The 2017-18 Budget: Governor's Gann Limit Proposal

The 2017-18 Budget: Governor’s Gann Limit Proposal MAC TAYLOR • L E G I S L A T I V E A N A L Y S T • MARCH 2, 2017 2017-18 BUDGET 2 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET EXECUTIVE SUMMARY Voters Passed Gann Limit in 1979 to Constrain Government Spending. In the wake of Proposition 13 (1978)—the landmark initiative that limited local property taxes—voters passed another measure that limited the spending side of government operations. Proposition 4 (1979) amended the State Constitution to impose spending limits—technically, appropriations limits—on the state and most local governments. The limits are sometimes referred to as “Gann limits” in reference to one of the measure’s coauthors, Paul Gann. The fundamental purpose of the limits was to keep inflation- and population-adjusted appropriations under the 1978-79 level. The measure required revenues in excess of the limit to be rebated to taxpayers. Gann Limit a Big Factor in Budgeting Until Proposition 111 (1990) Reduced Its Effects. The state’s appropriations limit, or SAL, was a significant factor in state budgeting during the 1980s. In fact, the state had revenues in excess of its SAL in 1986-87 and was required to rebate $1.1 billion to taxpayers (equal to over $2 billion in today’s dollars). Proposition 111 made several changes to the Gann Limit that reduced its effects on state and local budgeting. The measure required excess revenues to be determined over a two-year period rather than in a single year, making excess revenues less likely. The measure also changed the population and inflation growth factors in a way that created more “room” under the limit. Since passage of Proposition 111, the SAL has rarely affected state budgeting. Governor Proposes to Not Count $22 Billion Under Gann Limit. Not mentioned in the Governor’s 2017-18 budget summary is a proposal to adopt a new SAL calculation methodology. Essentially, the Governor proposes to no longer count $22 billion of school-related spending toward the state’s appropriations limit. As the Governor is not proposing to count these funds toward local limits, this means that the Governor does not count the funds anywhere under Gann Limit calculations. In effect, the funds become “nowhere money” under the calculations. Proposal Creates $22 Billion in New State Spending Capacity. A core principle of the Gann Limit is that spending from tax revenues must be counted at either the state or local level (unless specifically exempted under the Constitution). If such spending is unaccounted for, appropriations can be greater than intended under the Gann Limit. The figure on page 4 shows the effect of the Governor’s proposal. By not counting $22 billion in spending toward the limit (labeled “nowhere money” in the figure), the Governor frees up a like amount of room—essentially new state spending capacity under the Gann Limit. Governor’s Proposal Violates Spirit of the Gann Limit. The Governor’s proposal contradicts long-standing policies regarding the implementation of the Gann Limit. Keeping spending under the 1978-79 level was the fundamental purpose of Proposition 4. By not counting $22 billion in spending toward the limit, the Governor’s proposal allows for more government spending capacity than the 1978-79 level, thus violating the spirit of Proposition 4. Accordingly, we believe that the plan would be highly vulnerable to legal challenges. We recommend that the Legislature reject the Governor’s proposal and direct the administration to produce SAL calculations for the 2017-18 budget using their prior methodology. www.lao.ca.gov Legislative Analyst’s Office 3 2017-18 BUDGET Gann Limit Now Appears to Be a Real Budget Constraint. In this report, we offer our own SAL calculations using the administration’s prior methodology. We find that the state has only a few billion dollars of room under the SAL. While the Gann Limit has not been a focus of budgetary discussions for some time, this finding is not entirely unexpected, as state room under the SAL tends to shrink as economic expansions persist. In addition, we identify issues outside of the Governor’s proposal that—if addressed—would further erode room under the SAL. Furthermore, if revenues increase in the May Revision or the Legislature approves additional tax levies, the state could find itself on the brink of exceeding the SAL. Options for Legislative Consideration. Should this scenario come to pass, there are a few options for the Legislature to consider. First, the Legislature could do nothing, in which case excess revenues over two consecutive years would be divided between Proposition 98 spending and taxpayer rebates. Second, the Legislature could reduce taxes either through lower rates or increased tax credits or deductions. Third, the Legislature could shift appropriations from items subject to the SAL to purposes that are exempt from the limit. These include debt service; certain capital outlay projects; and funding for cities, counties, and certain special districts (to the extent these local governments have room under their limits). Finally, other options exist to shift up to several billion dollars in room from school and community Governor's Proposal Undermines college districts to the Gann Limit by Creating More State Spending Capacity state without violating the spirit of the Gann 2016-17 Estimates (In Billions) Limit. (We note that $140 such actions could Nowhere Moneya 120 be designed to hold State Appropriations Limit districts harmless.) 100 While these options 80 could relieve some pressure on state 60 budgeting, the gain to the state would be far 40 smaller than under the 20 Governor’s proposal, meaning the SAL Current Law Governor's Proposal could constrain state a Money that the Governor does not count under the state or local appropriations limit calculations. budgeting at least in "Nowhere money" translates to increased state spending capacity. the near future. 4 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET INTRODUCTION In the late 1970s, voters passed two major years, “room” under the limit—available spending initiatives that constrained government operations: capacity for the state’s tax-supported funds—has Proposition 13 (1978) and Proposition 4 (1979). been shrinking. The Governor’s 2017-18 budget Proposition 4 added Article XIII B to the State proposes a new interpretation of the Gann Limit that Constitution, which established an appropriations allows for significantly more state spending capacity. limit on the state and most types of local The new interpretation would change long-standing governments. These limits are also referred to as methods used to calculate the Gann Limit. “Gann limits” in reference to one of the measure’s This report provides our assessment of the coauthors, Paul Gann. Governor’s proposal. First, we provide background The fundamental purpose of the Gann Limit— on the Gann Limit, including a discussion of its described in Section 1 of the measure—was to keep history and explanation of the complex calculations real (inflation adjusted) per person government required by Proposition 4. We then describe the spending under 1978-79 levels. While the Gann Governor’s proposal. Finally, we provide our Limit has been a nonfactor for state finances in recent assessment of the proposal and recommendations. HISTORY OF THE GANN LIMIT California in the Late 1970s. During the late 60 percent immediately following the measure, the 1970s, the state amassed large budget surpluses. state was given the responsibility of allocating local Over a few fiscal years, revenues significantly property taxes among local governments, and the exceeded spending, and the state effectively held state took various actions to provide fiscal relief to much of this excess in reserves as opposed to local governments. spending the funds or returning them to taxpayers. Proposition 4 Limited Government Spending. In 1977-78, the state had a reserve equal to over In Proposition 13’s wake, voters approved $11 billion in today’s dollars, or nearly 20 percent Proposition 4 in 1979. This measure amended the greater than total reserves proposed by the Constitution to impose an appropriations limit Governor in the 2017-18 budget. Unlike California’s on the state and most local governments. The recent budgeting experience—in which the state’s fundamental purpose of the appropriations limit elected leaders and voters have prioritized reserves, is to keep real per capita government spending including the 2014 passage of Proposition 2—many under the 1978-79 level. It did this by requiring at that time viewed the surpluses negatively. Some a complex set of calculations to be performed believe they contributed to voters approving each year to compare appropriations to the Propositions 13 and 4. limit. If the state has revenues that cannot be Proposition 13 Limited Property Taxes. In appropriated because of the limit—meaning the 1978, voters passed Proposition 13, the landmark state has “excess revenues”—the measure required decision to limit property taxes. The measure had the excess revenues to be returned to taxpayers. a profound effect on state and local government. (Proposition 4 also required the state to reimburse Local property tax revenues dropped by about local governments for state-imposed mandates, but www.lao.ca.gov Legislative Analyst’s Office 5 2017-18 BUDGET the administration’s proposal does not affect the to encompass school districts, community college mandate-reimbursement process.) districts, and county offices of education.) Legislature Faced Decisions in Implementing Gann Limit Constrained State Spending in the Measure. The Gann Limit was intended to Mid-1980s. Figure 1 shows historical calculations constrain spending by the state and well over of the state’s appropriations limit, or SAL, and 1,000 local governments. To accomplish this, appropriations subject to the limit. Initially, the Proposition 4 used general, rather than specific, Gann Limit had little effect on state budgeting. In language requiring the Legislature to interpret part, this was because prior-year surplus balances parts of the measure in its implementation. were factored into the calculations, giving the Moreover, the Legislature was given the state more room under the limit than otherwise responsibility to define some aspects of the would have been the case. During the late 1970s measure, including the measure of population used and early 1980s high inflation and slow revenue for purposes of adjusting the appropriations limits. growth increased room under the limit. By the (We described these numerous choices in our mid-1980s, however, strong revenue growth quickly December 1979 report, An Analysis of Proposition 4: brought state appropriations to the limit. In fact, The Gann “Spirit of 13” Initiative.) As we describe the state had excess revenues of $1.1 billion in later in this report, the Legislature implemented the 1986-87—equal to over $2 billion in today’s dollars. measure to minimize the effect on school districts. Proposition 4 required the excess to be rebated to (In this report, we use the term “school district” taxpayers. Figure 1 History of the State Appropriations Limit (In Billions) $120 100 80 “Room” State Appropriations Limit 60 40 Appropriations Subject to the Limit 20 1978-79 1983-84 1988-89 1993-94 1998-99 2003-04 2008-09 2013-14 Note: Figure reflects administration's January 2016 estimates. 6 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Proposition 98 (1988) Changed How Excess allocated to additional Proposition 98 spending Revenues Are Distributed. In 1988, voters passed with the rest allocated to taxpayer rebates. Lastly, Proposition 98. Proposition 98 is the state’s Proposition 111 exempted additional categories of constitutional minimum funding guarantee for appropriations from the Gann Limit. schools and community colleges. Proposition 98 Taxpayer Rebates Not Triggered Since also amended the Constitution to require a portion Mid-1980s. In the early 1990s, the SAL rarely of excess revenues to be spent on Proposition 98 affected state budgeting because of the changes programs. made by Proposition 111. As revenues surged Voters Changed Gann Limit in 1990. during the dot-com boom of the late 1990s, Proposition 111 (1990) significantly changed however, the state approached the limit. The state the Gann Limit. First, the measure changed the had excess revenues in 1999-00, but because population and inflation growth factors in a appropriations were under the limit in 2000-01, way that created more room for state and local additional Proposition 98 spending and taxpayer appropriations. Second, it required excess revenues rebates were not required. The 2001 recession to be determined over a two-year period rather and resulting decline in state revenues created than in a single year, making it less likely to trigger substantial room under the limit by 2001-02. (We taxpayer rebates and additional Proposition 98 discussed the SAL issues from around this time spending. Third, the measure changed how excess in our April 2000 report, The State Appropriations revenues were to be distributed. Specifically, Limit.) Since 2001-02, the state has continued to Proposition 111 required that half of the excess be have considerable room under the limit. HOW THE STATE APPROPRIATIONS LIMIT WORKS Each year, Article XIII B requires the state to Initial Calculations for 1978-79 perform a series of complex calculations. In this Established the Base section, we explain the current rules of the SAL Limit Based on Appropriations in 1978-79. calculation. The fundamental purpose of the Gann Limit is to Annual SAL Calculations Included in Budget keep real per capita government spending under the Bill, Subject to Budget Process. Statutes require the 1978-79 level. In order to accomplish this task, the Governor to include SAL calculations in his or her measure required a series of complex calculations annual budget proposal to the Legislature. (Detail to determine the 1978-79 base, as summarized of these calculations can be found in Schedules in Figure 2 (see next page). The Legislature faced 12A through 12E in the Appendix of the Governor’s various choices in implementing these calculations, Budget Summary. Historical SAL estimates but for simplicity’s sake, we focus here on those can be found in Chart L on the Department of choices relevant to the Governor’s proposal. Finance website.) Under state law, the estimate First Step Was to Determine “Proceeds “shall be subject to the budget process.” Currently, of Taxes.” The Gann Limit does not constrain Section 12.00 of the annual budget bill lists the state appropriations from all government revenues. appropriations limit, and declares that any court Rather, it applies the limit to appropriations from action to review or void this determination must be proceeds of taxes. Essentially, this means that stated within 45 days of the budget taking effect. www.lao.ca.gov Legislative Analyst’s Office 7 2017-18 BUDGET appropriations from tax levies are subject to the support local programs. State subventions are limit. For example, revenues from the state’s “big exempted from the state’s limit and counted under three” taxes—the personal income tax, sales and local limits. Proposition 4 left state subventions use tax, and corporation tax—were included in largely undefined—thus, the Legislature was the initial calculation of state proceeds of taxes. left with the task of determining what types of Appropriations from non-tax revenues, such as fees programs would be considered state subventions. In to provide a service to feepayers, are not subject to our 1979 report on implementing the Gann Limit, the Gann Limit and therefore were not included in we addressed the trade-offs inherent in adopting the initial calculations. different interpretations of state subventions, Second Step Was to Determine Appropriations calling this “one of the most important tasks From Proceeds of Taxes. The next step in the initial confronting the Legislature in implementing calculations was to sum appropriations from funds Proposition 4.” that received proceeds of taxes. Article XIII B Regarding schools, the Legislature allows for various exemptions from the SAL, which implemented Proposition 4 to count base are detailed in Figure 2. Of particular relevance per-pupil funding at the school district level. The to Governor’s proposal are “state subventions to state counted the remaining funds—including local government,” particularly to school districts. categorical programs over which the state exercised Generally, state subventions are state funds that relative control—under the state’s appropriations limit. We detail our review of legislative intent concerning Figure 2 how the Gann Limit applies to Initial State Appropriations Limit school districts in the box on Calculations for 1978-79 Base Year pages 10 and 11. Resulting Amount Is Step 1: Determined “Proceeds of Taxes” Appropriations Subject • Revenues from all general state taxes, including: – Personal income tax. to Limitation. After – Sales and use tax. determining proceeds of – Corporation tax. • Investment income from tax revenues. taxes and appropriations • User fees in excess of cost. • Prior-year surplus. from those proceeds of taxes, the remaining amount— appropriations subject to limitation—was deemed Step 2: Determined Appropriations From Proceeds of Taxes • Appropriations from funds into which proceeds of taxes are to be the 1978-79 base year deposited less: – State “subventions” to local government. SAL. The SAL was grown – Debt service. for population and inflation – Withdrawals from reserve funds. – Federal or court mandates. in 1979-80 and 1980-81 and became effective for the 1980-81 fiscal year. In the Total, Appropriations Subject to Limitation next section, we describe how the SAL grows each year. 8 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Calculating Year-to-Year Changes in the SAL Multiply Current Year’s SAL by SAL Growth Factor. The current year’s SAL is the Figure 3 shows the annual SAL calculations starting point for determining the upcoming for the upcoming fiscal year. Step 1 shows the year’s SAL. The current year’s SAL is multiplied calculation of the SAL, step 2 shows the calculation by the “SAL growth factor,” an annual measure of appropriations subject to the limit, and step 3 of inflation and population growth. As noted shows the determination of whether the state earlier, Proposition 111 changed the inflation and has excess revenues. Below, we walk through the population measures used to compute the SAL annual steps necessary to compute the SAL. Figure 3 State Appropriations Limit (SAL) Calculations for Upcoming Fiscal Year Step 1: Calculate the SAL Step 2: Calculate Appropriations Subject to the Limit Current Year’s Limit Step 1: Determine “Proceeds of Taxes” • Revenues from all general state taxes, such as: Multiplied by: – Personal income tax. – Sales and use tax. SAL Growth Factor – Corporation tax. • Percent growth in fourth quarter per capita • Investment income from tax revenues. personal income. • User fees in excess of cost. • Prior-year surplus. Multiplied by • Change in population determined as follows: – Percent growth in average daily attendance multiplied by Proposition 98 share of budget. Plus Step 2: Determine Appropriations From Proceeds of Taxes – Percent growth in civilian population multiplied • Appropriations from funds into which proceeds by non-Proposition 98 share of budget. of taxes are deposited less: – State “subventions” to local government. – Debt service. – Withdrawals from reserve funds. – Federal or court mandates. – Refund of taxes. Plus/Minus: – Qualified capital outlay. Transfers of Responsibility – Appropriations from certain gas tax revenues. • Between governments. – Appropriations resulting from natural disasters. • Between taxes and fees. SAL for Upcoming Fiscal Year Appropriations Subject to the Limit Step 3: Determining Excess Revenues If appropriations subject to the limit reach the SAL, any revenue in excess of the SAL over two consecutive years must be: • Appropriated for purposes exempt from the SAL; and/or • Split between taxpayer rebates and additional Proposition 98 spending. www.lao.ca.gov Legislative Analyst’s Office 9 2017-18 BUDGET growth factor. The current SAL growth factor is by the Proposition 98 share of the state determined by multiplying the two items below: budget (roughly 40 percent) and growth in the civilian population is weighted by • Measure of Inflation. The annual the non-Proposition 98 share of the state change in per capita personal income is budget (the other roughly 60 percent). determined using (1) California 4th quarter The sum of these two population growth personal income, as measured by the rates results in the estimate of change in U.S. Bureau of Economic Analysis, and population used in the SAL growth factor. (2) the civilian population of the state, as measured by the Department of Finance. Account for Transfers of Responsibility. From time to time, governments transfer • Measure of Population Growth. The SAL responsibility for providing services to other growth factor’s change in population governments or to the private sector. For is a weighted average of change in the example, the state might transfer responsibility school population and change in the for operating a park to a local government. In civilian population. Specifically, growth this example, Proposition 4 requires the state and in average daily attendance is weighted local government to agree on an amount to be Exploring Legislative Intent In assessing the Governor’s Gann Limit proposal, we reviewed historical documents to understand legislative intent regarding state subventions to school districts. Below, we summarize our findings. Implementing Legislation Defined Subventions to Cities, Counties, and Special Districts Based on Degree of Control. Proposition 4 (1979) was generally silent on how expansive the definition of subventions should be; however, our office and others at the time pointed to one phrase in the measure that provided some guidance. Specifically, Section 8(a) of the measure references state subventions “for the use and operation of local government,” suggesting that the degree of local control over the use of funds could guide whether they should be considered state subventions. The Legislature appears to have adopted this view. The 1981-82 Governor’s Budget Summary states, “the implementing legislation provides that state funded programs which are administered locally will be subject to limitation at the state level because the legislature determines the size and scope of these programs.” The summary then lists several programs that “are provided to local government for general purposes and their use is not restricted by statutes.” Most State Education Funding Counted at School District Level With Remainder Counted at State Level. Concerning school districts, the state adopted a similar approach, with funding counted at different levels based generally on degree of local control. Specifically, the state counted at the state level around $900 million in categorical programs and about $1.5 billion that the state provided at the time to address disparities in funding across districts. This latter funding—provided in response to the Serrano court decision—was provided through “equalization formulas.” The remaining roughly $4 billion in state education funding over which school districts had more control was counted at the school district level. Chapter 1205 of 1980 (SB 1352, Marks), the implementing legislation, stated: 10 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET transferred from the state’s appropriations limit used in determining appropriations subject to to the local government’s appropriations limit. the SAL. The first step is to determine revenues Proposition 4 also requires adjustments in the limit from proceeds of taxes. (Schedules 12B and 12 C if responsibility for a program is transferred from a in the Appendix of The 2017-18 Governor’s Budget tax to a fee. Summary lists the revenues currently excluded Resulting Amount Is the SAL for the from the SAL.) The next step is to determine the Upcoming Fiscal Year. After multiplying the amount of appropriations from those proceeds. current year’s limit by the SAL growth factor and After reducing the appropriations by the adding or subtracting any transfers of responsibly, various exemptions, such as subventions to local if applicable, the resulting amount is the SAL for governments, the resulting amount is appropriations the upcoming fiscal year. subject to the state limit. The total level of these appropriations cannot exceed the SAL for that year. Calculating Appropriations Today’s process is nearly identical to the Subject to the State Limit process used to determine the initial 1978-79 base Similar Process to Initial Calculation of SAL that we described earlier but with a few small 1978-79 Base. Step 2 of Figure 3 shows the process differences. Specifically, Proposition 111 added The Legislature…finds and declares…that equalization of the financial capabilities of school districts is a matter of statewide interest and concern and that state money provided to school districts to achieve this end is properly excluded from “state subventions” to local school districts as that term is used in Article XIII B of the California Constitution. Similarly, the various categorical aid programs provided by the state are provided as a matter of statewide public policy. The changing character of children and neighborhoods and the resultant changing needs of local school districts require flexibility in providing these programs which can only be achieved by characterizing these programs as state programs, thereby excluding state support for these programs from state subventions to local school districts. The 1981-82 Governor’s Budget Summary confirms the intent of the Legislature: State subventions for K-12 school districts are divided, with a portion subject to the state appropriations limit and a portion subject to school district limits. The state has augmented the basic K-12 educational program through a series of “equalization formulas” designed to bring the schools into substantial compliance with the Serrano court mandate. In view of the control which rests with the state over these and other categorical program expenditures, the implementing legislation provides that expenditures above the basic program level are the responsibility of the state and therefore a part of the state’s appropriations limit. Local school districts are responsible for making available to all children a basic level of education. This basic program level is subject to limit at each school district. State subventions for community colleges are treated similarly to subventions for school districts. The portion of state support dedicated to equalization will be placed, along with state-supported categorical programs, in the state base. The remainder of the community college subventions augment local revenues and are subject to limitation at each community college district. In summary, concerning school districts, the state implemented Proposition 4 by placing nearly two-thirds of state aid under the districts’ limits. Amounts in excess of these levels—including categorical aid—were placed under the state’s limit. www.lao.ca.gov Legislative Analyst’s Office 11 2017-18 BUDGET three new categories of exempt appropriations: spent up to its limit), Proposition 4 requires that (1) appropriations resulting from certain these excess revenues be: emergencies, (2) certain capital outlay projects, and • Appropriated for purposes exempt from (3) appropriations from certain gas tax revenues. the SAL; and/or Determining Excess Revenues • Split between additional Proposition 98 If the state over any two-year period has spending and taxpayer rebates. revenues that it has not appropriated (because it has HOW GANN LIMIT WORKS FOR SCHOOL DISTRICTS State Law Sweeps School District Room, State Minimized Effects of Proposition 4 on Essentially Maximizing State Flexibility. State School Districts. In some cases, a school district’s statutes detail the process by which districts local proceeds of taxes exceed a school district’s administer their limits. First, school districts appropriations limit. This happens, for example, grow their appropriations limits using a process in periods of strong property tax growth when similar to that of the state. Next, school districts revenue growth exceeds growth in appropriations estimate their proceeds of taxes—including their limits. In these cases, statutes limit Proposition 4’s local property tax shares and subventions that effects on school districts by allowing school they receive from the state. State statute essentially districts that would otherwise exceed their limits to maximizes the amount of state education funding increase their limit by notifying the state Director that can be counted under school district limits. of Finance. The school district increases its limit by Specifically, if a school district’s limit is greater than the amount needed to keep appropriations under its proceeds of taxes—in other words, if a school their limit and the state makes a like downward district has room under its limit—additional state adjustment to its limit to keep the overall level of education funding is included in the calculation government spending under the real per capita to bring the school district’s appropriations up to 1978-79 level. its limit. (For purposes of this calculation, only Available Data Suggest School and the funding provided through the Local Control Community College Districts Could Have More Funding Formula is included. Categorical funds Than $4 Billion in Room. Some districts have are counted at the state level.) Statewide, however, an appropriations limit that exceeds the revenue not all state education funding can be included they receive from local property taxes and state under school districts’ collective limits. The subventions. In other words, these districts have balance of state aid that cannot be absorbed under room left over even after the state has counted all school district limits is counted at the state level. of their apportionment funding toward their local This mechanism essentially counts as much state limits. Based on the reports that districts file with education aid as possible at the school district the state, we think the available room could exceed level while counting all funds at either the state or $4 billion statewide. Of this amount, the bulk is local level. (The state applies a similar process for reported by community college districts. Possible administering community college district limits.) factors that could explain why college districts have 12 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET more room than school districts include differences varying practices for administering changes to in the funding formulas for the two systems and local limits over time. GOVERNOR’S PROPOSAL Proposes New Interpretation of Gann Limit state limit roughly $8 billion in categorical aid to Provisions. The administration’s SAL calculations school districts. The Governor excludes these funds included in the Governor’s 2017-18 budget proposal from the state limit by categorizing them as state adopt a new interpretation of the Proposition 4 subventions to local government. implementation statutes. The Governor proposes Does Not Count Additional State Subventions to no longer count $22 billion in state education at Local Level. Most importantly, the Governor’s appropriations toward the state limit. First, the proposal does not count the $22 billion in Governor proposes to no longer count under the additional state subventions as local proceeds of state limit roughly $14 billion of state funding taxes. In other words, the Governor does not count that cannot be absorbed under school district the funds under either the state’s or school districts’ limits. (This is our estimate; the administration limits. In effect, the funds become “nowhere declined to provide us its estimate.) Second, the money,” meaning they are not accounted for under Governor proposes to no longer count under the Gann Limit calculations. ASSESSMENT Proposal Creates $22 Billion in Proposal Raises Legal Concerns State Spending Capacity Governor’s Proposal Contradicts “Nowhere Money” Creates More Spending Long-Standing SAL Interpretation. Based on our Capacity. Figure 4 (see next page) compares our review of the Legislature’s intent in implementing estimates of state spending capacity under current Proposition 4—described earlier in the text law with the Governor’s proposal. Even though box—it is clear that the state intended to count the state would still be spending the $22 billion under the state’s limit (1) categorical programs in school aid, the Governor proposes to no longer and (2) funding provided through equalization count these appropriations under the Gann Limit. formulas. (Today’s version of this latter funding This frees up $22 billion in room under the SAL is the $14 billion of state aid that cannot be that can be used for new state spending. The absorbed under school district limits.) In 1980, the Governor’s proposal, therefore, can be viewed as Legislature declared its intent that these programs creating more government spending capacity than are a matter of statewide interest and that their the real per capita 1978-79 level, thus undermining funds should not be counted at the local level. the Gann Limit. The 1981-82 Governor’s Budget Summary also confirms this intent, stating that this funding was www.lao.ca.gov Legislative Analyst’s Office 13 2017-18 BUDGET be greater than intended Figure 4 under the Gann Limit. Governor's Proposal Undermines Specifically, the Constitution Gann Limit by Creating More State Spending Capacity states that “With respect 2016-17 Estimates (In Billions) to any local government, $140 ‘proceeds of taxes’ shall Nowhere Moneya include subventions received 120 State Appropriations Limit from the State . . . and, with 100 respect to the state, proceeds of taxes shall exclude 80 such subventions.” By not 60 counting the additional state subventions as school 40 district proceeds of taxes, 20 the nowhere money created in the Governor’s proposal Current Law Governor's Proposal allows for more government a Money that the Governor does not count under the state or local appropriations limit calculations. spending capacity than was "Nowhere money" translates to increased state spending capacity. intended by the voters in passing, and later modifying, “the responsibility of the state and therefore a part the Gann Limit. of the state’s appropriations limit.” The Governor San Francisco Lost Similar Gann Limit Case. now proposes to change this long-standing SAL In 1992, the California Supreme Court decided interpretation. a similar case concerning appropriations limit Proposed Interpretation of Statute Appears calculations—San Francisco Taxpayers Association to Conflict With Constitution. The administration v. Board of Supervisors of the City and County of points to statutes as the basis for their proposed San Francisco. San Francisco included retirement change in SAL interpretation. Existing statutes are contributions in its initial appropriations limit clear that the funds in question are not counted calculations. In the mid-1980s, the Board of as school district proceeds of taxes. The statutes Supervisors decided to exclude the contributions were written that way, however, because when the and “rebench” its appropriations limit as if the Legislature implemented Proposition 4, it chose to contributions had always been excluded. In this count the funds at the state level. case, rebenching the limit removed San Francisco’s The Constitution requires that appropriations retirement contributions from its 1978-79 base from state proceeds of taxes be counted either year limit. San Francisco then recalculated its as state appropriations subject to the limit or appropriations limit by growing the new, lower base as subventions that are then counted as local year limit by the same growth factors it originally government proceeds of taxes (unless specifically used. The result of the rebenching process was a excepted under the Constitution). If some lower appropriations limit. appropriations are not counted at one level or While excluding retirement contributions from the other, total government appropriations could the calculations meant San Francisco counted less 14 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET appropriations toward the limit, the rebenching retirement contributions,” the court noted, “would also reduced San Francisco’s appropriations limit. do violence to that goal.” In other words, rebenching the limit offset much The language of the court is notable of the “gain” that San Francisco achieved from because in this case San Francisco rebenched excluding the contributions. The move would have its appropriations limit, offsetting much of the been advantageous to San Francisco, however, if advantage San Francisco would have otherwise retirement contributions were growing faster than achieved from not counting retirement their appropriations limit. contributions toward the limit. In other words, The court ruled against San Francisco’s the court ruled against San Francisco despite its exclusion of retirement contributions, finding efforts to address the nowhere money problem in that “the manifest purpose of Proposition 4 was its plan. By failing to address the nowhere money to limit the overall growth of governmental problem in his proposal, the Governor’s plan seems appropriations.” “To remove from the spending to run further afoul of the Constitution than San limit such a large category of appropriations as Francisco’s previously invalidated plan. RECOMMENDATION Recommend Legislature Reject Governor’s the Legislature reject the Governor’s proposal Proposal. The Governor’s proposal contradicts and direct the administration to produce SAL long-standing policies regarding the calculations for the 2017-18 budget using the current implementation of the Gann Limit. By creating law methodology. Using that methodology as a nowhere money—state school spending that is starting point, the Legislature could then consider counted neither at the state nor local level—the options—such as designating more appropriations plan, in our view, would be highly vulnerable to to categories exempted from the SAL—to preserve legal challenges. Accordingly, we recommend that room under the state’s Gann Limit. LAO CALCULATION OF SAL If the Legislature rejects the Governor’s SAL Establishing a Baseline proposal, it will need to consider alternative Figure 5 (see next page) shows our estimate estimates of the SAL in developing the 2017-18 of what the administration’s SAL estimate would budget. (We note that the administration declined have been under the current law methodology. We to provide us with SAL estimates under the start with the administration’s January 2017 SAL current law methodology.) Below, we first develop estimates, back out administration calculations of an estimate of what the administration’s SAL education subventions, and insert our calculation estimates would have been under the current law of what education subventions would have been methodology. We then identify additional issues under the previous (current law) SAL calculation we came across while evaluating the Governor’s method. In other words, the only place where proposal. these calculations differ from those displayed in www.lao.ca.gov Legislative Analyst’s Office 15 2017-18 BUDGET Figure 5 State Nearing State Appropriations Limit (SAL) Under Current Law Methodology LAO Estimates (In Billions) 2015-16 2016-17 2017-18 Calculation of SAL Limit $94.0 $99.8 $103.0 Calculation of Appropriations Subject to Limit Administration’s Proceeds of Taxes $142.7 $147.4 $152.2 Department of Finance noneducation exemptions -$21.4 -$23.6 -$22.7 Education subventionsa -30.5 -27.9 -29.3 Subtotal, Adjusted Exemptions (-$52.0) (-$51.5) (-$52.0) Adjusted Appropriations Subject to the Limit $90.8 $95.9 $100.2 Calculation of Room Under SAL LAO Estimate of Room Under SAL (Current Law Methodology) $3.3 $3.9 $2.8 a See Figure 6 for detail. The 2017-18 Governor’s Budget Summary is the baseline, we determined that the administration line in Figure 5 labeled “education subventions.” seems to have overstated state subventions in its Figure 6 details the adjustments we made to the January 2016 SAL calculation by over $6 billion administration’s education subventions to reflect annually for 2014-15 through 2016-17. These the current law methodology. overstated state subventions had the effect of State Nearing SAL Under Current Law decreasing state appropriations subject to the limit, Methodology. Our calculations suggest that if the thus increasing the amount of room under the SAL. administration provided SAL calculations under Our estimates in Figures 5 and 6 correct for these the current law methodology, the state would have overstated subventions. The Appendix at the end of little room under the SAL, as shown in Figure 5. this report provides more information about this Specifically, the state would end 2015-16 through issue. 2017-18 with between $2.8 billion and $3.9 billion Other Issues for Legislative Consideration of room under the SAL. Prior Administration Calculations Appear In the course of our review of the Governor’s to Have Overstated Room Under SAL. In the proposal, we identified additional SAL issues course of our work to establish this part of our SAL outside of the Governor’s proposal that merit Figure 6 Deriving Estimate of Education Subventions Under Current Law Methodology (In Billions) 2015-16 2016-17 2017-18 Department of Finance Estimate (New Methodology) $52.1 $51.0 $51.2 Remove categorical program spending -7.7 -8.0 -7.7 Reflect state funding not absorbed under school district limits -13.9 -15.1 -14.3 LAO Estimate (Current Law Methodology) $30.5 $27.9 $29.3 16 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET legislative attention. Addressing some of these Count Mandate Payments at State Level issues would further erode state room under the Pursuant to Constitution. Proposition 4 SAL while others would create additional state specifically requires state costs to reimburse local room. While we think these issues merit attention, government for mandated programs to be counted further examination of the Gann Limit and its at the state level. Beginning in January 2015, the history at both the state and local levels easily administration counted mandate reimbursements could uncover information that would change to school districts as state subventions. In order to SAL estimates by billions of dollars one way or the be consistent with Proposition 4, we recommend other. For example, we found that among the many that the Legislature count education mandate estimates of state costs to comply with federal and payments toward the SAL. This would reduce state court mandates (which are exempt from the limit), room under the SAL by $451 million in 2014-15, the administration probably could have included $3.8 billion in 2015-16, $1.4 billion in 2016-17, and additional health and human services costs related $287 million in 2017-18. (We note that a portion to federal overtime regulations. This would increase of these payments that did not actually reduce the room under the SAL. mandate backlog could be counted at the local Include Road Improvement Charge in level. Because most school districts have no room Proceeds of Taxes. The administration’s 2017-18 under their limits with which to absorb additional SAL calculation excludes revenues from the road state funding, however, essentially all of the monies improvement charge proposed as part of the would be counted at the state level in any case.) Governor’s transportation package. The road Adjust SAL Downward to Account for Recent improvement charge assesses a $65 charge on all School District Limit Adjustments. As described vehicles. Generally, to be considered a fee, the earlier, school districts that would otherwise exceed charge would have to approximate the cost of the their limits can increase their limit by notifying the motorist’s use of the roads or the cost of providing state Director of Finance. When this occurs, school a service directly to the fee payer. For example, districts increase their limit by the amount needed the Department of Motor Vehicles assesses a fee to keep appropriations under their limit. The state to individuals who apply for a driver’s license. is then supposed to make a downward adjustment The fee approximates the cost to the state of to the SAL to keep the overall level of government providing that service. The Governor’s proposed spending capacity under the real per capita 1978-79 road improvement charge, on the other hand, level. assesses a $65 levy on all vehicles—regardless of The administration’s calculations the motorist’s usage of public roads—and uses the appropriately adjust the SAL for shifts expected revenue for the broad public benefit of improving to occur in 2017-18. In recent years, however, the transportation infrastructure. There is, therefore, administration reflected these shifts by adjusting a strong argument that this assessment is a tax. education subventions rather than reducing the Accordingly, we recommend that the Legislature SAL. This essentially had a one-time effect on state count the $1.1 billion that the administration room under the SAL as opposed to the ongoing, estimates the charge will raise in 2017-18 as compounded effect that would have occurred if proceeds of taxes. This would reduce room under the administration had been adjusting the SAL. the SAL in that year by a like amount. We recommend that the Legislature adjust the SAL downward to appropriately count for these www.lao.ca.gov Legislative Analyst’s Office 17 2017-18 BUDGET prior-year shifts. We estimate that adjusting this recommend that the Legislature adjust the 2017-18 issue for 2012-13 through 2016-17 combined would SAL upward by $50 million, thereby creating an reduce the SAL by $1.1 billion by 2017-18. The equivalent amount of room in the state’s limit. effect in 2015-16 and 2016-17 would be partially Legislature Could Shift Room Under School offset by removing the administration’s education District Limits to State. State law limits the Gann subvention adjustment. Limit’s effect on school districts by shifting state Adjust SAL Upward for Unnecessary room to districts that would otherwise exceed their Transfer of Responsibility Adjustment. The limits. As currently structured, however, room Governor’s 2017-18 budget plan proposes to reduce is only shifted in one direction—from the state the SAL by $50 million to reflect a transfer in to school districts. As noted earlier, schools and responsibility. Specifically, the administration community colleges appear to have over $4 billion proposes to shift the responsibility for University in room under their limits. The Legislature could of California graduate medical education from change state law to shift room in both directions, the General Fund to tobacco tax funds approved thereby allowing the state to capture the room at by voters in Proposition 56 (2016). A provision in the school and community college district level. Proposition 56, however, amends the Constitution This option would not require a change in where to state “no adjustment in the appropriations limit education spending is counted under Gann Limit of any entity of government shall be required . . . as calculations. In addition, this option would not a result of revenue appropriated from” a fund increase overall government spending capacity, created by the measure. In other words, we do not meaning it could increase state flexibility under the think the adjustment is necessary. Accordingly, we SAL without violating the spirit of the Gann Limit. CONCLUSION Governor’s Proposal Violates Spirit of the In our 2017-18 Budget: Overview of the Gann Limit. The fundamental purpose of the Governor’s Budget, we stated that the Governor’s Gann Limit is to keep real per capita government personal income tax estimates for 2017-18 appear spending under the 1978-79 level. The Governor’s too low. If we are correct and revenues increase in proposal expands government spending capacity, the May Revision, the state may find itself on the thereby violating the spirit of Proposition 4. brink of exceeding the SAL. Beyond 2017-18, the We recommend that the Legislature reject the SAL could continue to constrain the state if the Governor’s proposal. economic expansion continues. The SAL could Gann Limit Now Appears to Be a Real Budget constrain state spending to a greater extent with Constraint. In this report, we offer SAL calculations the passage of additional taxes for transportation or under the current law methodology. Our estimates other purposes. suggest that the state is nearing the SAL. While Options to Respond to Tightening SAL. If the Gann Limit has not been a focus of budget the state finds itself with excess revenues for two discussions for some time, this finding is not consecutive years, there are a few options for the entirely unexpected, as state room under the SAL Legislature to consider. First, the Legislature could tends to shrink as economic expansions persist. do nothing, in which case excess revenues would 18 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET be divided between Proposition 98 spending and an action would not require a change in where taxpayer rebates. Second, the Legislature could education spending is counted under Gann reduce taxes either through lower rates or increased Limit calculations and would not increase overall tax credits or reductions. The Legislature also government spending capacity, meaning it would could shift appropriations from items subject to the not violate the spirit of the Gann Limit. Such SAL to purposes that are exempt from the limit. actions could also be designed to hold schools These include debt service; certain capital outlay harmless. While these options could relieve some projects; and subventions for cities, counties, and pressure on state budgeting, the gain to the state certain special districts (to the extent these local would be far smaller than under the Governor’s governments have room under their limits). proposal. This means that the SAL could continue Finally, options exist that could shift up to to constrain state budgeting even if the state acts several billion dollars in room from school and to capture some or all of the room under school community college districts to the state. Such district limits. www.lao.ca.gov Legislative Analyst’s Office 19 2017-18 BUDGET 20 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET APPENDIX: Prior Administration Calculations Appear changes made by LCFF. Because categorical aid to Have Overstated Room Under SAL is counted at the state level, the decrease in that funding is not reflected in the figure. Local Control Funding Formula (LCFF). The 2013-14 and 2014-15 Subventions Increased 2013-14 budget reflected a major restructuring of Substantially After 2013-14 Budget. Figure A2 (see education finance. In general, the LCFF gave more next page) shows how the amount of subventions control to school districts by decreasing the amount for 2013-14 and 2014-15 changed after January of categorical funding and increasing general 2013. As shown in the figure, state aid not absorbed purpose funding. The LCFF also increased funding under school district limits—again, reflected as a for low-income and English learner students. negative number in the administration’s displays— Effect on State Appropriations Limit (SAL) decreased substantially beginning in January 2014. Calculations. Figure A1 shows calculations By the time the estimates were finalized, total state of education subventions from the Governor’s education subventions increased by $4.7 billion for January 2013 budget proposal. As explained in 2013-14 and $6.6 billion for 2014-15. The decrease the main text of this report, the Legislature has in state aid not absorbed under school district implemented the Gann Limit to count at the state limits does not make sense given that school level categorical aid and state funding that cannot district funding was growing much faster than be absorbed at the school district level. The LCFF local limits over the period. In other words, we proposal reduced the amount of categorical aid would expect the increased Proposition 98 funding and increased general purpose funding. This is to have decreased room under the state limit rather reflected as an increase in K-12 LCFF and other than the increase in room that was shown on apportionments in the figure. Because district administration displays. appropriations limits would have increased by Calculations Appear to Have Overstated much less than the increase in general purpose Room Under the SAL. Using California funding, state aid not absorbed at the school Department of Education data, we have replicated district level increased (reflected as a larger negative most of the administration’s January 2016 number). This increase made sense given the education subvention Figure A1 calculations. However, State Subventions to Districts in we have been unable Governor’s 2013-14 Budget Proposal to replicate the (In Millions) administration’s estimates Estimated Proposed of state aid not absorbed 2012-13 2013-14 Change under school district K-12 LCFF and other apportionments $21,469 $29,660 $8,191 limits—the key issue Other K-12 funding 2,435 1,124 -1,311 discussed above. Our State aid not absorbed under school -1,709 -6,778 -5,069 district limits model suggests that the Community college funding 3,527 4,142 615 negative value in this line Total, Education Subventions $25,722 $28,148 $2,426 should have been several LCFF = Local Control Funding Formula. www.lao.ca.gov Legislative Analyst’s Office 21 2017-18 BUDGET billion dollars larger Figure A2 beginning in 2013-14. This State Education Subventions Increase Substantially would have decreased Beginning in January 2015 the amount of state (In Millions) subventions to districts. 2013-14 In 2014-15, for example, Revised Actual we estimate that state aid Jan. 2014 Jan. 2015 Difference not absorbed under school K-12 LCFF and other apportionments $29,496 $30,869 $1,373 district limits totaled Other K-12 funding 1,089 1,147 58 Community college funding 3,917 3,548 -369 nearly $9 billion rather State aid not absorbed under school district limits -6,436 -2,757 3,679 than the nearly $3 billion Total Subventions, Education $28,066 $32,807 $4,741 in the final display that 2014-15 was included in the Revised Actual Governor’s January 2016 Jan. 2014 Jan. 2016 Difference budget summary. Because K-12 LCFF and other apportionments $34,849 $34,259 -$590 the higher number Other K-12 funding 425 854 429 increases appropriations State aid not absorbed under school district limits -10,645 -2,940 7,705 Community college funding 4,324 3,322 -1,002 subject to the state limit, Total Subventions, Education $28,953 $35,495 $6,542 reflecting it in the final LCFF = Local Control Funding Formula. 2014-15 SAL calculation would have reduced the amount of room under the SAL from $9.4 billion to roughly $3 billion. We note that the final administration estimate for the 2014-15 SAL was included in the Governor’s January 2016 budget proposal. In other words, the administration has “closed” its estimates for that fiscal year. 22 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET www.lao.ca.gov Legislative Analyst’s Office 23 2017-18 BUDGET LAO Publications This report was prepared by Ryan Miller, with assistance from Kenneth Kapphahn and others, 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. 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. 24 Legislative Analyst’s Office www.lao.ca.gov