The 2017-18 Budget: An Overview of the Governor's Proposition 56 Proposals

The 2017-18 Budget: An Overview of the Governor’s Proposition 56 Proposals MAC TAYLOR • L E G I S L A T I V E A N A L Y S T • FEBRUARY 2017 Summary Proposition 56 Increases Tobacco Taxes and Directs the Use of Those Revenues. In November 2016, voters approved Proposition 56, which increases excise taxes on tobacco products by $2. The measure also prescribes how to distribute the revenues from the increased tax. In some cases, Proposition 56 requires the new revenue to supplement existing spending on the programs. The measure dedicates the bulk of the new revenue to Medi-Cal. The Proposition 56 revenues dedicated to Medi-Cal are required to supplement, not supplant, the existing spending on the program. Revenue Estimate Reasonable; Allocation Amounts Generally Follow Requirements. Overall, we are comfortable with the administration’s $1.4 billion revenue estimate for 2017-18. In all but one instance, the Governor’s allocation proposals follow the amounts prescribed in the measure. For State Board of Equalization (BOE) enforcement activities, however, the Governor’s budget provides $5.8 million when the measure requires BOE to receive $6 million annually. Supplantation or Not? Questions have been raised as to whether the Governor’s proposals for the use of Proposition 56 Medi-Cal revenues meet the initiative’s requirement to supplement existing spending. The Governor’s Medi-Cal proposal uses the Proposition 56 revenue to pay for typical year-to-year cost increases in the program. Taken at face value, voter approval of Proposition 56 arguably demonstrates a desire to increase Medi-Cal funding beyond year-to-year growth in the program. The administration, however, argues that the Proposition 56 revenues are used to increase Medi-Cal spending above the 2016-17 Budget Act level and therefore the revenues do not supplant existing resources. In our review, we found few court decisions regarding supplantation. Legislature Could Consider Alternative Uses of Medi-Cal Funds. Under the administration’s revenue estimates, using the Proposition 56 Medi-Cal revenues differently—by increasing provider rates, for example—would have trade-offs. In particular, the Legislature would need to allocate an additional $1.3 billion from the General Fund to pay for the costs Proposition 56 covers under the Governor’s proposal. Should revenue estimates be higher in May, however, the Legislature may have more flexibility to allocate additional revenues to Medi-Cal. 2017-18 BUDGET INTRODUCTION Proposition 56 was approved by voters in the provisions of Proposition 56 and the Governor’s November 2016 to increase taxes on cigarettes budget proposals. We then discuss whether the and other tobacco products. Questions have been Governor’s proposals for Medi-Cal could be viewed raised as to whether the Governor’s proposals as supplanting General Fund resources and identify for allocating Proposition 56 revenues meet the the relevant case law. We conclude by describing initiative’s requirement to supplement—and not some trade-offs for the Legislature to consider in supplant—existing spending in several areas. To allocating the Proposition 56 revenues. examine these questions, we begin by reviewing BACKGROUND Proposition 56 increased the state’s excise tax steps for allocating the revenue, which we describe on cigarettes and other tobacco products beginning below. April 1, 2017. In most cases, excise taxes are levied • Step One. The measure requires that new on the distributors of goods. Typically, increasing revenues raised by the measure first replace excise taxes raises prices for consumers. In this revenue losses—or “backfill”—to certain section, we describe the tax provisions of the sources (particularly existing state tobacco measure and how the measure distributes those funds and sales taxes) that occur as a result revenues for various purposes. of the measure. These revenue losses occur due to lower consumption of tobacco Taxes products due to the higher taxes. Increases Tobacco Excise Taxes. Beginning in April, the excise tax on a pack of cigarettes • Step Two. The State Board of Equalization will increase from 87 cents to $2.87. Existing law (BOE) receives up to 5 percent of requires taxes on other tobacco products—such as remaining funds to pay for the costs of cigars—to increase any time the tax on cigarettes administering the tax. increases. Accordingly, taxes on other tobacco • Step Three. Specified state entities receive products also will increase by $2—from the fixed dollar amounts for specific purposes. equivalent of $1.37 per pack of cigarettes to $3.37. The measure also extends the definition of other • Step Four. Remaining funds are tobacco products to include electronic cigarettes, allocated—using specified percentages—to which previously were subject only to sales tax. various programs, primarily to augment spending on health care services for Allocation of Revenues low-income individuals and families Measure Prescribes the Distribution of the covered by the Medi-Cal program. Revenues. Revenues from the new tobacco taxes Medi-Cal provides health care services to are deposited directly into a new special fund. As low-income Californians. shown in Figure 1, the measure outlines a series of 2 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Figure 1 How Measure Directs New Tax Revenue Be Spent Program or Entitya Amount Purpose Step 1: Replace Lost Revenues Existing Tobacco Tax Funds Determined by BOE To maintain tobacco-related revenues that tobacco tax funds would have received before this measure. State and Local Sales and Use Tax Determined by BOE To maintain tobacco-related revenues the state and local governments would have received before this measure. Step 2: Pay for Tax Administration State Board of Equalization (BOE)— 5 percent of For costs to administer the tax. administration remaining funds Step 3: Allocate Specific Amounts for Various State Entitiesb Various state entities—enforcementc $48 million For various enforcement activities of tobacco-related laws. University of California (UC)— $40 million For physician training to increase the number of primary care and physician training emergency physicians in California. Department of Public Health (DPH)— $30 million For education on preventing and treating dental disease. State Dental Program California State Auditor $400,000 For audits of agencies receiving funds from new taxes, at least every other year. Step 4: Distribute Remaining Funds for State Health Programs Medi-Cal —Department of Health 82 percent of For increasing the level of payment for health care, services, and Care Services remaining funds treatment provided to Medi-Cal beneficiaries. California Tobacco Control 11 percent of For tobacco prevention and control programs aimed at reducing illness Program—DPH remaining funds and death from tobacco-related diseases. Tobacco-Related Disease Program— 5 percent of For medical research into prevention, early detection, treatments, UC remaining funds and potential cures of all types of cancer, cardiovascular and lung disease, and other tobacco-related diseases. School Programs— 2 percent of For school programs to prevent and reduce the use of tobacco products California Department of Education remaining funds by young people. a The measure limits the amount of revenues raised that could be used to pay for administrative costs, to be defined by the State Auditor through regulation, to not more than 5 percent for each recipient of funding. b Predetermined amounts will be adjusted proportionately by BOE annually, beginning two years after the measure went into effect, if the BOE determines that there has been a reduction in revenues resulting from a reduction in the consumption of cigarette and tobacco products due to the measure. c Funds distributed to Department of Justice ($36 million), DPH ($6 million), and BOE ($6 million). For Some Allocations, New Revenues Cannot supplant—or replace—existing state resources for Replace General Fund Dollars. For some of the the programs. Figure 2 (see next page) shows the allocations show in Figure 1, the measure specifies allocations that contain this provision and the that the new revenues are to supplement and not language included in the measure. GOVERNOR’S BUDGET PROPOSALS This section describes the administration’s of these proposals in our other program-specific estimates for the new tobacco tax revenues and how analyses.) As Proposition 56 becomes effective the administration proposes to use those revenues. April 1, 2017, there will be one quarter of revenue (We discuss the programmatic aspects of some in 2016-17. The administration proposes to allocate www.lao.ca.gov Legislative Analyst’s Office 3 2017-18 BUDGET the revenue generated in 2016-17 in 2017-18. As a special funds. The Governor’s budget did not result, the uses of the funds described below reflect provide a backfill to the tobacco tax that supports five quarters of revenue proposed for spending in the General Fund, which the measure requires. 2017-18. The administration plans to correct this error in the May Revision and estimates this backfill to be Revenue Estimates $4.2 million. The administration projects that the new $1.1 Million for Tax Administration in tobacco taxes will raise $368 million in 2016-17 2017-18. The Governor’s Budget proposes to spend and $1.4 billion in 2017-18 for the new special $1.1 million for BOE to administer the new taxes. fund, for a total of $1.8 billion. Of this total, the This amount is well below the maximum level, or administration estimates that $24 million will “cap,” established by Proposition 56. (Based on the come from taxes on electronic cigarettes. Figure 3 administration’s revenue and backfill projections, shows how the administration would allocate the we estimate that this cap will be $88 million revenues to the various Proposition 56 purposes. in 2017-18.) As noted below, Proposition 56 We discuss these allocations in more detail below. separately provides funding for BOE’s enforcement activities. Backfill, Administration, and Audits $400,000 for State Auditor in 2017-18. The $37.2 Million for Backfill Payments in Governor’s Budget proposes to spend $400,000 for 2017-18. The administration estimates that the the State Auditor to conduct audits required by new special fund will make backfill payments Proposition 56. This amount is $100,000 below the totaling $37.2 million in 2017-18. The proposed cap for 2017-18 (with five quarters of revenue) but budget allocates all of this money to existing equal to the cap in subsequent years. Figure 2 Non-Supplantation Provisions in Proposition 56a Program or Entity Language of the Measure Enforcementb These funds are not to be used to supplant existing state or local funds for these same purposes (Section 30130.57, paragraph e). Medi-Cal To the extent possible given the limits of funding under this article, payments and support for the nonfederal share of payments for healthcare, services, and treatment shall be increased based on criteria developed and periodically updated as part of the annual state budget process, provided that these funds shall not be used to supplant existing state general funds for these same purposes (Section 30130.55, paragraph a). Tobacco Control Program These funds are not to be used to supplant existing state or local funds for these same purposes (Section 30130.55, paragraph b). UC Tobacco-Related Disease The funds shall not be used to supplant existing state or local funds Research for these same purposes (Section 30130.55, paragraph c). School Programs These funds shall not be used to supplant existing state or local funds for these same purposes (Section 30130.55, paragraph b). a Section references are from Revenue and Taxation code. b Includes enforcement funds allocated to Department of Justice, Office of the Attorney General, Department of Public Health, and the State Board of Equalization. 4 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Proposals for Specified Dollar Proposal for Medi-Cal Amounts in the Measure Over $1.3 Billion to Medi-Cal. As required $58.3 Million for Enforcement Activities. The by the measure, the Governor’s budget allocates administration allocates $45 million for local law the bulk of the Proposition 56 revenues to enforcement grants ($37.5 million through the Medi-Cal. (Of this amount, $1.2 billion would Department of Justice and $7.5 million through be allocated to Medi-Cal in 2017-18 and the the Department of Public Heath, respectively) to remainder would be allocated in 2018-19 due prevent illegal sales of tobacco products. In addition, to Medi-Cal’s accounting structure.) These the administration allocates $7.5 million to the Proposition 56 revenues largely would support Department of Justice for tobacco law enforcement anticipated cost increases in the program activities, particularly enforcing compliance with from 2016-17 to 2017-18. The measure restricts tax obligations. Lastly, the administration allocates Proposition 56 revenues from supplanting $5.8 million to BOE for regulating the distribution existing General Fund support for Medi-Cal. of tobacco products. This amount is less than the While the administration does not reduce overall annual $6 million (or $7.5 million for five quarters state funding for Medi-Cal as a result of the of revenue) specified by the measure. Under the Proposition 56 revenues, the administration’s Governor’s proposal, these funds supplement existing programs, which is required by the measure. Figure 3 $37.5 Million for State Oral Health Governor’s Budget Proposal for Program. The administration proposes to use Proposition 56 Revenue the Proposition 56 funds to support 11 additional (In Millions) positions at the Department of Public Health’s Program or Entity Amounta (DPH’s) Oral Health Program (OHP). Proposition 56 Backfill existing fundsb $37 provides the department significant discretion in BOE administrationc 1 how to use the resources allocated to the state dental Fixed Allocations Enforcement 58 program. OHP proposes using the new funds to UC Physician Training 50 implement a forthcoming California State Oral DPH State Dental Health Program 38 Health Plan, which is currently past due. California State Auditor 0.4 Remaining Allocations $50 Million for Graduate Medical Education. Medi-Cald 1,324 The administration proposes allocating $50 million DPH Tobacco Control Program 179 to the University of California (UC) for graduate UC Tobacco-Related 81 Disease Research medical education. The administration uses School Programs 32 Proposition 56 revenue in place of $50 million Total $1,799 General Fund revenue that the administration a Amounts reflect five quarters of revenue. b Replaces lost revenue to existing tobacco tax funds as well as estimates supported graduate medical education state and local sales and use taxes. Excludes General Fund backfill, which Department of Finance indicates will be reflected in in 2016-17. (General Fund for UC generally May. c is not earmarked for specific purposes.) The Includes enforcement funds allocated to the Department of Justice, Office of the Attorney General, Department of Public Health, and administration proposes repurposing the the Board of Equalization. d Includes $87 million which will be expended in 2018-19. $50 million General Fund for the Governor’s BOE = Board of Equalization; UC = University of California; and DPH = Department of Public Health. commitment to provide a 4 percent unallocated base funding increase to UC. www.lao.ca.gov Legislative Analyst’s Office 5 2017-18 BUDGET proposals do not include any new policy changes Proposal for Department of Public to provider rates or fee-for-service payments. We Health—Tobacco Control describe the use of the Proposition 56 revenues $178.5 Million for DPH Tobacco Control in more detail below. Board (TCB). Using revenues from Proposition 99, Over $900 Million Supports Increased TCB works to reduce smoking and exposure to Managed Care Costs. The majority of second-hand smoke in California through a variety Proposition 56 Medi-Cal revenue would go of statewide and community-based activities. to managed care plans under the Governor’s TCB proposes to use the additional revenue from proposal. Based on data from the Department of Proposition 56 to support 26 additional staff Finance, a large portion of that revenue would and award additional competitive grants to local pay for the state’s increased share of cost for governments and community-based organizations. the Patient Protection and Affordable Care Act These grants would expand prevention and (ACA) Medi-Cal optional expansion. (Each year reduction programs and other local smoking the state’s share of cost under the expansion cessation activities. TCB also would boost phone increases as federal funds decline.) In effect, hotline services for smoking cessation. These funds these payments would backfill the anticipated supplement TCB’s existing efforts, as required by decline in federal funds. Proposition 56 revenues the measure. also would pay almost all of the annual capitated rate adjustment that managed care plans receive Proposal for Medical Research to cover the increased cost of providing services and School Programs year to year. In addition, some portion of these $80.7 Million for UC Research. The funds would support costs associated with Governor’s budget allocates almost $81 million higher utilization of Hepatitis C medications and in Proposition 56 revenues to support tobacco- caseload increases. related medical research. The measure requires Remainder Paid to Medicare. The Governor UC to allocate these grants on a competitive basis proposes using the remaining $323 million to individuals or entities within California. These to support increased payments to the federal funds supplement existing research grants for government. Most of this funding would pay tobacco-related medical research, as required by for increased payments for Medicare premiums, the measure. which Medi-Cal covers for those program $31.5 Million for Schools. The administration beneficiaries who also are eligible for Medicare. allocates $31.5 million to the California Department of Education’s Tobacco Use Prevention Education program. This program provides competitive grants to schools to educate students on avoiding tobacco use. These funds supplement exiting tobacco-related school programs, as required by the measure. 6 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET LAO FINDINGS Revenue Estimates and Allocations education (at least according to administration estimates) arguably does not meet this goal. Governor’s Overall Estimate for Proposition 56 Revenues Reasonable. Our revenue Supplantation or Not for Medi-Cal? assumptions differ from the administration’s in As noted earlier, we believe the Governor’s two ways. First, we expect a stronger consumer proposals for tobacco enforcement, TCB, response to the tax increases, which would reduce medical research, and school programs meet the revenue. (This response includes both lower proposition’s requirements that the new revenues rates of actual tobacco consumption and higher supplement existing funds to the programs. rates of tax avoidance.) Second, we expect higher We discuss whether the Governor’s use of revenues from certain parts of the new taxes—such Proposition 56 Medi-Cal funds meets the measure’s as the new tax on electronic cigarettes—which requirements below. would increase revenue. These differences largely Common Sense View of Supplantation. Some offset each other, so we are comfortable with the believe that the Governor’s proposal does not administration’s overall revenue estimate. comply with the measure’s non-supplantation Generally, Administration’s Proposals requirements for Medi-Cal. One of the purposes Allocate Funds to the Required Programs. In of Proposition 56, as outlined in the measure, was all but one instance, the Governor’s allocation to “provide funds to increase funding for existing proposals follow the amounts prescribed in the health care programs and services.” Taken at face measure. Specifically, the measure requires BOE value, voter approval of Proposition 56 arguably to receive $6 million annually ($7.5 million for five demonstrates a desire to increase funding to quarters of revenue) for enforcement activities. Medi-Cal beyond year-to-year growth in the The administration’s proposal only provides program absent policy changes. The Governor’s $5.8 million in 2017-18. The administration argues proposal, by contrast, uses the new revenues to pay that the measure does not require the funds to be for typical year-to-year cost increases in Medi-Cal. allocated to BOE but simply designated as revenue Proposition 56 funds are not used to increase owed BOE. The measure states, in relevant part, provider rates or expand the current scope of the “Six million dollars ($6,000,000) annually to the Medi-Cal program in any way. board to be used to enforce laws.” Governor’s View of Measure’s Requirements. Use of Graduate Medical Education Funds As noted in Figure 2, Proposition 56 directs that May Not Meet Goal of Measure. While the its revenues “shall not be used to supplant existing measure does not require Proposition 56 revenues state general funds for these same purposes,” to supplement existing resources for medical namely, state Medi-Cal payments. The Governor’s education programs, the measure does state those proposal takes a literal view of this text. That is, funds are to be used “for the purpose and goal the administration argues that the existing General of increasing the number of primary care and Fund support to Medi-Cal is the amount provided emergency physicians training in California.” in the 2016-17 Budget Act, which, relative to the Using the Proposition 56 revenues to replace Governor’s 2017-18 budget proposal, does not General Fund resources used for graduate medical www.lao.ca.gov Legislative Analyst’s Office 7 AN LAO B R I E F decline. Moreover, under the Governor’s proposal, rationale, the court stated that “the state could cut the majority of the Proposition 56 revenues pay Medi-Cal funding entirely and replace it with all for the state’s increased share of cost for the ACA with [Proposition] 10 funds, claiming at the same Medi-Cal expansion, thereby supplanting federal time that they were not ‘supplanting’ existing funds, not state funds, which the measure does not services because the services no longer existed.” explicitly prohibit. Potential Alternatives Relevant Case Law Thin. In our review, we found few court decisions regarding supplantation. Legislature Could Consider Alternative Uses Though Superior Court decisions generally are of Medi-Cal Funds. Should the Legislature disagree not binding precedent, one California Superior with the administration’s interpretation of the Court decision (Children and Families Commission requirements under Proposition 56, the revenues of Fresno County et al. v. Edmund G. Brown, Jr., for Medi-Cal could be used to increase fee-for- et al) considered issues concerning supplantation service payments or managed care rates. Using of funds related to Proposition 10 (1998), another the Proposition 56 revenues to increase provider voter-approved tobacco measure. In that case, payments would have trade-offs. In particular, the the question before the court was whether the Legislature would need to allocate an additional state could shift Proposition 10 revenues from $1.3 billion from the General Fund to Medi-Cal to First 5 Commissions to Medi-Cal. Proposition 10 pay for the costs Proposition 56 covers under the stipulated, “no monies from [Proposition 10] shall Governor’s proposal. Under the Governor’s revenue be used to supplant state or local General Fund estimates, doing so could require reductions to money for any purpose.” The court found that other programs or smaller budget reserves. Should transferring funds from Proposition 10 to avoid the revenue estimates be higher in May, however, cuts in Medi-Cal was “disingenuous.” Under that the Legislature may have more flexibility to allocate additional revenues to Medi-Cal. CONCLUSION The Governor’s proposal for the use of problematic, although we cannot be certain Proposition 56 revenues generally allocates the how the courts would interpret the proposal if revenues to the entities and in the amounts enacted. In any case, the Legislature must make its specified in the measure. The proposed use of own determination about how to implement the the revenues for Medi-Cal, however, may be Medi-Cal provisions of the measure. LAO Publications This brief was prepared by Carolyn Chu, with assistance from various analysts, and reviewed by Jason Sisney. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. 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