The 2017-18 Budget: Overview of the Governor's Budget

The 2017-18 Budget: Overview of the Governor’s Budget MAC TAYLOR • L E G I S L A T I V E A N A L Y S T • JANUARY 13, 2017 2017-18 BUDGET 2 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET EXECUTIVE SUMMARY This publication is our office’s initial response to the 2017-18 Governor’s Budget proposal, which was presented to the Legislature on January 10, 2017. (Over the next couple of months, we will publish analyses considering key parts of the proposal in more detail.) Governor Identifies $1.6 Billion Budget Problem. In preparing the 2017-18 budget, the administration concluded that the state’s fiscal condition has worsened. According to the administration, absent new budget solutions, the state would face a deficit of $1.6 billion at the end of 2017-18. The primary reason for this deterioration in the budget’s position is the administration’s lower estimates of revenues, particularly those from the personal income tax (PIT). The administration also identifies a net increase in General Fund costs relative to the June 2016 budget package, including $1.8 billion in costs related to Medi-Cal, the state’s Medicaid program. Governor Proposes $3.2 Billion in Actions to Reduce Spending Growth. To address this estimated $1.6 billion budget problem, the Governor’s budget includes more than $3.2 billion in actions to reduce General Fund spending growth. The most significant of these actions is related to the Proposition 98 minimum funding guarantee for schools and community colleges. Altogether, the administration estimates these actions would eliminate their projected deficit and leave a balance in the 2017-18 year-end discretionary reserve of $1.6 billion. Under the administration’s revenue assumptions, the state’s Proposition 2 (2014) rainy day fund would grow to $7.9 billion—for a combined $9.4 billion in total reserves. Budget’s PIT Estimate for 2017-18 Seems Too Low. In 2017-18, the administration estimates that PIT will grow $2.7 billion, or 3.3 percent. In a normal growth year unaffected by recession or major policy changes, we expect PIT growth to exceed 5 percent. The weak growth that the Governor envisions for PIT is possible in 2017-18, but seems inconsistent with parts of the administration’s own economic outlook. For these reasons, we believe the Governor’s estimate of PIT growth in 2017-18 is probably too low. As a result, by the May Revision, the state could have considerably more General Fund revenue in 2017-18 than now projected by the administration. Part of any such increases would be required to go to schools under the Proposition 98 minimum guarantee as well as mandatory reserve deposits and debt payments under Proposition 2. Plan for High Level of Uncertainty. We have long encouraged the Legislature to plan for the next economic downturn by building reserves and concentrating any new commitments on one-time purposes. In addition, the Legislature now faces new uncertainties, as federal actions could significantly affect the state budget’s bottom line in future years. We encourage the Legislature as a first step in its budget deliberations to set a target level for the state’s total reserves (that is, the combined amount of discretionary and mandatory reserves available to address future budget emergencies). Facing uncertainties about the future of the economy and federal policy, the Legislature may want to set its target for state reserves at—or preferably above—the level the Governor now proposes. www.lao.ca.gov Legislative Analyst’s Office 3 2017-18 BUDGET 4 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET OVERVIEW On January 10, 2017 the Governor presented Lower Revenue Estimates. Relative to the his 2017-18 budget proposal to the Legislature. assumptions in the June 2016 budget plan, the Figure 1 shows the General Fund’s condition from administration estimates that revenues associated 2015-16 through 2017-18 under the Governor’s with the “Big Three” state taxes are down budget assumptions and proposals. (These numbers $3.2 billion in 2015-16 and 2016-17 combined. reflect actions the Governor took to address the This includes downward revisions in the personal administration’s estimated budget problem, which income tax (PIT) ($1.3 billion), the sales and we describe below.) The administration now use tax ($871 million), and the corporation tax estimates 2016-17 will end with $6.8 billion in total ($1 billion). As shown in Figure 2 (see next page), the reserves. This is $1.7 billion less than assumed in the administration also assumes a modest 2.9 percent June 2016 state budget plan. Under the Governor’s growth in Big Three revenues between 2016-17 and plan, the state would add to reserves in 2017-18, 2017-18. ending that fiscal year with $9.4 billion in total Additional Medi-Cal Spending. The Governor reserves. This would consist of: (1) $1.6 billion in the estimates there are some increases in General state’s discretionary reserve, the Special Fund for Fund spending in the current year relative to the Economic Uncertainties (SFEU), and (2) $7.9 billion assumptions in the June 2016 budget package. in the state’s mandatory reserve, the Budget The major net increase is related to Medi-Cal, the Stabilization Account, which is governed by the state’s Medicaid program. The administration terms of Proposition 2 (2014). estimates Medi-Cal costs in 2016-17 are higher than June 2016 estimates by $1.8 billion. This is Governor Identifies attributed to a one-time retroactive payment of $1.6 Billion Budget Problem drug rebates and a miscalculation of costs. In preparing the 2017-18 budget, the administration concluded that the state’s fiscal condition has worsened, and, Figure 1 absent new budget solutions, Governor’s Budget: General Fund Condition the state would have an SFEU (In Millions) reserve deficit of $1.6 billion 2015-16 2016-17 2017-18 at the end of 2017-18. (The Revised Revised Proposed estimated size of the SFEU Prior-year fund balance $3,508 $5,024 $1,028 deficit traditionally is called Revenues and transfers 115,500 118,765 124,027 the “budget problem” that Expenditures 113,983 122,761 122,520 Ending fund balance $5,024 $1,028 $2,535 must be addressed during Encumbrances 980 980 980 the annual budget process.) SFEU balance 4,044 48 1,555 In this section, we discuss Reserves SFEU balance $4,044 $48 $1,555 the major reasons that the BSA balance 3,529 6,713 7,869 administration is estimating Total Reserves $7,574 $6,761 $9,424 a deterioration in the SFEU = Special Fund for Economic Uncertainties (the General Fund’s traditional budget reserve) and BSA = Budget Stabilization Account. budget’s condition. www.lao.ca.gov Legislative Analyst’s Office 5 2017-18 BUDGET Figure 2 Governor’s Budget: Near-Term Revenue Estimates General Fund (Dollars in Millions) Change From 2016-17 2015-16 2016-17 2017-18 Amount Percent Personal income tax $78,947 $83,136 $85,866 $2,730 3.3% Sales and use tax 24,890 24,994 25,179 185 0.7 Corporation tax 9,902 10,389 10,878 489 4.7 Subtotal, “Big Three” Revenues ($113,739) ($118,519) ($121,923) ($3,404) (2.9%) Other revenues $4,799 $3,922 $3,815 -$107 -2.7% Net transfersa -3,038 -3,676 -1,711 — — Total, Revenues and Transfers $115,500 $118,766 $124,027 $5,261 4.4% a Includes transfers from the General Fund to the Proposition 2 (2014) Budget Stabilization Account. Reductions in Other General Fund Spending. in actions to reduce General Fund spending The administration also assumes some large growth that otherwise might occur. Figure 3 expenditure reductions that improve the summarizes the administration’s estimates budget’s bottom line condition. For example, the of the Governor’s proposed actions. The most administration estimates over $600 million in significant action is related to the Proposition 98 General Fund savings when the statutory authority minimum funding guarantee for schools and for the Coordinated Care Initiative ceases following community colleges. Compared to June 2016, the Director of Finance’s determination that the the administration proposes adjusting required program is not cost-effective. The administration General Fund spending downward by $1.7 billion also pays for some growth in the state’s Medi-Cal to meet new estimates of the minimum guarantee. spending using $1.2 billion in special fund resources Figure 3 from Proposition 56 (2016). Governor’s Proposed $3.2 Billion in Actions to (This measure increased Address Budget Problem state taxes on cigarettes (In Millions) and other tobacco Administration’s Estimate of Budget Problem -$1,601 products.) Budget Actions Adjust Proposition 98 General Fund spending $1,695 Major Features of the Eliminate affordable housing funding 400 Governor’s Budget Cancel scheduled transfer for state office buildings 300 Delay child care rate augmentations 104 $3.2 Billion in Reduce California Health Facilities Financing Authority spending 85 Proposed Actions Eliminate health care workforce augmentation 67 Eliminate Major Risk Medical Insurance Fund 65 to Reduce Spending Eliminate funding for housing and disability income advocacy 45 Growth. To address its Phase out Middle Class Scholarships 36 estimated $1.6 billion Other actions, such as not funding timely implementation of some 359 recent legislation budget problem, the Governor’s Budget Estimate of 2017-18 SFEU Balance $1,554 Governor’s budget includes SFEU = Special Fund for Economic Uncertainties. more than $3.2 billion 6 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET The administration also proposes cancelling two by recession or major policy changes, we expect 2016-17 budget items. These are: (1) a $400 million PIT growth to exceed 5 percent. Between 2009-10 set-aside for affordable housing, which was and 2016-17 (using the administration’s estimates contingent on changes in state law that have not for 2015-16 and 2016-17), annual PIT growth has occurred, and (2) $300 million for the replacement averaged over 8 percent. Moreover, PIT growth and renovation of state office buildings. Altogether, has exceeded the Governor’s 2017-18 estimates the administration estimates these actions would in 18 of the past 21 years, with the three weaker eliminate its projected $1.6 billion deficit and leave years coinciding with the last two U.S. economic a balance in the 2017-18 year-end discretionary recessions. (Some of these years were affected by tax reserve of $1.6 billion. policy changes, but if we were to adjust for those Other Proposals. The Governor’s budget factors, the story would be similar.) also includes some other policy proposals. First, The weak growth that the Governor the Governor assumes the Legislature will ratify envisions for PIT is possible in 2017-18, but seems 13 labor agreements that include pay increases inconsistent with parts of the administration’s and implement the Governor’s plan to prefund own economic outlook, which assumes economic retiree health benefits. In addition, the budget and stock price growth for several years after 2016. assumes pension costs will rise as a result of the For example, the administration assumes that the statewide pension boards’ changing actuarial S&P 500 will grow 6.3 percent in 2017. Yet, the assumptions. Second, the Governor proposes administration projects declining total capital gains a new interpretation of law that would create in 2017. We cannot reconcile these conflicting billions of dollars of new state spending capacity projections. Currently, we also think that wage under the constitutional state appropriations limit growth probably will exceed the administration’s (Proposition 4 of 1979) by changing the “Gann estimates in 2017-18. In conclusion, normal PIT Limit’s” complex calculations. Third, the Governor growth may or may not materialize for 2017-18, proposes transferring the operation of in-patient, but based largely on the administration’s own mental-health treatment beds at three prisons economic outlook, we believe the Governor’s from the Department of State Hospitals (DSH) 3.3 percent estimate of PIT growth in 2017-18 is too to the California Department of Corrections and low. Rehabilitation (CDCR). The proposal would be The Budget Situation Will Change by May effective July 1, 2017 and redirects $250 million Revision. By the May Revision, the state will from DSH to CDCR for this purpose. In addition, have more information on its fiscal condition. as discussed in the box on the next page, estimated As noted above, it is possible that the state could special fund spending in the Governor’s plan grows have considerably more revenue in 2017-18 than in 2017-18. now projected by the Governor. Any increased revenues would be partially offset by higher school LAO Comments spending requirements under Proposition 98 Governor’s PIT Estimate for 2017-18 Seems and higher budget reserve and debt payment Too Low. The PIT is the state General Fund’s requirements under Proposition 2. As such, only dominant revenue source. In 2017-18, the Governor a portion of any increased revenues would be estimates that PIT will grow $2.7 billion, or available for discretionary purposes. By May, the 3.3 percent. In a normal growth year unaffected administration’s expenditure estimates also will be www.lao.ca.gov Legislative Analyst’s Office 7 2017-18 BUDGET adjusted upward or downward, and the Legislature assumption at this point as there is no way of can consider whether it agrees with the proposed knowing precisely what actions the new Congress implementation of current state policies in the and President will pursue. There may be some budget plan (such as the use of Proposition 56 near-term benefit to state tax revenues based on revenues, which are being used to support growth changes in federal tax policies (perhaps requiring in Medi-Cal spending under the Governor’s plan). new state tax legislation to conform to those federal We will examine the administration’s proposals policies). Other possible federal policy changes, in more depth in our budget analysis publications however, could affect the economy, reduce federal over the next couple of months. funding, and/or increase state costs substantially Added Uncertainty at the Federal Level. The in future years—especially potential changes in Governor’s budget proposal assumes no major federal health care programs. changes in federal policy. This is a reasonable Proposed Special Fund Expenditures and Reserves Special Fund Spending Proposed to Grow by $6.5 Billion. Hundreds of state special funds receive fee and other revenues and typically pay for services provided to people and businesses that pay the fees. Total special fund spending is proposed at $54.6 billion in 2017-18—up from $48.1 billion in 2016-17. Some of the largest proposed items are: • A nearly $1.2 billion increase in special fund spending for a variety of transportation programs. (We discuss the Governor’s transportation funding package in more detail later in this report.) • An additional $3.6 billion from special funds for various health and human services programs, including new money from the Proposition 56 (2016) tobacco tax and the hospital quality assurance fee that was extended by Proposition 52 (2016). • $1.3 billion to allocate revenues from the Greenhouse Gas Reduction Fund, as well as changes in other special funds. Growing Special Fund Reserves. The state borrowed from many special funds to help address General Fund budget problems during the last recession. Since then, the General Fund has paid back billions of dollars in loans to special funds. In 2011-12, aggregate reserves in California’s special funds totaled $8 billion. During 2016-17, the administration estimates aggregate special fund reserves will reach $16 billion (excluding the mandatory Proposition 2 reserve). In 2017-18 the Governor proposes nearly $500 million more in loan repayments from the General Fund to various special funds. Even with the spending increases described above, special fund reserves—sometimes conservatively estimated in the past—are estimated to remain above $12 billion. We continue to advise the Legislature to scrutinize special fund finances closely. In some cases, after considering special funds’ service and revenue levels and employee cost trends, one-time or ongoing reductions in special fund fees may be justified. 8 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Plan for High Level of Uncertainty. We have its budget deliberations to set a target level for the long encouraged the Legislature to plan for the state’s total reserves (that is, the combined amount next economic downturn by building reserves of discretionary and mandatory reserves available and concentrating any new commitments on to address future budget emergencies). Facing one-time purposes. In addition, the Legislature uncertainties about the future of the economy and now faces new uncertainties, as federal actions federal policy, the Legislature may want to set its could significantly affect the state budget’s bottom target for state reserves at—or preferably above— line in future years. As we have suggested in the the level the Governor now proposes. past, we encourage the Legislature as a first step in PROGRAM AREAS Proposition 98 These changes in revenue have implications for the state’s Proposition 98 maintenance factor Below, we highlight the major components of obligations. As a result of the lower revenue in the Governor’s Proposition 98 package and provide 2015-16, the state is no longer required to make some high-level comments about the package. the $379 million maintenance factor payment Major Features of Governor’s Plan included in the June budget plan. In 2016-17, the state creates a somewhat higher new maintenance Minimum Guarantees for 2015-16 and factor obligation ($838 million, as compared to the 2016-17 Revised Downward. Figure 4 compares $746 million obligation assumed in the June budget the Governor’s estimates of the 2015-16 and 2016-17 plan). minimum guarantees with the estimates made in 2015-16 and 2016-17 Spending Reduced June 2016. Compared to the June 2016 estimates, by Shifting and Deferring Payments. The the guarantee is down $379 million in 2015-16 administration proposes to reduce Proposition 98 and $506 million in 2016-17. These drops are spending to match the lower estimates of the primarily explained by the reductions in estimated 2015-16 and 2016-17 minimum guarantees. To state revenue. General Fund tax revenue counting reduce spending in 2015-16, the administration toward the guarantee has been revised down shifts certain one-time school payments from $1.5 billion in 2015-16 and $1.6 billion in 2016-17. 2015-16 to 2016-17. To accommodate this shift Figure 4 Tracking Changes in the Proposition 98 Minimum Guarantee (In Millions) 2015-16 2016-17 June 2016 January 2017 June 2016 January 2017 Estimate Estimate Change Estimate Estimate Change Minimum Guarantee General Fund $49,722 $48,989 -$733 $51,050 $50,330 -$720 Local property tax 19,328 19,681 353 20,824 21,038 215 Totals $69,050 $68,671 -$379 $71,874 $71,368 -$506 www.lao.ca.gov Legislative Analyst’s Office 9 2017-18 BUDGET of payments and reduce spending in 2016-17 to New K-12 Funding in 2017-18 Dedicated the guarantee, the Governor proposes to defer to LCFF and Deferral Repayment. The largest an $859 million payment for the Local Control ongoing proposal is a $744 million augmentation to Funding Formula (LCFF). Specifically, the LCFF. The proposed augmentation is approximately administration proposes to provide this funding equal to the cost of applying the statutory in July 2017 rather than in June 2017, as originally 1.48 percent cost-of-living adjustment (COLA). scheduled. This delay would allow the state to count The Governor estimates LCFF would be 96 percent the payment toward the 2017-18 guarantee instead funded in 2017-18, about the same percentage as of the 2016-17 guarantee. in 2016-17. The Governor proposes to use most of 2017-18 Guarantee Increases $2.1 Billion Over the remaining increase to eliminate the payment Revised 2016-17 Level. The Governor’s budget deferral created in 2016-17. Under this proposal, includes $73.5 billion in total Proposition 98 schools would receive 13 months of payments in funding in 2017-18. As shown in Figure 5, this 2017-18—12 normal monthly LCFF payments plus reflects a 3 percent increase over the revised a one-time payment of $859 million related to the 2016-17 level. Test 3 is operative in 2017-18, with prior-year deferral. the higher guarantee driven primarily by the About Half of New Community College increase in per capita General Fund revenue. The Funding Is for Apportionments, Half for One-Time administration estimates that the state creates Initiatives. About half of new community college a new maintenance factor obligation in 2017-18 funding is for apportionments (consisting of of $219 million, bringing the total outstanding $94 million for a 1.48 percent COLA, $79 million obligation to $1.6 billion. for 1.34 percent enrollment growth, and $24 million Figure 5 Proposition 98 Funding by Segment and Source (Dollars in Millions) Change From 2016-17 2015-16 2016-17 2017-18 Revised Revised Proposed Amount Percent Preschoola $885 $975 $995 $20 2.0% K-12 Education General Fund $42,719 $43,829 $44,811 $982 2.2% Local property tax 17,052 18,236 19,200 965 5.3 Subtotals ($59,770) ($62,064) ($64,012) ($1,947) (3.1%) California Community Colleges General Fund $5,304 $5,443 $5,465 $22 0.4% Local property tax 2,630 2,803 2,959 156 5.6 Subtotals ($7,933) ($8,246) ($8,424) ($179) (2.2%) Other Agenciesa $82 $83 $80 -$3 -3.3% Totals $68,671 $71,368 $73,511 $2,143 3.0% General Fund $48,989 $50,330 $51,351 $1,021 2.0% Local property tax 19,681 21,038 22,160 1,121 5.3 a Consists entirely of General Fund. 10 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET for an unallocated increase). The remainder is for for rates and $7.8 million for 2,959 additional categorical programs and is mainly one time. By far State Preschool slots). Though not formalized the largest of these initiatives is $150 million one in statute, the agreement for 2017-18 assumed time for community colleges to develop “guided (1) annualization of the increases initiated the prior pathways”—detailed, term-by-term roadmaps year, (2) 2,959 additional State Preschool slots, and for students to complete academic programs, (3) $86 million in non-Proposition 98 General Fund accompanied by early academic planning and rate increases. The Governor’s budget proposes ongoing student support services. The budget also suspending much of this agreement for 2017-18 includes $20 million one time for innovation awards and extending implementation of the plan through to community colleges. Whereas the administration 2020-21. has been closely involved in implementing LAO Comments innovation awards in previous years, the proposal this year provides the Chancellor’s Office substantial Minimum Guarantee Not Likely to Change latitude to set award criteria and select winners. Much in 2015-16, Could Change Somewhat in Budget Plan Includes $601 Million in 2016-17. Within the range of potential revenue Additional Proposition 98-Related Funding. changes for 2015-16, the minimum guarantee likely In addition to the $2.1 billion increase in the would remain unchanged. For 2016-17, revenue 2017-18 minimum guarantee, the Governor’s estimates could be revised more substantially. For budget includes $601 million in funding from each dollar of higher or lower revenue, we estimate one-time sources. Of this amount, $400 million the minimum guarantee would rise or fall about is a proposed settle-up payment related to 50 cents. This dynamic is a result of Test 3 being meeting the 2009-10 minimum guarantee and the operative, with the minimum guarantee driven remainder is unspent Proposition 98 funding from largely by the year-to-year growth in General Fund previous years. The Governor proposes to use the revenue. combined $601 million for (1) the K-12 mandates Higher General Fund Revenue, Higher backlog ($287 million), (2) the Career Technical Minimum Guarantee Likely for 2017-18. As Education Incentive Grant program ($200 million), discussed earlier in this report, we believe the (3) deferred maintenance at the community administration’s estimate of state revenue is colleges ($44 million), and (4) fund swaps totaling low given its other economic assumptions. By $70 million (using one-time funds to support May, General Fund revenue in 2017-18 could be ongoing programs). significantly higher than assumed in January. Delays Implementation of Multiyear Child Holding other factors constant, higher revenue Care and Preschool Budget Agreement. As part estimates would increase the 2017-18 guarantee. of the 2016-17 budget package, the Legislature For example, if revenue were to increase in 2017-18 and the Governor agreed on a four-year plan by $2 billion above the Governor’s January level, to increase ongoing child care and preschool the minimum guarantee would increase by roughly funding by roughly $500 million (roughly $500 million (due to the state being required to $200 million in Proposition 98 General Fund make a maintenance factor payment). If revenue and $300 million in non-Proposition 98 General were to increase by $4 billion, the minimum Fund). In 2016-17, the state provided $145 million guarantee would increase by $1.5 billion (with the for the first year of implementation ($137.5 million state needing to make an even larger maintenance www.lao.ca.gov Legislative Analyst’s Office 11 2017-18 BUDGET factor payment). Revenue increases beyond about Governor Sends Unclear Message Regarding $4 billion likely would have no effect on the Tuition Increases. As in recent years, the minimum guarantee. (The General Fund likely Governor’s budget assumes UC and CSU do not would pay for all of these increases.) raise resident tuition. Unlike recent years, however, Recommend Relying on Mix of Ongoing he does not condition his proposed General Fund and One-Time Spending. The Governor’s budget increases on the segments holding resident tuition roughly balances new ongoing and one-time levels flat. Both UC and CSU have indicated an Proposition 98 spending in 2017-18. Regardless of interest in increasing resident tuition for 2017-18 the exact level of the 2017-18 minimum guarantee, (2.5 percent at UC and about 5 percent at CSU). The we recommend the Legislature adopt a final Governor has not taken a formal position on these budget plan that continues to rely upon on a mix proposals, though his Budget Summary declares of ongoing and one-time spending. Under this that “any tuition increases must be viewed in the approach, the Legislature could dedicate a portion context of reducing the overall cost structure at UC of any additional increases in the minimum and improving graduation rates at CSU.” guarantee to LCFF and California Community Legislature Has Key Role in Crafting UC’s Colleges apportionments while using the remainder and CSU’s Budgets. The Legislature has a key for one-time payments to reduce or eliminate the role in setting state higher education priorities, K-12 mandates backlog. We note that a stronger examining the universities’ budgets, and making 2017-18 fiscal year does not necessarily imply a associated spending decisions. Every year, the strong 2018-19 fiscal year. By setting aside some Legislature fundamentally decides (1) the total level funding for one-time purposes, the state would be of cost increases to support and (2) how to cover better positioned to accommodate a drop in the those cost increases. Some years, the Legislature 2018-19 guarantee without needing to make cuts to has decided to cover all spending increases using LCFF or community college apportionments. state General Fund support, explicitly “buying out” tuition increases or otherwise holding student Universities tuition levels flat. Other years, both state General No Notable Changes in Governor’s Budgetary Fund support and tuition levels have been raised. Approach for Universities. The Governor’s budget In still other years, state General Fund support has reflects the same basic approach to building fallen or been held flat, with tuition levels rising University of California’s (UC) and California State to cover cost increases. In the coming months, the University’s (CSU) budgets as proposed in the past Legislature will have an opportunity to decide what several years. The Governor’s main proposal for UC and CSU cost increases to support for 2017-18 each segment is a General Fund base increase (of and how best to cover those cost increases. about 4 percent for UC and 5 percent for CSU). Coordinated Care Initiative The Governor grants the segments considerable discretion in deciding how to spend these base Coordinated Care Initiative (CCI). In June increases, but, as in previous years, he loosely links 2012, the Legislature authorized the CCI as a these increases to expectations regarding UC and county pilot project that would ultimately be CSU performance. The Governor’s budget sets implemented in seven counties. The policy goals of forth no new enrollment growth expectations for the CCI demonstration project included improved UC and CSU. 12 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET coordination of health care and long-term care Rising General Fund Costs a Result of the for seniors and persons with disabilities (SPDs) IHSS MOE. Total IHSS program costs have and a reduction in the overall costs of caring for increased from around $6 billion to around this population. To achieve these goals, the CCI $10 billion between 2012-13 and 2016-17. Since made the following major policy changes in the the MOE was instituted, the General Fund has demonstration counties: borne a disproportionate amount of these IHSS program costs, growing at an average rate of • Integration of Medi-Cal and Medicare 20 percent annually, from $1.7 billion in 2012-13 to benefits under Medi-Cal managed care an estimated $3.5 billion in 2016-17. County IHSS for SPDs eligible for both Medi-Cal and program costs, by contrast, have increased at an Medicare (“dual eligibles”) opting into the average rate of around 5 percent annually over the demonstration program (known as Cal same period. MediConnect). Determination That the CCI Is Not • Mandatory enrollment of Medi-Cal Cost-Effective Automatically Terminates the CCI. recipients who are also on Medicare in The Governor’s budget reflects the determination managed care for their Medi-Cal benefits. that the CCI is not cost-effective, automatically ending the program in 2017-18. According to the • Integration of long-term services and administration, the increased General Fund costs supports (LTSS), including the In-Home associated with the IHSS MOE were the primary Supportive Services (IHSS) program factor in its determination that the CCI does not and other long-term care programs, into produce net General Fund savings. Medi-Cal managed care. However, Governor’s Budget Proposes • Introduction of state-level collective Continuation of Major Components of the CCI. bargaining for IHSS provider wages and The Governor’s budget proposes the continuation benefits. of major components of the CCI in the program’s demonstration counties, including: In addition, on a statewide basis, the CCI • Cal MediConnect. replaced counties’ share of IHSS program costs (historically 35 percent of the nonfederal portion • Mandatory enrollment of dual Medi-Cal of costs) with a maintenance-of-effort (MOE) and Medicare recipients in managed care. requirement whereby counties have been required to maintain their 2011-12 expenditure levels for • The integration of LTSS other than IHSS IHSS, with an annual growth factor of 3.5 percent under Medi-Cal managed care. plus any additional costs associated with locally In effect, on net, the Governor proposes to negotiated IHSS wage increases. (1) end the IHSS MOE and reintroduce state- State law authorizing the CCI contains county IHSS cost sharing at historic levels, saving a “poison pill” provision that automatically the General Fund approximately $600 million discontinues the pilot program if the Director of in 2017-18; (2) remove—in demonstration Finance determines that the CCI does not generate counties—IHSS from managed care and return annual net General Fund savings and is therefore its funding directly to counties (as opposed to not cost-effective. being part of managed care capitation rates); and www.lao.ca.gov Legislative Analyst’s Office 13 2017-18 BUDGET (3) eliminate—in demonstration counties—state- Cap-and-Trade level bargaining for IHSS provider wages and Proposed Expenditure Plan Contingent benefits. Statutory approval is required to continue on Extending Program With Two-Thirds Vote. the components of the CCI that the Governor has As shown in Figure 6, the budget proposes to proposed extending. spend $2.2 billion in cap-and-trade revenue in Issues for Legislative Consideration. Below, we 2017-18. This would be supported from $1.5 billion highlight several issues that the Legislature might in auction revenue assumed to be collected in consider as it evaluates the administration’s proposal: 2017-18 and almost $700 million in unallocated • Distinct Policy Considerations in prior-year collections. Consistent with current Evaluating Governor’s Proposal. law, 60 percent ($900 million) of 2017-18 revenue The IHSS financing structure and would be continuously appropriated to certain the coordination of health care and programs. Under the Governor’s proposal, the long-term care under managed care remaining $1.3 billion in proposed discretionary represent distinct, though related, policy spending would only be spent after the Legislature considerations. The Legislature might enacted—with a two-thirds vote—new legislation independently evaluate the fiscal and policy providing the Air Resources Board (ARB) with merits of what counties’ contribution the authority to operate a cap-and-trade program to IHSS costs should be (whether as a beyond 2020. If the Legislature enacted such cost-sharing arrangement or an MOE legislation, the budget would provide $500 million requirement) and the extent to which to support the Governor’s transportation funding health care and LTSS should be integrated package. The remaining $755 million would be under managed care. allocated for other categories of programs designed to reduce green house gas (GHG) emissions. In • How Should IHSS Interface With addition, under the Governor’s proposal, the Managed Care? The Legislature might Department of Finance would have the authority consider how the removal of the IHSS to reduce allocations to discretionary programs program from the demonstration project proportionally if less auction revenue is available to will alternatively advance or hinder the support the proposed expenditures. policy goals of increasing care coordination Extending Cap-and-Trade With Two-Thirds and reducing the overall costs of health Vote Has Merit. The Governor’s proposal to care and long-term care. reauthorize cap-and-trade beyond 2020 and to do • IHSS MOE Impact on Counties. The so with a two-thirds vote has merit. The Legislature elimination of the CCI shifts significant IHSS recently enacted legislation to reduce statewide program costs from the General Fund back GHG emissions to 40 percent below 1990 levels to the counties ($600 million in 2017-18). by 2030. The cap-and-trade program is likely one Legislative consideration might be given of the most cost-effective policies to help the state to how the state might help ease counties’ achieve these new targets. transition to a higher share of IHSS costs as Moreover, extending cap-and-trade with a counties seek to rebalance their revenues and two-thirds vote, instead of a simple majority vote, expenditures in light of the CCI’s elimination. has a couple of additional benefits. First, it provides 14 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET additional legal certainty Figure 6 regarding the ARB’s 2017-18 Cap-and-Trade Expenditure Plan ability to operate the (In Millions) cap-and-trade program Program Amount that includes auctioning Continuous Appropriations of allowances beyond High-speed rail $375 2020. (There is an ongoing Affordable housing and sustainable communities 300 court case challenging the Transit and intercity rail capital 150 Transit operations 75 ARB’s authority to auction Subtotal, Continuous Appropriations ($900) allowances and collect Discretionary Spending revenue.) Auctioning Public transit and active transportation projects $500 allowances, rather Clean transportation and petroleum use reduction 363 than giving all of the Transformative Climate Communities 142 Carbon sequestration 128 allowances away for free, Short-lived climate pollutants 95 is generally considered Energy efficiency and renewable energy 28 an important feature of Subtotal, Discretionary Spending ($1,255a) Total $2,155 a well-designed cap-and- a Does not total due to rounding. trade program. Second, a two-thirds vote provides and the Legislature could choose to allocate the Legislature greater funds differently than proposed by the Governor flexibility to use cap-and-trade revenue on its in 2017-18 if the Legislature had a different set highest priorities by removing the current legal of spending priorities. However, the Governor’s requirement to spend revenue only on activities proposal unnecessarily restricts Legislative that reduce GHGs. For example, the Legislature spending authority. The Legislature does not have could consider using revenue to offset costs to to make budget allocations contingent on future businesses and households through rebates or legislation to extend cap-and-trade. It currently has tax reductions and/or fund its highest priority the authority to appropriate this funding regardless programs, including potentially those that do of whether it adopts the Governor’s proposed policy not reduce GHGs. We discussed many of these change to extend cap-and-trade. considerations in greater detail in our 2016 report Cap-and-Trade Revenues: Strategies to Promote Transportation Legislative Priorities. Funding Package Reasonable to Consider Extension and Governor’s Proposal. The Governor’s proposed Spending Proposal Together, but Proposal budget for 2017-18 includes a package of proposals Unnecessarily Restricts Legislative Authority. The to increase funding for transportation programs. issues of ongoing authority for cap-and-trade and Except for a few key differences discussed below, how to spend auction revenues are related, and it is the funding package is similar to the package reasonable to consider them together. For example, proposed by the Governor in the fall of 2015 as as described above, extending cap-and-trade with part of a special session on transportation funding. a two-thirds vote would give the Legislature a Revenue from the proposed funding package much wider range of spending options to consider, www.lao.ca.gov Legislative Analyst’s Office 15 2017-18 BUDGET would phase in during 2017-18 and 2018-19 and to meet current and future needs. It is generally provide a permanent ongoing increase thereafter. agreed upon that current levels of funding for The budget estimates that the package would transportation programs are insufficient to generate an average of $4.2 billion annually over meet these needs. Thus, we think the Governor’s the next ten years, which is somewhat higher than attention to transportation funding makes sense. the Governor’s earlier proposal. Specifically, the However, in reviewing the proposed package the package includes annual revenues of: (1) $2.1 billion Legislature will want to consider its priorities for from a $65 vehicle registration tax, (2) $1.1 billion funding transportation and how they compare with from increasing gasoline excise tax rates and the specific programs that the Governor’s package indexing the rates for inflation, (3) $500 million would fund. In our 2016 report, The 2016-17 from cap-and-trade auction revenues, Budget: Transportation Proposals, we recommended (4) $425 million from increasing diesel excise making highway maintenance the highest priority tax rates and indexing the rates for inflation, and for new funding. This is because such maintenance (5) $100 million from efficiencies at the California is more cost-effective than allowing highways Department of Transportation. In addition, the to degrade to the point where they require budget package assumes that $706 million in prior major rehabilitation. The Governor’s plan would loans from transportation accounts are repaid over significantly underfund the estimated need for the next three years. highway maintenance projects. Figure 7 shows how the increased annual transportation revenues would be allocated under Figure 7 the Governor’s proposal. As shown in the figure, Proposed Annual Expenditure of New Transportation Funds the package allocates two-thirds of the revenue to rehabilitate state highways ($1.6 billion) and for (In Millions) local roads ($1.2 billion). The package allocates State highway rehabilitation $1,600 $275 million for a corridor mobility program Local roads 1,200 Transit and intercity rail capital 400 that was not included in the Governor’s earlier Corridor mobility improvements 275 proposal. The proposal also includes $120 million Trade corridor improvements 250 for highway maintenance. Local partnership grants 250 Highway maintenance 120 LAO Comments. Much of the state’s Active transportation 100 transportation infrastructure is aging and needs Local planning grants 25 maintenance, rehabilitation, and improvements Total $4,220 LAO Publications The Overview section of this report was prepared by Ann Hollingshead and Ryan Miller, and many other LAO staff members (listed at www.lao.ca.gov/staff) also contributed to the publication. 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. 16 Legislative Analyst’s Office www.lao.ca.gov