achieves levels agree that the state’s current school funding $224 million in 2012-13 savings, growing to system is overly complex, inequitable, inefficient, roughly $675 million in annual savings (by 2014-15, and highly centralized. Consequently, the when the program otherwise would have been fully Governor’s proposal to simplify and streamline the implemented). existing methods for allocating funding deserves Includes 2012-13 Midyear Trigger Reductions. both credit and serious consideration. We believe The Governor’s back-up plan includes $4.8 billion several components of the proposal are particularly in trigger reductions if his ballot measure is rejected sound, including immediate increases in categorical by voters. The Governor proposes to implement flexibility, a moderate phase-in period for the new these reductions by rescinding the $2.4 billion K-14 formula, and additional funding “weights” for deferral pay-down and reducing general purpose disadvantaged students. The Legislature could use funding for schools and community colleges by this basic structure but make some modifications to $2.4 billion. Paying down existing deferrals is ensure its important policy priorities are preserved. intended to have no associated programmatic For example, the state could maintain some general effect but the reduction in general purpose funding requirements to ensure additional funds actually would reflect a base cut. Under this scenario, K-12 are spent on disadvantaged students. Alternatively, per-pupil programmatic funding would decline rather than one general purpose weighted formula, 6 percent from the current-year level. the Legislature could consolidate all K-12 funding into a few thematic block grants. Several components merit Proposal to Expand CCC Categorical Program Serious consideration Flexibility Has Promise, But More Detail Is The Governor’s plan addresses several of the Needed. The Governor’s plan to expand the number longstanding, fundamental, widely recognized of categorical programs in the CCC flex item also problems with the state’s K-12 and community appears to be consistent with recommendations college funding systems. Though the Legislature we have made in the past. By placing additional might find ways to improve upon the Governor’s programs in the flex item, districts likely would specific restructuring plans, we recommend have more freedom to decide for themselves how the Legislature adopt the Governor’s basic best to allocate funds to targeted purposes. This restructuring approaches (regardless of the could help districts operate their services more state’s revenue situation). In this fiscal climate, efficiently and effectively, such as by consolidating particularly with so many existing outstanding various separately administered student counseling www.lao.ca.gov Legislative Analyst’s Office 21 2012-13 BUDGET programs into one comprehensive program. The reductions districts have experienced in recent Governor’s full proposal, however, is not yet clear. years—and the potential for additional reductions Specifically, the administration has indicated that if the November election does not result in new it intends to introduce provisional language that state revenue—we agree with the Governor’s will attach certain conditions to how districts assessment that now is not the time to initiate spend such funds. The Legislature will need to have major new programs. As such, we recommend this language before deciding on the merits of the the Legislature adopt the proposal to not initiate Governor’s proposal. the Transitional Kindergarten program, for the Mandate Approach Has Several Strong Points. associated revenue limit savings of $224 million. As with the state’s existing K-12 categorical funding The Legislature could consider prioritizing state system, the state’s existing K-14 mandate system preschool slots for low-income children specifically also is widely recognized as having fundamental affected by the change in kindergarten start date. problems. A broadly representative mandate work Moreover, in the context of this change—and the group that the Legislature asked our office to significant reductions proposed for the state’s convene last year identified nine serious flaws with child care programs—the Legislature may want the state’s existing system, including significant to modify or reject the Governor’s proposed administrative burden for districts, wide variation $58 million cut to the state preschool program. in reimbursement rates for completing the same concerns with Governor’s Overarching sets of activities, reimbursement regardless of Proposition 98 approach outcomes, and very high disallowance rates of audited claims. The Governor’s restructuring The Governor’s Proposition 98 proposal builds approach addresses many of these problems. It one budget plan that is based upon revenues that provides upfront, standardized per-student funding would not materialize until midyear and then has a for all districts using a relatively simple allocation relatively severe back-up plan in case the revenues process that does not involve extensive paperwork. ultimately do not materialize. Such an approach Also, by first eliminating all nonessential activities, generates significant uncertainty for school the state is able to reduce associated costs, thereby districts, as discussed below. freeing up resources that can be used to fund Governor Proposes Relatively Severe districts that do not participate in the existing Back-Up Plan for Schools. Given his back-up plan process (one of the main factors that drives up the would cut schools and community colleges by cost of most restructuring proposals). Though the $4.8 billion (including $2.4 billion in programmatic Legislature might want to make some changes to reductions), schools and community colleges the Governor’s proposal (for example, eliminating/ would bear most of the midyear trigger reductions. suspending a different set of mandates and/ Schools have difficulty, however, in downsizing or adjusting the amount of block grant funding operations midyear given students already have provided), we recommend the Legislature adopt the been assigned to classes, teachers are working Governor’s restructuring approach. on year-long contracts, and the number of Adopt Kindergarten Proposal, Prioritize instructional days already has been decided. Access to Preschool for Low-Income Children. Most Districts Likely to Build 2012-13 Budgets Given the major funding and programmatic Based Upon Governor’s Back-Up Plan. Because 22 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET the Governor’s basic plan relies on revenues that back-up plan. As a result of all these factors, some of have not yet materialized and ultimately might not these districts could run out of cash the last part of the materialize, and because large midyear reductions school year, be unable to make payroll, and require an are so disruptive, most districts likely would feel emergency state loan (for which the district pays all compelled to adopt budgets assuming the Governor’s associated costs and loses local control for a period up back-up plan. Under this scenario, districts to 20 years). Though the administration indicates it would adopt 2012-13 budgets that already contain is willing to work with districts to ameliorate some of $2.4 billion in programmatic reductions statewide. these issues, reaching agreement is likely to be difficult That is, they already would make the reductions some and most of the modifications likely to be considered would be hoping to avoid. If revenues ultimately (such as a new layoff window after the election) still did materialize, these districts likely would restore would be disruptive. reserve levels immediately but not make major Consider Unintended Consequences of programmatic adjustments until the following school Trigger Approach. Though the 2012-13 budget year (2013-14). While districts could make relatively situation under the Governor’s plan is awkward for minor programmatic adjustments midyear (such as school districts, his plan would improve notably hiring additional instructional aides), more significant the outlook for schools over the subsequent four programmatic changes (such as reducing class size years. Nonetheless, the Governor’s trigger approach and hiring additional teachers) likely would not be has significant consequences for school districts undertaken. This is because even these enhancements in 2012-13. As detailed above, for 2012-13, most can be disruptive if implemented midyear, resulting school districts will feel compelled to make the in the shuffling of students among classes and programmatic reductions imposed by the triggers. corresponding changes in students’ teachers. Given this is the case, the Legislature needs to be Districts That Budget More Optimistically Could very deliberate in structuring a trigger package, as it Face Very Difficult Midyear Situations. By contrast, in essence would determine the size and quality of districts that feel compelled to be more optimistic California’s 2012-13 K-14 education program. The and build their budgets assuming the tax measure Legislature should be especially careful in setting the is adopted could face very difficult midyear fiscal size of the trigger reduction, determining the specific situations. Under this scenario, districts would have K-14 reductions to impose, and designing tools to few options for making $2.4 billion in programmatic help districts respond given all the constraints they reductions midyear. Given current statutory face in making midyear adjustments. Alternatively, restrictions, districts cannot lay off teachers midyear. given the potentially unintended consequences of They also typically negotiate changes in the length the trigger as well as the major disruptions caused by of the work year with affected unions, with districts midyear reductions, the Legislature could consider needing to follow certain typically lengthy legal building a budget without midyear cuts. In this case, procedures if they wish to declare impasse and impose the Legislature could focus on a funding level it could changes to the teacher contract. Moreover, districts afford despite the revenue uncertainties and then use with reserve levels at the state-allowed minimums any ballot-measure revenue as one-time investments would not have sufficient reserves to cover a reduction in 2012-13 to pay down existing Proposition 98 as large as the one proposed under the Governor’s obligations. www.lao.ca.gov Legislative Analyst’s Office 23 2012-13 BUDGET HEaLtH and Human SErvicES C al WorK s and s uBsidized C hild C are The CalWORKs Basic program would effectively continue the current CalWORKs program, The Governor’s budget proposes to reduce including current cash assistance levels and General Fund support for CalWORKs and employment services, for eligible adults for up to subsidized child care—the state’s primary 24 months. After 24 months in CalWORKs Basic, sources of cash assistance and work support for families working a sufficient amount of hours California’s low-income families—by a total of (30 hours for single-parent families, 35 hours about $1.4 billion. These savings would be achieved for two-parent families, and 20 hours for single- primarily by: (1) reducing cash grants received parent families with a child under the age of six) by a significant portion of current CalWORKs in unsubsidized employment would be eligible recipients, (2) further limiting eligibility for for an additional 24 months (48 months total) of subsidized child care and CalWORKs employment cash assistance, employment services, and child services, and (3) reducing the maximum amount care through the CalWORKs Plus program. the state pays child care providers. To manage Families who fail to meet these work participation these significant reductions, the Governor requirements—for various reasons—would be proposes to prioritize funding in these programs transferred to the Child Maintenance program. on efforts to increase work participation and In addition, all families with parents who are not support for families that are most likely to achieve work-eligible (such as those with undocumented self-sufficiency through employment. immigrant parents) would be placed in the new major Proposals Child Maintenance program rather than the CalWORKs program. Families in the Child Restructuring the CalWORKs Program. Maintenance program would receive reduced cash Currently, the CalWORKs program provides assistance (27 percent below current CalWORKs 48 months of cash assistance, employment services, levels) and no employment services or child care. and child care to support efforts of low-income Participation in the Child Maintenance program families to achieve self-sufficiency through a variety would not be time limited. Time limits in both the of welfare-to-work activities (such as employment, CalWORKs Basic (24 months) and the CalWORKs education, training, and other activities to remove Plus (an additional 24 months) would be applied barriers to work). In addition, the current program retroactively to all CalWORKs recipients, provides non-time-limited cash assistance—on including those exempted from work participation behalf of children—to families not participating in requirements or in sanction status. welfare-to-work activities. In 2011-12, a combined Although these three programs would total of $5.4 billion in federal, state, and local funds continue to serve the same population as the support these activities. current CalWORKs program, a majority of current Under the Governor’s proposal, the current recipients would face a reduced cash grant and all CalWORKs program would be replaced by a recipients would face more restrictive limitation three-part system, consisting of two CalWORKs on receipt of employment services and child care. subprograms—CalWORKs Basic and CalWORKs Altogether, the Governor’s proposed restructuring Plus—and a new Child Maintenance program. would reduce General Fund expenditures for 24 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET CalWORKs by an estimated $942 million. The (1) current CalWORKs recipients, (2) former Governor’s budget also proposes to transfer CalWORKs recipients, and (3) other low-income $736 million in federal Temporary Assistance working families not receiving CalWORKs for Needy Families (TANF) block grant funds cash assistance. The Governor proposes to (the primary source of federal funding for the reduce funding for these programs by roughly CalWORKs program), made available by the $450 million, or almost 30 percent. The bulk of CalWORKs restructure, to the Student Aid this reduction (about $300 million) results from Commission to fund Cal Grants. This transfer limiting eligibility for receiving child care services is necessary to fully realize the General Fund to families that meet the work participation savings from the reduced CalWORKs expenditures requirements described above. Additionally, the described above, while continuing to satisfy proposal would reduce the maximum amount requirements for state maintenance-of-effort in the state pays child care providers (saving about programs which fulfill the goals of the TANF $80 million) and reduce family income eligibility program. thresholds from 70 percent of state median Tightening Work Participation Requirements. income (SMI) to 200 percent of the federal poverty The Governor’s proposal would narrow the scope level, which equates to 62 percent of SMI (saving of work activities which allow a family to meet about $45 million). These policy changes would its CalWORKs work participation requirement. also apply to and result in some savings for the The first way the proposal would do this is by CalWORKs Stage 1 child care program, reflected limiting countable activities to a more restrictive in the CalWORKs budget item. The administration list of federal requirements. More specifically, estimates that its package of child care-related the Governor’s proposal would eliminate the reductions would eliminate about 62,000 slots from opportunity for CalWORKs recipients to pursue a current total of about 293,000 slots. higher education beyond 12 months of vocational Restructuring the State’s Subsidized Child training or receive mental health or substance Care System. Additionally, the Governor’s abuse treatment as part of welfare-to-work proposal would begin consolidating funding and activities. Additionally, the proposal would allow administration for several child care programs in recipients to participate only in unsubsidized 2012-13 with a goal of shifting administration from employment (as opposed to subsidized employment CDE and local contractors to the Department of or education) after 24 months of cash assistance. Social Services and county welfare departments This narrowed employment eligibility definition in 2013-14. This consolidation means that there would also apply to all subsidized child care would no longer be a dedicated funding stream programs, limiting eligibility for subsidized for low-income working families that have never child care to those families who meet the work received CalWORKs cash assistance. Depending requirements described above for the CalWORKs on local priorities and funding availability, county Plus program. welfare departments could choose to continue Reducing Funding for Subsidized Child Care. offering services to these families. By eliminating The 2011-12 budget provides about $1.6 billion subsidized child care for all families who are in state and federal funds to CDE to administer not working sufficient hours in unsubsidized subsidized child care programs. These include employment, as well as ultimately transferring the specific programs targeted at three populations: responsibility for the state’s subsidized child care www.lao.ca.gov Legislative Analyst’s Office 25 2012-13 BUDGET system to DSS and county welfare departments, delivery system has some merit. Specifically, the the Governor’s proposal would focus the intent proposal would replace multiple state programs— of these programs on supporting low-income and multiple reimbursement rates, contract families’ ability to find and retain unsubsidized administrators, and eligibility criteria—with one employment. uniform approach. Potential Trade-Offs of the Governor’s LaO comments Proposal. Although we find the Governor’s Governor’s Proposal Has Some Strengths. proposal has some advantages, it also has Currently, the CalWORKs program is focused potential drawbacks. Most clearly, the reductions on two primary goals: (1) supporting the efforts proposed by the Governor would have significant of low-income families to find work and become negative impacts on many of California’s self-sufficient and (2) ensuring a basic level of low-income families. Regarding CalWORKs, subsistence for all families in the state. In an the Legislature may wish to consider whether environment of limited resources, these goals often reductions made to families most in need of compete with one another for funding support. support to achieve self-sufficiency would be too The Governor’s proposal recognizes that, given severe. Similarly, the Legislature may want to current funding constraints, it is difficult to fully consider whether the Governor’s proposal too achieve both goals of the CalWORKs program. significantly restricts eligibility criteria and time Accordingly, the proposal would focus reforms in lines for subsidized child care. More generally, the CalWORKs program on achieving the goal of the Legislature should consider whether focusing emphasizing work. CalWORKs and subsidized child care primarily In general, we find that the reforms proposed on supporting efforts of low-income families to by the Governor are consistent with his stated obtain employment is consistent with its priorities priorities for the program. Evaluating the merit or whether other objectives are also important. of supporting work over providing subsistence is Focusing these programs on a different set of largely a matter of legislative priorities; however, objectives and priorities than the Governor this approach does have budgetary advantages. would not necessarily eliminate opportunities First, by targeting resources to a specific, smaller for budgetary savings; however, the potential for portion of low-income families, the Governor is savings could be less. more likely to achieve his objective with limited The direction in which the Legislature elects resources. Second, the Governor’s focus on to focus these programs will likely dictate specific work would improve the state’s ability to meet reforms and help to determine such matters overall program work participation requirements as which state and local entities would be best established by the TANF program—which the positioned to administer a streamlined child care state is currently failing to do. Failing to meet these system. We therefore encourage the Legislature, requirements could result in significant federal before evaluating or taking action on any specific sanctions and reductions to the state’s federal reform proposals, to carefully consider its primary TANF block grant. We similarly find that the goals for these programs, with recognition that Governor’s attempt to consolidate, streamline, and pursuit of specific goals likely involves trade-offs. prioritize the state’s overly complicated child care 26 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET m edi -C al LaO comments Governor’s dual Eligibles Proposal Proposal Has Merit, but More Information The Governor’s budget proposes to shift certain Needed. The Governor’s proposal has merit Medi-Cal beneficiaries who are also eligible for because it could reduce costs and improve the Medicare, known as “dual eligibles,” from fee-for- coordination of care for dual eligibles. However, service to managed care plans. (Under managed more information is needed to assess how the care, a health plan is responsible for providing proposal would affect the medical care provided to certain medical services to enrollees who prepay a these beneficiaries and the proposal’s fiscal impact fixed amount.) Dual eligibles tend to be low-income to the state. The proposed shift of dual eligibles senior and persons with disabilities with multiple to managed care is an expansion of a four-county chronic conditions. They represent some of the demonstration program that was authorized by state’s most expensive and medically complicated the Legislature in 2010-11 but has not yet been health cases and are among the state’s highest implemented. Since the results of the pilot will not users of long-term care services, including costly be available for the Legislature to evaluate before the nursing home care. Under the Governor’s proposal, budget is due to be enacted, useful data that could managed care plans would cover long-term services assist the Legislature in assessing the merits of this for dual eligible beneficiaries, including In-Home proposal and whether the proposed savings are Supportive Services (IHSS), Community-Based achievable will not be available. Before considering Adult Services, and nursing home care. The shift the Governor’s proposal, the Legislature will need of dual eligibles to managed care would begin on more information, including details on the proposed January 1, 2013 in eight to ten counties that would design and financing of managed care benefits be most likely to have capacity to coordinate care for dual eligibles, as well as on the assumptions for these beneficiaries. The enrollment of dual underlying the savings estimates associated with the eligibles into managed care throughout the rest of Governor’s proposal. For example, it is uncertain the state would be completed over the following how the provision of non-medical services, such as few years. The administration projects the proposal IHSS, would be authorized and financed in the new will achieve ongoing savings of $1 billion General managed care arrangement. Fund beginning in 2013-14, mainly due to: (1) the h F P ealThy amilies roGram Medicare program sharing its savings with the state Proposal and (2) lower utilization of high-cost Medi-Cal long-term care services such as nursing home care. The Healthy Families Program (HFP)— The Governor’s budget assumes net savings of currently administered by the Managed Risk $679 million General Fund in 2012-13, mainly due Medical Insurance Board (MRMIB)—provides to a payment deferral to all Medi-Cal providers. health, dental, and vision benefits through Payments would be delayed by one or two weeks, participating managed care health plans for thereby shifting them into the next fiscal year. children who are not eligible for Medi-Cal. The Governor’s proposal links the payment delay The Governor’s budget proposes to achieve with the shift of dual eligibles into managed care. $64 million in net General Fund savings in 2012-13 However, it is unclear whether it is necessary to by taking a number of actions related to HFP. implement the shift of dual eligibles in order to This estimate reflects the savings generated by the implement the payment deferral. proposal to reduce the rates paid to HFP managed www.lao.ca.gov Legislative Analyst’s Office 27 2012-13 BUDGET care providers by 25.7 percent, on average, effective 43,000 HFP enrollees who live in a county October 1, 2012—bringing these rates to Medi-Cal without an existing Medi-Cal managed levels. In addition, the Governor proposes to care plan would be transitioned into gradually transition HFP enrollees—approximately fee-for-service Medi-Cal. (Under a fee-for- 878,000 children—to the Medi-Cal Program service arrangement, providers are paid for administered by the Department of Health Care each good or service they provide.) Services (DHCS) by June 30, 2013. General Fund The Governor’s budget also proposes to support would shift from MRMIB to DHCS. The eliminate MRMIB by July 1, 2013. The other four transition of HFP enrollees would happen in three programs that MRMIB administers would be phases over a nine month period, as follows: transferred to DHCS at that time. • Phase 1 (October Through December 2012). Beginning October 1, 2012, about LaO comments 411,000 HFP enrollees who are enrolled in Proposal Has Merit, but Key Details Are a managed care plan that directly contracts Lacking. The Governor’s proposal has merit with Medi-Cal would stay in the same plan because it could reduce state costs while continuing and transition to Medi-Cal. to provide managed care to most HFP enrollees. The administration, however, has not provided • Phase 2 (January Through March 2013). details on several key issues related to the shift Beginning January 1, 2013, the remaining of HFP enrollees into Medi-Cal that would 424,000 HFP enrollees who live in a county enable legislative evaluation of this proposal. with an existing Medi-Cal managed care For example, the administration should provide plan would transition into those plans. more information about how continuity of care For example, HFP enrollees would shift would be maintained for enrollees who move from one commercial managed care plan from managed care into fee-for-service Medi-Cal. to another commercial managed care plan The administration should also provide more operated by a different corporation. information about how eligibility determinations • Phase 3 (January Through June 2013). and enrollment functions would work under the Beginning January 1, 2013, the remaining new arrangement. OtHEr ExPEnditurE iSSuES C al G ranTs • Increase the minimum required grade point Proposal average (GPA) for students to qualify for Cal Grants. The GPA requirements for high Citing dramatic increases in Cal Grant costs school entitlement awards would increase since adoption of the entitlement programs in from 3.0 to 3.25 for Cal Grant A and from 2001, the Governor’s budget proposes several new 2.0 to 2.75 for Cal Grant B (which serves restrictions in Cal Grant eligibility and award lower-income students). The Community amounts. The Governor estimates these new College transfer entitlement requirement restrictions would result in $302 million of General would increase from 2.4 to 2.75. Funds savings. The major proposals are to: 28 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET • Reverse the California Student Aid LaO comments Commission’s (CSAC’s) recent decision Of the Governor’s financial aid proposals, to expand access to transfer entitlement we believe two merit serious consideration, one awards. Currently students must begin should be modified, and one is problematic given university studies in the academic term its potential to increase state costs. We also are immediately following community college concerned that the Governor’s plan does not take enrollment to qualify for the transfer into account potential increases in Cal Grant costs award. The CSAC decision would allow that the state would incur if the universities raised an interruption in studies prior to trans- their tuition/fee levels. ferring. By reversing this decision, the Governor’s Proposals to Avoid Two Program administration estimates it will avoid $70 Expansions Make Sense in This Environment. We million in new General Fund costs. believe the Legislature should seriously consider the Governor’s proposals to reverse CSAC’s decision to • Halt the planned increase in allowable expand access to transfer entitlement awards and student loan default rates at Cal Grant- maintain the current default limit at 25 percent. In eligible institutions. The default limit is the current fiscal environment, we think foregoing currently 24.6 percent but is scheduled program expansions that could necessitate further to increase to 30 percent for 2012-13. The program reductions in other areas makes sense. Governor’s proposal would retain the In the future when the state fiscal condition current limit, which prevents institu- has improved the Legislature could consider tions with higher rates (primarily private whether these are areas it would prioritize for new for-profit colleges) from participating in investments. the Cal Grant program. Some Increases in GPA Requirements Appear • Lower the current annual grant cap of Warranted but Legislature Should Deliberate on $9,708 for students attending private Where to Draw the Line. Students with very low colleges and universities. The new cap GPAs are unlikely to be prepared for postsecondary would be $5,472 for students attending education. Awarding Cal Grants to these students, private non-profit institutions and $4,000 who have very low academic persistence and for those attending private for-profit completion rates, provides little long-term benefit institutions. to the students or the state. Raising the GPA requirement at the low end of the scale (such as Major Financial Aid Fund Shifts. The the 2.0 requirement for Cal Grant B) would better Governor’s proposal would shift $736 million in target state resources to students who can benefit Cal Grant costs from the General Fund to federal from postsecondary education. In contrast, the TANF funds. This fund swap would have no net Governor’s proposal to raise the Cal Grant A effect on total funding for Cal Grants. As discussed minimum GPA above 3.0 could affect a large earlier in this report, the Governor’s proposal number of academically well-qualified students would cut CalWORKs services in order to free up with financial need. Where to draw the line in each TANF funding for Cal Grants. case is a policy decision that will require balancing concerns about cost effectiveness and college access. www.lao.ca.gov Legislative Analyst’s Office 29 2012-13 BUDGET Proposal to Reduce Grant Amounts Could from the federal government to continue payment Result in Higher State Costs. The Governor’s of UI benefits. Currently, California’s outstanding proposal recognizes the need to constrain costs federal loan is about $10 billion. California is in the fast-growing Cal Grant programs. We are required to make annual interest payments on this concerned that the proposal to reduce awards for loan. The first payment ($303 million) was made students at private colleges could reduce access in September 2011 and the second (an estimated for needy students while actually increasing state $417 million) is due September 2012. As interest costs after the first year. The state subsidy for payments must be made from state funds, the cost financially needy students at private institutions of future payments is likely to fall on the General (from Cal Grants) is substantially lower than the Fund. Below, we discuss the Governor’s approach to total subsidy provided to similar students at UC addressing the UI insolvency issue in 2012-13. and the California State University (CSU). The state Proposal could incur greater costs if enrollment shifts from private to public institutions. If the Legislature Funding Source for Interest Payments on wishes to limit maximum award amounts, it will be the Loan to the UI Fund. Similar to 2011-12, important to consider longer-term impacts on state the Governor proposes to avoid General Fund costs and student choices. If, on the other hand, interest costs in 2012-13 by: (1) making an interest the Legislature’s goal is to limit the use of state payment of $417 million from the General Fund resources at colleges with poor outcomes, we would and (2) immediately covering the cost to the recommend an approach based more directly on General Fund with a loan from the state’s disability institutional outcomes instead of institution type. insurance (DI) fund. In addition, the Governor is Does Not Take Into Account Potential proposing to institute a new employer surcharge, Increases in Cal Grant Costs. By statute, Cal Grant payable to the Employment Training Fund, which award amounts keep pace with tuition at UC and would be used to pay the state’s federal interest CSU. As a result, the university governing boards payment in 2013-14 and subsequent years, as well can unilaterally increase state Cal Grant costs as General Fund payments over the next few years by raising tuition. (For example, the universities’ to repay the DI fund loans made in 2011-12 and most recent tuition increases resulted in additional 2012-13. The surcharge would not be used to pay Cal Grant costs of about $90 million above the down the principal on the state’s federal loan. The budgeted level.) Thus, if the universities raise amount of the surcharge in each year would be tuition for 2012-13, Cal Grant costs would increase based on EDD’s projections of interest costs in the beyond the level anticipated in the Governor’s following year. The EDD estimates that the annual budget. increased cost to employers will be between $40 and $61 dollars per employee over the next few u i F i nemPloymenT nsuranCe und nsolvenCy years, gradually declining as the federal loan is paid In 2008, historically high demand for off. unemployment insurance (UI) benefits began to Increase the Minimum Monetary Eligibility push the cost of providing UI benefits beyond the Requirement. The Governor’s budget also state’s available resources. As a result, in 2009 the proposes to increase the earnings threshold an state’s UI fund (the Unemployment Fund) became unemployed worker must satisfy to receive UI insolvent. Since that time, California has borrowed benefits. Presently, to qualify for UI benefits, an 30 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET unemployed worker must have earned at least $900 impact of repaying the federal loan almost entirely in the highest quarter or $1,300 in any one quarter on employer costs, and (3) does not address the of his/her 12-month base period. These thresholds structural imbalance in the UI fund. To address have not been adjusted for changes in wage levels these issues, as discussed in our policy reports since 1992. Under the Governor’s proposal, these mentioned above, the Legislature could consider limits would be increased to $1,920 and $3,200 a more comprehensive plan—one which makes respectively. The EDD estimates that this change more significant increases to employer taxes and/ would reduce annual UI benefit payments by or decreases to benefit payments—to address the $30 million (less than one percent of total annual structural imbalance in the UI program and allow benefit payments). for more timely repayment of the federal loan. LaO comments C aP - and -T rade r evenues Proposal Governor’s Proposal Does Little to Address UI Fund’s Long-Term Insolvency. As the funds raised As part of its plan to address climate change, by the Governor’s proposed employer surcharge the state will begin implementing a cap-and- would be limited to repayment of interest on trade program in 2012-13. The program places a loans to keep the UI fund solvent, the proposal “cap” or limit on the sources of greenhouse gases does little to address either the insolvency of the responsible for 85 percent of the state’s emissions. UI fund or the long-term structural imbalance The ARB will issue carbon allowances that these between UI fund revenues and expenditures. sources will, in turn, be able to “trade” (buy Continuing to carry a balance on the loan to the and sell) in a newly created carbon market. The UI fund poses several problems for California Governor’s budget assumes that cap-and-trade that necessitate corrective action. We provide an auctions will generate $1 billion in state revenues in-depth discussion of the UI fund insolvency in 2012-13. Under the administration’s plan, issue in a number of recent policy reports, these revenues would be invested in (1) clean and including California’s Other Budget Deficit: The efficient energy, (2) low-carbon transportation, (3) Unemployment Fund Insolvency and Managing natural resource protection, and (4) sustainable California’s Insolvency: The Impact of Federal infrastructure development. The budget also Proposals on Unemployment Insurance. assumes that $500 million of the revenues will It is important to note that inaction with regard be used to offset General Fund costs of existing to the insolvency will result in automatic and programs. According to the administration, since gradually increasing federal employer UI-related actual cap-and-trade revenues will not be known tax increases which pay down the principal on until late in 2012-13, the planned expenditures are the federal loan to the state’s UI fund. The first not specified by program in the proposed budget. increment of this tax increase will be implemented Rather, the administration plans to submit an in 2012, and will result in increased employer taxes expenditure plan to the Legislature after the first of around $300 million annually. Altogether, the cap-and-trade auction—which would be after the potential drawbacks of the Governor’s proposal 2012-13 budget is enacted—and allocate funds to are that it: (1) would take longer to repay the specific programs not sooner than 30 days after federal loan (resulting in higher interest costs) than submitting this plan. otherwise would be the case, (2) concentrates the www.lao.ca.gov Legislative Analyst’s Office 31 2012-13 BUDGET LaO comments administration, the state would provide counties with an unspecified amount of ongoing funding The Governor’s proposal raises several issues beginning in 2013-14 for costs incurred during for legislative consideration. For example, since the prior fiscal year. As a result of the proposed there are legal constraints associated with the use changes, the budget reflects (1) a one-time of cap-and-trade revenues, it will be important for $10 million General Fund augmentation in 2011-12 the Legislature to consider any potential legal risks to help counties prepare for the transition and with the proposal. Moreover, the administration’s (2) $11.2 million in General Fund savings in DJF approach provides the Legislature with no operations in 2012-13. In addition, the Governor’s opportunity to develop a detailed plan on the use of budget delays implementation of the current-year the revenues as part of the budget process in order trigger reduction related to charging counties for to ensure that the plan is aligned with legislative wards in DJF. priorities. We would also note that because the auction rules developed by ARB include both floor LaO comments and ceiling prices for allowances, actual cap-and- We have recommended in the past that trade revenues for 2012-13 could range from counties be given full responsibility for juvenile roughly $1 billion to almost $3 billion. wards to encourage the development of efficient and J J r uvenile usTiCe ealiGnmenT effective local policies to reduce delinquency. While Proposal the administration’s proposal merits consideration, there are a number of issues the Legislature should Currently, counties initially oversee all examine in reviewing this proposal. These include juveniles entering the criminal justice system and (1) creating a funding formula for the payments are responsible for almost all juveniles determined to counties, (2) identifying whether counties to be offenders. The state, on the other hand, houses have or could develop sufficient capacity to house the most serious offenders in facilities run by the additional serious juvenile offenders, (3) developing Division of Juvenile Facilities (DJF). The Governor incentives for increased efficiency and improved proposes to shift full responsibility for all juvenile outcomes (such as reduced recidivism of these offenders to counties. Specifically, DJF would stop juvenile offenders), and (4) assessing potential receiving new juvenile wards on January 1, 2013. unintended consequences of this proposal (such as However, DJF would continue to house individuals a possible increase in the number of juveniles tried admitted to state facilities prior to this date until as adults and sentenced to state prison). the completion of their terms. According to the 32 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET www.lao.ca.gov Legislative Analyst’s Office 33 2012-13 BUDGET 34 Legislative Analyst’s Office www.lao.ca.gov 2012-13 BUDGET www.lao.ca.gov Legislative Analyst’s Office 35 An LAO REpORT 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 website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 36 Legislative Analyst’s Office www.lao.ca.gov