LAO

The 2017-18 Budget: California's Fiscal Outlook

Legislative Analyst's Office · lao-3507 · Report · 2016-11-16

Read the report at Legislative Analyst's Office ↗

The 2017-18 Budget: California’s Fiscal Outlook YEARS OF SERVICE MAC TAYLOR • L E G I S L A T I V E A N A L Y S T • NOVEMBER 16, 2016 2017-18 BUDGET 2 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET TABLE OF CONTENTS Executive Summary �� 1 Introduction �� 3 Chapter 1: General Fund Through 2017-18 �� 7 Outlook for the 2017-18 Budget ��7 LAO Comments ��9 Chapter 2: The Economy and Revenues ��11 The Economy ��11 Revenues ��17 Chapter 3: Spending Outlook �� 23 Education ��24 Proposition 98 ��24 Universities ��30 Financial Aid ��32 Child Care ��33 Health and Human Services ��34 Medi-Cal ��35 In-Home Supportive Services ��37 Developmental Services ��38 SSI/SSP ��39 CalWORKs ��40 Child Welfare Services ��42 Judiciary and Criminal Justice ��42 Judicial Branch ��43 Corrections and Rehabilitation ��43 Employee Compensation and Retirement Costs ��44 State Employee Pay and Benefits ��44 CalSTRS ��45 Unemployment Insurance ��46 Debt Service on Infrastructure Bonds ��47 Chapter 4: The General Fund After 2017-18 �� 49 Economic Uncertainty ��49 Budget Uncertainties ��53 LAO Comments ��54 www.lao.ca.gov Legislative Analyst’s Office i 2017-18 BUDGET Legislative Analyst’s Office www.lao.ca.gov (916) 445-4656 Legislative Analyst Mac Taylor State and Local Finance Education Jason Sisney Jennifer Kuhn Carolyn Chu Ryan Anderson Justin Garosi Edgar Cabral Ann Hollingsheada Natasha Collins Seth Kerstein Jason Constantouros Ryan Millera Virginia Early Nick Schroeder Paul Golaszewski Brian Uhler Judy Heiman Brian Weatherford Dan Kaplan Kenneth Kapphahn Corrections, Transportation, and Environment Paul Steenhausen Anthony Simbol Brian Brown Health and Human Services Drew Soderborg Mark C. Newton Ashley Ames Ginni Bella Navarre Jackie Barocio Amber Didier Ross Brown Callie Freitag Rachel Ehlers Ben Johnson Helen Kerstein Brian Metzker Anita Lee Lourdes Morales Shawn Martin Sonja Petek Caitlin O’Neil Ryan Woolsey Jessica Peters Meredith Wurden Jonathan Peterson Administration, Information Services, and Support Sarah Kleinberg Tina McGee Karry Dennis Fowler Izet Arriaga Sarah Barkman Michael Greer Sarah Scanlon Vu Chu Sandi Harvey Jim Stahley Rima Seiilova-Olson Anthony Lucero a Fiscal Outlook publication coordinators. ii Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Executive Summary In this report, we describe our office’s assessment of the condition of the California economy and budget over the 2016-17 through 2020-21 period. Outlook Subject to Considerable Uncertainty. The condition of the state’s budget depends on many volatile and unpredictable economic conditions, including fluctuations in the stock market. Even in the short term, these conditions cannot be predicted with precision. They are even more difficult to anticipate years in the future. As such, while we have reasonable confidence in our expectations about the economy’s performance in 2017-18, we are much less able to anticipate the economic future in each year thereafter. To reflect these uncertainties, this report emphasizes one estimate of the near-term budget condition through 2017-18 and displays two different estimates of the budget’s condition in 2018-19 through 2020-21. Positive 2017-18 Budget Outlook. For the near term, under our current economic projections and assuming the state makes no additional budget commitments, we estimate the state would end the 2017-18 fiscal year with $11.5 billion in total reserves. This total includes $2.8 billion in discretionary reserves, which the Legislature can appropriate for any purpose, and $8.7 billion in required reserves, which will be available for a future budget emergency. These reserve levels reflect the continued progress California has made in improving its budget situation. State Is Increasingly Prepared to Weather a Mild Recession. For the longer term, we estimate the condition of the state budget under two different economic scenarios. They are: (1) an economic growth scenario, which assumes the economy continues to grow, and (2) a mild recession scenario, which assumes the state experiences a mild economic downturn beginning in the middle of 2018. Under the growth scenario, we estimate the budget remains in surplus over the outlook period. Under the recession scenario, we find that the state would have enough reserves to cover almost all of its operating deficits through 2020-21. This means, under our assumptions, the state could weather a mild recession without cutting spending or raising taxes through 2020-21. New Commitments or Policy Changes Would Affect Outlook. Importantly, these estimates assume the state does not make any changes in any year during the outlook period to its current policies and programs. In addition, the outlook also assumes no new changes in federal policy, even though the recent election results suggest some such changes are now likely. Any such state or federal policy changes could have a significant impact on the state’s “bottom line.” www.lao.ca.gov Legislative Analyst’s Office 1 2017-18 BUDGET 2 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Introduction Each year, our office publishes the Fiscal revenue outlooks for the out-years, based on two Outlook in anticipation of the upcoming 2017-18 different economic scenarios (described further budget process. In this report, we summarize our below). The shaded area in the figure illustrates the office’s assessment of the condition of the California uncertainty around these two scenarios. Through economy and budget for the upcoming fiscal year 2017-18, revenues could be a few billion dollars (2017-18) as well as the following three years (through above or below our estimates. After 2017-18, 2020-2021). Below, we explain the organization of revenues could be many billions of dollars above or this report and the basis for our projections. below our illustrative scenarios, with uncertainty growing in each subsequent year. Organization of This Report This report is organized to reflect our Uncertainty in the Outlook. As this report is uncertainty about our projections while still published, the first day of the 2017-18 fiscal year is producing what we hope is a useful planning over seven months away. Our expectations about document for the Legislature. As such, we the budget’s condition over the forecast period depend, in Figure 1 large part, on our assumptions More Uncertainty in Each Subsequent Year of the Outlook about trends in the economy Range of Possible Revenue Estimates (In Billions) and the stock market. While there is uncertainty over $145 these assumptions in the near term, that uncertainty 140 becomes even greater in each subsequent year. As such, we 135 have reasonable confidence Economic Growth Scenario in our expectations about the 130 economy’s performance in 2017-18, but we are much less 125 able to anticipate the economic Mild Recession Scenario 120 future in each year thereafter. Figure 1 illustrates this point 115 with regard to General Fund revenues. The figure shows our 110 revenue outlook for the near 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 term, and our two separate Outlook www.lao.ca.gov Legislative Analyst’s Office 3 2017-18 BUDGET emphasize the near-term economic and budget Chapter 4 Presents Two Out-year Scenarios. outlook in Chapters 1 through 3 and present In Chapter 4, we present two estimates of the out-year budget and economic scenarios in state’s General Fund condition in 2018-19 through Chapter 4. This organization is discussed in greater 2020-21. These estimates are based on two different detail below. examples of how the economy could perform over Chapters 1 and 2 Present One Near-Term the outlook period. They are: (1) an economic growth Scenario. In Chapter 1 of this report, we present scenario, which assumes the economy continues to our assessment of the condition of the state General grow throughout the outlook period, and (2) a mild Fund for 2015-16, 2016-17, and 2017-18. Chapter 2, recession scenario, which assumes an economic similarly, discusses our estimates of key revenue downturn—with a big stock market decline—begins trends and economic performance through 2017-18. in the middle of calendar year 2018. These alternate All of our projections through 2017-18 are based scenarios are only two of many possible future on a consensus economic forecast (developed economic realities. Actual experience could be more before the election). In these years, there is less positive than the growth scenario or more negative uncertainty regarding our assumptions. Also, we than the mild recession scenario. hope that presenting one scenario will better assist How We Build Our Outlook the Legislature as it plans for the upcoming 2017-18 budget process. However, our estimates of revenues, Three Main Outlook Techniques for expenditures, and reserve requirements will change Spending. In broad terms, we use three different in the following months—especially after the large methodologies to build our spending outlook in influx of 2016 tax return payments in April 2017. Chapter 3. They are: Chapter 3 Presents Outlook for State • Formula-Driven Outlooks. These Spending. In Chapter 3 of this report, we discuss programs have constitutionally required our state General Fund spending outlook, again minimum funding levels based on emphasizing the near term. We also comment formulas with specified inputs. These on key spending trends over the entire outlook include the formulas for determining period. Generally, these out-year trends are based schools and community college funding on our economic growth scenario. The spending (Proposition 98) and reserve deposits and estimates aim to reflect the cost of maintaining the debt payments (Proposition 2). state’s existing program commitments and budget act policies over the outlook period. (As such, we • Outlooks Based on Caseload, have generally provided adjustments to address the Utilization, and Price. These programs impact of inflation with the aim of maintaining experience changes in funding levels the purchasing power of current legislative based on a combination of changes in commitments.) Our estimates also assume the state their number of participants (caseload), makes no changes to its programs and policies the intensity at which participants use in the future. This does not mean, however, we services (utilization), and the costs believe these policies will or should stay the same. per enrollee (price). Examples include On the contrary, the essence of budgeting is Medi-Cal, the state’s insurance program making year-to-year adjustments to spending to for low-income Californians, and the accommodate legislative priorities. California Department of Corrections 4 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET and Rehabilitation, which operates the capital gains. As a result, ordinary movement in state’s correctional facilities and parole the stock market—over just a period of weeks system. The outlook for these programs use or months—can result in billions of dollars in models that identify relationships between higher or lower revenues for the state. Our revenue economic and demographic trends and estimates also assume current laws and policies spending levels. stay in place—both at the state and federal levels. For example, our outlook assumes the tax on • Discretionary Outlooks. These programs managed care organizations will expire at the end have funding levels that are generally of 2018-19, consistent with current law. Similarly, determined by legislative priorities. We our estimates of growth in the sales and use tax typically assume a continuation of recent reflects a quarter-cent reduction in the tax rate after budget practices—for example, funding December 2016 as that provision of Proposition 30 for universities and employee salaries and (2012) expires. health benefits. Effects of November 2016 Voter Initiatives Revenues Depend on Volatile Economic Included. Our fiscal outlook reflects the fiscal Indicators. Our revenue outlook depends, in large effects of propositions approved by the voters on part, on our assumptions about the performance of the November 8, 2016 ballot. (We have assumed the economy and the stock market. In particular, that Proposition 66, which deals with the death revenues from the personal income tax, which penalty processes, is approved, although votes are make up about 70 percent of General Fund still being counted.) revenues, depend on highly volatile estimates of www.lao.ca.gov Legislative Analyst’s Office 5 2017-18 BUDGET 6 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Chapter 1: General Fund Through 2017-18 This chapter summarizes our office’s state General Fund, the state’s main operating assessment of the near-term condition of the account. OUTLOOK FOR THE 2017-18 BUDGET Figure 2 displays our estimate of the General 2016-17: Revised Reserve Levels of $7�5 Billion Fund condition through 2017-18. We estimate that The estimated $1 billion decrease in 2016-17 2016-17 will end with $7.5 billion in total reserves, reserves is the net result of the following: about $1 billion lower than the assumptions in • $510 Million Downward Revision to the budget act. Assuming no new commitments Entering Fund Balance. We include are made in the 2017-18 budget, we estimate total two revisions to the budget condition reserves will grow to $11.5 billion at the end of before 2015-16 that affect the current the fiscal year—an increase of $4 billion. This budget situation. First, based on our $11.5 billion total includes $2.8 billion in the estimates of required funding for schools Special Fund for Economic Uncertainties (SFEU), and community colleges, we assume the the state’s discretionary budget reserve, and state will pay an additional $351 million $8.7 billion in the Budget Stabilization Account in “settle up” payments related to earlier (BSA), the state’s required budget reserve. minimum funding guarantees. (We discuss Figure 2 these settle up payments LAO General Fund Condition further in Chapter 3.) (In Millions) Second, our estimate 2015-16 2016-17 2017-18 reflects a $159 million Prior-year fund balance $2,935 $3,715 $1,717 reduction in prior years’ Revenues and transfers 115,643 119,991 128,123 estimated revenue Expenditures 114,863 121,988 126,109 collections and accruals. Ending fund balance $3,715 $1,717 $3,731 Encumbrances 966 966 966 SFEU balance 2,749 751 2,765 • Revenues Lower Reserves by $1.7 Billion in 2015-16 SFEU balance $2,749 $751 $2,765 and 2016-17. Between BSA balance 3,420 6,714 8,694 2015-16 and 2016-17, we Total Reserves $6,169 $7,466 $11,459 estimate revenues will SFEU = Special Fund for Economic Uncertainties (the General Fund’s discretionary budget reserve) and BSA = Budget Stabilization Account. be lower than the budget www.lao.ca.gov Legislative Analyst’s Office 7 2017-18 BUDGET act estimates by $1.7 billion. In particular, with 2015-16 and 2016-17 are together less our estimates for total revenues—across than $2 billion. As a result, we assume no the two fiscal years—associated with the additional true ups are made, leaving the sales and use tax (SUT) and corporation already revised 2015-16 deposit and initial tax (CT) are $2.6 billion lower than budget 2016-17 deposits unchanged. act assumptions. These shortfalls, however, are partially offset by net upward revisions 2017-18 Outlook: in our estimate of personal income tax Year Ends With $11�5 Billion Reserve (PIT) revenues over the two fiscal years— Revenues and Transfers Grow $8.1 Billion. $923 million below budget estimates in We estimate that revenues and transfers will grow 2015-16 and $1.7 billion above estimates in by $8.1 billion in 2017-18, including a $6.4 billion 2016-17. (5.4 percent) increase in the “Big Three” revenues: the PIT, SUT, and CT. Most of this growth is driven • Expenditures Lower by $1.2 Billion by a 6.9 percent year-over-year increase in the PIT. in 2015-16 and 2016-17. We estimate Spending Grows $4.1 Billion. We estimate expenditures in 2015-16 and 2016-17 will that General Fund expenditures—absent any new be lower than budget act assumptions program commitments—would grow $4.1 billion by a net $1.2 billion. Two factors explain between 2016-17 and 2017-18. This increase is in most of the lower spending. First, General part attributable to a $1.4 billion increase in the Fund Proposition 98 spending declines General Fund share of the minimum funding by $640 million in 2015-16, due to lower guarantee for schools and community colleges. state revenues and higher local property Another $1.5 billion is attributable to the net taxes. Second, in 2016-17, we assume increase in spending related to health and human the $400 million set-aside for affordable services programs, including about an $800 million housing in the budget package is not spent increase in Medi-Cal, the state’s health insurance because it was contingent on changes in program for low-income Californians. Various state law that did not occur. other spending items grow too. In contrast, • Required BSA Deposits Unchanged. spending declines between 2016-17 and 2017-18 due Proposition 2 establishes a minimum to the expiration of many one-time expenditures amount that the state must deposit each in the 2016-17 budget. These items include, year into the BSA, the state’s required for example, one-time spending on deferred budget reserve. Under the measure’s “true maintenance, capital outlay, and several criminal up” provisions, the state revisits these justice programs. estimates twice: once in each of the two Reserves Grow to $11.5 Billion. Based on our subsequent budgets. However, the 2016-17 current estimates of revenues, particularly those budget package set aside a $2 billion related to capital gains, we estimate the state will optional deposit and specified that these be required to make an initial deposit of $2 billion funds would be used to meet true up into the BSA for the 2017-18 fiscal year. In addition, requirements for 2015-16 and 2016-17. based on our estimates that growth in revenues will The estimated true up deposits associated outpace expenditures, and assuming no new budget 8 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET commitments are made, we estimate 2017-18 would $7.5 billion balance estimated in 2016-17, bringing end with additional reserves of $2 billion in the total reserves to $11.5 billion by the end of 2017-18. SFEU. Together, these reserves would build on the LAO COMMENTS Positive 2017-18 Budget Outlook. Based on less in discretionary reserves. (The $4 billion our current economic and budget projections, we revenue decline over the two fiscal years would be estimate the General Fund will end 2017-18 with offset by lower Proposition 98 and Proposition 2 $11.5 billion in total reserves, including $2.8 billion requirements.) In this scenario, the Legislature in discretionary reserves. (That $2.8 billion amount would have significantly fewer discretionary is displayed in our figures as the balance in the resources in the 2017-18 budget process. SFEU.) These reserve levels reflect the continued Outlook for Future Shapes Decisions Today. progress California has made in improving its Under our current estimates, the Legislature will budget situation. The state budget remains on face decisions in the 2017-18 budget process about steady footing. how to allocate the $2.8 billion in discretionary Lower 2017-18 Revenue Estimates Would reserves. The Legislature could opt to hold some Mean Fewer Discretionary Resources. Our revenue or all of this in reserves or make some new outlook is based, in part, on assumptions about one-time or ongoing commitments. The choices the stock market. As we describe in Chapter 2, this the Legislature makes for these funds may depend, outlook makes certain assumptions about how in large part, on its consideration of the future estimated and final PIT payments will strengthen prospects for the state budget. We present two during the second half of 2016-17. We believe these possible out-year budget scenarios in Chapter 4 of assumptions are reasonable, but if they do not come this report. We hope these scenarios help inform to pass, our revenue estimates easily could be about the Legislature’s decisions as the 2017-18 budget $2 billion lower in both 2016-17 and 2017-18. In process begins. this case, 2017-18 would end with over $2 billion www.lao.ca.gov Legislative Analyst’s Office 9 2017-18 BUDGET 10 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Chapter 2: The Economy and Revenues THE ECONOMY Our near-term projections are based on a by a different firm.) Using these consensus views consensus of economists about the likely trend about the U.S. economy, our office develops a of the U.S. economy through 2018, as reported California-specific macroeconomic scenario. in October (prior to the election) by Moody’s Our near-term economic projections are Analytics, a national economics consulting firm. summarized in Figure 3 and compared to the This differs from our most recent projections, administration’s May 2016 projections—the which were premised on the analyses of just underlying basis for the revenue estimates in the the economists at Moody’s Analytics. (The 2016-17 state budget—in Figure 4 (see next page). administration’s projections are based on analyses Our near-term projections reflect the consensus Figure 3 LAO Economic Assumptions Through 2018 Percent Change Unless Otherwise Noted United States 2015 2016 2017 2018 Real gross domestic product 2.6% 1.6% 2.3% 2.2% Personal income 4.4 3.3 4.3 4.8 Wage and salary employment 2.1 1.7 1.1 0.8 Unemployment rate (percent) 5.3 4.9 4.6 4.6 Consumer price index 0.1 1.1 2.3 2.2 Core Personal Consumption Expenditures price index 1.4 1.6 2.0 1.6 Federal funds rate (percent) 0.1 0.4 1.0 1.9 Housing permits (thousands) 1,178 1,158 1,294 1,366 S&P 500 (annual average) 2,061 2,078 2,165 2,231 California 2015 2016 2017 2018 Personal income 6.4% 3.9% 5.0% 5.6% Wage and salary employment 3.0 2.6 1.9 1.6 Unemployment rate (percent) 6.2 5.4 5.3 5.2 Consumer price index 1.5 2.3 2.8 2.7 Housing permits (thousands) 98 96 98 100 Single-unit permits 45 47 50 52 Multifamily permits 53 49 48 48 Population growth 1.0 1.0 0.9 0.9 Note: Based generally on Moody’s Analytics’ October 2016 U.S. macroeconomic “consensus scenario,” a scenario that incorporates the central tendency of a range of baseline projections from various institutions and professional economists. S&P 500 index levels, however, are lowered from those assumed in the Moody’s Analytics’ consensus scenario. The California-specific assumptions above reflect a California state macroeconomic scenario developed by the LAO based on the U.S. consensus scenario. www.lao.ca.gov Legislative Analyst’s Office 11 2017-18 BUDGET Figure 4 Comparison to 2016-17 Budget Acta Economic Assumptions Percent Change Unless Otherwise Noted 2016 2017 2018 Budget Act LAO Budget Act LAO Budget Act LAO June 2016 Nov. 2016 June 2016 Nov. 2016 June 2016 Nov. 2016 United States Real gross domestic product 2.1% 1.6% 2.8% 2.3% 2.7% 2.2% Personal income 3.9 3.3 4.9 4.3 5.1 4.8 Wage and salary employment 1.9 1.7 1.4 1.1 0.9 0.8 Unemployment rate (percent) 4.8 4.9 4.7 4.6 4.7 4.6 Consumer price index 1.0 1.1 2.2 2.3 2.0 2.2 Federal funds rate (percent) 0.6 0.4 1.4 1.0 2.4 1.9 S&P 500 (annual average) 2,075 2,078 2,117 2,165 2,160 2,231 California Personal income 5.5% 3.9% 5.3% 5.0% 4.5% 5.6% Wage and salary employment 2.1 2.6 1.7 1.9 1.1 1.6 Unemployment rate (percent) 5.3 5.4 5.2 5.3 5.1 5.2 Consumer price index 2.2 2.3 2.8 2.8 2.6 2.7 Housing permits (thousands) 107 96 126 98 142 100 Single-unit permits 51 47 62 50 71 52 Multifamily permits 55 49 64 48 71 48 Population growth 0.9 1.0 0.9 0.9 0.9 0.9 a The 2016-17 Budget Act reflected the administration’s May 2016 revenue assumptions, this figure, therefore, describes the administration’s May 2016 economic assumptions as those reflected in the 2016-17 Budget Act, which was passed in June 2016. view that the economic expansion is likely to Economic expansions do not die of old age. continue in the U.S. over at least the next couple (Australia, for example, just marked 25 years of of years. This, however, is not a certainty. The its current expansion—now the longest in the possibility exists that a slowdown or recession developed world.) Instead, expansions commonly could emerge in the short term. In addition, the Figure 5 October consensus of economists does not reflect Current Economic Expansion federal policy and budget changes that may result Already Among Longest in U.S. History from this month’s election of a new President and a Data Since 1854 new Congress. Number of The U�S� Economy Economic Expansion Months April 1991 to March 2001 120 Long Economic Expansion Continues. The March 1961 to December 1969 106 national economy has been expanding since the end December 1982 to July 1990 92 of the last recession in June 2009. This month marks July 2009 to present 89 (so far) July 1938 to February 1945 80 the 89th month of the expansion, which makes it December 2001 to December 2007 73 the fourth-longest in the U.S. since at least 1854, as April 1975 to January 1980 58 shown in Figure 5. Early next year, if the expansion April 1933 to May 1937 50 continues, it will surpass the expansion of the 1980s Average Economic Expansion, 1945 to 2009 58 to become the third longest in U.S. history. Source: National Bureau of Economic Research. 12 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET end because of imbalances that build up and We note, however, that wage growth recently has “overheat” the economy. Economic shocks and picked up somewhat. A related uncertainty is how major changes in the economy or public policy also much “slack” remains in the labor market—as in, can depress activity enough to end an expansion. how many more people not currently seeking work While policy makers should note this expansion’s will return to the labor force in the coming years. age, they also should be aware that economic Labor market slack can help prolong the expansion expansions have been getting longer. The last by preventing the economy from overheating. three lasted an average of 95 months—longer than The California Economy the 58-month average for expansions since 1945. Improved management of U.S. monetary policy California’s economy has grown at a good pace and other government policies have been credited in recent years. Different groups and regions have with a reduction in macroeconomic volatility over shared in that growth to varying degrees. time. Also credited are better management by Incomes Up. According to the Census Bureau’s businesses of inventories, the rise of the relatively American Community Survey (ACS), median stable service sector, and technological change. household income in California rose 4 percent When Will the Expansion End? Economists in 2015—slightly outpacing the nationwide and other forecasters (including us) are not growth rate of 3.8 percent. California’s $64,500 good at projecting the end of expansions far in median household income ranked 9th among the advance. (That is one reason why—later in this 50 states. With 6.2 percent growth in 2015, median publication—we consider one scenario of what household incomes reported in the ACS data for could happen to the state budget if a mild recession the San Francisco-Oakland metro region was hits around 18 months from now.) History provides surpassed, among the nation’s large metro areas, us with a few instructive lessons to foreshadow only by Atlanta’s 7.1 percent growth. Median the demise of the current expansion. The past household incomes grew by 3.3 percent in the Los few U.S. expansions have ended about three years Angeles-Orange County region, 2.6 percent in after the economy reached what is considered “full the Inland Empire (Riverside and San Bernardino employment.” Once an economy reaches that point, Counties), and 1.6 percent in San Diego County. wages and inflation may accelerate, necessitating (We note, however, that these ACS results have a tighter monetary policy (including higher interest relatively high margin of error for San Francisco- rates). The U.S. unemployment rate has been at Oakland, San Diego, and the Inland Empire.) or below 5 percent—a commonly estimated level Official Poverty Rate Down. According to of full employment—since last October. If the ACS data, the official poverty rate in California fell experience of the past few expansions repeated from 16.4 percent in 2014 to 15.3 percent in 2015, itself, the current expansion would continue over representing about 370,000 fewer Californians the next couple of years. counted under this poverty measure. While this Some economists, however, have been saying official poverty measure (OPM) is just above the that the lack of robust wage growth, among other national average, California’s high housing costs factors, suggests that full employment currently mean that its “supplemental poverty measure” requires an even lower unemployment rate. That (SPM)—which accounts for forms of public reasoning would be consistent with an expansion assistance not included in the OPM and adjusts that continued for an even longer period of time. poverty thresholds for housing costs and other www.lao.ca.gov Legislative Analyst’s Office 13 2017-18 BUDGET factors—is much higher than the rest of the California’s labor force participation rate— country’s. Based on data from 2013 through those participating in the labor force as a 2015, California’s SPM is 20.6 percent—versus percentage of the population aged 16 and 14.4 percent for the rest of the country. older—grew from 62 percent in September Job Growth Has Been Outpacing the Nation. 2015 to 62.6 percent in September 2016 (its In September, the number of payroll jobs in highest level in over two years), according California was up by about 380,000 over the prior to U.S. and state labor surveys. On a year, a growth rate of 2.3 percent—better than seasonally adjusted basis, the number of the 1.7 percent job growth rate for the nation as a those participating in the labor force whole. California’s job growth rate over the past grew by 380,000 statewide (an increase year ranks 14th best among the 50 states. Among of 2 percent) over the past year, including the state’s major employment sectors, professional 131,000 in Los Angeles County (an increase and technical services jobs (many of them in of 2.6 percent there). Those choosing technology) are up 4.6 percent over the past year, not to be in the labor force because they and construction jobs are up 4.2 percent. Oil and were discouraged over their job prospects gas jobs, which account for only a small fraction of dropped more than 10 percent over the last the state total but are very important in some areas 12 months to just 68,000 statewide—down such as Kern County, are down 12.5 percent over from over 175,000 in early 2011. the past 12 months, but losses have slowed with • Full-Time Work Up. According to more stable energy prices recently. Current Population Survey data, almost While California’s official unemployment all of the net growth in California jobs rate—5.5 percent as of September—remains over the past year has been in full-time tied for 10th worst with three other states, it has positions, as the percent of those employed dropped half a percentage point in the last year working full-time in the state grew from and 6.7 percentage points from its high point 80.3 percent a year ago to 80.6 percent now. in October 2010. In Los Angeles County, the Between September 2015 and September seasonally adjusted jobless rate was 5 percent in 2016, the three-month moving average of September 2016—down 1.2 percentage points private-sector hourly earnings grew by from one year before. In September, unadjusted more than 3 percent. The number of those unemployment rates in the state ranged from just working part-time for economic reasons 3.1 percent in San Mateo County to 22.7 percent in (generally because there is insufficient Imperial County (among the nation’s highest local demand from their employer) dropped unemployment rates). Imperial County’s September 11 percent over the past year to 946,000— unemployment rate was down 2.3 percentage points down from over 1.5 million in 2010. from one year before. Other rural and agricultural areas continue to have high unemployment rates. • Jobless Claims and Underemployment Other Labor Market Improvements. By many Down. Initial jobless claims have fallen to measures, California’s labor market has been near prerecession levels—under 40,000 per heating up: week in some periods this year. California’s • Participation Up. Even as more and “U-6” jobless rate—a broader jobless more baby boomers reach retirement age, measure that counts those unemployed, 14 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET marginally attached to the labor force, and Silicon Valley Job Growth. Jobs in the San working part-time for economic reasons— Jose region (Santa Clara and San Benito Counties) fell to 11.6 percent in September (down grew by a net 3.6 percent during the 12 months 1.7 percentage points from one year before). ending in September—far outpacing job growth in This remains high compared to the rest of the state and its other large metro areas. The bulk the nation, but California’s U-6 rate is far of the region’s job growth came in professional below its 22.1 percent annual peak in 2010. and business services—primarily in technology- dominated job categories. Other contributors LAO Projections for 2016 Through 2018. As to Silicon Valley job growth have been private shown in Figures 3 and 4, our office anticipates that education and health facilities, construction, and personal income in California will grow a modest restaurants. The San Francisco (San Francisco and 3.9 percent in 2016—faster than the 3.3 percent San Mateo Counties) and East Bay (Alameda and growth rate expected for the U.S. as a whole. Contra Costa Counties) regions recorded 2.6 percent While the 3.9 percent growth rate is disappointing, year-over-year job growth through September, with we note that wages and salaries—the largest noteworthy growth rates in technology, health care, component by far of personal income subject to and construction, among other sectors. state taxation—are expected to grow by 5.2 percent, Bay Area Contributes Heavily to State Taxes. which is consistent with the fairly strong trend of The state PIT makes up about 70 percent of state personal income tax (PIT) withholding growth we General Fund revenues. As shown in Figure 6 have been seeing this year. The anticipated wage (see next page), Bay Area residents—16.8 percent and salary growth in 2016 offsets weak growth of the state’s population—receive 29.1 percent of in some other personal income categories like the income reported on state resident tax returns dividends, interest, and rent and transfers (such as of 2014 and pay 37 percent of the income taxes as Social Security payments), some parts of which assessed. This means that per capita PIT payments are not subject to the state income tax. Our current by Bay Area residents are far above those of any projections anticipate stronger personal income other region in the state. Among the state’s major and wage growth in 2017 and 2018, as California’s regions listed in Figure 6, the Bay Area’s per capita unemployment rate dips below 5 percent. We tax payments are almost twice those of Orange anticipate less growth in jobs and more growth County, the next highest area. Below Orange in wages over the next few years, as the labor County on the list, all other major regions of the market tightens more and nears full employment. state have per capita PIT payments below the California’s minimum wage also will increase in statewide average. future years under state law. The Bay Area contributes so much to PIT The Bay Area because individuals there, on average, have higher incomes than those in other areas of the state. In While the Los Angeles area economy is bigger, California’s income tax system, those with higher the Bay Area has contributed disproportionately incomes pay taxes at higher marginal rates. In to state tax revenue and economic growth in terms of median adjusted gross income shown on recent decades. This continues to be the case state tax returns, eight of the top ten counties in today. Because of the Bay Area’s importance to the the state are in the Bay Area. Prior research by our economy and budget, we focus on it in this section. office has shown that Bay Area residents also spend www.lao.ca.gov Legislative Analyst’s Office 15 2017-18 BUDGET Figure 6 Bay Area Contributes Disproportionately to State Income Tax Revenues 2014 Resident Tax Returns 2014 Population Adjusted Gross Income Personal Income Tax Assessed Percent of Percent of Percent of Number Statewide Amount Statewide Amount Statewide Per County (Millions) Total (Billions) Total (Billions) Total Capita ($) San Francisco/Oakland/ 6.5 16.8% $346.2 29.1% $22.6 37.0% $3,474 San Jose MSAs Orange County 3.1 8.1 107.3 9.0 5.7 9.3 1,821 Ventura County 0.8 2.2 26.4 2.2 1.2 2.0 1,439 Los Angeles County 10.1 26.1 282.9 23.8 14.5 23.7 1,434 San Diego County 3.2 8.4 97.0 8.2 4.6 7.6 1,425 Central Coasta 1.4 3.7 39.1 3.3 1.8 3.0 1,282 Napa, Solano, and 1.1 2.7 31.4 2.6 1.3 2.2 1,267 Sonoma Counties Sacramento MSA 2.2 5.8 58.8 4.9 2.4 3.9 1,063 North Stateb 1.2 3.2 22.4 1.9 0.7 1.2 612 San Joaquin Valleyc 4.1 10.7 72.1 6.1 2.4 4.0 593 Riverside and 4.4 11.4 81.2 6.8 2.5 4.0 559 San Bernardino Counties Other residentsd 0.4 1.0 23.5 2.0 1.3 2.1 3,498 Totals 38.7 100.0% $1,188.2 100.0% $61.2 100.0% $1,581e a Includes Monterey, San Luis Obispo, Santa Barbara, and Santa Cruz Counties. b Includes all counties north of San Francisco, Napa, Sonoma, Vallejo-Fairfield, and Sacramento MSAs. c Includes Fresno, Kern, Kings, Madera, Merced, San Joaquin, Stanislaus, and Tulare Counties. d Includes California resident tax returns with (1) an address in another California county or (2) an out-of-state address. Returns with out-of-state addresses collectively had $1.1 billion of tax assessed, the vast majority of the total shown on this line. Excludes nonresident tax returns, which collectively had $2.5 billion of tax assessed. e Statewide average. MSA = metropolitan statistical area. more, on average, on goods subject to the sales tax, capital investments in the Bay Area have fallen from compared to other regions of the state. Per capita 2014 and 2015 levels, they remain substantial and assessed valuation—for local property taxes—also there is little evidence that a significant slowdown of is higher in the Bay Area than in other areas of the the Bay Area technology sector is imminent. state. Housing Costs a Growing Concern. Home Dependence on the Bay Area. The state’s job prices and rents remain very high in both the Bay growth has been centered in the Bay Area, and its Area and Los Angeles, as well as other parts of the key income, sales, and property taxes are all paid state. Housing affordability is a growing concern in disproportionately by Bay Area residents. Boom California. Given the importance of the Bay Area times in the Bay Area tend to mean the statewide to the state budget, as noted above, we focus below economy and the state budget are doing well. on housing affordability issues there. Economic weakness there hinders the economy and Over the past year, the San Francisco-Oakland can throw the state budget into a tailspin. With the and San Jose metro areas have experienced home Bay Area economy dependent on what has been a price growth of 5.7 percent and 4.7 percent, thriving technology sector, one major risk to the respectively. This is well below the double-digit state’s near-term economic health is the possibility growth that occurred in these areas in recent years. of a big slowdown in that sector. While venture Nonetheless, home prices remain high compared 16 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET to just about anywhere else. Median home prices More residential construction would moderate in the San Jose ($944,000) and San Francisco- home price growth over the long term. Building Oakland ($813,000) areas ranked first and second activity in the Bay Area generally has returned highest among major urban areas in the country. to prerecession levels. Building permits in San Rents continued to rise quickly in the San Francisco-Oakland are at their highest levels since Francisco-Oakland (12 percent) and San Jose 2006. Despite this recovery, building levels remain (13 percent) areas in 2015, according to ACS low relative to other urban areas throughout the data. Monthly rents in San Jose ($2,300) and San country. Over the past year, the San Francisco- Francisco-Oakland ($2,000) were rivaled only by Oakland and San Jose areas approved about those in Honolulu among major urban areas. While 2.8 building permits per 1,000 residents—well below there is some anecdotal and survey information the national average among major urban areas of showing that rents have stabilized or fallen slightly 3.9 permits per 1,000 residents. Other urban areas in 2016, other data sources, such as Zillow’s rental with rapidly growing economies—such as Austin, index, show 3 percent to 4 percent growth in rental Houston, Portland, and Raleigh—approved over costs this year in parts of the Bay Area. (ACS data six permits per 1,000 residents during the past year. on rents for 2016—which is generally considered to Over the long term, a constrained supply of new be the most comprehensive—will not be available housing may limit prospects for job and economic until next year.) growth in the Bay Area. REVENUES Figure 7 displays our office’s revenue outlook display revenue estimates through 2020-21 under through 2017-18. This outlook reflects the U.S. two possible economic scenarios—an economic economic projections of an October 2016 consensus growth scenario and a recession scenario.) of economists, described earlier. (In Chapter 4, we Figure 7 LAO November 2016 Revenue Outlook General Fund (Dollars in Millions) Change From 2016-17 2015-16 2016-17 2017-18 Amount Percent Personal income tax $79,039 $85,085 $90,959 $5,874 6.9% Sales and use tax 24,766 24,747 25,024 277 1.1 Corporation tax 10,032 9,892 10,162 269 2.7 Subtotals, “Big Three” Revenues ($113,837) ($119,724) ($126,144) ($6,420) (5.4%) Insurance tax $2,561 $2,376 $2,456 $80 3.4% Other revenues 2,219 1,779 1,650 -129 -7.3 BSA transfer -1,814 -3,294 -1,979 1,315 — Other transfers -1,160 -593 -148 446 — Totals, Revenues and Transfers $115,643 $119,991 $128,123 $8,132 6.8% BSA = Budget Stabilization Account. www.lao.ca.gov Legislative Analyst’s Office 17 2017-18 BUDGET Revenue Estimates $1.7 Billion Below of the quarter-cent Proposition 30 (2012) SUT Budget Assumptions for 2015-16 and 2016-17 rate after December 2016. We describe near-term Combined. Our revenue estimates for 2015-16 and estimates of these tax revenues in more detail 2016-17 combined are modestly lower than the below. administration’s May 2016 estimates that served as Personal Income Tax the basis for the June 2016 budget plan, as shown in Figures 8 and 9. In particular, our estimates June 2016 Cash Receipts Were Disappointing . . . of sales and use tax (SUT) and corporation tax As the Governor signed the 2016-17 Budget Act, (CT) revenues are $2.6 billion below budget act PIT cash collections for June came in $888 million assumptions for 2015-16 and 2016-17 combined. below projections, as shown in Figure 10. June On the other hand, our estimate of PIT revenues is is an important revenue collection month as $768 million above budget assumptions for those taxpayers submit estimated payments for that year’s two fiscal years combined, somewhat offsetting tax liability. (Estimated payments are quarterly our weak SUT and CT estimates. After accounting payments made by individuals and businesses for minor revenues and transfers, our bottom line on expected taxable income for which there is no estimates of General Fund revenues and transfers withholding, such as realized capital gains on sales are $1.7 billion below budget assumptions. of stocks and other assets.) Estimated payments Strong PIT Growth Drives Healthy Revenue fell short of projections by $622 million (about Growth in 2017-18. Looking beyond the current 9 percent) in June 2016. Moreover, withholding fiscal year, we estimate that the state’s “Big Three” came in nearly 6 percent, or $250 million, below revenues—PIT, SUT, and CT—will grow 5.4 percent projections. in 2017-18, as shown in Figure 7. This growth is . . . But Recent Collections Have Been on driven by a projected 6.9 percent year-over-year Target. Since June 2016, however, cash receipts increase in the PIT, which makes up about have largely hit their mark. Withholding and 70 percent of General Fund revenues. We estimate “other Franchise Tax Board collections” (such SUT and CT to grow by 1.1 percent and 2.7 percent, as final payments) exceeded budget projections respectively, in 2017-18. Year-over-year growth in by $72 million and $312 million, respectively. the SUT would be higher were it not for the end Offsetting these results, estimated payments and Figure 8 Comparing LAO November 2016 Revenue Estimates With June 2016 Budget Act Assumptions General Fund (In Millions) 2015-16 2016-17 LAO Budget Act LAO Budget Act Total Nov. 2016 June 2016 Change Nov. 2016 June 2016 Change Change Personal income tax $79,039 $79,962 -$923 $85,085 $83,393 $1,691 $768 Sales and use tax 24,766 25,028 -262 24,747 25,727 -980 -1,242 Corporation tax 10,032 10,309 -277 9,892 10,992 -1,100 -1,377 Subtotals, “Big Three” Revenues ($113,837) ($115,299) (-$1,462) ($119,724) ($120,113) (-$389) (-$1,851) Other revenues and transfers $1,806 $1,702 $104 $267 $197 $70 $174 Totals, Revenues and $115,643 $117,001 -$1,358 $119,991 $120,310 -$319 -$1,677 Transfers 18 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET refunds were worse than Figure 9 projections ($198 million and Comparing LAO November 2016 Revenue $221 million, respectively). Estimates With June 2016 Budget Act Assumptions In total, PIT receipts over the General Fund (In Billions) July through October period fell short of projections by $2.0 Personal Income Tax just $34 million (or about Sales and Use Tax 1.5 two-tenths of 1 percent). Corporation Tax June Collections and Other Revenues and Transfers 1.0 the Weak Early 2016 Stock Market. Our working theory 0.5 is that much of the recent trend in estimated payments can be explained by stock market performance since -0.5 early 2016. Figure 11 (see next page) shows S&P 500 index -1.0 values from January 2016 through October 2016. As -1.5 shown in the figure, the index 2015-16 2016-17 was under 1900 for much of the first quarter of 2016. We Assuming Steady Stock Prices, PIT Estimates think that this may help explain the disappointing Exceed Budget Projections Through 2016-17. If level of estimated payments in June. Since then, our assumptions come to pass, we estimate that however, the market has largely recovered. Our taxpayers will make larger estimated and final economic projections assume that the S&P 500 payments beginning in December 2016 through index will average 2,078 in 2016 and 2,165 in 2017, early 2017 than was projected in the state budget notably higher than early 2016 levels. package. This would essentially “make up” for Figure 10 Recent PIT Cash Trends Better Than June 2016 (In Millions) June 2016 July 2016 Through October 2016 DOF DOF Actual Projections Difference Actual Projections Difference PIT withholding $4,138 $4,388 -$250 $17,536 $17,464 $72 Estimated payments 6,187 6,808 -622 3,139 3,336 -198 Other FTB collections 685 618 66 2,796 2,483 312 FTB refunds -450 -351 -99 -1,741 -1,520 -221 Proposition 63 allocation -186 -202 16 -382 -383 1 Totals $10,373 $11,261 -$888 $21,347 $21,381 -$34 PIT = personal income tax; DOF = Department of Finance; and FTB = Franchise Tax Board. www.lao.ca.gov Legislative Analyst’s Office 19 2017-18 BUDGET the weak June collections. Relative to budget act S&P 500 index returns to first quarter 2016 levels, assumptions, this has the effect of shifting revenues our estimates of taxpayers’ estimated and final from 2015-16 into 2016-17. On net, we estimate PIT payments described above could prove billions of revenues will be $768 million higher than assumed dollars too high for 2016-17 and 2017-18 combined. in the budget for 2015-16 and 2016-17 combined. Sales and Use Tax Healthy PIT Growth in 2017-18. Looking beyond the current fiscal year, our assumptions of Sales Tax Estimates Down. Estimated General wages and salaries and capital gains continue to Fund SUT revenue totaled $24.8 billion in 2015-16, be higher than the administration’s most recent $262 million lower than the amount assumed in assumptions. While our estimates of personal the June 2016 budget plan. We estimate that SUT income growth are below state budget assumptions, revenues remain steady at around $24.7 billion we currently project stronger growth in 2018. These in 2016-17, about $1 billion lower than budget and other factors result in healthy PIT growth of assumptions. Thereafter, estimated SUT revenues nearly 7 percent in 2017-18. increase slightly to $25 billion in 2017-18. Risks to PIT Estimates. Our revenue estimates Reasons for Sales Tax Weakness. This are premised upon our near-term projections short-term weakness in SUT revenue is due about the economy and assumptions about the to several factors, including: (1) lower-than- stock market. If those assumptions do not come expected revenue in 2015-16, (2) a quarter-cent to pass, revenues in 2016-17 and 2017-18 could rate reduction, and (3) modest growth in be a few billion dollars higher or lower than the California personal income. At the end of 2015-16, estimates reflected in Figure 7. If, for example, the SUT revenue was about a quarter of a billion dollars below the budget’s Figure 11 assumption, setting a lower S&P 500 Index Has Recovered From First Quarter Dip starting point for subsequent growth. The temporary 2,300 quarter-cent rate established by Proposition 30 will expire 2,200 at the end of 2016. This rate expiration likely will reduce 2,100 annual SUT revenue growth by about 3 percentage points 2,000 in 2016-17 and in 2017-18 relative to revenue growth 1,900 with constant tax rates. Finally, we project modest 1,800 personal income growth of 3.9 percent in 2016, bringing down our near-term SUT 1,700 Jan Mar May Jul Sep estimates. 2016 20 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Corporation Tax increased consumer and business consumption. Consequently, we project CT revenue to decline by Corporate Profits Expected to Grow about 1 percent in 2016-17, followed by several years Slowly. The CT is levied on profits of California of growth that is roughly on pace with the broader corporations and, for multistate corporations, economy. a share of their total national profits. National CT Revenue Has Underperformed Budget corporate profits peaked in 2014 and declined Assumptions to Date. Our near-term estimates are over 2015. As described earlier in this chapter, consistent with recent cash flow trends. Through our near-term economic projections are based on the first four months of 2016-17, net CT receipts are the consensus of various economists about the 14 percent below budget act projections. Last year likely trend of the U.S. economy through 2018. had elevated levels of refunds, and we see this trend In those projections, national corporate profits continuing in 2016-17. grow relatively slowly over the next several years, as rising wages and commodity prices offset www.lao.ca.gov Legislative Analyst’s Office 21 2017-18 BUDGET 22 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Chapter 3: Spending Outlook Figure 12 displays our Figure 12 General Fund spending General Fund Spending Outlook estimates, by major (Dollars in Billions) program, through 2017-18. Estimates Outlook (Our spending projections Change for the entire outlook 2015-16 2016-17a 2017-18 From 2016-17 period are discussed in Education Programs Chapter 4.) Proposition 98b $49.1 $51.0 $52.4 2.7% One-Time and UCc 3.2 3.4 3.4 1.3 CSU 3.0 3.3 3.3 2.3 Temporary Spending Student Aid Commission 1.4 1.1 1.2 3.9 Obscure Underlying Child Care 0.9 0.9 1.1 17.5 Growth Rates. One-time Health and Human Services spending in the 2016-17 Medi-Cal 17.5 17.9 18.7 4.5 CalWORKs 0.7 0.7 1.0 48.2 budget package obscures SSI/SSP 2.8 2.9 2.9 1.5 underlying growth in IHSS 3.0 3.5 3.7 6.2 some of these programs. DDS 3.5 4.0 4.1 2.9 DSH 1.6 1.7 1.6 -4.3 This includes, for example, Other major programsd 2.2 2.4 2.4 0.6 one-time spending for Criminal Justice Programse deferred maintenance in CDCR 9.7 10.0 9.8 -1.1 the California Department Judiciary 1.6 1.8 1.8 -2.2 of Corrections and Infrastructure Debt Servicef 5.3 5.4 5.5 1.7 Rehabilitation, the judicial Other Programs CalSTRS 1.9 2.5 2.6 6.5 branch, and the universities. Proposition 2 debt paymentsg — — 2.0 — The estimate of “remaining Remaining programs 7.4 9.7 8.6 -11.8 programs” includes Totals $114.9 $122.0 $126.1 3.4% one-time funding of a Deferred maintenance spending, which the Department of Finance displays in a single line item, is allocated by department in 2016-17. $1 billion for the new State b Reflects General Fund component of Proposition 98 minimum guarantee. c Excludes Proposition 2 payments for the UC Retirement plan. These payments are included under “other programs.” Project Infrastructure Fund d Includes DHCS family health and state operations, DPH, DCSS, and DSS programs not itemized above. Smaller health and and other, smaller one-time human services programs are included in “remaining programs.” e Excludes smaller departments—such as the Department of Justice—that are included in “remaining programs.” items. Similarly, the figure f Debt service on general obligation and lease revenue bonds generally used for infrastructure. Does not include: (1) lease revenue debt service for community colleges, which is included under Proposition 98, or (2) UC’s and CSU’s debt service, overstates the underlying which is included in their respective line items. g growth in the California In 2015-16 and 2016-17, Proposition 2 debt payment amounts are reflected elsewhere. Included in 2017-18 is the entire estimate of Proposition 2 debt payment requirements. Work Opportunity and IHSS = In-Home Supportive Services; DDS = Department of Developmental Services; DSH = Department of State Hospitals; CDCR = California Department of Corrections and Rehabilitation; DHCS = Department of Health Care Services; Responsibility to Kids DPH = Department of Public Health; DCSS = Department of Child Support Services; and DSS = Department of Social Services. (CalWORKs) program www.lao.ca.gov Legislative Analyst’s Office 23 2017-18 BUDGET because 2017-18 spending in that program reflects carried in from prior years (see our “CalWORKs” General Fund backfill of one-time federal funds write-up for more information). EDUCATION Education Spending. In this section, we largely by Proposition 98, passed by voters in 1988. focus on Proposition 98, the universities, student The measure, modified by Proposition 111 in 1990, financial aid programs, and child care programs. establishes a minimum funding requirement, The “Proposition 98” section estimates total commonly referred to as the minimum guarantee. combined spending for elementary and secondary Both state General Fund and local property tax education (commonly referred to as K-12 revenue apply toward meeting the minimum education), the California Community Colleges, guarantee. In addition to Proposition 98 funding, and a large portion of the state’s subsidized schools and community colleges receive funding preschool program. The next section estimates from the federal government, other state sources spending for the University of California and (such as the lottery), and various local sources (such the California State University. The “Financial as parcel taxes). Aid” section focuses on spending for Cal Grants Calculating the Minimum Funding Guarantee. and Middle Class Scholarships. The last section The Proposition 98 minimum guarantee is estimates non-Proposition 98 General Fund determined by one of three tests set forth in the spending for the rest of the state’s preschool State Constitution (see Figure 13). These tests program as well as most child care programs. depend upon several inputs, including changes in K-12 average daily attendance, per capita personal Proposition 98 income, and per capita General Fund revenue. Proposition 98 Minimum Guarantee for Though the calculation of the minimum guarantee Schools and Community Colleges. State budgeting is formula-driven, a supermajority of the Legislature for schools and community colleges is governed can vote to suspend the formulas and provide Figure 13 The Tests and Basic Rules for Calculating the Minimum Guarantee Test 1—Share of General Fund • Ensures Proposition 98 General Fund is at least about 40 percent of state General Fund revenue. • Applies when it results in a higher funding level than Test 2. • Has been operative 4 of the last 28 years. Test 2—Growth in Personal Income • Adjusts prior-year Proposition 98 funding for changes in K-12 attendance and per capita personal income. • Applies when it results in a lower funding level than Test 3. • Has been operative 14 of the past 28 years. Test 3—Growth in General Fund Revenue • Adjusts prior-year Proposition 98 funding for changes in K-12 attendance and per capita General Fund revenue. • Applies when it results in a lower funding level than Test 2. • Has been operative 8 of the past 28 years. Note: The state has suspended Proposition 98 twice. 24 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET less funding than they require. This happened in reduces Proposition 98 General Fund costs on 2004-05 and 2010-11. In some cases, including a dollar-for-dollar basis. Coupling the increase as a result of a suspension, the state creates a in property tax revenue with the decline in the higher out-year funding obligation referred to as a guarantee results in Proposition 98 General Fund “maintenance factor.” The state is required to make dropping $640 million. progress toward meeting this higher obligation Further Downward Revisions in General Fund when year-to-year growth in state General Fund Revenue Unlikely to Affect 2015-16 Minimum revenue is relatively strong. Though in most years Guarantee. Under our latest revenue estimates, the state has provided an amount at or close to the the operative test for calculating the guarantee in minimum guarantee, the state has discretion to 2015-16 changes from Test 2 to Test 3. Whenever provide any amount above the minimum guarantee. Test 3 is operative, statute requires the state to make a supplemental appropriation if needed to 2015-16 and 2016-17 Updates ensure Proposition 98 funding grows as quickly 2015-16 Minimum Guarantee Down as the rest of the budget. In 2015-16, shifting $378 Million From Budget Act Estimate. The to Test 3 results in the state needing to make a decrease in the minimum guarantee (see Figure 14) $53 million supplemental appropriation. This is due to our estimated $1.4 billion drop in General additional funding raises the guarantee up to Fund tax revenue relative to budget act estimates. As the Test 2 level. In 2015-16, were General Fund a result of this revenue drop, the state is no longer revenue to be further revised downward by as required to make the $379 million maintenance much as $1.6 billion, the required supplemental factor payment included the June budget package. appropriation would increase correspondingly, This drop in the guarantee is offset by a $1 million bringing the guarantee back up to the Test 2 level. increase due to various other adjustments. That is, further revenue declines in 2015-16 likely 2015-16 Local Property Tax Estimate Revised would have no effect on the minimum guarantee. Upward. Though the minimum guarantee has 2016-17 Minimum Guarantee Down $10 Million fallen from budget act estimates, Proposition 98 From Budget Act Estimate. At the time of budget local property tax revenue is up $262 million. The enactment, Test 3 was the operative test in 2016-17. bulk of this increase is attributable to higher-than- Even under our latest estimates, Test 3 remains expected transfers from Educational Revenue operative. In Test 3 years, the minimum guarantee Augmentation Funds to schools and community builds upon the prior-year funding level adjusted colleges. The increase in property tax revenue for changes in per capita General Fund revenue and Figure 14 Updating Estimates of 2015-16 and 2016-17 Minimum Guarantees (In Millions) 2015-16 2016-17 June November June November Budget Plan LAO Estimate Change Budget Plan LAO Estimate Change Minimum Guarantee General Fund $49,722 $49,082 -$640 $51,050 $50,973 -$77 Local property tax 19,328 19,589 262 20,824 20,891 67 Totals $69,050 $68,672 -$378 $71,874 $71,864 -$10 www.lao.ca.gov Legislative Analyst’s Office 25 2017-18 BUDGET K-12 attendance. Compared with June budget act the state has acted to reduce associated spending. assumptions, we estimate General Fund revenue is For purposes of our outlook, we assume the state $1.4 billion lower in 2015-16 and $350 million lower in designates the $351 million as payment toward its 2016-17. Because the drop in the prior year is greater outstanding settle-up obligation. (The state currently than the drop in the current year, the year-to-year has an outstanding settle-up obligation of about growth rate increases. The higher growth rate offsets $1 billion, mostly related to the 2009-10 minimum the decline in the prior-year funding level. After guarantee. The state creates a settle-up obligation updating for various other inputs, including slightly when the minimum guarantee rises above the lower estimates of K-12 attendance, the minimum level initially assumed in the budget act.) Under guarantee is only $10 million below the level assumed this approach, the $351 million is not built into the in June. Under the latest inputs, the state creates 2016-17 Proposition 98 base. $321 million in new maintenance factor, for a total 2017-18 Budget Planning outstanding maintenance factor obligation at the end of 2016-17 of $873 million. The new maintenance 2017-18 Guarantee $2.6 Billion Higher Than factor created dropped from the June budget package Revised 2016-17 Level. As shown in Figure 15, we level of $746 million, due largely to the higher General estimate that the minimum guarantee will grow Fund growth rate. Forecast Assumes Figure 15 State Funds at the Revised Proposition 98 Key Inputs and Outcomes Through 2017-18 Estimates of the Prior-Year (Dollars in Millions) and Current-Year 2015-16 2016-17 2017-18 Minimum Guarantees. Although the 2015-16 Minimum Guaranteea General Fund $49,082 $50,973 $52,354 minimum guarantee has Local property tax 19,589 20,891 22,132 fallen by $378 million, the Totals $68,672 $71,864 $74,486 state allocated funding to Change From Prior Year schools and community General Fund -$948 $1,891 $1,380 Percent change -1.9% 3.9% 2.7% colleges based upon the Local property tax $2,474 $1,301 $1,241 higher June 2016 estimate Percent change 14.5% 6.6% 5.9% of the guarantee. After Total guarantee $1,526 $3,193 $2,621 Percent change 2.3% 4.6% 3.6% adjusting for changes in Operative Test 3 3 2 various program costs, Maintenance Factor we estimate that currently Amount created (+) or paid (-) — $321 -$894 authorized 2015-16 Total outstandingb $525 873 — spending exceeds the Growth Rates minimum guarantee by K-12 average daily attendance -0.2% -0.2% -0.2% Per capita personal income (Test 2) 3.8 5.4 2.7 $351 million. Historically, Per capita General Fund (Test 3)c 3.7 4.4 4.9 in virtually all cases K-14 cost-of-living adjustment 1.0 0.0 1.1 when the prior-year or a Assumes state funds at revised estimate of minimum guarantee each year. b Outstanding maintenance factor is adjusted annually for changes in K-12 attendance and per capita current-year guarantee has personal income. c been revised downward, As set forth in the State Constitution, reflects change in per capita General Fund plus 0.5 percent. 26 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET from $71.9 billion in 2016-17 to $74.5 billion in freed up for other purposes moving forward, the 2017-18, an increase of $2.6 billion (3.6 percent). state already has committed through previous Test 2 is operative, with the guarantee adjusted for budget agreements to $276 million in higher a 2.7 percent increase in per capita personal income 2017-18 spending. The net effect of these changes, and a 0.2 percent decline in K-12 attendance. In in combination with the $2.6 billion increase in the addition, because General Fund revenue is growing minimum guarantee, results in the state having more quickly than per capita personal income, $2.8 billion to spend on its 2017-18 Proposition 98 the state is required to make an $894 million priorities. maintenance factor payment. After making this State Could Achieve Almost Full payment, the state would end the year with no Implementation of the Local Control Funding outstanding maintenance factor for the first time Formula (LCFF) in 2017-18. In recent years, since 2005-06. the state has dedicated most new Proposition 98 Nearly Half of Increase Covered With funding to implementing the LCFF. If the Property Tax Revenue. Of the $2.6 billion increase state continued this practice in 2017-18, we in Proposition 98 funding, state General Fund estimate it could fund 99 percent of LCFF’s full revenue covers $1.4 billion and local property implementation cost. Specifically, we estimate the tax revenue covers $1.2 billion. The main factor state could spend $2.5 billion to close the remaining explaining the increase in property tax revenue LCFF gap, increasing per-student LCFF funding is a 5.3 percent increase in assessed property by 4.5 percent over 2016-17 levels. Our estimate values. This factor accounts for about $930 million assumes community colleges continue to receive of the increase. The other large contributing 11 percent of Proposition 98 funding, the state factor is a $340 million increase in the ongoing funds previously agreed-upon commitments, and savings associated with the dissolution of Figure 16 redevelopment agencies. $2.8 Billion Increase in Proposition 98 Funding Projected for 2017-18 This increase is primarily (In Millions) due to the phase out of 2016-17 Budget Act Spending $71,874 certain one-time costs Back out one-time actions: related to recent changes Secondary school career technical education grants (year two) -$292 in the dissolution process. CCC maintenance and instructional equipment -154 CCC Innovation Awards -25 $2.8 Billion Available CCC intersegmental college partnerships -15 for Proposition 98 CCC zero-textbook-cost degree startup funding -5 Priorities. As shown in Adult education consortia technical assistance -5 Subtotal (-$496) Figure 16, the 2016-17 Fund previously approved commitments: Budget Act provided Secondary school career technical education grants (year three)a $200 $71.9 billion in funding for Preschool rate and slot increasesb 76 Subtotal ($276) schools and community New Funds Available in 2017-18 $2,833 colleges. Of this amount, 2017-18 Minimum Guarantee $74,486 $496 million was allocated a The state could fund all or a portion of this program with unspent prior-year funds. b for one-time activities. Reflects augmentations of $44 million for the full-year cost of increasing the Standard Reimbursement Rate effective January 1, 2017; $24 million for the full-year cost of additional slots that will begin on April 1, 2017; and $8 million for the partial-year cost Though this funding is of additional slots that will begin on April 1, 2018. www.lao.ca.gov Legislative Analyst’s Office 27 2017-18 BUDGET other K-12 categorical programs are adjusted for scenarios have built in the additional state General changes in attendance and cost of living. Fund revenue resulting from the recent passage 2017-18 Guarantee Moderately Sensitive of Proposition 55, which extended the income to Declines in State Revenue. We estimate that tax rates paid by high-income earners for an General Fund revenue could fall as much as additional 12 years. (Though it does not affect the $500 million below our estimates in 2017-18 with calculation of the guarantee, the recent passage of no change in the minimum guarantee. Even at Proposition 51 is another significant development this lower level, Test 2 would remain operative and for schools and community colleges. The measure year-to-year revenue growth would be large enough provides $9 billion in bonds for building and to require the state to pay down all remaining renovations school facilities.) maintenance factor. For each additional dollar of Under Growth Scenario, Minimum Guarantee revenue decline beyond this level, the guarantee Continues to Rise. As shown in the top part of would drop by about 40 cents. Regarding possible Figure 17, the minimum guarantee under the revenue increases, the minimum guarantee is growth scenario increases from $71.9 billion mostly insensitive to any increase above the in 2016-17 to $83.5 billion in 2020-21. The level assumed in our outlook. We estimate that average annual growth rate under this scenario 2017-18 General Fund revenue could increase is 3.8 percent. Under this scenario, the state about $5.5 billion before having any effect on creates little new maintenance factor, ending the the minimum guarantee. (An increase of this period with about $200 million in outstanding magnitude would make Test 1 operative and maintenance factor obligation. provide schools and community colleges about Under Recession Scenario, Minimum 40 cents of each dollar above the $5.5 billion Guarantee Declines in 2018-19 and Remains threshold.) For the purpose of this sensitivity Below Growth Scenario. As shown in the middle analysis, we assume prior-year revenue and other part of Figure 17, the guarantee under the recession inputs remain constant. Changes to these factors scenario declines by $1.4 billion (1.9 percent) from could affect the thresholds and make the guarantee 2017-18 to 2018-19. In 2018-19, the state creates more more or less sensitive. than $4 billion in new maintenance factor. Even with the state making maintenance factor payments Outlook for Later Years the subsequent two years, the state ends the period Many Economic Scenarios Could Unfold Over with $3.1 billion in outstanding maintenance the Period. State General Fund revenue over the factor obligation. Under the recession scenario, the next four years is likely to be affected by a variety guarantee grows from $71.9 billion in 2016-17 to of short-term developments (such as swings in the $78.1 billion in 2020-21, an average annual growth stock market) as well as long-term trends (such rate of 2.1 percent. As shown in the bottom section as growth in housing prices). In this section, we of Figure 17, by 2020-21 the minimum guarantee describe how the minimum guarantee would under the recession scenario is more than $5 billion respond to two hypothetical economic scenarios— below the level in the growth scenario. (Though this one assuming continued moderate growth over scenario assumes the recession does not begin until the period and one assuming a mild recession 2018-19, the 2017-18 year also is affected due to state beginning in the middle of 2018. (These scenarios accrual policies.) are discussed in greater detail in Chapter 4.) Both 28 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Recession Scenario Serves as Cautionary some of the available Proposition 98 funding for Tale. Although the recession scenario illustrates one-time activities. If the guarantee experiences one way an economic downturn could unfold, a year-over-year decline, the expiration of this the timing and magnitude of the next recession is one-time funding provides a buffer that reduces highly uncertain. Rather than being a prediction, the likelihood of cuts to ongoing school and the recession scenario serves as a cautionary tale community college programs. about the volatility of Proposition 98 funding. Local Property Tax Revenue Projected to To provide a measure of protection against such Rise Steadily Over the Period. Unlike the state volatility, the state in recent years has allocated General Fund, which tends to be highly sensitive Figure 17 Proposition 98 Outlook Under Two Economic Scenarios (Dollars in Billions) 2016-17 2017-18 2018-19 2019-20 2020-21 Economic Growth Scenario General Fund Tax Revenue $122.9 $129.5 $135.8 $142.0 $147.2 Minimum Guarantee $71.9 $74.5 $77.5 $80.7 $83.5 Year-to-year change — $2.6 $3.0 $3.2 $2.8 Percent change — 3.6% 4.1% 4.1% 3.4% Operative Test 3 2 2 3 3 Maintenance Factor Amount created (+) or paid (-) $0.3 -$0.9 — $0.2 $0.0 Total outstandinga 0.9 — — 0.2 0.2 Key Factors Per capita personal income (Test 2) 5.4% 2.7% 4.5% 4.7% 3.8% Per capita General Fund (Test 3)b 4.4 4.9 4.6 4.3 3.4 Mild Recession Scenario General Fund Tax Revenue $122.9 $127.6 $124.3 $128.0 $133.9 Minimum Guarantee $71.9 $73.8 $72.4 $73.8 $78.1 Year-to-year change — $1.9 -$1.4 $1.5 $4.2 Percent change — 2.7% -1.9% 2.0% 5.7% Operative Test 3 2 3 1 1 Maintenance Factor Amount created (+) or paid (-) $0.3 -$0.2 $4.4 -$0.7 -$1.4 Total outstandinga 0.9 0.7 5.1 4.5 3.1 Key Factors Per capita personal income (Test 2) 5.4% 2.7% 4.5% 1.1% 1.7% Per capita General Fund (Test 3)b 4.4 3.5 -2.9 2.7 4.4 Comparison of Scenarios Minimum Guarantee Economic Growth Scenario $71.9 $74.5 $77.5 $80.7 $83.5 Mild Recession Scenario 71.9 73.8 72.4 73.8 78.1 Difference — $0.7 $5.1 $6.9 $5.4 a Outstanding maintenance factor is adjusted annually for changes in K-12 attendance and per capita personal income. b As set forth in the State Constitution, reflects change in per capita General Fund plus 0.5 percent. www.lao.ca.gov Legislative Analyst’s Office 29 2017-18 BUDGET to short-term economic developments, property LCFF, the Legislature would have an additional tax revenue typically grows at a steadier rate. $1.5 billion to $2.5 billion per year to spend on Under both our scenarios, the outlook assumes other Proposition 98 priorities. Under the recession that property tax revenue grows from $20.9 billion scenario, we estimate the state would not fully fund in 2016-17 to $25.6 billion by 2020-21. Property LCFF until 2020-21. tax revenue covers about 40 percent of the annual Pension Costs Rising Over the Period. increases in the minimum guarantee under the Employer contributions to the California State growth scenario and about 65 percent of the Teachers’ Retirement System (CalSTRS) and increases under the recession scenario. Property California Public Employees’ Retirement System tax revenue projections are driven primarily by (CalPERS) are a key factor affecting the budgets assumptions of growth in assessed property values. of schools and community colleges. (CalSTRS We assume assessed values grow about 5.5 percent administers the pension system for teachers and per year over the outlook period. other certificated employees, whereas CalPERS K-14 Cost-of-Living Adjustments (COLA) administers the pension system for classified Projected to Remain Low. The statutory COLA for employees.) The 2014-15 budget included a most K-14 programs is based upon a national price plan to fully fund the CalSTRS pension system index for state and local government goods and within about 30 years. Under the plan, district services. Our outlook assumes the statutory COLA contribution rates increase from 8.25 percent remains low throughout the period—hovering of payroll in 2013-14 to 19.1 percent of payroll around 1 percent. by 2020-21. In addition, the governing board K-12 Attendance Projected to Decline. Our of CalPERS has taken action in recent years to outlook assumes that K-12 attendance declines by increase rates and pay down these liabilities more 0.2 percent per year in 2016-17 and 2017-18 and by quickly. The latest actuarial estimates suggest 0.3 percent per year later in the period. The largest that employer contribution rates for CalPERS factor explaining this decline is the outlook for will increase from 11.4 percent in 2013-14 to birth rates. Whereas the state had about 550,000 21.1 percent by 2020-21. Compared with 2013-14 births in 2007-08, births had dropped to about levels, total district contributions to CalSTRS and 500,000 in 2010-11. We assume births remain at CalPERS are anticipated to be nearly $6 billion this lower level throughout the period and that the higher annually by 2020-21. (Of this total cost school-age population declines as these smaller increase, about 70 percent relates to CalSTRS.) cohorts of students replace their larger cohort Under the growth scenario, these higher costs predecessors. We also assume relatively stable rates represents about one-quarter of the $24 billion of migration from other states and countries. cumulative increase in Proposition 98 funding LCFF Could Reach Full Implementation Soon, districts would receive by 2020-21. Under the Grow for COLA Thereafter. Under our growth recession scenario, these costs represent about scenario, we estimate the state could fully fund the one-third of the $19 billion cumulative increase in LCFF as soon as 2018-19. In this and subsequent Proposition 98 funding. years, growth in Proposition 98 funding would Universities be more than sufficient to cover the LCFF targets as adjusted for changes in attendance and cost of Overview of Public Universities. The living. Under the growth scenario, after supporting state has two public university systems. The 30 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET University of California (UC) educates slightly we forecast these as part of overall state employee more than 250,000 full-time equivalent (FTE) costs. (We include Hastings College of the Law undergraduate and graduate students at ten in our consolidated forecast of relatively small campuses. The California State University (CSU) state programs, as the state provides less than educates almost 400,000 FTE undergraduate $15 million General Fund annually for the college.) and graduate students at 23 campuses. These Assume Annual General-Purpose Base counts include resident and nonresident students. Increases Over Forecast Period. We assume Resident enrollment comprises 83 percent of total the state will provide UC and CSU with annual systemwide enrollment at UC and 94 percent at base increases from 2017-18 through 2020-21. CSU. Both university systems receive support Consistent with state actions in 2013-14, 2014-15, for their undergraduate and graduate programs and 2016-17, we assume UC and CSU receive the from a combination of state General Fund and same dollar increases. Specifically, we calculate student tuition revenue. In 2015-16, UC received base augmentations for both university systems $3.2 billion in state General Fund and $3 billion in by increasing UC’s General Fund appropriation student tuition revenue. CSU received $3 billion by 4 percent annually. UC and CSU likely would in state General Fund and $2.3 billion in student use these base augmentations to cover increases tuition revenue. in operational costs and state facility debt service Challenges in Basing UC and CSU Forecasts costs, as well as support some enrollment growth. on Current Law, Base Instead on Current Practice. Assume Two Other Increases for CSU in Whereas the State Constitution, state law, and 2017-18. In addition to annual general purpose federal law notably constrain some areas of the state base increases, we assume CSU receives an ongoing budget (for example, K-14 education and health augmentation of $26 million beginning in 2017-18 care), they do not notably constrain budgeting for associated with savings generated from policy UC and CSU. In any given year, the Legislature changes made to the Middle Class Scholarship and the two university systems have significant program in 2015-16. We also assume an additional discretion in deciding both what cost increases to $5.1 million ongoing augmentation to cover fund and how to fund those increases. As current projected increases in CSU’s lease revenue debt law does not contain explicit guidance relating to service. Both assumptions are based on previously UC and CSU cost increases, we assume UC and agreed schedules of payments implemented by the CSU costs will increase similar to recent years. We Legislature in prior years. describe the baseline and specific assumptions we Based on These Assumptions, UC and CSU use for the UC and CSU forecasts below. Spending Grows a Combined $118 Million in The Baseline for the University Forecasts. 2017-18. Under these assumptions, General We use UC’s and CSU’s main state General Fund support in 2017-18 grows by $43 million Fund appropriations as the starting point for (1.3 percent) for UC and $75 million (2.3 percent) our forecasts. These main appropriations include for CSU. The increases in 2017-18 are less than ongoing and one-time funding the state provided 4 percent because of the significant amount of in 2016-17. For UC, however, we back out one-time one-time funds the state provided to UC and CSU Proposition 2 payments for outstanding pension in 2016-17. For the remainder of the forecast period, liabilities. For CSU, we exclude cost increases for state spending on UC and CSU increases each retiree health and most pension contributions, as year by 4 percent and 4.1 percent, respectively. By www.lao.ca.gov Legislative Analyst’s Office 31 2017-18 BUDGET 2020-21, state spending on UC and CSU reaches Financial Aid $3.8 billion for each system, reflecting increases of Overview of State’s Financial Aid Programs. about 15 percent over their 2016-17 levels. The California Student Aid Commission (CSAC) is Spending Would Increase if State Funded responsible for administering most state financial Enrollment Growth on Top of Base Increases. The aid programs. The largest of these programs is the university forecasts assume UC and CSU fund Cal Grant program, which serves about 330,000 enrollment growth from their base increases. If undergraduate students. This program primarily the Legislature funded enrollment growth on top covers tuition for financially needy students who of the base increases in 2017-18 (as it has the past meet academic and other eligibility requirements. two years), it would cost the state $29 million at The program currently costs $2 billion and is CSU and between $11 million and $16 million funded almost entirely with a combination at UC for each 1 percent growth. (The range for of state General Fund and federal Temporary UC reflects the notably different per-student Assistance for Needy Families (TANF) monies. funding rates provided by the Legislature in recent The second largest CSAC program is the Middle budgets—$5,000 per student in 2015-16 and $7,400 Class Scholarship program. This program provides per student in 2016-17.) partial tuition coverage for UC and CSU students Spending Also Could Be Affected by Tuition who do not meet the financial need criteria for a Decisions. The UC and CSU forecasts noted above Cal Grant but whose family income and assets fall make no explicit assumption about tuition levels. below certain thresholds. Currently costing less Historically, however, state General Fund and than $100 million, this program is funded entirely tuition decisions have been closely intertwined. In with state General Fund. some prior years, the state has provided additional Key Assumption About Cal Grant General Fund on the condition UC and CSU do Participation. For Cal Grants, we assume not raise tuition levels. In other years, when state participation growth of 2 percent each year. This General Fund has been reduced, UC and CSU assumption is based on two factors. First, we have raised tuition levels. Since 2011-12, the main assume Cal Grant participation grows in line with systemwide tuition charges at UC and CSU have projections of high school graduates. We believe been flat. In May 2015, the UC Regents endorsed this is a reasonable assumption given the Cal a long-term plan that would increase tuition Grant high school entitlement program accounts levels at about the rate of inflation beginning for three-quarters of Cal Grant recipients. Average in 2017-18. CSU also has initiated discussions annual growth in high school graduates over the with stakeholders to adopt tuition increases (of forecast period is projected to be slightly less than 4.9 percent for undergraduates and 6.5 percent for half of 1 percent. Second, we assume Cal Grant graduates) in 2017-18. We estimate every 1 percent participation increases another 1.5 percent each increase in the main systemwide tuition charge year due to ongoing efforts to increase the share of would raise $19 million and $16 million for UC and eligible students receiving awards. In recent years, CSU, respectively, in 2017-18. If tuition levels were such efforts appear to have increased Cal Grant raised, the Legislature, as in the past, could decide participation beyond what would be expected based whether the additional revenue should supplement on demographic trends alone. Moreover, the federal or replace General Fund support. government recently made additional changes to 32 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET simplify the aid application process for students would be around $230 million higher by 2020-21. applying for the 2017-18 academic year. As a rule of thumb, assuming no other program Other Key Assumptions Underlying Forecast. changes, we estimate every 1 percent increase in For Cal Grants, we also assume the award Cal Grant participation increases annual costs by amount for new students attending nonprofit roughly $20 million. Financial aid costs throughout colleges is reduced from $9,084 to $8,056 starting the period also could be higher if UC and CSU were in 2017-18 (consistent with state law). Additionally, to increase tuition. Assuming no other program we assume the state continues to use the same changes, we estimate each 1 percent increase in amount of federal TANF funds to offset a portion tuition would increase financial aid spending by of General Fund Cal Grant costs. For Middle roughly $15 million annually. Class Scholarships, we assume the final phase in Child Care of award amounts scheduled under current law, with maximum tuition coverage increasing from Overview of State-Subsidized Child Care. The 30 percent in 2016-17 to 40 percent in 2017-18. state subsidizes child care for some low-income, We assume year-to-year changes in participation working families. Specifically, the state guarantees consistent with changes in high school graduates. subsidized care for families participating in the Consistent with changes in tuition and fee levels California Work Opportunity and Responsibility over the past two years, we assume flat tuition to Kids (CalWORKs) program. Slots for other at UC and CSU throughout the period as well as families are capped, with the lowest-income 5 percent annual increases in UC’s Student Services families receiving priority. The 2016-17 budget Fee. Additionally, we assume the continued phase provides $982 million in non-Proposition 98 out of loan assumption programs and the removal General Fund for subsidized child care. Below, of one-time state operations funding for CSAC. we discuss the forecast for non-Proposition 98 Based on These Assumptions, General Fund General Fund child care spending, excluding Costs Increase $44 Million in 2017-18. Under Stage 1 CalWORKs child care ($40 million these assumptions, financial aid costs grow from non-Proposition 98 General Fund). We include $2 billion in 2016-17 to $2.1 billion in 2017-18— Stage 1 in our forecast for the Department of Social growth of $44 million (2 percent). Of this amount, Services. (Child care programs are supported with $28.3 million reflects higher net Cal Grant costs state and federal funding. In 2016-17, CalWORKs and $20.5 million is associated with higher Middle and non-CalWORKs child care programs received Class Scholarship costs. These two cost increases a total of $1 billion in federal funds, roughly are offset by $5.2 million in reductions associated two-thirds of which came from the Child Care with the phase out of loan assumption programs and Development Block Grant and one-third from and backing out prior-year one-time funds. TANF.) Costs Over Forecast Period Very Sensitive to Assumptions Underlying Child Care Assumptions About Cal Grant Participation and Forecast. As part of the 2016-17 budget package, Tuition Levels. Growth in Cal Grant participation the Legislature and the Governor agreed on a could be higher than the level assumed in our multiyear plan to increase spending on child forecast. For instance, had we assumed recent care and preschool. The plan would result in a growth rates in participation continue throughout roughly $300 million non-Proposition 98 increase the forecast period, annual Cal Grant spending in child care and preschool spending by 2019-20. www.lao.ca.gov Legislative Analyst’s Office 33 2017-18 BUDGET Some parts of the agreement, such as certain rate 0.3 percent reduction in non-CalWORKs caseload increases, were detailed in statute or provisional (reflecting a decline in the birth-to-four population) budget language. Other parts, such as set-asides coupled with a slight decline in projected Stage 3 for future rate increases, were reflected in back-up caseload. budget documents. For the child care forecast, Out-Year Child Care Costs. We project child we assume the state adheres to all associated care spending will grow to nearly $1.2 billion in statutory provisions as well as provides all the 2018-19, an increase of $56 million (5 percent). future set-asides included in the multiyear plan. In This is due largely to the set-aside for future rate addition, the forecast assumes the state will adjust increases specified in the multiyear budget deal. non-CalWORKs child care and preschool spending Costs grow slightly in the following two years. annually for COLA and the change in the birth- California in Midst of Responding to New to-four population in California (consistent with Federal Requirements. The federal government state law). reauthorized the Child Care and Development Child Care Costs Projected to Increase Block Grant in 2014—creating a new set of Notably in 2017-18. We project General Fund child requirements for states. Most notably, the federal care spending to increase from $941 million in government changed: how states are to set provider 2016-17 to $1.1 billion in 2017-18, an increase of reimbursement rates, how frequently states are $165 million (17.5 percent). The bulk of this increase to inspect providers, how long a family can be ($158 million) is due to annualizing rate increases eligible for child care, and how much states must initiated in January 1, 2017 and implementing spend on activities designed to improve the quality additional rate increases in 2017-18 consistent of child care. Decisions the Legislature makes in with the multiyear budget deal. The rest of the implementing the new federal requirements could increase is due to applying a 1.12 percent COLA significantly increase state costs. Any associated to non-CalWORKs programs and accounting for cost increases would be on top of the cost increases slightly higher projected Stage 2 caseload. These included in our forecast. cost increases are partly offset by a projected HEALTH AND HUMAN SERVICES Overview of Health Services Provided. the Patient Protection and Affordable Care Act California’s major health programs provide health (ACA), also known as federal health care reform. coverage and additional services for various In addition, the state supports various public health groups of eligible persons—primarily poor families programs. Although state departments oversee the and children as well as seniors and persons with management of these programs, the actual delivery disabilities. The federal Medicaid program, known of many services is carried out by counties and as Medi-Cal in California, is the largest state health other local entities. Health programs are largely program both in terms of funding and number federally and state funded. of persons served. The Medi-Cal population has Overview of Human Services Provided. grown substantially since January 2014, reflecting The state provides a variety of human services an expansion of those eligible for Medi-Cal and and benefits to its citizens. These include income a streamlining of eligibility requirements under maintenance for the aged, blind, and disabled; 34 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET cash assistance and welfare-to-work services for in the later years of the outlook reflect growth in low-income families with children; protection of Medi-Cal spending, due primarily to underlying children from abuse and neglect; the provision program growth in caseload and costs per enrollee, of home-care workers who assist the aged and assumed additional spending from Proposition 55, disabled in remaining in their own homes; the increasing state share of costs for the optional and community services and state-operated Medi-Cal expansion population, and the assumed facilities for the mentally ill and developmentally sunset of the managed care organization (MCO) disabled. Although state departments oversee the tax at the end of 2018-19. Other significant factors management of these programs, the actual delivery explaining this spending growth include increased of many services is carried out by county welfare caseload, utilization of services per consumer, and child support offices, and other local entities. and costs due to statutorily scheduled minimum Most human services programs have a mixture of wage increases in both IHSS and the provision of federal, state, and county funding. community-based developmental services. Overall Spending Trends. The 2016-17 budget Although the average projected annual increase provides $33 billion in General Fund spending in HHS spending from 2016-17 through 2020-21 for health and human services (HHS) programs. is 8.1 percent, there is substantial variation in We now estimate that these General Fund costs spending growth rates by program. For example, will be slightly higher—by $247 million—in part over these years, General Fund spending growth reflecting higher Medi-Cal costs to serve enrollees for Medi-Cal averages 10.9 percent per year, who are dually eligible for Medi-Cal and Medicare. while the Supplemental Security Income/State Based on current-law requirements, we project that Supplementary Program (SSI/SSP) is projected to General Fund spending for HHS programs will grow more modestly, with average annual growth increase to $34.7 billion in 2017-18 and $38.2 billion of 3 percent. General Fund spending for the in 2018-19. A majority of the growth in 2017-18 CalWORKs program is projected to decline after reflects higher General Fund Medi-Cal spending, 2017-18, in part reflecting both projected caseload due mainly to underlying program growth in declines as well as the infusion of non-General caseload and costs per enrollee and an increasing Fund funding sources to support the program. state share of costs for the optional Medi-Cal Below, we discuss spending trends in the major expansion population under federal health care HHS programs. reform. Other significant factors explaining this Medi-Cal growth include increased caseload and costs per consumer in both In-Home Supportive Services Overall Spending Trends. We estimate that (IHSS) and the provision of community-based 2016-17 General Fund spending for Medi-Cal developmental services, as well as a reduction local assistance will be $17.9 billion—0.7 percent of available federal TANF block grant funding (or $130 million) higher than what was assumed in CalWORKs (which increases General Fund in the 2016-17 Budget Act. This mainly reflects spending) assumed in our outlook in 2017-18 and higher General Fund spending on Medicare subsequent years relative to 2016-17. Part A and B premiums for beneficiaries dually We project that spending for HHS programs enrolled in Medi-Cal and Medicare as a result will reach $45.4 billion in 2020-21 in our economic of updated projections of 2017 premiums from growth scenario. The bulk of the spending growth the federal government. General Fund support www.lao.ca.gov Legislative Analyst’s Office 35 2017-18 BUDGET increases 4.5 percent to $18.7 billion in 2017-18 and ACA expansion. Total enrollment in June 2016 increases an additional 15.9 percent to $21.7 billion represents a net increase of roughly 800,000 (or in 2018-19. General Fund costs are projected to 6 percent) from total enrollment in June 2015. increase in 2017-18 largely as a result of underlying Caseload Growth Projected to Continue. program growth in caseload and per-enrollee costs We assume enrollment among families, children, as well as increased costs associated with the newly and the optional expansion population will grow eligible population under the ACA (the so-called annually at a rate of about 1 percent throughout “optional expansion population”) as the state the outlook period. This translates into growth cost share for this population increases. (Under of about 100,000 enrollees per year across these the ACA, the state’s cost share for the optional populations. We also assume enrollment among expansion population is 5 percent beginning in seniors and persons with disabilities will grow at 2017, increasing to 10 percent by 2020 and beyond.) their historical annual rates of about 3 percent and In addition to underlying program growth and 2 percent, respectively, throughout the outlook the optional expansion, costs are projected to period. This translates into growth of roughly increase in 2018-19 as a result of the passage of 50,000 enrollees per year among seniors and person Proposition 55. We assume Proposition 55 will with disabilities. result in $2 billion in additional funding from Projected Growth in Managed Care and the General Fund for Medi-Cal in 2018-19. (We Fee-for-Service (FFS) Expenditures. The note that the actual amount of revenue Medi-Cal underlying sources of growth in Medi-Cal are receives in 2018-19 as a result of Proposition 55 will changes in caseload and per-enrollee costs. The vary between zero dollars and $2 billion depending latter is dependent on growth in health care prices on decisions by the administration.) Absent the paid by the program in managed care and FFS. We additional funding resulting from Proposition 55, estimate that under our economic growth scenario Medi-Cal’s budget in 2018-19 would otherwise overall expenditures in managed care will grow have grown by 5.2 percent relative to 2017-18. by about 5 percent annually through 2020-21. Our General Fund cost growth in 2019-20 and 2020-21 outlook also assumes overall FFS expenditures is projected to be 14.3 percent and 9.2 percent, will grow by about 4 percent annually throughout respectively (assuming Proposition 55 continues to the outlook period. These projections are subject result in $2 billion in additional funding annually to considerable uncertainty, particularly if future from the General Fund for Medi-Cal). This largely movements in managed care capitated rates or FFS reflects the sunset of the current MCO tax, the costs differ substantially from recent historical state’s increased share of cost for the optional trends. expansion population, and an end to increased State Share of Cost for ACA Optional federal funding for the Children’s Health Insurance Expansion Begins in 2017. From 2014 through Program (CHIP). 2016, the federal government pays 100 percent of Caseload Continues to Grow. In June 2016— the costs for the optional expansion population. the most recent month for which enrollment Under current law, the federal share will decline counts may be considered nearly complete—total from 2017 to 2020, with the state eventually paying Medi-Cal caseload was around 13.6 million. This 10 percent of the cost of health care services for includes nearly 3.4 million individuals who became the optional expansion population. Our outlook newly eligible for Medi-Cal under the optional assumes General Fund costs associated with this 36 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET population of roughly $900 million in 2017-18 Coordinated Care Initiative (CCI) Assumed growing to over $1.6 billion in 2020-21. to Continue. The CCI is a seven-county CHIP Federal Funding. CHIP is a joint federal- demonstration project consisting of three main state program that provides health coverage to components: (1) the optional enrollment of “dual children in low-income families but with incomes eligibles” into managed care plans that integrate too high to qualify for Medicaid. In California, their Medi-Cal and Medicare benefits (known as both CHIP and Medicaid coverage are provided “Cal MediConnect”); (2) mandatory enrollment through Medi-Cal. The ACA authorizes an of dual eligibles into managed care for their increase in the federal share of cost for CHIP from Medi-Cal benefits; and (3) making Medi-Cal- 65 percent to 88 percent. The higher federal share of funded long-term services and supports, including cost will be available from October 1, 2015 through IHSS, available exclusively through managed September 30, 2019. On a full-year basis, this results care. Current law requires CCI to demonstrate in General Fund savings of over $600 million. net General Fund savings—as estimated by the However, federal funding for CHIP has only Department of Finance—to remain operative each been appropriated through September 30, 2017. fiscal year. We assume CCI remains operative Our outlook assumes Congress will appropriate throughout the outlook period. additional funding for CHIP beyond September 30, Outlook Accounts for Passage of 2017 and that the enhanced federal cost share Proposition 52. Our outlook accounts for the authorized by ACA will continue through passage of Proposition 52, which extends the September 30, 2019. After September 30, 2019, our hospital quality assurance fee permanently. While outlook assumes the enhanced federal cost share recent federal regulations governing Medicaid will no longer be available, consistent with what is managed care have the potential to require changes authorized under the ACA, and the federal share of to the fee to obtain federal approval, we assume cost will revert to the historical level of 65 percent. the fee will be approved by the federal government MCO Tax Assumed to End After July 1, 2019. and that the General Fund savings generated by the Chapter 2 of the 2015-16 Second Extraordinary fee will not be impacted by any necessary changes. Session (SB2X 2, Hernandez) imposes a revised We assume the fee will result in General Fund MCO tax on most managed care plans for three savings of $850 million in 2017-18, growing to over years ending July 1, 2019. We assume the MCO tax $1 billion by 2020-21. is not extended by the Legislature beyond this time In-Home Supportive Services and therefore ends after July 1, 2019. In 2017-18 and 2018-19, we assume the MCO tax results in General Fund expenditures for IHSS are annual General Fund savings of about $1.7 billion estimated to be $3.5 billion in 2016-17, increasing in Medi-Cal. (The net General Fund savings from to about $3.7 billion in 2017-18. This increase is the MCO tax are about $1.3 billion in each year primarily due to projected caseload and hours-per- after accounting for the General Fund impact of consumer growth, which we assume will continue other tax provisions associated with the MCO tax.) throughout the outlook period. We project that We assume the General Fund savings in Medi-Cal IHSS expenditures will reach nearly $5 billion by phase down to about $450 million in 2019-20 as a 2020-21. To a large degree, this growth reflects the result of Medi-Cal being budgeted on a cash basis, implementation of statutorily scheduled statewide before being phased out entirely in 2020-21. minimum wage increases that will significantly www.lao.ca.gov Legislative Analyst’s Office 37 2017-18 BUDGET increase the average cost per consumer, particularly in 2017-18 in order to prepare for the launch of paid beginning in 2018-19. In addition, implementing sick leave in 2018-19. a new paid sick leave policy for IHSS providers County Costs of IHSS Continue to Depend beginning in 2018-19 will likely increase IHSS on CCI. As we discussed in the Medi-Cal section costs, but the full fiscal impact of this policy is of this report, we assume CCI continues to be uncertain. These cost pressures are projected to implemented throughout the outlook period. be partially offset by: (1) increases to the county Therefore, we also assume that the county MOE maintenance-of-effort (MOE) that reduce the state for IHSS will continue, increasing by 3.5 percent share of IHSS costs, and (2) the end of General per year plus a share of any wages and benefits Fund support for the restoration of IHSS service negotiated at the county level. Should the CCI be hours previously reduced by 7 percent (this General discontinued and the MOE unwound, counties’ Fund support is set to expire with the sunset of contributions to IHSS would return to the share of the current MCO tax at the end of 2018-19). These cost levels in place prior to CCI—about 35 percent factors are discussed in more detail below. of the nonfederal share of IHSS program costs. Rising Statewide Minimum Wage Will This increase in county contributions to IHSS costs Increase Hourly Cost of Care. The newly enacted could decrease our projected state share of cost statewide minimum wage increases—set to for the IHSS program by hundreds of millions of gradually raise the state’s minimum wage to $15 dollars annually in the out-years. per hour by 2022—will generally increase wages Restoration of the IHSS Service Hours for IHSS providers. Since the current average wage Previously Reduced by 7 Percent Tied to MCO Tax for IHSS providers is about $11 per hour (above Existence. Beginning in 2016-17, the General Fund the current statewide minimum wage), we project will support the restoration of the IHSS service that the major costs of the scheduled minimum hours previously reduced by 7 percent so long as wage increases will begin when wages increase to the MCO tax is in place. Since the MCO tax is set $12 per hour and above, beginning in 2019. When to expire at the end of 2018-19 under current law the statewide minimum wage increases are fully and continuation of the tax beyond the sunset date implemented in 2022, we estimate the costs of the is uncertain, our outlook projections assume that minimum wage increases to total about $1.5 billion this General Fund support for the restoration of General Fund per year, growing with growth in service hours will not be included beginning in caseload and hours per consumer. 2019-20. We estimate that discontinuing General Costs, Implementation of Paid Sick Leave Fund support would result in General Fund savings for IHSS Providers Uncertain. Beginning on of about $300 million annually, growing with July 1, 2018, IHSS providers will be eligible— growth in caseload and hours per consumer. For pursuant to 2016 legislation—to earn up to further discussion of the MCO tax, please reference 8 hours annually of paid sick leave, ramping up the “Medi-Cal” section of this report. to 24 hours annually when the minimum wage is Developmental Services increased to $15 per hour (scheduled for January 1, 2022). The implementation details of paid sick We estimate that General Fund spending leave are uncertain and could require significant for the Department of Developmental Services administrative effort. We anticipate there could be (DDS) will total $4.0 billion in 2016-17. We project some administrative costs related to paid sick leave that General Fund expenditures will increase 38 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET by $118 million in 2017-18 and reach a total of federal funding—annually through 2019, we note $4.4 billion by 2018-19. By 2020-21, we project that there is a possibility of a loss of federal funds General Fund expenditures to reach $5.6 billion. during this time if the terms of the agreements are These projected expenditure increases are mostly not met. In such circumstances, the General Fund due to cost increases for community services would likely be called upon to backfill the lost resulting from (1) a growing caseload (we project federal funding. Second, we find that compliance 4 percent annual growth) and (2) increased costs by March 2019 with new federal requirements per consumer. The increased costs per consumer related to Medicaid-funded community-based in the community are higher due in part to services could drive additional state spending not changes in service utilization as well as impacts included in our outlook. We have not accounted of statutorily scheduled minimum wage increases for these potential costs due to the high level of throughout the outlook period. (We note that, due uncertainty regarding the timing and order of to incomplete data, our estimated minimum wage magnitude of these costs. impacts are highly uncertain.) Overall, estimated SSI/SSP expenditure increases are partially offset by reductions in the cost for developmental centers State expenditures for SSI/SSP are estimated (DCs) as a result of individuals transitioning out of to be $2.9 billion in 2016-17 and are projected the DCs due to anticipated closures. We assume DC to remain at about the same level in 2017-18. We closures will occur consistent with DDS’ projected estimate that caseload growth will increase state timelines, with Sonoma DC scheduled to close by costs by about $20 million annually through the the end of 2018 and Fairview DC and the general outlook period. We have also assumed that the treatment area at Porterville DC scheduled to close state provides each year over the forecast period a by the end of 2021. COLA on the state-funded SSP portion of the SSI/ Potential Fiscal Pressures. There are a few SSP grant. Such a COLA was enacted as part of the potentially significant fiscal pressures that could 2016-17 budget package. We estimate an ongoing drive further spending not assumed in our outlook. COLA would increase SSI/SSP General Fund costs First, we assume that DDS will maintain federal by $60 million to $90 million annually, resulting in Medicaid funding for individuals in Intermediate total spending on SSI/SSP reaching approximately Care Facility living units at Porterville and $3.2 billion by 2020-21. Fairview DCs found by the Department of Public Housing and Disability Income Advocacy Health to be out of compliance with federal Program Could Increase Caseload, State Costs. certification requirements. Effective July 1, 2016, The 2016-17 budget provided $43.5 million of the state successfully negotiated settlement one-time General Fund support—to be spent over agreements with the federal government related to three years—for the Housing and Disability Income these decertified units to continue federal funding Advocacy Program. Under this program, counties through December 2016 with the possibility may receive additional funding to help individuals of one-year extensions through 2019, if certain apply for disability-related income support, which requirements are met. While we assume that includes SSI/SSP. If this program leads to more the state will be able to successfully extend the approved SSI/SSP applications, then caseload—and termination dates of the agreements—and therefore therefore state costs—could increase. www.lao.ca.gov Legislative Analyst’s Office 39 2017-18 BUDGET CalWORKs amount of about $120 million relative to 2016-17. These changes include: We estimate that General Fund spending in • Costs From Repeal of Maximum Family the CalWORKs program will be $709 million Grant (MFG) Policy. The MFG policy in 2016-17, roughly consistent with the 2016-17 specifies, with limited exceptions, that a Budget Act. This 2016-17 estimate, however, masks family may not receive an increase to its two adjustments that offset one another: first, CalWORKs grant to reflect the birth of a increased General Fund costs of $90 million to child if the family continuously received backfill a reduction in certain realignment funds assistance in the ten months prior to the previously estimated to be available to support the child’s birth. The 2016-17 budget package program and, second, a roughly equal amount of repeals the MFG policy effective January General Fund savings due to lower-than-expected 2017, increasing the grants received by caseload. From this 2016-17 funding amount, we some families. The 2016-17 budget includes project that General Fund spending in CalWORKs $109 million from all funds to pay for will increase by roughly $340 million (48 percent) increased cash assistance from repealing the to a little over $1 billion in 2017-18 (and then MFG policy during the latter half of decrease in following years) reflecting the net effect 2016-17. We estimate that total General of (1) savings due to declining caseload, (2) net Fund spending in CalWORKs will rise by costs related to the implementation of prior policy roughly $110 million in 2017-18 to reflect a changes, and (3) changes in the availability of other full year of the policy’s repeal. funding sources. We discuss each of these factors in greater detail below. • Costs From 1.43 Percent Grant Increase. Savings From Declining Caseload. In recent Pursuant to a statutory mechanism, years, improvements in the state’s economic maximum CalWORKs grant amounts were situation have been accompanied by moderate increased by 1.43 percent in October 2016. reductions in the CalWORKs caseload. Under The 2016-17 budget includes $36 million our economic growth scenario, which features from all funds to pay for this grant increase the continuation of relatively positive economic in 2016-17. We estimate that total General conditions, we project that the CalWORKs Fund spending in CalWORKs will rise by caseload will continue to gradually decline, but roughly $10 million in 2017-18 to reflect a at a slower rate than in recent years. We estimate full year of implementation. that declining caseload will result in General Fund savings in 2017-18 of about $150 million relative • Costs From Child Care Rate Increases. to 2016-17, with progressively smaller amounts of The 2016-17 budget package increased additional savings in later years. reimbursement rates for Stage 1 child care Net Costs From Implementation of Prior providers effective January 2017 and Policy Changes. CalWORKs program spending in included $20 million from all funds to pay the near term will be influenced by several recent for these higher rates during the latter half policy changes that are not yet fully implemented. of 2016-17. We estimate that total General Taken together, we estimate that these changes will Fund spending in CalWORKs will rise by increase General Fund spending in 2017-18 by a net roughly $20 million in 2017-18 to reflect a full year of implementation. 40 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET • Savings From Higher Minimum Wage. in some of these other programs. Specifically, the The state’s minimum wage increased state could replace a portion of the TANF block to $10 per hour in January 2016 and grant funds allocated to CSAC with General Fund is statutorily scheduled to increase to instead of replacing one-time TANF funds with $10.50 per hour in January 2017 and General Fund in CalWORKs. For simplicity, our $11 per hour in January 2018, with outlook assumes the backfill for one-time TANF additional increases in later years. funds will occur in CalWORKs and that the Increases to the minimum wage are amount of TANF funds allocated to CSAC remains expected to result in increased earnings constant at the level assumed in the 2016-17 Budget for some families enrolled in CalWORKs. Act in later years in the outlook. Whether the Families enrolled in CalWORKs with backfill for one-time TANF funds takes place in higher earnings receive lower cash grants CalWORKs or in CSAC, the effect on the state’s and some families will have earnings that General Fund bottom line is the same. exceed eligibility thresholds and cause Second, state law dedicates the growth them to leave the program, resulting in in certain realignment funds to pay for grant savings. The 2016-17 budget assumes increases, including certain increases that are savings of $26 million (all funds) from an currently supported in part by the General Fund, increased minimum wage during 2016-17. such as the repeal of the MFG policy and the We estimate additional General Fund 1.43 percent grant increase described above. savings from a higher minimum wage of As realignment funds dedicated to fund grant roughly $20 million in 2017-18. increases grow each year, General Fund support for repealing the MFG policy and 1.43 percent Changes in Availability of Other Funding grant increase is offset. We estimate that growth in Sources. In addition to General Fund support, the dedicated realignment funds will reduce General CalWORKs program is supported by federal TANF Fund spending by about $30 million in 2017-18 block grant funds, realignment funds, and county relative to our 2016-17 estimates. We further funds. Changes in the amount of funding available estimate, based on our economic growth scenario, from these sources affect how much General Fund that growth in dedicated realignment funds will support is required in CalWORKs. We estimate not be sufficient to fully offset the General Fund that General Fund support for CalWORKs in costs of repealing the MFG policy and providing 2017-18 will increase relative to 2016-17 by roughly the 1.43 percent grant increase before the end of $370 million to reflect two main changes in 2020-21. funding available from these other sources. Trends in Total Spending From All Funds. First, the 2016-17 budget includes about Figure 18 (see next page) displays projected total $400 million in one-time TANF funds that are CalWORKs spending from all funding sources, carried over from not being spent in prior years. consistent with our economic growth outlook We assume that General Fund spending in scenario and our assumptions about available CalWORKs will increase in 2017-18 to backfill TANF block grant and realignment funding these one-time funds available in 2016-17. We note described above. As shown in the figure, we that the state allocates TANF block grant funds estimate that total spending will be roughly to other programs in the state budget and has $5.3 billion in 2016-17—about $90 million less flexibility to backfill the one-time TANF funds www.lao.ca.gov Legislative Analyst’s Office 41 2017-18 BUDGET Figure 18 Projected Total CalWORKs Program Fundinga (In Millions) 2016-17 2017-18 2018-19 2019-20 2020-21 Federal TANF block grant funds $2,584 $2,194 $2,194 $2,194 $2,194 Realignment funds dedicated to grant increasesb 281 308 366 424 462 Other realignment/county fundsc 1,774 1,772 1,771 1,770 1,770 General Fund 709 1,050 896 748 636 Totals $5,348 $5,324 $5,227 $5,136 $5,062 a Excludes Kin-GAP and TANF funds transferred to the California Student Aid Commission. b Dedicated funds provided from the 1991 realignment Child Poverty and Family Supplemental Support Subaccount. c Includes funding from the 1991 realignment Family Support Subaccount, the 1991 realignment CalWORKs MOE Subaccount, and a 2.5 percent county share of cash assistance costs. TANF = Temporary Assistance for Needy Families; Kin-GAP = Kinship Guardianship Assistance Program; and MOE = maintenance-of-effort. than assumed in the 2016-17 Budget Act because of least partially in the short run—by growing county lower-than-expected actual caseload as described savings that result from a gradual reduction in the previously. Total spending from all funds is number and duration of group home placements. projected to decrease slightly by about $20 million The 2011 realignment transferred fiscal in 2017-18, with further decreases (in both total responsibility for child welfare services from spending and General Fund support) in later years, the state to the counties. The State Constitution largely reflecting declining caseloads and increases requires the state to provide funding for any to the state’s minimum wage. statewide policy changes, such as CCR, that have the effect of increasing overall county costs. Child Welfare Services Accordingly, the Legislature appropriated nearly State Costs for the Continuum of Care Reform $120 million General Fund in 2016-17 for county (CCR) Expected to Increase in 2017-18, Before welfare departments to implement CCR. We project Declining in Subsequent Years. Legislation passed General Fund costs for CCR implementation in 2015 and 2016, collectively known as CCR, to increase to about $180 million in 2017-18. In makes significant changes to the way the state cares time, counties’ CCR-related savings are expected for children in foster care. The CCR aims to reduce to exceed their CCR-related costs, and General the state’s reliance on relatively costly group home Fund support would no longer be required. The placements while expanding foster children’s access amount and timing of CCR-related county savings to mental health and other supportive services. The are uncertain, however, and will affect how much, CCR increases overall county costs in the short if any, General Fund is needed for CCR beyond run by requiring higher service levels and program 2017-18. standards. These higher costs will be offset—at JUDICIARY AND CRIMINAL JUSTICE The major state judiciary and criminal judicial branch and the California Department of justice programs include support for the state Corrections and Rehabilitation (CDCR). 42 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Judicial Branch Corrections and Rehabilitation General Fund spending for the support of the judicial branch in 2016-17 is estimated to be General Fund spending for support of CDCR $1.8 billion. Our forecast assumes that judicial operations in 2016-17 is estimated to be $10 billion. branch spending will be, on net, roughly the same Our forecast assumes that CDCR spending will level in 2017-18. While certain one-time funding decline in 2017-18 by just over 1 percent to about increases for the courts will expire at the end of $9.8 billion. This primarily reflects the effect of the current year, we assume that such savings (1) the expiration of certain one-time funding will be offset by spending increases in 2017-18. increases at the end of the current year and First, we assume inflation adjustments for the (2) the implementation of Proposition 57 and compensation of court employees of roughly Proposition 66 (as discussed in more detail below). $50 million each year over the forecast period. Our forecast for 2018-19 assumes that General Second, as we discuss in more detail below, we Fund spending for the support of CDCR will estimate that the implementation of Proposition 63 decline again slightly but then increase annually and Proposition 66 will increase annual court costs. thereafter to about $9.9 billion by the end of the Our forecast assumes that General Fund spending forecast period, due to modest annual growth in on the courts will reach almost $1.9 billion by the the inmate population. (Funding for increased end of the outlook period. CDCR employee compensation costs is included Implementation of Proposition 63 and under “Remaining programs” in Figure 12 at the Proposition 66. In November 2016, voters beginning of this chapter, not the CDCR line.) approved two propositions that will likely increase Implementation of Proposition 57 and judicial branch costs over the forecast period. Proposition 66. Proposition 57, recently First, Proposition 63 creates a new court process approved by voters, (1) makes certain nonviolent to ensure that individuals convicted of offenses offenders eligible for parole consideration—in that prohibit them from owning firearms do not some cases earlier than otherwise, (2) expands continue to have them. Second, Proposition 66 CDCR’s authority to reduce inmates’ sentences implements various changes to court procedures through credits, and (3) mandates that judges for legal challenges to death sentences, such determine whether youths are subject to adult as imposing time limits on those challenges sentences in criminal court. Our forecast assumes and revising rules to increase the number of that the prison population will decline in the available attorneys for those challenges. Our short term resulting from the implementation forecast assumes that the full implementation of of Proposition 57. (Absent the passage of Proposition 63 and Proposition 66 will increase Proposition 57, the state’s prison population would judicial branch costs over the forecast period in the likely have increased modestly over the forecast high tens of millions of dollars annually. We note period, primarily due to an estimated increase that the actual fiscal effects of the propositions on in the number of offenders with relatively long the judicial branch will depend heavily on how the sentences.) We assume that the measure will courts choose to implement certain provisions. reduce the prison population and associated costs primarily due to some nonviolent offenders serving shorter prison terms. However, by the end www.lao.ca.gov Legislative Analyst’s Office 43 2017-18 BUDGET of the forecast period, we project that the prison rather than only at specified prisons. If the state population will slightly exceed current levels, due changes the way it houses condemned inmates, to the underlying growth trend. the measure could result in state prison savings. In addition to changing the court procedures We assume that such changes are implemented— for legal challenges to death sentences, resulting in savings reaching the tens of millions of Proposition 66 (as discussed earlier) also allows the dollars annually over the forecast period. state to house condemned inmates in any prison, EMPLOYEE COMPENSATION AND RETIREMENT COSTS As discussed below, our outlook assumes have expired or are scheduled to expire in 2017-18. continuation of recent employee compensation The employees associated with these 15 bargaining practices, pension funding policies, and current units—including managers and supervisors— pension system investment return assumptions. represent about three-fifths of the state’s General State spending may increase significantly above Fund payroll cost and nearly 70 percent of the state our growth scenario assumption if any of the workforce. Similar to recently ratified agreements following occur: (1) investment returns are lower with most of the bargaining units that already have than the state’s pension boards assume; (2) the MOUs for 2017-18, our outlook assumes that in state’s pension boards change their investment or these 15 future agreements the state will (1) provide other actuarial assumptions; (3) the state agrees to annual pay increases near the rate of inflation, larger pay increases for state employees in order to (2) pay one-half of the “normal cost” by 2018-19 implement the Governor’s retiree health prefunding to start prefunding retiree health benefits, and plan; or (4) other factors arise that increase state (3) maintain the state’s current share of employee employee compensation and retirement costs. health premiums. Including pay and benefit increases that have already been agreed to and the State Employee Pay assumed compensation increases described above, and Benefits General Fund costs in 2017-18 would be about Significant Costs Expected From Collective $400 million above 2016-17 levels. By 2020-21, Bargaining. Much of the state’s employee the cumulative increase in General Fund state compensation costs are determined by what is employee costs under this scenario would be more included in labor agreements—referred to as than $1 billion above 2016-17 spending levels. To memoranda of understanding (MOUs)—between the extent that future MOUs provide smaller or the state and its 21 rank-and-file state employee larger compensation increases, these amounts bargaining units. The Legislature must ratify MOUs would vary. before they go into effect. The administration Rising Health Benefit Costs. In 2015-16, the typically extends similar compensation increases to state paid about $4 billion for active and retired managers and supervisors. state employee health benefits: about $2 billion The Legislature may be asked to ratify new for active employees (about half from the General agreements for 15 bargaining units whose MOUs Fund) and about $2 billion for retirees (nearly 44 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET all paid initially from the General Fund, with benefits—creating pressure to increase their pay roughly half of the costs recovered from other beyond what we currently assume. funds). By 2020-21, we estimate that these costs CalSTRS will exceed $5 billion. These growing costs result from increased payments for health services and a State Contribution Made Up of Three growing retiree base. Components. In 2016-17, the state’s contribution to CalPERS Pension Costs Rising . . . In recent the California State Teachers’ Retirement System years, the state’s contribution rates to the California (CalSTRS) totals 8.6 percent of statewide teacher Public Employees’ Retirement System (CalPERS) compensation, as measured on a two-year lag. The pension plans have increased due to investment contribution is a combination of three components. losses during the recession and CalPERS’ decisions First, the state contributes a base amount of about to change certain actuarial assumptions. Our 2 percent to CalSTRS’ main pension program. growth scenario assumes that CalPERS maintains Second, Chapter 26 of 2014 (AB 1469, Committee its current assumption of a 7.5 percent discount on Budget) provides for a state supplement to pay rate. We estimate that the state’s contributions to down a share of CalSTRS’ $76 billion unfunded CalPERS will increase each year, with General liability. Figure 19 shows how the funding plan Fund payments climbing above 2016-17 levels by assigns responsibility for CalSTRS’ unfunded about $200 million in 2017-18 and very roughly liabilities as of the most recent actuarial valuation. $1 billion by 2020-21. In 2016-17, the state’s supplemental rate is . . . But Could Rise Above Our Assumptions. 4.3 percent. Finally, the state contributes about CalPERS indicates that it expects average investment Figure 19 returns to be lower over Responsibility for CalSTRS' $76 Billion Unfunded Liability the next decade than the As of June 30, 2015 (In Billions) 7.5 percent it currently assumes. To the extent that investment returns are lower than this assumption, Districts the state’s annual costs will increase to pay higher unfunded liabilities. Alternatively, the CalPERS board could decide to lower its assumed rate of return—requiring the state to State contribute more money each year to both the normal cost and the unfunded liability. Increases in the normal cost 10 20 30 40 50 60 $70 also could increase employee Note: Figure does not show $0.3 billion portion of unfunded liability that is not assigned to either the state or districts under the funding plan. costs to prefund their pension www.lao.ca.gov Legislative Analyst’s Office 45 2017-18 BUDGET 2.3 percent of compensation to a program that on recent estimates from CalSTRS, we assume protects retirees’ pension benefits from the effects that the state’s share would not be eliminated until of inflation, known as the Supplemental Benefits after our outlook period. Accordingly, we assume Maintenance Account. that the state’s contribution rate will be 8.6 percent Previous LAO Outlooks Had Projected through 2020-21. As shown in Figure 20, we Near-Term State Savings. In our November estimate that state contributions to CalSTRS would 2015 Fiscal Outlook report, we described how total $2.6 billion in 2017-18 and would rise steadily the state’s share of CalSTRS’ unfunded liabilities with growth in payroll to $3 billion in 2020-21. had decreased since the Legislature passed the Figure 20 funding legislation in State Contributions to CalSTRS 2014. Accordingly, state Continue to Rise Under LAO Outlook contributions were expected (In Billions) to decline by several hundred million dollars beginning $3.5 SBMA in 2017-18. This projection Supplement reflected the CalSTRS 3.0 Base policy at that time, which 2.5 would have set the state’s supplemental rate to the 2.0 rate necessary to pay down the state’s share by the 1.5 mid-2040s. Recent Board Decision 1.0 Pays Down State Share Faster. In June 2016, the 0.5 CalSTRS board voted to maintain the state’s 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 supplemental rate at Actual Outlook Period 4.3 percent until the state’s SBMA = Supplemental Benefits Maintenance Account. share of CalSTRS’ unfunded liabilities is eliminated. Based UNEMPLOYMENT INSURANCE Interest Payments on Federal Loans. Reserves make annual interest payments on these federal in the state’s unemployment insurance (UI) trust loans. California’s outstanding loan balance is fund were exhausted in 2009, requiring the state to estimated to be roughly $4 billion at the end of borrow from the federal government to continue 2016, with a 2016-17 General Fund interest payment payment of UI benefits. The state is required to of $111 million. Based on projected unemployment 46 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET rates in our economic growth outlook scenario, the Fund interest payment of roughly $50 million in remaining federal loans are estimated to be repaid 2017-18. by the end of 2018, with a final estimated General DEBT SERVICE ON INFRASTRUCTURE BONDS Debt Service Ratio (DSR) Has Fluctuated General Fund revenues will increase somewhat Historically. The DSR—the ratio of annual faster than debt service costs. We assume that the General Fund spending on debt service costs to state gradually sells bonds that have been approved annual General Fund revenues and transfers—is by voters or the Legislature. These bonds include often used as one indicator of the state’s debt some of the remaining unsold infrastructure bonds burden. As shown in Figure 21, the DSR has that voters approved in 2006, 2008, and 2014 as varied considerably in past decades between about well as a portion of the school bond approved in 3 percent and 6 percent. In the late 2000s, the DSR November 2016 (Proposition 51). Our projections do grew to about 6 percent as large bond measures not include any additional debt service costs for new were approved and state revenues dropped due to bonds that may be authorized by the voters or the the recession. More recently, however, the DSR has Legislature during the forecast period. declined to about 5 percent. The modest decline in the Figure 21 DSR occurred for a variety Debt Service Ratio Expected to Decline Somewhat of reasons, including Percent of General Fund Revenues and Transfers Spent on Debt Service rebounding General Fund 7% revenues, refinancing of Authorized, existing debt, and state 6 but Unsold policies shifting some state 5 debt costs from the General Fund to special funds—such 4 as in transportation. 3 DSR Expected to Fall Below 5 Percent. We 2 Bonds Already Sold estimate that the DSR will 1 fall below 5 percent over the next several years. This 95-96 00-01 05-06 10-11 15-16 20-21 is because we project that Projection under the growth scenario www.lao.ca.gov Legislative Analyst’s Office 47 2017-18 BUDGET 48 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Chapter 4: The General Fund After 2017-18 In this chapter, we present two estimates state’s budget condition. Other uncertainties, of the budget’s condition through 2020-21. particularly changes in state or federal policy These estimates are sensitive to two types or implementation, could similarly change of uncertainty: economic uncertainty and the budget’s bottom line condition—in either other budget uncertainty. Different economic direction—by hundreds of millions or even billions outcomes can result in billions of dollars of of dollars. difference in our bottom line estimates for the ECONOMIC UNCERTAINTY To reflect the economic uncertainty inherent Revenues in our budget outlook, we analyze the budget’s Revenues Over Outlook Differ Dramatically condition under two scenarios of the economy’s Between Two Scenarios. Figure 22 (see next performance over the next five years: (1) an page) displays our revenue outlook under both economic growth scenario and (2) a mild recession the growth and recession scenarios. Under our scenario. Under the growth scenario, we assume economic growth scenario, between 2016-17 and moderate, but steady, growth in employment, 2020-21, we assume there is 4.6 percent growth in personal income, and the stock market as the the state’s “Big Three” tax revenues: the personal economy continues to grow throughout the entire income tax (PIT), sales and use tax, and corporate outlook period. Under the recession scenario, we tax. Growth in the PIT drives the majority of this assume the state experiences a mild economic overall increase over the period. In the recession downturn, with a big stock market decline, scenario, over the entire outlook period, we assume beginning near the middle of calendar year 2018. revenues are roughly $40 billion lower than they For reference, this downturn is roughly comparable are under the growth scenario. Much of this decline to the dot.com bust of the early 2000s. (Following is attributable to a decline in PIT revenues in a review of our recession modeling, we have 2018-19, 2019-20, and 2020-21. reduced somewhat the recession-period revenue loss, compared to last year’s Fiscal Outlook.) Both Spending scenarios account for passage of Proposition 55, Expenditures Grow 4.5 Percent in Growth which extended higher income tax rates on Scenario. Figure 23 (see page 51) compares our high-income earners, as well as the fiscal effects estimates of expenditures under the growth resulting from measures approved by voters at the scenario and the recession scenario. Under our November 2016 election. economic growth scenario, we assume 4.5 percent growth in overall General Fund expenditures www.lao.ca.gov Legislative Analyst’s Office 49 2017-18 BUDGET between 2016-17 and 2020-21. This rate reflects, scenario. In particular, this includes the formulas in particular, significant growth in health and for determining schools and community college human service (HHS) program spending. Under funding (Proposition 98) and debt payments the growth scenario, we assume spending on major (Proposition 2). Together, expenditures related to HHS programs reaches $45.2 billion in 2020-21, an these two programs are roughly $20 billion lower 8.1 percent average annual increase from 2016-17. relative to the growth scenario over the outlook The bulk of this increase is related to expenditures period. These changes are primarily driven by our in Medi-Cal, the state’s health insurance program assumptions about lower revenues, including those for low-income Californians. Between 2016-17 and related to capital gains, in the recession scenario. 2020-21, we assume expenditures in this program Moderate Increase in Costs for Some grow from nearly $18 billion to over $27 billion in Programs in Recession Scenario. In our the growth scenario. assumptions about spending under the recession Automatic Reductions in Formula-Driven scenario, we estimate expenditures are moderately Programs in Recession Scenario. Relative to higher for certain caseload-driven HHS programs. the growth scenario, expenditures are lower We do not estimate changes in spending under the in formula-driven spending in the recession recession scenario associated with other programs. Figure 22 Revenue Outlook Under Growth and Recession Scenarios General Fund (Dollars in Billions) Estimates Outlook Average Annual 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 Growtha Economic Growth Scenario Personal income tax $79.0 $85.1 $91.0 $95.8 $100.5 $104.7 5.3% Sales and use tax 24.8 24.7 25.0 26.0 26.7 27.3 2.5 Corporation tax 10.0 9.9 10.2 10.5 10.9 11.2 3.2 Subtotals, “Big Three” Revenues ($113.8) ($119.7) ($126.1) ($132.3) ($138.1) ($143.2) (4.6%) Other revenues $4.8 $4.2 $4.1 $4.3 $4.8 $4.9 4.3% BSA transfer -1.8 -3.3 -2.0 -1.8 -1.6 -1.6 — Other transfers -1.2 -0.6 -0.1 0.1 0.2 0.2 — Totals, Revenues and $115.6 $120.0 $128.1 $134.8 $141.0 $146.7 5.1% Transfers Mild Recession Scenario Personal income tax $79.0 $85.1 $89.1 $88.4 $89.0 $93.6 2.4% Sales and use tax 24.8 24.7 25.0 24.6 25.1 26.1 1.4 Corporation tax 10.0 9.9 10.2 7.9 10.0 10.2 0.8 Subtotals, “Big Three” Revenues ($113.8) ($119.7) ($124.3) ($120.9) ($124.0) ($129.9) (2.1%) Other revenues $4.8 $4.2 $4.1 $4.3 $4.7 $4.9 4.0% BSA transfer -1.8 -3.3 -1.9 -0.9 -1.0 -1.0 — Other transfers -1.2 -0.6 -0.1 -0.1 -0.2 0.2 — Totals, Revenues and $115.6 $120.0 $126.4 $124.1 $127.6 $133.9 2.8% Transfers a From 2016-17 to 2020-21. BSA = Budget Stabilization Account. 50 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET For example, we do not make changes to programs Legislature can appropriate funds in the SFEU for with largely discretionary budgets set by the any purpose, while the use of funds in the BSA is Legislature annually. In the presence of a tightening more restricted. Below, we present our estimates budget condition, however, the Legislature would of total reserves under the growth and recession likely make different choices about these parts of scenarios. For the purposes of this section, the budget, among others. “operating surpluses” or “operating deficits” equal the increases or decreases in total budget reserves Reserves in each fiscal year. The state has two budget reserves: the Special Operating Surpluses Assuming Continued Fund for Economic Uncertainties (SFEU) and the Economic Growth. Figure 24 (see next page) Budget Stabilization Account (BSA). Both reserves displays operating surpluses under the economic help insulate the budget from situations where growth scenario. If our assumptions held and revenues underperform budget assumptions. The current laws and policies remained in place, the Figure 23 General Fund Expenditure Estimates Under Growth and Recession Scenarios (Dollars in Billions) Estimates Outlook Average Annual 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 Growtha Economic Growth Scenario Education Programs Proposition 98b $49.1 $51.0 $52.4 $54.2 $56.3 $57.9 3.2% Non-Proposition 98 8.6 8.7 9.0 9.4 9.7 10.0 3.6 Health and Human Services 31.2 33.0 34.5 38.0 41.6 45.2 8.1 Criminal Justice 11.3 11.7 11.6 11.6 11.7 11.7 -0.1 Infrastructure Debt Servicec 5.3 5.4 5.5 5.8 6.0 5.8 2.0 Other Programsd 9.4 12.2 13.2 13.3 14.0 14.8 5.0 Totals $114.9 $122.0 $126.1 $132.3 $139.3 $145.5 4.5% Percent Change 6.2% 3.4% 4.9% 5.3% 4.5% Mild Recession Scenario Education Programs Proposition 98b $49.1 $51.0 $51.7 $49.1 $49.5 $52.5 0.7% Non-Proposition 98 8.6 8.7 9.0 9.4 9.7 10.0 3.6 Health and Human Services 31.2 33.0 34.5 38.2 42.2 46.0 8.6 Criminal Justice 11.3 11.7 11.6 11.6 11.7 11.7 -0.1 Infrastructure Debt Servicec 5.3 5.4 5.5 5.8 6.0 5.8 2.0 Other Programsd 9.4 12.2 13.1 12.5 13.3 14.2 3.9 Totals $114.9 $122.0 $125.3 $126.5 $132.4 $140.3 3.6% Percent Change 6.2% 2.7% 1.0% 4.6% 6.0% a From 2016-17 to 2020-21. b Reflects the General Fund component of the Proposition 98 minimum guarantee. Average annual growth in the minimum guarantee—the General Fund and Local Property Tax revenue combined—is 3.8 percent in the growth scenario and 2.1 percent in the recession scenario. c Debt service on general obligation and lease revenue bonds generally used for infrastructure. Does not include: (1) lease revenue debt service for community colleges, which is included under Proposition 98, or (2) UC’s and CSU’s debt service, which is included in non-Proposition 98 education spending. d Includes employee compensation and retirement cost increases as well as small departments not included in the above categories. Note: Program groups are defined to include departments listed in Figure 12. www.lao.ca.gov Legislative Analyst’s Office 51 2017-18 BUDGET General Fund would be in Figure 24 surplus through 2020-21. General Fund Surpluses and Reserve Deposits BSA deposits would range Under Economic Growth Scenario between $1.6 billion and (In Billions) nearly $2 billion over the Rainy Day Fund Deposit period, with the BSA balance $4.5 Remaining Operating Surplusa available for future budget 4.0 emergencies. The remaining 3.5 operating surpluses would 3.0 be available for new budget commitments—spending 2.5 increases or tax reductions— 2.0 or building larger reserves. 1.5 (The figure assumes no sales 1.0 tax reductions under two existing state laws due to 0.5 growing SFEU balances.) 2017-18 2018-19 2019-20 2020-21 In Recession Scenario, a Amount that can be allocated in budget or used to build additional reserves. Reserves Cover Operating Deficits Through 2020-21. Figure 25 shows operating Figure 25 surpluses and deficits and Reserve Balances Cover total reserve balances under Operating Deficits in Mild Recession Scenario the recession scenario. Under (In Billions) these assumptions, by the $4 end of 2017-18 the state has Operating Surplus $10.4 billion in total reserves. 3 Operating Deficit (Covered by Reserves)a Under this scenario, the state 2 would exhaust that reserve 1 balance by the end of 2020-21, ending with a small portion -1 of that year’s operating -2 deficit—just $154 million— that is not covered by reserves. -3 This means, under these -4 assumptions, the state could -5 weather a mild recession -6 2017-18 2018-19 2019-20 2020-21 without cutting spending or $10.4 $9.0 $5.2 -$0.2 raising taxes through 2020-21. Total Reserves Available If deficits continued in a A small portion ($154 million) of the operating deficit in 2020-21 is not covered by reserves. 2021-22, the state would face 52 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET decisions about how to solve a budget problem at recession scenario and less optimistic than that time. the growth scenario. Ongoing commitments Budget Situation Worse With New, Ongoing compound each year, such that their out-year effect Commitments. Both the growth and recession is much larger than their annual amount. For scenarios assume the state makes no additional example, if the state committed $1 billion in new commitments in any year over the period. If the ongoing annual spending in 2017-18, total reserves state did make such commitments, the budget would be lower by around $4 billion in 2020-21. outlook would be worse than displayed in the BUDGET UNCERTAINTIES In addition to economic uncertainty described (CalPERS) has indicated it expects average above, other factors, notably those related to policy investment returns over the next decade to be lower decisions, could leave the budget in better or worse than the 7.5 percent it currently assumes. If the condition in the out-years. We describe some of CalPERS board reduced its assumed rate of return these uncertainties below. to match its assumptions, the state would have Decisions by the Legislature. Both the growth to pay much more each year to both the normal and recession scenarios assume there is no change cost and unfunded liability. This could increase in state policies. For example, we assume the tax state costs annually by hundreds of millions or on managed care organizations (MCO) will expire, even billions of dollars—during and/or after our consistent with current law, in 2019. Currently, outlook period. In addition, in both the growth some General Fund costs and savings are tied to and recession scenarios, our outlook assumes the MCO tax. Our outlook assumes the MCO tax $2 billion in additional General Fund annual will expire, resulting in: (1) General Fund costs of appropriations for Medi-Cal under the provisions about $1.7 billion for Medi-Cal (to backfill the loss of Proposition 55, beginning in 2018-19. However, of MCO tax revenues), (2) General Fund savings decisions by the Director of Finance about how to of about $300 million for In-Home Supportive implement this part of Proposition 55 could result Services (IHSS), and (3) roughly $400 million in some or all of that $2 billion not being provided, more in corporation and insurance taxes. If the thereby lowering state costs. Legislature extended the tax, the out-year budget Decisions by the Federal Government. Our condition would improve under both scenarios by outlook assumes no major changes in federal policy about $1 billion annually. Similarly, our outlook over the outlook period. Various decisions by the assumes recent budgetary practices in programs federal government, however, could influence with largely discretionary budgets set by the future state General Fund costs, in particular for Legislature—including expenditure increases for some HHS programs. For example, recent federal employee compensation and the universities— regulations governing Medicaid managed care continue. If the Legislature did not provide these may require changes to the state Hospital Quality increases, the budget condition would improve. Assurance Fee. Similarly, there is uncertainty about Decisions by Other State Entities. The whether the federal government will provide federal California Public Employees Retirement System financial participation for newly enacted paid sick www.lao.ca.gov Legislative Analyst’s Office 53 2017-18 BUDGET leave for IHSS providers. The federal government could be hundreds of millions of dollars higher also could change provisions of the Affordable Care or lower than our assumptions. In addition, for Act. These decisions—and others—could cost or both scenarios, the outlook assumes minimum save the state billions of dollars over the outlook wage increases go into effect as scheduled under period. current law. However, under certain economic and State Minimum Wage Costs. Our multiyear budgetary conditions, the law allows the Governor budget outlook includes hundreds of millions to delay the scheduled minimum wage increases. If of dollars in additional costs related to the state the state pursued these delays under the recession minimum wage increase. For several programs, scenario, the budget’s condition would improve however, these costs are highly uncertain. Actual somewhat. state budgetary costs related to the minimum wage LAO COMMENTS Budget Estimates Are Highly Uncertain. After the state were to make significant ongoing budget 2017-18, General Fund revenues could be billions of commitments in 2017-18 or later, reserve balances dollars higher than those in the growth scenario or would be insufficient to cover operating deficits billions of dollars lower in a recession that is more in a mild recession and the state could face much severe than the one we display. Budget shortfalls more difficult choices—such as reducing spending would occur sooner, in particular, if a recession or increasing taxes—to balance the state budget. began before the middle of 2018. Shortfalls could Similarly, difficult choices would arise if the next be greater if the recession were more severe than recession is more severe than the mild one we have the mild downturn we illustrate here or if the modeled in this report. state made additional budget commitments. On Plan for Size of Next Economic Downturn. the other hand, the budget could be in even better As it crafts future budgets, the Legislature each condition if the economy expanded faster, state year will allocate discretionary funds among spending was lower, or the stock market performed reserves, one-time spending, and ongoing budget better than we assume in our growth scenario. commitments based on its priorities. In deciding State Is Increasingly Prepared to Weather a what level of reserves to hold, the Legislature Mild Economic Recession. Our recession scenario may want to consider the size of a potential shows that the state budget is much better prepared future recession for which it would like to plan. to weather a mild economic downturn with In the presence of a more severe recession, the minimal disruptions to programs. However, the state would face larger budget deficits. As such, reserve balances displayed in this chapter assume weathering a more severe recession would require the state makes no new budget commitments— more preparation now, while the economy is still whether spending increases or tax reductions. If growing. 54 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET www.lao.ca.gov Legislative Analyst’s Office 55 2017-18 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. 56 Legislative Analyst’s Office www.lao.ca.gov