The 2013-14 Budget: Overview of the Governor's Budget

The 2013-14 Budget: Overview of the Governor’s Budget MAC TAylor • le g i s lA Ti v e A nAl y sT • J AnuAry 2013 2013-14 Budget 2 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget ExEcuTivE Summary Governor’s Proposal Presents Budget With $1 Billion Projected Reserve. On January 10, 2013, the Governor released his 2013-14 budget package. Similar to our November 2012 forecast, this latest package reflects a significant improvement in the state’s finances, due to the economic recovery, prior budgetary restraint, and voters’ approval of temporary tax increases. Specifically, the Governor proposes $138.6 billion in General Fund and special fund spending in 2013-14, up 4.5 percent from 2012-13. The administration forecasts that the state’s General Fund budgetary balance will be $1 billion at the end of 2013-14 under the Governor’s plan. Includes Education, Health, and Debt Repayment Proposals. The budget contains major proposals in education, including a new formula for financing schools and additional General Fund resources for the public university systems. The package also presents options for expanding Medi-Cal under the federal health care reform law. In addition, the Governor’s multiyear budget plan includes proposals to eliminate most of the so-called “wall of debt,” a group of selected budgetary obligations now totaling around $30 billion that were incurred in recent years. LaO comments Transition From Multibillion Dollar Annual Deficits to “Baseline” Budgets. Over the past several years, each January Governor’s budget has included billions of dollars in proposed solutions—expenditure reductions, revenue increases, borrowing, and other actions—in order to close budget shortfalls. Now, however, the state has reached a point where its underlying expenditures and revenues are roughly in balance. With the exception of education funding, the remainder of state General Fund spending reflects a baseline budget. This means that state- supported program and service levels established in 2012-13 generally continue “as is” in 2013-14. Under our and the administration’s fiscal forecasts, this situation would likely continue into 2014-15. Governor’s Focus on Fiscal Restraint and Paying Off Debts Appropriate. The Governor’s emphasis on fiscal discipline and paying off the state’s accumulated budgetary debts is commendable, especially in light of the risks and pressures that the state still faces. We note that there are still considerable risks to revenue estimates given uncertainty surrounding federal fiscal policy and the volatility inherent in our revenue system. In addition, under the Governor’s multiyear plan, the state would still have no sizable reserve at the end of 2016-17 and would not have begun the process of addressing huge unfunded liabilities associated with the teachers’ retirement system and state retiree health benefits. As such, the state faces daunting budget choices even in a much-improved fiscal environment. Issues Highlighted by Governor Merit Legislative Consideration. While there will still be important decisions to make on the administration’s budget plan, the Legislature is being asked by the Governor to consider a variety of significant policy issues. Probably the most important are the K-12 school finance formula and the Medi-Cal expansion under federal health care reform. www.lao.ca.gov Legislative Analyst’s Office 3 2013-14 Budget In addition, the Governor has proposed a new model for funding and providing adult education services, changes in the way the state funds community college enrollment, and caps on the number of state-subsidized college units. His budget presentation also discusses potential changes to state infrastructure financing. We believe these issues are worthy of serious legislative consideration and have, in the past, offered alternatives for addressing many of them. 4 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget OvErviEw The Governor’s Budget Proposal Proposed Budget Would End 2013-14 With $1 Billion Reserve. The Governor’s budget package On January 10, 2013, the Governor released projects General Fund revenues of $98.5 billion his 2013-14 budget package. That spending plan in 2013-14. The budget assumes $97.7 billion proposes $138.6 billion in General Fund and in General Fund expenditures, producing an special fund expenditures, as shown in Figure 1. $851 million operating surplus in 2013-14. The Contrary to recent years in which the state faced budget package estimates that the General Fund multibillion-dollar deficits, this latest package will end 2013-14 with a $1 billion reserve. (The reflects a significant improvement in the state’s Governor plans again to suspend the transfer to a finances. This report offers an overview of the separate reserve, the Budget Stabilization Account Governor’s budget proposal, including our [BSA] created by Proposition 58 in 2004.) reactions to the plan. Differences From LAO’s November 2012 How the administration arrived at its Forecast. Our November 2012 publication, Budget Forecast Figure 1 Projected 2012-13 Budget expenditures Surplus Would Erase Deficit From Prior (Dollars in Millions) Year. For 2012-13, Change From 2012-13 2011-12 2012-13 2013-14 the administration Fund Type Revised Revised Proposed Amount Percent estimates that General General Funda $86,404 $92,994 $97,650 $4,656 5.0% Special funds 33,853 39,648 40,928 1,279 3.2 Fund revenues will Budget Totals $120,257 $132,642 $138,578 $5,936 4.5% be $95.4 billion and Selected bond funds $6,104 $12,295 $7,248 -$5,046 -41.0% expenditures will be Federal funds 73,063 85,830 78,841 -6,989 -8.1 $93 billion, as shown in a Includes Education Protection Account created by Proposition 30 (2012). Figure 2. This $2.4 billion operating surplus will Figure 2 erase the $2.2 billion governor’s Budget deficit that remained general Fund Condition after 2011-12 and leave Includes Education Protection Account (In Millions) the General Fund with a 2011-12 2012-13 2013-14 small reserve as it enters revised revised Proposed 2013-14. (Throughout Prior-year fund balance -$2,282 -$1,615 $785 this report, amounts Revenues and transfers 87,071 95,394 98,501 for the General Fund Total resources available $84,789 $93,779 $99,286 include revenues from Expenditures $86,404 $92,994 $97,650 the Education Protection Ending fund balance -$1,615 $785 $1,636 Account, created by Encumbrances $618 $618 $618 reserve -$2,233 $167 $1,018 Proposition 30 [2012]). www.lao.ca.gov Legislative Analyst’s Office 5 2013-14 Budget The 2013-14 Budget: California’s Fiscal Outlook, forecast includes about $500 million in estimated that the Legislature and Governor would lower net repayments of such loans. In need to address a $1.9 billion budget problem by some cases, the administration proposes to June 2013. The Governor’s budget, on the other delay repayment dates and in other cases, it hand, produces a $1 billion reserve at the end of plans to repay loans earlier. 2013-14. The $2.9 billion difference between our office’s estimate and that of the administration is Key components of the Budget Plan mostly explained by the following factors: The Governor’s 2013-14 budget contains major • Higher Tax Revenues ($1.1 Billion). new proposals for schools and community colleges Across the three fiscal years (2011-12, and continues the implementation of the federal 2012-13, and 2013-14), the administration’s Patient Protection and Affordable Care Act (ACA). forecast includes about $1.1 billion in In addition, the budget proposes General Fund higher revenues. Specifically, this total spending increases for the public university systems includes higher revenues from the personal and revises previously projected savings associated income tax (PIT) ($1.4 billion) and the sales with the dissolution of RDAs and cap-and-trade and use tax (SUT) ($0.2 billion), and lower auction revenues. Figure 3 outlines the major new revenues from the corporation tax (CT) proposals contained in the Governor’s budget. (-$0.6 billion). Includes Major Proposition 98 Proposals. The Governor’s budget contains major new • Higher Estimates of Savings ($1 Billion). Proposition 98 proposals for schools and The administration’s January forecast community colleges. Most notably, the budget includes about $700 million in higher replaces much of the current system of K-12 finance savings associated with the dissolution with a new funding formula. The new formula of redevelopment agencies (RDAs) and allows more local control because it has virtually no $300 million in higher savings from using state requirements for programmatic spending. The cap-and-trade revenues to offset programs spending plan also includes substantial funding to traditionally supported by the General pay down existing K-14 payment deferrals, reducing Fund. the need for school districts and community • Revenues From Health Taxes and colleges to borrow to meet their cash needs. Fees ($0.7 Billion). The administration Uses Proposition 39 Funding for Projects at has proposed extending the hospital Schools and Community Colleges. By changing quality assurance fee ($310 million) the method used by multistate businesses and reauthorizing the gross premiums in determining their state taxable income, tax on Medi-Cal managed care plans Proposition 39 (2012) increases corporate tax ($364 million). revenues. The Governor’s budget includes all such revenue in the calculation of the Proposition 98 • Lower Repayments of Special Fund minimum guarantee. In addition, Proposition 39 Loans ($0.5 Billion). Our November requires that half of the new revenues fund energy forecast assumed the repayment of about efficiency programs through 2017-18. The budget $1.3 billion in special fund loans from proposes to use that funding for projects at schools the General Fund. The administration’s and community colleges. 6 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget Increases Funding for UC and CSU. The two alternatives for this optional expansion— budget package proposes a 5 percent base increase one in which the state would administer an ($125 million each) in 2013-14 for University of expanded version of its current Medi-Cal Program California (UC) and California State University and another in which counties administer (CSU). This funding is in addition to the the expansion while meeting state eligibility $125 million that last year’s budget provided to requirements. The ACA also includes several each of the systems for 2013-14 in exchange for not provisions that will likely result in additional increasing tuition levels in 2012-13. The Governor enrollment among the currently eligible Medi-Cal also has a multiyear plan that would provide population. The budget provides a $350 million 5 percent base increases in 2014-15 and 4 percent General Fund “placeholder” for these additional in the subsequent two years. As a result of these costs for the currently eligible population. increases, the Governor expects tuition levels to The administration’s multiyear Forecast remain flat through 2016-17. In addition, the budget proposes to shift debt-service costs for general Forecasts Balanced Budgets. The obligation bonds into UC’s and CSU’s budgets. administration’s multiyear budget projection Implementing the ACA. The ACA provides reflects both its updated revenue and expenditure states with the option to expand Medi-Cal projections, as well as projections of various coverage to certain adults with incomes up to proposals made by the Governor in his 2013-14 138 percent of the federal poverty level who are budget plan. The administration projects that not currently eligible. The budget package suggests future General Fund revenues will exceed Figure 3 Major Proposals in the governor’s Budget General Fund (In Millions) Proposed savings Repay fewer special fund loansa $1,042 Reauthorize the gross premiums tax on Medi-Cal managed care plans 364 Extend the hospital quality assurance fee 310 Transfer funds from court construction account to the General Fund 200 Use prior appropriations over revised Proposition 98 guarantee level for QEIA 172 Suspend newly identified state mandates 104 Use highway account revenues to pay transportation debt service 67 Proposed Augmentations Provide augmentation for UC and CSU 250 Expand CalWORKs employment services 143 other Policy Proposals Begin to implement K-12 funding formulab — Restructure adult education programb — Use Proposition 39 funds for energy efficiency projects at K-14 schools — Base community college funding on census of students at end of termb — Cap number of state subsidized college units per student — Expand Medi-Cal via a state- or county-based model — a Relative to administration’s multiyear forecast as of June 2012. The LAO’s November 2012 forecast projected special fund loan repayments to be about $500 million lower than the June 2012 multiyear forecast. b Funded within Proposition 98 and has no net effect on General Fund expenditures. QEIA = Quality Education Investment Act. www.lao.ca.gov Legislative Analyst’s Office 7 2013-14 Budget expenditures annually—thereby producing annual of debt obligations causes part of the difference operating surpluses of at least $47 million (in in projected operating surpluses. In 2016-17, 2014-15) and as much as $994 million (in 2016-17). for example, the Governor proposes several By the end of 2016-17, the administration projects billion dollars more spending to pay outstanding the accumulation of a $2.5 billion General Fund obligations to schools and local government, end a reserve. Transfers to the other state reserve, the longstanding lag in state contributions to employee BSA, are assumed to be suspended by the Governor pensions, and retire special fund loans. throughout the forecast period. LaO comments Projects Smaller Future Surpluses Than LAO’s Forecast. Our November forecast also Transition From Multibillion Dollar Annual reflected a significant improvement in state Deficits to Baseline Budgets. Over the past finances, albeit with much larger surpluses beyond several years, each January the Governor’s budget 2013-14. Specifically, our forecast produced an has included billions of dollars in proposed over $1 billion operating surplus in 2014-15, solutions—expenditure reductions, revenue growing thereafter to a $7.5 billion surplus in increases, borrowing, and other actions—in order 2016-17. The differing formats of the forecasts make to close massive budget shortfalls. Now, however, comparisons difficult. Some of the difference can the state has reached a point where its underlying be explained by the administration having its own expenditures and revenues are roughly in balance. estimates of future revenues and expenditures, For instance, the administration is proposing a including estimates of caseload growth for many limited set of actions (such as delaying repayment state programs. For example, in 2016-17 the of some special fund loans and authorizing two administration projects $700 million less in local health-related taxes) in order to keep the budget in property taxes (which offset state funding to balance, build a modest reserve, and fund a limited schools) and higher health and human services number of augmentations (the most prominent costs of perhaps a few hundred million dollars. being for the state universities). With the exception A significant portion of the disparity, however, of education funding, the remainder of state appears to relate to fiscal and policy proposals General Fund spending reflects a baseline budget. in the Governor’s plan, which were not included This means that state-supported program and in our forecast of current state laws and policies. service levels established in 2012-13 would generally In particular, the Governor’s university funding continue as is in 2013-14 under the Governor’s plan. proposals result in higher expenditures in 2016-17 Under our and the administration’s fiscal forecasts, in the administration’s multiyear forecast. Among this situation would likely continue into 2014-15. the differences are the Governor’s proposals Governor’s Focus on Fiscal Restraint and to eliminate most of the wall of debt, a group Paying Off Debts Is Appropriate. In his budget of selected budgetary obligations now totaling presentation, the Governor stressed fiscal around $30 billion that were incurred in recent discipline, including the importance of paying off years. Our forecast projected less spending to the state’s accumulated budgetary debts. We think repay these obligations through 2016-17, given the this emphasis is commendable, especially in light lack of formal legislative action to date to adopt of the risks and pressures that the state still faces. several elements of the Governor’s wall of debt As we noted in the Fiscal Outlook, there are still plan. Higher proposed spending to repay wall considerable risks to revenue estimates given: 8 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget (1) uncertainty at the federal level over “fiscal cliff” are: (1) a new K-12 funding formula, and (2) two issues related to the debt limit and sequestration, options for implementing Medi-Cal expansion and (2) normal volatility in our state revenue under federal health care reform. In addition, the structure. In addition, despite the Governor’s Governor has proposed a new model for funding commitment to paying down much of the wall of and providing adult education services, changes debt, the state would still have no sizable reserve in the way the state funds community college at the end of 2016-17 under his multiyear plan and enrollment, and caps on the number of state- would not have begun addressing huge unfunded subsidized college units. He also has suggested liabilities associated with the teachers’ retirement various changes to the state’s role in funding system and state retiree health benefits. As such, infrastructure. We believe these issues are worthy the state potentially faces some daunting choices of serious legislative consideration. On many of even in this much-improved fiscal environment. these issues, we have identified similar problems Governor Poses Important Policy Choices for as the Governor, while offering alternative ways to the Legislature. While there will still be important address those problems. Given that the Legislature fiscal decisions to make on the administration’s will not be required to deal with addressing huge budget plan, the Legislature is being asked by the budgetary shortfalls, we believe addressing the Governor to consider a variety of significant policy challenges posed by the Governor would be well issues. Probably the two most important ones worth the time and effort. EcOnOmicS and rEvEnuES administration’s Administration Forecast Completed Prior Economic Forecast to New Year’s Day Federal Tax Legislation. The administration completed its current economic Forecast Assumes Continuing Economic forecast in early December, consistent with its Recovery. Similar to recent economic forecasts traditional schedule. Of the forecasts shown in from the administration and our office, the 2013-14 Figure 5, only the U.S. forecast by IHS Global Governor’s Budget economic forecast assumes Insight was completed after final congressional continuation of the current moderate economic passage on January 1, 2013 of the American recovery in the U.S. and California. Figure 4 (see next Taxpayer Relief Act (ATRA). The act averted page) summarizes the administration’s economic certain aspects of the fiscal cliff, a variety of forecast for calendar years 2012 through 2015, and previously scheduled federal tax increases and Figure 5 (see page 11) compares the administration’s spending reductions. Although Congress and the forecast to recent forecasts from our office, the President agreed to halt scheduled income tax rate University of California, Los Angeles (UCLA) increases on all but the highest rate brackets and Anderson School of Management, and IHS Global delay scheduled spending cuts in domestic and Insight—a major economic forecasting firm (which defense programs, ATRA allowed increased income does not provide California-specific forecasts). All of taxes to go into effect for many upper-income the recent California forecasts assume continuing, Americans, as well as higher payroll taxes for most moderate job growth and improvements in the state’s workers. housing sector over the next few years. www.lao.ca.gov Legislative Analyst’s Office 9 2013-14 Budget Near-Term Economic Prospects Slightly of personal income. The IHS Global Insight Weaker Under Some Recent Forecasts. Previous forecasts 2.8 percent growth in U.S. personal forecasts by both the administration and our income in 2013—1 percentage point below the office assumed that Congress and the President administration’s forecast—due largely to this would take actions to avert the fiscal cliff, but forecast’s incorporation of the end of the payroll tax ATRA results in a set of federal actions that cut. Overall U.S. economic growth (as expressed differ from those assumed in prior forecasts. For by the increase in real gross domestic product) example, contrary to the assumptions embedded is just slightly lower in IHS Global Insight’s in recent state economic forecasts, ATRA allowed forecast. While that forecast acknowledges an an immediate end to the temporary payroll tax economic drag resulting from higher payroll taxes cut (likely resulting in near-term decreases in and increased income taxes on upper-income economic activity) but extended for 2013 provisions Americans, this drag is largely offset in the near that allow businesses to offset the immediate costs term by more rapid growth in some sectors of the of certain new equipment and software (“bonus economy, the bonus depreciation tax policy, and a depreciation,” which likely results in near-term decline in recently elevated personal savings rates, increases in economic activity). which should allow consumers to maintain much The loss of take-home pay resulting from of their recent spending patterns despite reduced higher payroll taxes is included in the calculation take-home pay. Figure 4 LaO comments Administration’s January 2013 economic Forecast Federal Policy Is the united states 2012 2013 2014 Key Forecast Risk Now. Percent change in: The administration’s Real gross domestic product 2.1% 1.8% 2.8% forecast is similar to our Personal income 3.5 3.8 4.8 office’s November 2012 Wage and salary employment 1.4 1.5 1.6 Consumer price index 2.1 1.9 2.0 forecast. The federal Unemployment rate 8.1 7.8 7.4 actions included in ATRA Housing starts (millions) 0.8 1.0 1.3 likely mean slightly weaker Percent change from prior year 25.3 27.9 31.4 Federal funds rate 0.1 0.1 0.1 prospects for the overall U.S. and state economies California 2012 2013 2014 in 2013, due mainly to Percent change in: the end of the payroll tax Personal income 5.1%a 4.3%a 5.5% cut, as compared with Wage and salary employment 2.0 2.1 2.4 both the administration’s Unemployment rate 10.6 9.6 8.7 Housing permits (thousands) 57 81 123 recent forecast and our Percent change from prior year 21.7 42.7 51.6 own forecast of two Single-unit permits (thousands) 27 37 63 months ago. The major Multiunit permits (thousands) 30 44 60 a remaining uncertainties The administration’s economic forecast appropriately reflects various one-time effects of Facebook’s 2012 initial public offering (IPO) of stock. This assumes that the official federal survey accurately in the near term are the captures these effects. Other economic forecasts, including our office’s prior forecasts, omit these one-time effects. If the IPO had been excluded from this administration forecast, growth in California series of upcoming federal personal income would have been 4.7 percent in 2012 and 4.5 percent in 2013. Most of the IPO effects on personal income were heavily concentrated in the fourth quarter of 2012, which affects Proposition 98 decisions concerning and state appropriations limit calculations for 2013-14 and 2014-15. 10 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget (1) the statutory cap on U.S. public debt known Prolonged Federal Impasse Could Damage the as the debt ceiling; (2) the delayed 8 percent to Economic Recovery. A prolonged impasse by federal 10 percent cuts to many federal spending programs leaders concerning the debt ceiling and sequestration known as sequestration, which are now scheduled to decisions could dampen consumer, business, and begin on March 1, 2013; and (3) the expiration at the investor confidence in the coming weeks, thereby end of March of the current “continuing resolution” damaging the modest economic recovery. The that funds federal government operations. The debt 2011 debt ceiling debate coincided with a notable ceiling raises the biggest concerns for the economy slowing of economic growth, as measured by in the near term. While U.S. government debt several key economic statistics: employment, gross reached its cap of $16.4 trillion on December 31, domestic product, motor vehicle sales, and business 2012, the federal government now is implementing investment, among others. If a similar impasse a series of financial maneuvers that allow it to pay were to occur in the coming weeks, economic its legal obligations despite an inability to issue growth in 2013 could be noticeably weaker than the additional debt. Without a debt ceiling increase or administration’s projections. A stock market slump, similar action, these maneuvers will be exhausted, if it were to occur, would pose a particular threat to and the federal government will have to delay the state budget, given the state’s progressive PIT payments on some of its obligations beginning rates and reliance on capital gains of high-income at some point around late February or early taxpayers. March 2013. The recent state economic forecasts all assume that the federal government will adopt some Figure 5 Comparing Administration’s Economic Forecast With Recent Forecastsa 2013 2014 IHS IHS Global Global LAO UCLA DOF Insight LAO UCLA DOF Insight November December January January November December January January 2012 2012 2013 2013 2012 2012 2013 2013 United States Percent change in: Real gross domestic 1.8% 1.7% 1.8% 1.7% 3.0% 2.8% 2.8% 2.7% product Personal income 3.9 3.7 3.8 2.8a 4.9 4.9 4.8 5.0 Wage and salary 1.3 1.4 1.5 1.4 1.8 1.7 1.6 1.7 employment California Percent change in: Personal income 4.7% 3.3% 4.3% NA 5.5% 5.2% 5.5% NA Wage and salary 2.3 1.4 2.1 NA 2.5 2.2 2.4 NA employment Unemployment rate 9.6 9.7 9.6 NA 8.7 8.4 8.7 NA Housing permits (thousands) 83 75 81 NA 113 130 123 NA a The forecasts make various assumptions about federal tax and spending policies in 2013 and beyond. The IHS Global Insight forecast— developed after passage of January 2013 federal tax legislation—incorporates the expiration of the payroll tax reductions at the end of 2012, which affects 2013 personal income growth in particular. NA = Not applicable. www.lao.ca.gov Legislative Analyst’s Office 11 2013-14 Budget spending decreases, as well as additional tax administration’s increases, gradually over the long term. Nevertheless, revenue Forecast the implementation of sudden spending cuts at the Figure 6 summarizes the administration’s levels envisioned in the current sequestration law revenue forecast through 2016-17 and lists major could reduce economic activity somewhat below differences between this new forecast and both the forecasted levels in the near term. In particular, 2012-13 Budget Act forecast from June 2012 and our segments and regions of the economy with high office’s November 2012 forecast. Figure 7 (see page 14) concentrations of federally funded activity, such provides more detail concerning these comparisons as the San Diego region (with significant military related to 2012-13 and 2013-14 revenues. and federally funded research activities), could be negatively affected. Personal income Tax California-Specific Economic Risks. In addition The Governor’s budget forecasts that PIT to federal policy risks, all of the recent economic revenues booked to the General Fund and forecasts shown in Figure 5 assume continuing Education Protection Account for 2012-13 will total improvement in California’s housing markets $60.6 billion, an increase of $6.8 billion (13 percent) and construction industry. While recent housing over the updated 2011-12 PIT forecast. Around trends have been notably positive, with rising home one-fourth of this year-over-year growth results prices and increased sales, these trends could be from the full phase-in of rate increases for upper- easily upset in the near term by a sharp decline income taxpayers under Proposition 30. For 2013-14, in consumer and investor confidence resulting the budget forecasts that PIT revenues will climb to from a prolonged debt ceiling debate. In addition, $61.7 billion, an increase of 1.8 percent. Assumed there remains some uncertainty concerning how accelerations of income from 2013 to 2012—as some individuals and businesses will react to several recent taxpayers sought to avoid higher federal taxes related state-level policy changes, including the temporary to the fiscal cliff—affect year-over-year growth PIT and SUT increases approved in Proposition 30 during this period. In general, these accelerations and the state’s greenhouse gas reduction policies increase PIT revenues in the forecast for tax year (including cap-and-trade auctions). 2012 and, in turn, decrease the projected growth rate Risks From Middle East Conflicts. Among the for tax year 2013. other risks to the economic forecast are continuing Administration Has Increased Its PIT conflicts in the Middle East, such as the civil war Estimates. The administration has increased its in Syria and recently heightened tensions involving prior projections for state PIT revenues. Compared Israel and Iran. While weak energy demand growth to the June 2012 forecast, the new projections has caused major declines in oil prices recently, increase PIT revenues by $379 million for 2012-13. which have benefited consumers and businesses, (This increase occurs despite an approximately sudden price spikes can result from instability in the $600 million decrease in the administration’s May Middle East. Such price spikes, if they were to occur, 2012 projection of PIT revenues resulting from the could weaken the modest economic recovery. Facebook initial public offering.) In addition, the new forecast shows higher 2013-14 PIT revenues of $1.5 billion compared to the administration’s June 2012 multiyear budget forecast. 12 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget The new projections include revised PIT policies, which we discussed in our November estimates for previous fiscal years. For example, Fiscal Outlook publication, final information on similar to what we discussed in November 2012, the 2011-12 revenues seemingly will not be available budget adjusts the entering 2011-12 fund balance until at least the middle of 2014—around 700 days upward due primarily to higher PIT revenues for after the end of the fiscal year—with comparable 2010-11 and prior years. (The budget also includes lags for each succeeding year’s revenues.) new nonrevenue adjustments to the entering Higher Capital Gains Forecast, Among Other fund balance.) In addition, PIT revenues booked Changes. Based in part on the Department of to 2011-12 are now projected to be $878 million Finance (DOF) analysis of new tax agency data higher than in the June 2012 forecast. Some of these released in late November 2012, the administration differences relate to the state’s increasingly complex has revised its forecast of California residents’ accrual policies, which shift revenues collected net capital gains in tax year 2011 upward from from one fiscal year to another in the state’s $52 billion in the 2012-13 budget forecast to budget calculations. (Historically, for example, this $68 billion now. This, in turn, seems to contribute Governor’s budget forecast would be the last official to higher capital gains projections for future update of 2011-12 revenues. Under the new accrual years. At the same time, the administration has Figure 6 Administration’s Multiyear revenue Forecast General Fund and Education Protection Account Combined (In Millions) 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 Personal income tax $53,836 $60,647 $61,747 $67,550 $71,981 $75,344 Sales and use tax 18,652 20,714 23,264 24,920 26,733 27,261 Corporation tax 7,949 7,580 9,130 9,655 10,169 10,592 Subtotal, “Big Three” taxes ($80,437) ($88,941) ($94,141) ($102,125) ($108,883) ($113,197) Insurance tax $2,165 $2,022 $2,198 $2,413 $2,480 $2,550 Other revenues 2,959 2,631 2,185 1,878 1,876 1,919 Net transfers and loans 1,509 1,800 -23 -563 -1,956 -325 Total revenues and Transfers $87,071 $95,394 $98,501 $105,853 $111,283 $117,341 Differences—Governor’s Forecast Minus 2012-13 Budget Act Forecast Estate tax — -$45 -$290 -$725 -$1,180 NA Taxes and other revenues $516 -660 1,394 -170 1,266 NA Net transfers and loansa -275 212 1,280 43 -572 NA Totals $241 -$493 $2,384 -$852 -$486 — Differences—Governor’s Forecast Minus LAO November 2012 Forecast Taxes and other revenues $863 -$385 $632 $1,462 $1,281 $568 Transfer of Proposition 39 revenue to new fundb — — 475 500 513 525 Other transfers and loans (net)a -275 169 651 -441 -1,528 -212 Totals $589 -$216 $1,758 $1,521 $265 $881 a A positive number generally indicates that the Governor’s budget forecast assumes fewer General Fund loan repayments to special funds. A negative number generally indicates that the Governor’s budget forecast assumes more General Fund loan repayments to special funds. Differences in transfers other than loans also are reflected in this line. b Amounts listed are the transfers of Proposition 39 (2012) revenue to the Clean Energy Job Creation Fund that were assumed in the LAO November 2012 forecast. This transfer of revenues is omitted from the Governor’s budget proposal. NA = Not applicable. www.lao.ca.gov Legislative Analyst’s Office 13 2013-14 Budget lowered its overall forecast of Californians’ wage individuals and businesses to accelerate receipts of income in 2011 and 2012, particularly estimates of capital gains, dividends, and wages from 2013 to 2012, wage growth for upper-income taxpayers. While in order to avoid higher federal tax rates related to the we do not expect to release a complete updated fiscal cliff. December and early January withholding revenue forecast until May 2013, our preliminary data show that wage and bonus income subject observations are that DOF’s overall adjustments for to such withholding has increased substantially 2011 and 2012 seem reasonable based on currently compared to last year. Similar to both our and the available data. At this time, we find their 2012-13 administration’s revenue forecasts in recent months, and 2013-14 PIT forecasts—those most relevant for the updated administration forecast assumes that the upcoming budget process—to be reasonable. California tax filers accelerated 20 percent of the 2013 Will Be an Unusual Year of PIT capital gains they otherwise would realize in 2013 to Collections. While the administration’s near-term 2012, along with 10 percent of dividends and 1 percent PIT projections seem reasonable at this time, we of wages. To the extent that PIT payments continue to observe that the next few months will produce PIT exceed DOF projections through the rest of January, collection data that will be particularly challenging it may mean that these accelerations are occurring at to interpret. This unusual period already has begun, a greater level than assumed. This, in turn, may mean with overall December 2012 PIT collections running increased 2012 tax revenue (benefiting the 2011-12 $2.2 billion (41 percent) above those of December and 2012-13 fiscal years) and decreased 2013 tax 2011, or $1.3 billion (22 percent) above DOF’s forecast revenue (affecting 2012-13 and 2013-14), compared to for the month in the 2012-13 Budget Act. A significant current projections. portion of these increases may relate to decisions by Figure 7 Comparisons With Prior Revenue Forecasts General Fund and Education Protection Account Combined (In Millions) 2012-13 2013-14 LAO Governora DOF Multiyear LAO Governora Budget Act November January Forecast November January June 2012 2012 2013 June 2012 2012 2013 Personal income taxb $60,268 $59,860 $60,647 $60,234 $61,712 $61,747 Sales and use taxb 20,605 20,839 20,714 23,006 22,721 23,264 Corporation taxc 8,488 8,535 7,580 8,931 9,119 9,130 Subtotal, “Big Three” taxes $89,361 $89,234 $88,941 $92,171 $93,551 $94,141 Insurance tax $2,089 $2,050 $2,022 $2,110 $2,212 $2,198 Estate tax 45 — — 290 — — Other revenues 2,804 2,695 2,631 2,849 2,129 2,185 Net transfers and loans 1,588 1,631 1,800 -1,303 -1,149 -23d Total Revenues and Transfers $95,887 $95,610 $95,394 $96,117 $96,743 $98,501 Difference—Governor’s Forecast Minus Budget Act Forecast -$493 $2,384 Difference—Governor’s Forecast Minus LAO Forecast -$216 $1,758 a Reflects Governor’s budget proposals, which contribute to differences from prior forecasts concerning net transfers and loans in particular. b Includes additional revenues from Proposition 30 (2012). c November 2012 and January 2013 forecasts include additional revenues from Proposition 39 (2012). d Governor’s January 2013 forecast reflects administration’s plans to repay fewer special fund loans in 2013-14 and not to transfer a portion of Proposition 39 revenues from the General Fund to a new fund created by the measure. 14 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget It will be difficult to assess these January temporary tax increase begins this month, halfway variances in the near term due to a variety of other through the 2012-13 fiscal year.) issues. Proposition 30, as approved in November Small Changes in Administration Estimates. 2012, retroactively raised PIT rates for upper-income The administration’s updated forecast of 2011-12 filers to the beginning of 2012. Most such taxpayers SUT revenues is $269 million lower than reflected in likely will have to make additional payments between the 2012-13 budget package, while its new projection December 2012 and April 2013, but we are unlikely for 2012-13 SUT revenues is $109 million higher. to have a good idea of when these payments have Compared to the June 2012 multiyear DOF forecast, come to the state’s coffers until at least April. Another 2013-14 SUT revenues are now projected to be complicating factor is the anticipated multiweek delay $258 million higher. in the tax filing season due to the recent decisions Mild Risk to the Forecast Due to Expiration by Congress and the President to adjust significant of Payroll Tax Cut. At this time, we observe some elements of the federal tax code. In addition, the state mild risks for the administration’s SUT forecast. Its faces routine difficulties in interpreting incoming forecast does not reflect the potential drag on taxable PIT collections, volatile as they are due to ups and retail sales resulting from the end of the temporary downs in the stock market. Potential stock market 2 percentage point reduction in federal payroll volatility coinciding with the upcoming federal debt taxes. Because of this expiration, after-tax incomes ceiling deliberations also could affect PIT collections for most Californians should be lower than the in the coming few months. For all of these reasons, we levels the administration assumed when projecting advise interpreting tax agency collection data between SUT revenue for 2012-13 and 2013-14. It is possible now and April with extreme caution. (Only “agency that this factor alone could result in a few hundred cash” reports released monthly by DOF are relevant million dollars less in SUT revenue—compared to for budgetary forecasting and tracking. “Controller’s the administration forecast—in 2012-13 and 2013-14 cash” reports are not useful for those purposes.) combined. As with the PIT, consumer and business Given the standard lags in receiving final tax data concerns related to the upcoming federal deliberations and the state’s accrual policies, it likely will be a year also could cause SUT revenue to lag projections. or two before reliable conclusions concerning 2012 corporation Tax and 2013 tax collections are known. By May, however, both we and the administration will have more data— Large Reductions in Non-Proposition 39 CT based on updated economic statistics and spring tax Revenue Forecast. As discussed in our November collections—to make more informed assessments of Fiscal Outlook publication, CT collections have been 2012-13 and 2013-14 PIT revenues. very weak recently, and there are major difficulties with forecasting this tax at the present time. Similar Sales and use Tax to our office’s November forecast, the administration In its new forecast, DOF projects General Fund now is lowering its 2012-13 Budget Act forecasts for SUT revenues to increase to $23.3 billion in 2013-14. CT revenues to reflect the recent dramatic weakness (This is 12.3 percent above the updated estimate for in CT collections. The administration now is 2012-13, with about one-third of this growth resulting projecting $7.6 billion, as compared to $8.5 billion from the full-year effect of the temporary one-quarter in the budget act. This $7.6 billion includes about cent SUT increase under Proposition 30. That $440 million of increased CT revenues due to passage of Proposition 39 in November 2012. Accordingly, www.lao.ca.gov Legislative Analyst’s Office 15 2013-14 Budget if Proposition 39 had not passed, CT revenues for the last decade. The General Fund now has around 2012-13 would be declining to $7.1 billion, a 16 percent $4 billion of outstanding budgetary loans from drop compared to the budget act projections from the state’s special funds. The state has considerable June 2012. While we cannot fully explain the flexibility about when to repay these loans, and to reasons for this precipitous drop, it is likely due in date, the Legislature has granted the administration part to major tax policy changes made in recent considerable discretion about when such repayments years. The administration’s 2013-14 forecast includes will occur. The Governor has stated his preference $900 million of Proposition 39 revenues, the growth to pay down these budgetary obligations as part of which accounts for part of the $1.6 billion increase of his multiyear plan to reduce the so-called wall in CT for that fiscal year. of debt. (The Legislature, however, has not taken a Additional Risks to the Forecast. Through formal action to date to indicate its agreement with December 2012, 2012-13 CT collections for the fiscal this and other aspects of the Governor’s wall of debt year to date were running 35 percent below collections proposals.) from the prior year and 32 percent below DOF’s Delays Proposed for Previously Planned 2013-14 year-to-date projections (from the June 2012 forecast). Loan Payments. In the administration’s 2012-13 The state clearly has had difficulty in forecasting the multiyear budget forecast of June 2012, it estimated effects of recent CT policy and other changes. Recent that the state would pay off $183 million of special collection trends suggest that CT projections may fund loans in 2012-13 and $1.6 billion of such loans need to be dropped further in the coming months. in 2013-14. Considering both currently scheduled loan repayment dates, as well as our understanding Estate Tax of when some departments would need to access Estate Tax Estimates Lowered to Zero Due the borrowed funds for special fund purposes, our to Congressional Action. Figures 6 and 7 display November forecast assumed that $1.3 billion of the administration’s prior estimates for California these loans would be repaid in 2012-13 and 2013-14 estate taxes. Consistent with our recent forecasts, combined. The Governor’s budget plan proposes the administration now has revised its estimates for instead that $752 million of loan repayments occur, these taxes down to zero due to the federal decision including $186 million in 2012-13 and $566 million to permanently end the federal tax credit to which in 2013-14. Compared to the assumed list of loan California’s estate tax has been linked for decades. repayments in our November Fiscal Outlook California’s estate tax law was approved by voters publication, the administration proposes to delay with passage of Proposition 6 in 1982. Proposition 6 repayments on prior loans from various special funds, prohibits a change to the relevant portions of the law including: unless it is approved by the state’s voters. For this • State Highway Account ($150 million). reason, the administration is correct to assume that current law prohibits collections of California state • The judicial branch’s Immediate and Critical taxes on estates of those who die in the future. Needs Account ($90 million). Special Fund Loan repayment Transfers • Hospital Building Fund ($75 million). A Part of the So-Called Wall of Debt. The state The budget plan also proposes to make repayments has lent balances of its special funds to the General to several other funds that were not included in our Fund in order to help address budget shortfalls over November list of assumed loan repayments. 16 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget All Loans Proposed to Be Paid Off by End of Recommend Legislature Take Charge of a 2016-17. The administration’s multiyear budget Repayment Plan. The Legislature has considerable plan proposes that all of the remaining loans from flexibility to direct the method and manner of special funds be paid off by the end of 2016-17. In the special fund loan repayments. We recommend that administration’s plan, $795 million of loans would it do so beginning this year. We also recommend be paid off in 2014-15, $2.2 billion in 2015-16, and that legislators hold hearings in 2013 concerning $557 million in 2016-17. (Our November forecast each one of the special funds proposed to be repaid assumed that around $1.2 billion of special fund loans in the Governor’s 2013-14 budget plan, as shown would remain outstanding as of the end of 2016-17, in Figure 8. These hearings would provide an given that there has been no formal legislative action important opportunity—with the special funds in to adopt the Governor’s wall of debt repayment plan.) line to be repaid hundreds of millions of dollars—to explore the operations of special fund programs. Figure 8 Special Fund Loan Repayments Proposed by the Governor for 2013-14 (In Thousands) Proposed Repayment Department Special Fund Amount Justice National Mortgage Special Deposit Fund $100,000 Resources Recycling and Recovery California Beverage Container Recycling Fund 94,400 Public Utilities Commission California High Cost Fund-B Administrative Committee Fund 75,000 Public Utilities Commission California Advanced Services Fund 75,000 Transportation State Highway Account, State Transportation Fund 50,000 Resources Recycling and Recovery Glass Processing Fee Account 39,000 Resources Recycling and Recovery PET Processing Fee Account, California Beverage Container Recycling Fund 27,000 Public Utilities Commission Public Utilities Commission Utilities Reimbursement Account 25,000 Energy Commission Renewable Resource Trust Fund 20,000 General Services Public School Planning, Design, and Construction Review Revolving Fund 15,000 Food and Agriculture Department of Agriculture Account, Department of Food and Agriculture Fund 15,000 Consumer Affairs Real Estate Appraisers Regulation Fund 8,100 Peace Officer Standards and Training Peace Officers’ Training Fund 4,000 Justice False Claims Act Fund 3,000 Consumer Affairs State Dentistry Fund 2,700 Consumer Affairs Professional Engineer & Land Surveyor Fund 2,500 Consumer Affairs Bureau of Home Furnishings & Thermal Insulation Fund 1,500 Consumer Affairs Behavioral Science Examiners Fund 1,400 Financial Institutions Credit Union Fund 1,350 Cal-EPA Rural CUPA Reimbursement Account 1,300 Justice Missing Person DNA Data Base Fund 1,000 Transportation Historic Property Maintenance Fund 1,000 Toxic Substances Control Site Remediation Account 1,000 Emergency Management Agency Victim-Witness Assistance Fund 900 ABC Appeals Board Alcoholic Beverage Control Appeals Fund 500 Alcohol and Drug Programs Driving-Under-the-Influence Program Licensing Trust Fund 400 Consumer Affairs Speech-Language Pathology & Audiology & Hearing Aid Dispensers Fund 300 Total $566,350 ABC = Alcoholic Beverage Control; CUPA = Certified Unified Program Agency; DNA = deoxyribonucleic acid; PET = polyethylene terephthalate. www.lao.ca.gov Legislative Analyst’s Office 17 2013-14 Budget In these hearings, legislators could ask special fund • What special fund activities are operating departments and program stakeholders these types of well and which are operating below questions: expectations? Is targeted additional • What level of reserves will the special fund special fund spending needed after the loan repayments? Will such spending be have after the proposed loan repayment is sustainable, given current fee levels? executed? • What level of reserves does the fund need • Do the special fund’s activities duplicate those in other state departments or at the to cope with routine seasonal cash flow local or federal level? Should any of these fluctuations and/or periodic annual declines activities be ended? Are new activities needed in revenue? (This answer is likely to vary to address important new state priorities? among special funds.) In addition to asking these questions about special • When was the last time that the fund’s fees funds proposed for immediate repayment, the were adjusted? Is a temporary or permanent Legislature also could consider whether any other fee decrease appropriate, given the proposed special funds—the ones proposed by the Governor loan repayment? to be repaid in later years—should instead be repaid now. ExPEndiTurE iSSuES Proposition 98 adjustments to Proposition 98 minimum Guarantee Proposition 98 funds K-12 education, the Estimate of 2012-13 Minimum Guarantee California Community Colleges (CCC), preschool, Changes Slightly, Grows Notably in 2013-14. and various other state education programs. The For 2012-13, the administration’s estimate of Governor’s budget increases total Proposition 98 the Proposition 98 minimum guarantee is funding by $2.7 billion—a 5 percent increase from $53.5 billion—down $54 million from the budget the revised current-year level. As shown in Figure 9, act estimate. Proposition 98-related spending, the General Fund share of Proposition 98 increases however, is estimated to be $163 million above by 9 percent whereas the share from local property the minimum guarantee. To bring spending tax revenues is projected to drop by 4 percent. (The down to the minimum guarantee, the Governor drop is due to the tapering off of the transfer of proposes to reclassify $163 million in 2012-13 one-time liquid assets from former RDAs.) Also appropriations as funds for meeting a statutory shown in the figure, the year-over-year increase obligation associated with the Quality Education in Proposition 98 funding is notably greater for Investment Act (QEIA). For 2013-14, the Governor community colleges (10 percent) than for K-12 proposes to fund at the administration’s estimate education (4 percent). About half of the additional of the minimum guarantee—$56.2 billion. The increase for the community colleges is related to the $2.7 billion year-to-year increase in the guarantee is Governor’s proposal to restructure adult education. 18 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget driven by the state’s healthy year-to-year increase in past two decades, the state has made numerous General Fund revenues. Part of this increase is due shifts in the allocation of property taxes among specifically to growth in Proposition 39 revenues, cities, counties, special districts, schools, and as discussed below. community colleges. These shifts change the Includes All Proposition 39 Revenues in amount of property tax revenues allocated to Proposition 98 Calculation. Proposition 39, schools and community colleges and—absent any passed by the voters in November 2012, requires adjustments to the Proposition 98 calculation—can most multistate businesses to determine their unintentionally increase or decrease the minimum California taxable income using a single sales factor guarantee. To ensure that these property tax shifts method, which has the effect of increasing state have no effect on the total amount of funding corporate tax revenue. The administration projects schools and community colleges receive, the that Proposition 39 will increase state revenue state “rebenches” the Proposition 98 minimum by $440 million in 2012-13 and $900 million in guarantee. The 2012-13 Budget Act rebenches the 2013-14. The Governor’s budget plan includes all guarantee to account for the shift of redevelopment- revenue raised by Proposition 39 in Proposition 98 related revenues. This adjustment allows the calculations, which has the effect of increasing the state to achieve dollar-for-dollar Proposition 98 minimum guarantee by $426 million in 2012-13 General Fund savings for the transfers of both and an additional $94 million (for a total increase ongoing residual property tax receipts and of $520 million) in 2013-14. one-time redevelopment-related liquid assets. In Rebenching Adjustment for Ongoing 2013-14, the Governor updates the rebenching Redevelopment Revenues Is Locked In. Over the adjustment to reflect the revised estimates of one-time redevelopment-related liquid assets but Figure 9 Proposition 98 Fundinga (Dollars in Millions) Change From 2012-13 2011-12 2012-13 2013-14 Actual revised Proposed Amount Percent Preschool $368 $481 $481 — — K-12 education General Fund $29,368 $33,406 $36,084 $2,679 8% Local property tax revenue 11,963 13,777 13,160 -618 -4 Subtotals ($41,331) ($47,183) ($49,244) ($2,061) (4%) California Community Colleges General Fund $3,279 $3,543 $4,226 $683 19% Local property tax revenue 1,974 2,256 2,171 -85 -4 Subtotals ($5,253) ($5,799) ($6,397) ($597) (10%) other Agencies $83 $78 $79 $1 1% Totals $47,035 $53,541 $56,200 $2,659 5% General Fund $33,097 $37,507 $40,870 $3,362 9% Local property tax revenue 13,937 16,034 15,331 -703 -4 a General Fund amounts include Education Protection Account funds. www.lao.ca.gov Legislative Analyst’s Office 19 2013-14 Budget does not update the adjustment to account for state relied heavily on deferring Proposition 98 revised estimates of ongoing residual property tax payments as a way to achieve budgetary savings. In revenues. 2008-09, for example, the state delayed $3.2 billion in Proposition 98 payments to achieve one-time major Proposition 98 Proposals General Fund savings. By 2011-12, a total of As shown in Figure 10, the Governor’s budget $10.4 billion in Proposition 98 payments were paid dedicates the increase in Proposition 98 funding late. The 2012-13 Budget Act dedicates $2.2 billion to to several education initiatives. For both schools retire a portion of the state’s outstanding deferrals. and community colleges, these proposals include The Governor’s 2013-14 plan continues to reduce the one-time payments to reduce deferrals as well number of late payments by setting aside $1.9 billion as ongoing programmatic funding increases. for this purpose. The 2013-14 proposal would reduce In addition, the budget provides a 1.65 percent the state’s outstanding deferrals from $8.2 billion cost-of-living adjustment for a few K-12 categorical to $6.3 billion. This reduction in deferrals would programs. The budget also funds a 0.10 percent diminish the need for school districts and increase in K-12 average daily attendance but community colleges to borrow to support operations assumes no increase in funded enrollment levels while awaiting the state’s late payments. at the community colleges. The Governor’s major Provides $1.6 Billion to Begin Implementing proposals are described in more detail below. As New K-12 Funding Formula. The Governor discussed later in this report, the Governor’s Budget proposes to significantly restructure the way the Summary also expresses interest in rethinking state allocates K-12 funding. Similar to last year’s school facility funding as an alternative to Figure 10 authorizing a new state governor’s Major Proposition 98 Budget Changes general obligation bond. (In Millions) (In addition to the proposals described in Technical Changes this report, the Governor Make technical adjustments $148 makes proposals relating Fund K-12 categorical growth 49 Fund K-12 revenue limit growth 3 to various aspects of Adjust for prior-year deferral payments -2,225 charter school funding Subtotal (-$2,025) and facilities, special Policy Changes Pay down deferrals $1,944 education funding and Transition to new K-12 funding formula 1,630 program consolidation, Allocate money for energy efficiency projects 450 and funding for online Provide funding for CCC adult education 300 Provide general-purpose funds for CCC 197 high school and Add two programs to K-12 mandate block granta 100 community college Provide cost-of-living adjustment for certain K-12 programsb 63 courses.) Fund new CCC online project 17 Swap one-time funds -17 Dedicates $1.9 Billion Subtotal ($4,684) to Paying Down Total Changes $2,659 Deferrals. During the a Adds Graduation Requirements and Behavioral Intervention Plans. b past several years, the Applies to special education, child nutrition, and California American Indian education centers. 20 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget proposal, the Governor’s plan would consolidate per student, respectively. Under the proposal, the K-12 revenue limits and almost all of the state’s California Department of Education (CDE) and roughly 60 categorical programs into one the CCC Chancellor’s Office could consult with streamlined funding formula with essentially no the California Energy Commission (CEC) and the associated programmatic spending requirements. California Public Utilities Commission (CPUC) to The formula would provide a base funding grant develop guidelines for districts in prioritizing the per student. The formula also would provide use of the funds. Upon project completion, school supplemental funding intended for districts districts and community college districts would to serve English learners and students from report their project expenditure information to low-income families as well as provide lower class CDE and the Chancellor’s Office, respectively. sizes in grades kindergarten through third and Proposes Major Changes for Adult Education. offer career technical education classes in high Under the Governor’s restructuring plan, state school. The budget proposal allocates $1.6 billion to support for adult education would be narrowed begin increasing district rates to a target base rate, to core instructional programs, including adult with the supplemental grants adjusted in tandem elementary and secondary education, vocational with base increases. Based on the administration’s training, English as a second language, and estimates, the formula would be fully implemented citizenship. The administration also indicates by 2019-20. interest in more clearly delineating among CCC Proposes $450 Million for School and adult education (noncredit instruction) and Community College Energy Efficiency Projects. collegiate coursework (credit instruction) to For a five-year period (2013-14 through 2017-18), ensure funding is better aligned to the type of Proposition 39 requires that half of the annual instruction offered. Perhaps the most notable revenue raised from the measure—up to part of the Governor’s restructuring plan is his $550 million—be transferred to a new Clean proposal to fund all adult education through the Energy Job Creation Fund to support projects CCC system. Specifically, the Governor proposes intended to improve energy efficiency and expand to eliminate school districts’ adult education the use of alternative energy. The Governor categorical program and consolidate all associated proposes to allocate all Proposition 39 energy- funding (about $600 million Proposition 98 related funding over the next five years exclusively General Fund) into the proposed new K-12 funding to school districts and community college districts formula. The Governor’s budget then provides a ($450 million in 2013-14 and $550 million annually base Proposition 98 General Fund augmentation for the next four years). For 2013-14, the Governor’s of $300 million to create a new adult education budget proposes to provide school districts categorical program within CCC’s budget. $400.5 million and community college districts According to the DOF, these funds would be $49.5 million for energy efficiency projects. (Under distributed to CCC districts using a formula based the administration’s approach, this spending on the number of students served in the prior would count toward meeting the Proposition 98 fiscal year. While CCC would be responsible for minimum guarantee.) The administration administering adult education, the Governor’s plan proposes to allocate this funding to districts on would allow community colleges to contract with a per-student basis, with school districts and school districts (through their adult schools) to community college districts receiving $67 and $45 provide instruction to students. www.lao.ca.gov Legislative Analyst’s Office 21 2013-14 Budget Provides Almost $200 Million in community college deferrals. A smaller payment Discretionary CCC Funds. The Governor’s budget would be required in 2016-17 to fully retire all also provides a base increase of $197 million in deferrals. In 2016-17, the plan also would use Proposition 98 General Fund support for the $2.1 billion in settle-up payments to reduce the CCC system. Unlike other state funds in the CCC K-14 mandate backlog. (Roughly $1.9 billion budget, the Governor’s proposal would allow the in outstanding mandate claims would remain Chancellor’s Office to make its own decision about unpaid.) In addition, the Governor proposes to how the funds would be distributed and for what retire all of the state’s obligations associated with purpose. For example, the Chancellor’s Office the Emergency Repair Program and QEIA by could choose to allocate the monies to districts 2016-17. for enrollment growth or a general faculty salary Positive aspects of Governor’s increase. Alternatively, the Chancellor’s Office Proposition 98 Budget Plan could designate the funds for various special purposes, such as to improve student achievement We believe the Governor’s Proposition 98 through a competitive grant program. budget plan has three particularly positive features, Addresses Two Large School Mandates. discussed below. The Governor’s budget includes a $100 million Balance of One-Time and Ongoing Spending augmentation to the school mandates block grant Reasonable. Of the Proposition 98 resources to reflect the addition of two large mandates: available for 2013-14, the Governor dedicates Graduation Requirements and Behavioral $1.9 billion for one-time purposes (paying down Intervention Plans (BIP). (The proposal does not school and community college deferrals) and uses identify how much funding is for each mandate but the remainder for ongoing programmatic increases. instead combines them into a single augmentation.) Although no one “right” mix of spending exists, we Notably, the Governor’s proposal only provides think the Governor’s generally balanced approach funding for the two mandates through the block is reasonable. Using such an approach would allow grant—it does not include any funding for districts the state to eliminate all school and community that choose to submit claims for reimbursement. college deferrals by 2016-17—prior to the expiration For BIP, the Governor also plans to introduce of Proposition 30’s PIT increases after the 2018 budget trailer bill language to more closely align calendar year. Under the Governor’s plan, however, state requirements with federal requirements, an outstanding mandate backlog of $1.9 billion which is intended to eliminate most of the state’s would remain. We recommend the Legislature also costs for reimbursing this mandate through the develop a plan to eliminate this backlog. claims process going forward. Proposal to Streamline School Finance System Proposes Retiring Many K-14 Obligations by Has Many Positive Features. The Governor’s End of 2016-17. The Governor’s budget package proposal to restructure the way the state allocates includes a multiyear plan to address many of the K-12 funding also has many strong components. state’s outstanding K-14 wall of debt obligations. Most importantly, it would replace a complicated, In 2013-14, 2014-15, and 2015-16, the Governor top-down system with one that is more proposes to use half of the year-to-year growth transparent, better linked with student costs, and in the Proposition 98 minimum guarantee to locally driven. It also would transition gradually to pay down the state’s outstanding school and the new system, ensuring that the vast majority of 22 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget districts receive funding increases in 2013-14 and Some concerns with Four of Governor’s the coming years, while simultaneously making Proposition 98 Proposals progress towards a more rational distribution Though we think the Governor’s Proposition 98 of funds. Though the Governor’s overall school plan has notable positive features, we have some finance plan has considerable merit, we believe the concerns with four of his proposals, as discussed Legislature could strengthen it by making a few below. modifications. Specifically, we recommend against Adult Education Restructuring Needed but the Governor’s plan to exclude two large programs Governor’s Plan Has Some Shortcomings. As that have particularly antiquated funding formulas we discuss in our recent report, Restructuring (Targeted Instructional Improvement Grant and California’s Adult Education System Home-to-School Transportation) from the new (December 2012), the existing adult education formula. Additionally, the Legislature likely will system has a number of major problems. Thus, the want to work with the administration to explore Governor should be commended for identifying ways to ensure that districts are using supplemental adult education reform as a high state priority. funds to benefit disadvantaged students as well as We also agree with the Governor on the need ensure districts have strong incentives to do routine to focus adult education on core instructional maintenance on their facilities (given the state’s programs such as English as a second language large investment in these facilities over the last and vocational education. We have some concerns, decade). however, with his plan to consolidate adult Proposal to Restructure BIP Mandate Has education within the CCC system. Community Several Benefits. Because revisions to federal law colleges vary significantly in terms of the extent now provide certain behavioral-related protections to which they consider adult education to be for students with disabilities, we believe most, if not part of their educational mission. As such, some all, current state BIP requirements do not provide CCC districts might not be prepared to assume significant additional benefit for students. Thus, responsibility for adult education programs. Given we believe the Governor’s proposal to repeal most the considerable variation across the state in terms of the state’s BIP requirements would not have of the availability of adult education instruction, adverse effects. Rather, the proposal likely would we also are concerned with the Governor’s plan to provide considerable state and local benefits. Most allocate funds to community colleges based solely notably, repealing the state requirements would on existing service levels. Given these and other eliminate the administrative work associated with concerns, we lay out an alternative approach in our claiming mandate reimbursements, free up time for recent report that would leverage the comparative more student-oriented activities, and offer schools advantages of both community colleges and adult more discretion over how best to meet the needs schools and allocate new funds for adult education of students with behavioral issues. Repealing the based on relative local needs. state BIP requirements also would allow the state to Proposal to Add Mandates to Block Grant redirect Proposition 98 funding from reimbursing Raises Several Questions. Another concern is mandate costs to potentially higher Proposition 98 related to the administration’s proposal to add priorities, such as implementing a better overall Graduation Requirements and BIP to the mandates K-12 funding system. block grant. In particular, the Governor’s proposal raises several questions about how to address www.lao.ca.gov Legislative Analyst’s Office 23 2013-14 Budget the exceptionally large costs of these mandates. for past mandate claims. In allowing the CCC The Governor’s approach appears to assume system to make its own spending decisions for the that most districts will continue to participate proposed base increase, the Legislature would lose in the mandates block grant rather than file assurance that the state’s highest CCC priorities claims separately. One potential problem with would be addressed. this plan is that it could be undermined if many Redevelopment Rebenching Approach Could districts decide to discontinue participation in Increase State Costs in Long Run. We also are the block grant and instead submit claims for concerned that the Governor’s proposal not to reimbursement. Because annual claims for the update the ongoing redevelopment rebenching Graduation Requirements and BIP mandates adjustment could result in substantial additional could be higher than $300 million, this risk seems General Fund costs (or foregone savings) in future notable. At the same time, the annual costs for years. In years when the Proposition 98 minimum these mandates ultimately could be significantly guarantee is determined by “Test 1,” rebenching for lower than $300 million since (1) the state recently local property tax shifts allows the state to achieve enacted legislation to require that some of these dollar-for-dollar General Fund savings. (The state costs be offset with other state funds, and (2) the automatically achieves these savings in a Test 2 Governor is proposing the statutory changes for or Test 3 year.) In 2012-13, the last year in which BIP discussed earlier that could eliminate most of the Governor is proposing to make an adjustment this mandate’s reimbursable costs. In determining for the transfer of ongoing redevelopment-related how to respond to the Governor’s mandates revenues to schools, the state is estimated to receive proposal, the Legislature will need to consider these savings. Over the next several years, however, and other factors. schools are expected to receive substantially No Assurance Governor’s Proposal for CCC more revenues as RDA debts are repaid. Without Base Funds Would Be Spent on State’s Priorities. updating the rebenching adjustment, the state We have relatively more serious concerns with could enter a Test 1 year and be unable to the Governor’s proposal to provide a nearly achieve dollar-for-dollar savings for all revenues $200 million unallocated base increase to CCC. transferred. We recommend the Legislature modify Over the past few years, the Legislature has the Test 1 factor, as needed, to account for the enacted several pieces of legislation specifying increase in revenues transferred to schools. This a number of priorities it desires to fund once approach would maximize General Fund savings new CCC resources become available. These and ensure Proposition 98 funding reflects more include a common assessment instrument to accurately the sizeable shift of local property tax place incoming CCC students into appropriate receipts to schools that is expected to occur over coursework, additional academic counselors to the next several years. help students identify and make progress toward Serious concerns with Governor’s their educational goals, and systemwide electronic Proposition 39 Proposal student transcripts to improve campus record- keeping and efficiencies. In addition to these As discussed in more detail below, we have recently enacted priorities, the state has a number several serious concerns with the Governor’s of outstanding CCC liabilities, including over Proposition 39 proposal. $300 million that is owed to community colleges 24 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget Treatment of Proposition 39 Revenues Highly other public facilities. Proposition 39 specifically Questionable. The Governor applies all revenue states that projects must be selected based on the raised by Proposition 39—including the revenue number of in-state jobs they would create and their required to be spent on energy-related projects— energy benefits. By dedicating all the energy-related toward the Proposition 98 calculation. This is a funding over the five-year period only to school and serious departure from our longstanding view of community colleges and excluding other eligible how revenues are to be treated for the purposes projects that potentially could achieve a greater of Proposition 98. It also is directly contrary to level of benefits, the Governor’s proposal very likely what the voters were told in the official voter guide would not maximize state energy and job benefits. as to how the revenues would be treated. Based We believe that a more effective approach would be on our view, revenues are to be excluded from to first evaluate the relative energy savings and job the Proposition 98 calculation if the Legislature benefits among all potential projects. cannot use them for general purposes—typically Plan to Distribute Funding Among Districts due to restrictions created by a voter-approved Also Not Based on Need. The Governor’s approach initiative or constitutional amendment. The voter to distributing Proposition 39 funding does not guide reflected this longstanding interpretation link funding with potential benefits. Instead, the by indicating that funds required to be used for Governor proposes to provide every school district energy-related projects would be excluded from the and community college district with funding on a Proposition 98 calculation. Given these concerns, per-student basis. This presumes the potential for we recommend the Legislature exclude from the energy savings is equal among all districts and does Proposition 98 calculation all Proposition 39 not focus on those school and community college revenues required to be used on energy-related energy projects likely to provide the greatest energy projects. This would reduce the minimum and job benefits. Most notably, the Governor’s guarantee by roughly $260 million. We also approach does not take into account that the need recommend the Legislature count the $450 million for energy efficiency projects varies by district, with in allocations for energy efficiency projects as the need depending on the size, age, and climate non-Proposition 98 expenditures (though the state zone of the facilities in each district. still could choose to spend a portion on schools and Proposal Lacks Other Key Components community colleges). Relative to the Governor’s Required by Proposition 39. Proposition 39 proposal, these two recommendations combined requires that monies from the Clean Energy Job would result in roughly $190 million in additional Creation Fund be appropriated only to agencies operational Proposition 98 support for schools with established expertise in managing energy and community colleges (with total state costs projects and programs. Proposition 39 also requires increasing by the same amount). that funding be coordinated with the CEC and Exclusive Focus on School and College CPUC to avoid duplication and maximize leverage Facilities Unlikely to Maximize Energy and Job of existing energy efficiency and clean energy Benefits. Proposition 39 requires that the Clean efforts. The Governor’s proposal does not appear Energy Job Creation Fund maximize energy and to adhere to these provisions. Specifically, because job benefits by, among other things, supporting the funding is to be appropriated to CDE and the energy efficiency retrofits and alternative energy Chancellor’s Office, the Governor’s proposal might projects in public schools, colleges, universities, and not meet the Proposition 39 provision requiring www.lao.ca.gov Legislative Analyst’s Office 25 2013-14 Budget funds be provided only to agencies with established Governor raises major concerns about energy-project expertise. Additionally, the Higher Education in california Governor indicates that CDE and the Chancellor’s The Governor’s Budget Summary highlights Office have the option to consult with CEC and several major concerns with the state’s higher CPUC—despite Proposition 39 requiring more education system. One of the administration’s formal CEC and CPUC involvement. concerns is the rising cost of higher education. Higher Education The Governor notes that UC and CSU increased their spending from 2007-08 to 2012-13 while California’s publicly funded higher education many other public agencies were making notable system consists of the UC, CSU, CCC, Hastings spending reductions. A large share of these College of the Law (Hastings), and the California additional university costs were borne by students Student Aid Commission. As shown in Figure 11, and families over this period (though the Governor the Governor’s budget provides $11.9 billion in notes that California public postsecondary General Fund support for higher education in institutions still have some of the lowest tuition 2013-14. This is $1.4 billion (13 percent) more than and fee levels in the country). The Governor also the revised current-year level. The bulk of the new expresses concern with poor student outcomes, funding is for base increases at the universities, noting that graduation rates are relatively low and a general purpose increase for the community CCC transfer rates are very low. Another concern colleges, adult education restructuring, and the Governor highlights is excess-unit taking, increased participation in Cal Grant financial aid which unnecessarily increases higher education programs. (Certain aspects of the CCC budget, costs. The Governor notes that some students take including adult education restructuring, are units far in excess of graduation requirements described earlier in the Proposition 98 section and, in turn, other students have more restricted of this report.) A portion of the total ongoing access to courses. In responding to these concerns, General Fund increase is linked with provisions the Governor concludes that UC, CSU, and CCC of the 2012-13 budget package that appropriated “need to move aggressively to implement reforms to $125 million each to UC and CSU in 2013-14 if they provide high-quality instruction at lower cost” by did not raise student tuition levels in 2012-13. making more efficient use of faculty resources. Figure 11 Higher education general Fund supporta (Dollars in Millions) Change From 2012-13 2011-12 2012-13 2013-14 Actual revised Proposed Amount Percent University of California $2,504 $2,567 $2,846 $279 11% California State University 2,228 2,492 2,809 317 13 California Community Colleges 3,612 3,802 4,503 701 18 Hastings College of the Law 8 9 10 — 3 California Student Aid Commission 1,533 1,624 1,722 98 6 grand Totals $9,885 $10,494 $11,890 $1,396 13% a For UC, CSU, and Hastings College of the Law, amounts include general obligation bond debt service in each year. For CCC, amounts include general obligation bond debt service and funding for the CCC Chancellor’s Office. For the California Student Aid Commission, amounts include federal Temporary Assistance for Needy Families and the Student Loan Operating Fund support that directly offset General Fund costs. 26 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget major Higher Education Proposals he proposes to change the way enrollment is calculated, as discussed below). Proposes Multiyear Plan to Increase State Proposes CCC Funding Incentive Initiative. Support of Higher Education. As part of his overall The Governor also proposes to change the basis approach to address higher education issues, the on which community college districts are funded Governor proposes a multiyear higher education for credit instruction. Currently, the amount of budget plan. The main funding component of the funding a district receives depends largely on the multiyear plan is 4 percent to 5 percent annual number of students enrolled at “census”—a point base General Fund increases for each of the defined in CCC regulations as one-fifth into a higher education segments over the next four given academic term (typically the third or fourth years (2013-14 through 2016-17). For 2013-14, the week of the semester). Beginning in 2013-14, the Governor provides base increases of $125 million Governor proposes to add a second CCC census each for UC and CSU, nearly $200 million date at the end of each term. Over a five-year for CCC, and slightly less than $400,000 for period, there would be a gradual shift in the Hastings. The Governor links these base increases relative weight of these census dates for purposes with the segments’ success in achieving certain of calculating district enrollment. By 2017-18, objectives, including improving graduation rates community colleges would be funded exclusively at all segments, increasing the CCC transfer rate, on the number of enrolled students at the end of and improving credit and basic skills course each term. According to DOF, any reduction in a completion. To help achieve these objectives, the district’s enrollment monies resulting from this Governor expects the segments to implement policy change would be automatically transferred certain strategies, including increasing the to that district’s categorical programs providing availability of courses, using technology to deliver student support services (such as tutoring and quality education to greater numbers of students counseling). According to the Governor, the in high-demand courses, improving course purpose of the proposed change is to promote management and planning, using faculty more student success by providing community colleges effectively, and increasing use of summer sessions. with incentives to ensure appropriate student Proposes No Tuition and Fee Increases Over placement and good course management. Extended Period. The Governor expects the Proposes to Cap Number of Units State universities to maintain current tuition and fee Subsidizes. In addition, the Governor proposes levels for the next four years. Given no increases placing a limit on the number of units the state went into effect in 2012-13, tuition and fee levels would subsidize per student. Under the proposal, would remain flat for a six-year period (2011-12 students taking units in excess of the cap generally through 2016-17). would be required to pay the full cost of instruction. No Enrollment Targets for Universities. For 2013-14 and 2014-15, the Governor proposes Unlike historical budget practice, the Governor a cap of 150 percent of the standard units needed includes no enrollment targets for UC and CSU to complete most degrees at UC and CSU (270 in the multiyear plan. The Governor indicates quarter-units at UC and 180 semester-units at the universities would have full discretion in CSU). Thereafter, the Governor proposes a cap of determining how many students to serve. The 125 percent of the standard required units at UC and Governor proposes to continue to fund community CSU—about one extra year of coursework. For the college districts based on enrollment (though www.lao.ca.gov Legislative Analyst’s Office 27 2013-14 Budget community colleges, the Governor proposes a cap education and then turn to an assessment of some of 90 semester-units beginning in 2013-14. This cap of his more specific higher education proposals. also equates to about one extra year of coursework Overarching Objectives Deserve Serious beyond that required for transfer. According to Consideration. We believe the administration the Governor, the unit cap is intended to create has identified several important areas of focus an incentive for students to shorten their time-to- for California’s higher education system in the degree, reduce costs for students and the state, and coming years. In particular, we generally agree increase access to more courses for other students. with the Governor on the need for structural Other Notable Higher Education Proposals. reforms that will increase the productivity of the In addition to the proposals highlighted above, higher education system and result in lower cost the Governor’s budget shifts about $400 million to per degree for students and the state. We also think begin funding general obligation bond debt-service the Governor’s emphasis on student success and payments within the universities’ budgets. (We student incentives reflects important state priorities discuss this proposal in more detail in a later section and could help focus both the higher education of this report.) The Governor also has two proposals segments’ and students’ efforts. relating to employee benefits at CSU. The Governor Changes to Governor’s Plan Needed to Ensure proposes to lock in state appropriations for CSU Objectives Are Met. If these overarching objectives retirement costs based on 2012-13 payroll costs, with are to be achieved, however, we believe that parts CSU bearing any additional retirement costs above of the Governor’s specific multiyear budget plan this payroll level moving forward. The Governor need to be further developed and refined. Though also seeks to provide CSU the statutory authority the Governor enumerates several performance to negotiate the share that current employees pay expectations for the universities (for example, for health care benefits. Additionally, the Governor improving graduation and transfer rates), his sets aside some funding in each segment to expand plan includes no clear way to hold the segments the number of online courses and fund other accountable for meeting these expectations. That related technology projects—$17 million for CCC is, the proposal neither contains specific outcome and $10 million each for CSU and UC. Though the targets nor requires the universities to report on Governor’s budget contains no policy proposals for progress toward meeting those targets. Absent the state’s student financial aid programs, it does specific targets and state monitoring, the Governor reflect higher Cal Grant costs as a result of increased and Legislature would have difficulty holding the participation. Specifically, the administration segments accountable for achieving these goals estimates 2012-13 costs are $61 million higher than and addressing the state’s priorities. This type of budget act estimates, with 2013-14 costs increasing accountability is of particular concern given the an additional $100 million from the revised 2012-13 existing mismatch between what the Governor has level. identified as state priorities and what the segments have identified as segmental priorities within their Governor’s Higher Education Plan on own budget plans. For example, the universities’ right Track but could Be improved own budget plans dedicate a significant portion of Below, we first discuss our assessment of the growth funding to faculty compensation increases. Governor’s overall vision and plan for higher Such a budget approach could perpetuate the 28 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget traditional, high-cost higher education delivery result in more modest and predictable tuition model for which the Governor expresses concern changes for students and their families. while leaving student success and incentive Governor’s Census-Date Proposal Misses initiatives unaddressed. Opportunity for More Meaningful Changes to More Thought Needed on Funding Allocations CCC Funding Model. We share the Governor’s to Segments. Despite the Governor’s concern concern that CCC’s current funding mechanism that the state’s public higher education system is creates incentives for colleges to enroll students inefficient, costly, and not producing acceptable but provides no strong incentives to help students outcomes, the central part of his multiyear plan is fulfill their broader academic objectives. We unallocated base increases. Yet, it is unclear exactly also agree with the administration that the CCC why additional state funding is needed to make funding model would benefit from being more the segments more efficient, reduce costs, and outcome-oriented. We are concerned, however, produce better outcomes. Moreover, the Governor’s that the Governor’s census-date proposal could plan for base increases generally attempts to create potential unintended consequences in the treat the segments equally. In the case of UC and classroom, such as grade inflation or reductions CSU, the Governor even proposes the identical in course rigor. The Governor’s proposal also has dollar amount (despite the two segments relying weak justification for redirecting any reduction in to different degrees on state support). The higher a district’s apportionment funds relating from the education segments, however, probably should not census-date change to that district’s categorical be treated identically (either in percentage or dollar programs. In effect, the Governor presupposes that terms). It is likely that a more rational, less arbitrary students do not complete their courses because allocation could prove more effective. For example, of inadequate support services, but many other if one segment could achieve greater improvement factors can affect completion rates that would in outcomes per dollar invested, the Legislature suggest a notably different reallocation of resources. could consider allocating a greater share of the (For example, added student support services augmentations to that segment. would do nothing to address a poorly designed or Locking in Tuition and Fee Levels for taught course.) Given these concerns, we suggest Extended Period Raises Concerns. Following the Legislature consider changes to the funding several years of steep tuition increases, the model that would place greater emphasis on more Governor’s desire to hold tuition and fees flat for meaningful outcome measures, such as rewarding 2013-14 is understandable. We have some concerns, colleges for student learning gains and program however, with his proposal also to hold tuition completions (such as obtaining a degree or skills and fees flat for an extended period. Extended certificate) rather than course completions. We also tuition freezes help students who are currently in suggest the Legislature rethink how best to use school but often lead to larger increases and greater any funds freed up under a new outcome-oriented tuition volatility for future students. Currently, funding model. tuition paid by students (after state grant aid) Unit Caps Merit Consideration. We think covers about 30 percent of education-related costs the Governor’s unit-caps proposal would provide at both universities and about 5 percent at CCC. A incentives for colleges to streamline academic long-term policy to maintain this share of cost or programs and improve academic counseling while gradually change it to a specified level likely would also providing incentives for students to develop www.lao.ca.gov Legislative Analyst’s Office 29 2013-14 Budget focused academic plans and reduce excess-unit additional detail on the assumed state education taking. Setting a specific unit cap, however, will savings related to redevelopment dissolution and require consideration of the reasons students compares these figures to past estimates. accrue excess units, including unavailability of Estimates Now Appear Reasonable but Still courses, inconsistent transfer requirements, and Face Significant Uncertainty. The redevelopment requirements of particular majors. The initial limit savings assumed in the budget appear reasonable (150 percent of standard requirements) likely would based on recently available information—including not have a significant impact at the universities the amount of residual property taxes distributed (as the administration indicates, most university to schools in January 2013 and the results of DOF’s students do not exceed this limit). The eventual December review of some former RDA assets. limit to be imposed at the universities after two However, these savings are subject to considerable years (125 percent of standard requirements) uncertainty and could vary by several hundred appears to be more in line with the goal of million dollars annually, with a greater chance of encouraging efficient completion, though remains the savings falling below the level assumed in the quite generous. As we have recommended in the Governor’s budget plan. Three primary factors past, we also believe a unit cap for the community contribute to this uncertainty: colleges, along the lines of the one the Governor • First, several key steps in the proposes, is reasonable. redevelopment dissolution process have yet dissolution of to occur. As a result, there is little reliable redevelopment agencies information on a large category of former RDA assets. Projected RDA Dissolution Savings Reduced by One-Third. The budget assumes General • Second, the willingness of RDA successor Fund savings from the dissolution of RDAs of agencies—the entities overseeing the $2.1 billion in 2012-13 and $1.1 billion in 2013-14. dissolution of RDAs—to comply with These amounts are about one-third (a total of state direction regarding redevelopment $1.6 billion) lower than dissolution has been uneven. For example, assumed in the 2012-13 Figure 12 budget. Distributions Comparing redevelopment Dissolution savings of residual property in governor’s Budget to Past estimates taxes—former RDA (In Millions) property tax revenues residual liquid not needed to pay agency Property Taxes Assets Totals debts—to schools are 2013-14 governor’s Budget nearly $1.4 billion less 2012-13 $784 $1,302 $2,086 than previously assumed, 2013-14 559 558 1,117 while distributions of Difference From 2012-13 enacted Budget 2012-13 -892 -177 -1,069 former RDA liquid 2013-14 -452 -42 -494 assets to schools are Difference From lAo Fiscal outlook (november 2012) about $200 million 2012-13 107 612 719 2013-14 66 -91 -25 less. Figure 12 provides 30 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget some successor agencies have not met (Exchange). (If a state chooses not anticipated timelines for performing to establish an Exchange, the federal certain procedures, while others have government will establish and administer disputed DOF findings regarding the an Exchange on the state’s behalf.) The availability of assets for distribution to Exchange will function as a central schools and other local governments. marketplace for individuals, families, and small businesses to purchase health • Finally, the outcomes of current and coverage. expected future litigation regarding redevelopment dissolution could affect • Creates Optional Medicaid Expansion. state savings. Beginning January 1, 2014, California has the option under the ACA to expand Federal Patient Protection and coverage under its Medicaid program affordable care act (known as Medi-Cal) to include most adults under age 65 with incomes at or The ACA, also referred to as federal health below 138 percent of the federal poverty care reform, is far-reaching legislation that makes level (FPL) who are not currently eligible significant changes to health care coverage and for Medi-Cal—hereafter referred to as delivery in California. The ACA is designed to the expansion population. Beginning in create a health coverage purchasing continuum January 2014, the federal matching rate that makes it easier for persons to access, purchase, for coverage of the expansion population and maintain health care coverage. As individuals’ will be 100 percent for the first three incomes rise and fall; as they become employed, years. The matching rate will gradually change employers or become unemployed; and decline between 2017 and 2020, at which as they age, they are to have access to different point the state will bear 10 percent of the sources of coverage along the coverage continuum. additional cost of health care services for Creating this continuum requires the modification the expansion population. of existing government programs and integration of these programs with new programs created by • Makes Changes to Outreach, Enrollment ACA. Some of the key ACA provisions include: Processes, and Eligibility Standards. • Creates Penalties for Certain Individuals Beginning January 1, 2014, the ACA generally Without Health Insurance Coverage. simplifies the standards used to determine Beginning January 1, 2014, the ACA eligibility for the Medi-Cal Program. In requires most U.S. citizens and legal addition, the ACA includes provisions aimed residents to have health insurance coverage at streamlining the enrollment processes or incur a penalty. This requirement and coordinating with other public entities is commonly known as the individual that will offer subsidized health insurance mandate. coverage to low– and moderate–income persons. There will also be enhanced • Establishes Health Benefits Exchanges. outreach activities aimed at enrolling The ACA provides for each state to uninsured individuals in health insurance establish a health benefits exchange coverage, including Medi–Cal. www.lao.ca.gov Legislative Analyst’s Office 31 2013-14 Budget The Legislature has already passed legislation • Establishing networks of providers to deliver to implement significant elements of the ACA. health care services. For example, Chapter 655, Statutes of 2010 • Setting payment rates to providers. (AB 1602, Perez), and Chapter 659, Statutes of 2010 (SB 900, Alquist), established the California • Processing claims billed by providers. Health Benefits Exchange. However, significant Counties could build upon their existing ACA implementation issues requiring legislative medical programs for indigents and Low Income policy decisions and statutory direction remain Health Programs (LIHPs) to operate the expansion. to be addressed over the next several months, as The county-based expansion would meet statewide discussed below. These issues include the major issue eligibility standards and cover a minimum benefits of whether or not to opt in to the optional Medicaid package similar to coverage requirements for health expansion under the ACA. plans offered on the Exchange. Counties would also Governor Outlines Two alternatives have the option of covering additional benefits (other For implementing Optional medi-cal Expansion than long-term care) for the expansion population. The administration indicates this approach would The administration has stated its commitment likely require federal approval. to adopting the optional Medicaid expansion authorized under the ACA. The Governor’s LaO comments on medi-cal budget summary document presents two distinct Expansion Proposal approaches—a state-based expansion and a county- More Information Is Needed. By discussing based expansion. However, the administration both approaches to the Medi-Cal expansion in neither indicates which approach it prefers nor broad terms, the Governor leaves important details provides an estimate of the fiscal impact on the state to be clarified later. For example, there are many for either approach. Accordingly, the budget does questions about how a county-based expansion not reflect any costs or savings related to the optional would operate, including: Medi-Cal expansion. State-Based Expansion Approach. Under the • Optional or Mandatory? Would operating state-based expansion approach, the state would the expansion be mandatory or optional for build upon the existing state-administered Medi-Cal counties? Program and managed care delivery system. Aside • Degree of Flexibility? What flexibility from long-term care, covered benefits for the would counties have in establishing and/ expansion population would be similar to benefits or expanding local delivery systems? For available to the currently eligible population. example, would counties be able to contract County-Based Expansion Approach. Under with existing Medi-Cal managed care this alternative approach, the counties would plans to provide services for the expansion have operational and fiscal responsibility for population? implementing the Medi-Cal expansion. Operational responsibilities include some functions performed County-Based Option Raises Policy and by the state and Medi-Cal managed care plans to Implementation Issues. The county-based option administer the program for the currently eligible raises important policy considerations for the population. Legislature. For example, the ACA envisions 32 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget and, in some instances, requires administrative realize savings associated with medically indigent streamlining and simplification of health adults becoming eligible for Medi-Cal under the care programs for low- and moderate-income expansion. The budget summary further asserts populations. Adopting the county-based option that state implementation of the ACA will require would potentially complicate these efforts. it to assess how much of these county savings Under the state-based option, state-administered “should be redirected to pay for the shift in health Medi-Cal would serve as the health care care costs to the state.” While the budget summary coverage program for nearly all qualified persons does not specify how this redirection would occur, with income below 138 percent FPL—thereby it refers to possible changes in the state-county simplifying program administration. In contrast, fiscal relationship. Under the state-based expansion the county-based option would potentially continue approach, the budget summary suggests an increase fragmentation of state and local health care in county programmatic and financial responsibility programs. Low-income childless adults would be for child care and other social service programs. enrolled in county-administered programs, while Similarly, under the county-based expansion families with children and persons with disabilities approach, the financial responsibility for a share of would be enrolled in the state-administered Medi-Cal costs for the expansion population would Medi-Cal Program. belong with the counties. The county-based option also raises questions LaO comments on changing about how the expansion would be implemented State-county relationship in all counties by January 1, 2014. Under a state Medi-Cal waiver, most counties currently Effects of ACA on State and County Finances administer LIHPs, which offer coverage to at least Are Subject to Significant Uncertainty. Any a portion of the expansion population. However, estimate of the net effects of ACA implementation the LIHPs differ from the state-administered on state and local finances is subject to substantial Medi-Cal Program in several ways, such as offering uncertainty at this time. Several major factors different provider networks and covered benefits. contribute to this uncertainty, including: (1) the In addition, there are a few counties that do not size of the newly eligible Medi-Cal population, currently operate LIHPs. Therefore, a significant (2) the extent to which this newly eligible amount of time might be needed for certain population will enroll in the program, (3) the counties to enhance their existing health coverage pace at which they will enroll, and (4) the average programs, or create new programs, in order to per-person costs. In addition, a significant number meet federal and/or state requirements for coverage of low-income Californians will remain uninsured provided to the expansion population. after the expansion is adopted—including the undocumented population—and it is unclear what Budget Suggests making major changes indigent health costs will remain after ACA is to State-county relationship fully implemented. These residual costs will vary Under current law, counties are responsible substantially from county to county depending on, for providing health care services to low-income among other things, the county’s demographics individuals without health care coverage—a group and existing health care delivery system. Other commonly referred to as the medically indigent. The aspects of the ACA, such as reduced federal budget summary document notes that counties will funding for hospitals that serve a disproportionate www.lao.ca.gov Legislative Analyst’s Office 33 2013-14 Budget amount of Medicaid and uninsured populations, associated with increased enrollment among also may have significant fiscal effects on counties individuals who are currently eligible for Medi-Cal, that operate public hospitals. but not enrolled in the program, until a more State Constitution Complicates Efforts to refined estimate can be developed. The ACA Change State-County Relationship. Given the contains several provisions that will likely increase provisions of the State Constitution (1) requiring enrollment among individuals who are currently the state to reimburse local governments for eligible for Medi-Cal, including simplified new programs and increased shares of costs for eligibility and enrollment procedures, enhanced programs and (2) limiting state authority to change outreach activities, and the individual mandate to many local government revenues, developing obtain health coverage. The state will be responsible an implementation plan that redirects county for 50 percent of the costs associated with the funds will be complex. Changes of the magnitude increased enrollment among individuals who suggested by the Governor may require voter- are currently eligible. At the time this overview approved amendments to the State Constitution, as was prepared, it is unclear whether there are any was the case with the 2011 program realignment. additional ACA-related costs that are included in Time Needed to Assess Changes in the administration’s placeholder estimate besides State-County Relationship. As suggested by costs associated with increased enrollment among the Governor, the significant effect of ACA the currently eligible. implementation on state and county finances Placeholder Cost Estimate May Be Too High. requires a careful reassessment of the current The estimated costs associated with the increase in state-county fiscal relationship. In light of the many enrollment among individuals currently eligible uncertainties regarding ACA implementation and for Medi-Cal is subject to significant uncertainty. the complexity inherent in modifying county fiscal Under a moderate-cost scenario that we think and program responsibilities, the Legislature may is most likely, we estimate that the health care find it appropriate to delay making permanent costs associated with this population would changes in county duties and resources until after be approximately $100 million in 2013-14— the effects of ACA implementation are clearer. significantly less than the $350 million included in the Governor’s budget. Using different but still Governor’s Budget includes Some aca plausible assumptions, we estimate state costs could implementation costs potentially be as low as $30 million or as high as But does not address all of the $250 million in 2013-14. Therefore, even under a aca’s State Fiscal Effects set of assumptions that would result in relatively The Governor’s budget plan incorporates some high state costs, our estimates are lower than the of the costs of ACA implementation. However, it placeholder in the Governor’s budget. does not include the fiscal effects of other aspects Fiscal Estimates Are Incomplete. There are of ACA implementation such as modifying or several potential costs and savings related to eliminating certain state programs. ACA implementation that are not included in Placeholder for Costs Associated With the Governor’s budget. As discussed above, the Increased Enrollment of Currently Eligible budget does not assume any state savings or costs Population. The Medi-Cal budget includes a associated with the optional Medi-Cal expansion. $350 million General Fund placeholder for costs In addition, the budget does not assume savings 34 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget from reduced enrollment in other state health it will also need to consider any related fiscal effects programs—such as the Family Planning, Access, as it constructs the state’s 2013-14 budget. Care, and Treatment Program and the Breast and california department of Cervical Cancer Treatment Program—that may corrections and rehabilitation result from the additional health coverage options made available under the ACA. The Legislature will Budget reflects Population Trends need to account for these and other ACA-related and recent administrative actions fiscal effects in the 2013-14 spending plan. Budget Proposal. The Governor’s budget Key aca Policy decisions remain provides $9 billion for the California Department In addition to decisions related to the optional of Corrections and Rehabilitation (CDCR) in Medi-Cal expansion discussed above, the state has 2013-14. This is an increase of $33 million (less than several other major ACA-related policy decisions one percent) above the 2012-13 level. The budget that have yet to be made—many of which have reflects recent population projections showing that potential fiscal effects in 2013-14. Some of the key the average inmate population will decline by about decisions facing the Legislature include: 3,600 inmates to 129,000 in the budget year, and the parolee population will decline by about 5,700 • Selecting the benefits that would be provided parolees to 43,000. These population reductions to the Medi-Cal expansion population if a are due to a 2011 policy to shift—or “realign”— state-based approach were adopted. responsibility for housing and supervising various • Determining how to implement the new lower-level adult offenders from the state to the Medi–Cal eligibility standards as required counties. Despite the projected decrease, the inmate by the ACA. population is expected to exceed a federal court- imposed cap on the prison population by about • Evaluating whether to modify or eliminate 7,000 inmates at the end of 2012-13. existing state health programs that provide Recent Administration Actions. On services to persons who would become January 7, 2013, the administration submitted newly eligible for Medi–Cal or other health a filing to the federal court requesting that it coverage in 2014. withdraw or modify the existing order requiring • Whether or not to establish a Basic Health the prison population cap. (In response to a court Program, a “Bridge Program” between order, the administration also submitted a plan for Medi-Cal and the Exchange (as proposed additional ways to reduce the prison population, by the Governor), or some other program such as early release of certain inmates. The intended to make coverage more affordable Governor, however, has indicated that he does for populations with incomes too high to not support this plan.) In addition, the Governor qualify for Medi-Cal. recently terminated an emergency proclamation, originally issued by Governor Schwarzenegger in These and other important ACA policy 2006, that allowed CDCR to involuntarily transfer decisions may be informed by additional federal inmates to out-of-state contract prisons. The state guidance that is expected in the coming months. currently houses about 8,900 inmates in out-of- As the Legislature considers these policy decisions, state facilities. www.lao.ca.gov Legislative Analyst’s Office 35 2013-14 Budget The Governor’s proposed budget for CDCR mandate process. We agree with the Governor that assumes the current inmate and parolee population the state needs to take action in each of these areas trends and that the state does not meet the existing of state government operations. court-ordered prison cap. The budget is also infrastructure consistent with the termination of the emergency proclamation, reflecting reduced expenditures Governor Suggest Changes Needed for for out-of-state contract beds. The reduced use of Infrastructure Spending Practices. The out-of-state beds, however, increases the number Governor’s Budget Summary indicates that the of inmates housed in in-state prisons, contributing administration is considering some changes to to the amount by which the state will exceed the the state’s infrastructure spending practices. The court-ordered population cap. The administration administration appears interested in identifying plans to completely eliminate the use of such alternatives that limit future bond authorizations out-of-state beds by July 2016. backed by the General Fund—currently the state’s Court Ruling on Population Limit May Not main source of infrastructure funding. Some Be Final Prior to 2013-14. It could take months alternatives mentioned in the Governor’s proposal or longer for the federal court to decide whether include reconsidering the state’s role in funding to end or modify the prison population limit local government infrastructure, identifying new currently in place, as has been requested by the funding sources, and creating new mechanisms to Governor. For example, it took more than a year for prioritize and limit capital spending. the U.S. Supreme Court to uphold the first ruling Possible Effects on Education and by a federal court to institute the prison cap in Transportation, Among Other Areas. The California. Consequently, there may be little action administration discusses potential infrastructure for the Legislature to take with regard to meeting changes in several policy areas. In transportation, the existing prison cap until the courts decide this the Governor plans to convene a working group issue. If, however, the federal courts do ultimately to identify state spending priorities, consider require the state to reduce its prison population to long-term, pay-as-you-go funding options, meet the existing or a modified cap, the Legislature and evaluate the division of responsibilities may want to ensure that any population reduction between state and local government. In higher plan that is implemented is consistent with education, the Governor once again proposes legislative priorities. Any plan to reduce the inmate to shift the universities’ general obligation bond population further would have budgetary impacts debt-service payments into their base budgets. (costs and savings), the exact amount depending on The administration asserts that this would limit the specific changes included in the plan. the segments’ capital spending by highlighting the trade-offs between spending on infrastructure Other issues versus operations. The Governor also suggests The Governor’s Budget Summary discusses that now is an appropriate time to consider the several major issues with important long-term state’s role in funding K-12 facilities and outlines implications for state and local finances. Below, the administration’s principles for any future we briefly discuss the Governor’s comments state funding. Lastly, the administration intends concerning infrastructure, the Unemployment to release a five-year infrastructure plan later Insurance (UI) Fund, and the local government this year, which will outline the administration’s 36 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget infrastructure priorities for the next five years. discuss options for developing such a process in (If released, this would be the first statewide plan our August 2011 report, A Ten-Year Perspective: since the introduction of the Governor’s budget California Infrastructure Spending. in 2008-09.) Consistent with the alternatives Accordingly, a five-year infrastructure plan discussed above, the administration states that and a renewed focus from the administration on the plan will rely less on future voter-authorized infrastructure planning would be positive steps. general obligation bonds than the state has over the The five-year plan or other infrastructure proposals past decade. from the Governor could provide a starting point Legislature Faces Key Infrastructure for discussions on future funding of the state’s Decisions. Over the next few years, the Legislature infrastructure. What is critical in the near term is faces key decisions regarding state infrastructure that the Legislature establish a coordinated process spending. Several infrastructure programs, such for reviewing the Governor’s plan and articulating as K-12 and higher education, have exhausted their its priorities. existing bond authority and lack state funding for unemployment insurance Fund insolvency any new projects. The Legislature and Governor also must determine how to proceed with the Federal Loans Total About $10 Billion. $11 billion water bond now scheduled for the The UI Fund has been insolvent since 2009, November 2014 statewide ballot. Additionally, state primarily reflecting recession-related growth in departments, as well as local governments that unemployment benefit payments that exceeded rely on state funds for infrastructure, continue to the available fund balance. The state has borrowed identify infrastructure needs with costs exceeding from the federal government since 2009 to available resources. If the state elects to maintain its continue paying unemployment benefits, and the current policies relating to infrastructure, meeting outstanding loan from the federal government is these infrastructure demands likely would require projected to be $10.2 billion at the end of 2013. The the Legislature to shift a larger share of the state’s Governor’s budget does not propose a solution to budget to infrastructure. the ongoing UI Fund deficit, but instead specifies Options for Legislative Consideration. that the Secretary for Labor and Workforce Given the state’s finite resources and other Development will initiate a series of meetings by non-infrastructure priorities, the Legislature February 1, 2013 to discuss solutions to repay the could consider other options for managing federal loan and stabilize the financial condition its infrastructure. In many program areas, of the UI Fund. The budget also assumes a these alternatives would be similar to the ideas $291 million General Fund interest payment on the presented by the Governor: prioritizing the state’s federal loan for 2013-14. infrastructure investments, reevaluating the scope Effects of the Continuing Insolvency. For each of infrastructure receiving state support, and year that the state carries a federal loan balance, identifying user fees or charges that could provide UI taxes paid by employers are incrementally additional funding. Developing a comprehensive increased. The proceeds from these increased tax plan that incorporates these alternatives, however, revenues are used to pay down the principal on the is a complex task that requires a well-defined state’s federal loan. Absent corrective action, the process for planning and financing projects. We administration projects that the federal loan will www.lao.ca.gov Legislative Analyst’s Office 37 2013-14 Budget not be fully repaid until sometime after 2020. Until reimbursement process has been a source of then, state interest payments on the federal loan friction between the state, schools, and other local remain a significant annual liability. governments. Last year, the state adopted a block Recommend Various Actions to Address grant program to improve the education mandate Program’s Financial Health. We have previously process. This year, the administration indicates found that California’s UI program has a structural that it will explore ways to improve the mandate mismatch between its revenues and benefit costs process for other local governments, with a focus that predates the recent recession and cannot on reducing state requirements and maximizing be sustained for the long term. In our October local flexibility. 2010 report, California’s Other Budget Deficit: Options for Improving Local Government The Unemployment Insurance Fund Insolvency, Mandate Reimbursement Process. Improving we recommended a balanced approach of tax the mandate reimbursement process makes sense. increases, benefit reductions, and eligibility changes The current process is lengthy, complex, and not to address the long-term financial health of the UI oriented toward promoting good outcomes. The program. These policy options are still viable, and Legislature may wish to explore greater use by the could be phased in over several years if the goal administration of the procedures authorized in were to minimize the potential adverse economic Chapter 329, Statutes of 2007 (AB 1222, Laird), effects of such proposals on UI beneficiaries and such as reimbursing local governments for their employers. reasonable costs to implement a mandate instead of requiring detailed cost documentation. Local Government mandates Source of Friction Between State and Local Governments. For many years, the state mandate 38 Legislative Analyst’s Office www.lao.ca.gov 2013-14 Budget www.lao.ca.gov Legislative Analyst’s Office 39 2012-13 Budget LAO Publications The Legislative Analyst’s Office (LAO) is a nonpartisan office that 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. 40 Legislative Analyst’s Office www.lao.ca.gov