The 2018-19 Budget: Repaying the CalPERS Borrowing Plan

The 2018-19 Budget: Repaying the CalPERS Borrowing Plan MAC TAYLOR LEGISLATIVE ANALYST APRIL, 2018 Summary State Beginning Repayments on Enacted Pension Borrowing Plan. The 2017-18 budget package authorized a plan to borrow $6 billion from the Pooled Money Investment Account (PMIA)—an account that is essentially the state’s checking account—to make a one-time supplemental payment to CalPERS. While annual state pension contributions will continue to rise over the next several years, this supplemental payment will reduce these contributions below what they would be otherwise. All funds that make pension payments, including the General Fund and most other state funds, will repay the loan over the next decade or so. While the General Fund started repaying the loan in 2017-18, other funds will begin payments in 2018-19. Legislative Requirements on Repayments. Authorizing legislation gives the administration the discretion to determine the timing of funds’ repayments, but also includes a variety of requirements. In particular, the legislation requires the administration to: (1) ensure each fund pays its proportionate share of the loan’s principal and interest, (2) develop a tracking system for the repayments, and (3) publish in each fund’s condition statement the amount of the loan that is due and payable each year. Administration’s Repayment Approach Raises Serious Concerns. The administration proposes $675 million in total repayments in 2018-19, including $400 million from the General Fund and $275 million from other state funds. In our view, the basic elements of the administration’s plan are reasonable. We have serious concerns, however, about some choices the administration made. In particular, primarily because some funds have structural deficits, the administration shifts $8.5 million in repayment costs among state funds. As a result, some funds make payments on behalf of other funds despite having different fee payers and supporting different programs. Further, the administration does not display these cost shifts in public budget documents. The administration also allocates interest costs to the entire pool of funds, rather than individual funds. Consequently, some funds will pay more or less than their proportionate shares of interest. For instance, had the administration allocated interest costs by fund, the General Fund (all else equal) would save of tens of millions of dollars over the lifetime of the loan as it is repaying more quickly than other funds. Issues Have Larger Outyear Implications. Under the administration’s plan, repayments among other state funds will double by 2021-22 and quadruple by 2023-24. If the administration maintains its repayment approach in future years, the issues described above will be exacerbated. As a result, the administration’s approach could lead to tens or even hundreds of millions of dollars in principal and interest costs being distributed inappropriately across funds. Recommended Approach. To address the concerns identified in this report, we recommend a modified approach. This recommended approach would: (1) be consistent with the authorizing legislation, (2) allocate costs appropriately and publicly, and (3) provide incentives to create more cost-effective outcomes. analysis full gutter 2018-19 BUDGET INTRODUCTION State Recently Enacted Pension Borrowing depending on a variety of factors, most notably Plan. As part of the 2017-18 budget package, CalPERS’ future investment performance. Chapter 50 (SB 84, Committee on Budget and Report Considers First Year of Fiscal Review) approved the Governor’s May Implementation of Loan Repayments. Senate Revision proposal to borrow $6 billion from Bill 84 indicates that state funds must repay their the state’s cash balances in the Pooled Money respective shares of the loan in proportion to their Investment Account (PMIA)—an account that is pension costs, but also gives the Department essentially the state’s checking account—to make of Finance (DOF) discretion to determine the a one-time supplemental payment to the California timing of the repayments and the methodology Public Employees’ Retirement System (CalPERS). for estimating the repayment costs across funds. While annual state pension contributions will As this is the first year that DOF will be allocating continue to rise over the next several years, these repayments by fund, the purpose of this this supplemental payment will reduce these report is to help the Legislature review the contributions below what they would be otherwise. administration’s approach. In this report, we first Plan Very Likely to Result in Long-Term State provide background on state funds, retirement Savings. The aim of this plan is to save the state liabilities, and debt repayments. Then, we outline money over the next few decades by slowing the the recently enacted pension borrowing plan. Next, pace at which the state’s annual pension costs rise. we describe how the state is repaying the loan, According to an analysis produced by CalPERS in including decisions made by the administration September, the plan has a 95 percent chance to in 2018-19. We then assess the administration’s save the state money. The median scenario from repayment approach. Because our assessment the analysis suggests the plan would save the identifies some serious concerns, we conclude state $3.1 billion over 20 years. The actual savings with a recommended alternative approach that we associated with the plan will be higher or lower believe is more consistent with legislative directives. than this amount, potentially by billions of dollars, BACKGROUND In this section, we provide background on (1) the Most Funds Have Specific Purposes. state’s use of various funds, (2) the state’s current Whereas the General Fund receives revenues from retirement liabilities, and (3) the requirements for various taxes and fees that can be used for any the state to address some of its outstanding debt public purpose, other funds have programmatic under the provisions of Proposition 2 (2014). restrictions. For instance, special funds have specific revenue sources (such as user fees) and State Funds programmatic uses established in state law. For State Has Hundreds of Funds. The state legal and policy reasons, there generally needs conducts its financial affairs through hundreds of to be a “nexus,” or connection, between the separate funds. We discuss three types of funds in fees paid into a special fund and the services this report. They are: (1) the General Fund, which is provided from those fee revenues. Bond funds the state’s main operating account; (2) other state also have legal restrictions on their use, as set funds, which includes special funds, bond funds, forth in voter-approved bond measures, and other and other “nongovernmental cost funds” (such as nongovernmental cost funds, such as retirement trust funds); and (3) federal funds. trust funds, also have restrictions. Federal funds come from agencies of the federal government and 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2018-19 BUDGET are expended by state departments in accordance over a few decades by making additional annual with federal rules. contributions to the pension plan. State Can Make Loans Between Funds. When Employer Contribution Rates Are Increasing. facing budget shortfalls in the past, the state has At a meeting in December 2016, the CalPERS loaned money from special funds to the General governing board voted to lower its investment Fund. These loans usually carry interest but have return assumption from 7.5 percent to 7 percent no set repayment period. The state also makes over three years. By assuming less money comes loans from the General Fund to special funds—for into the system through investment gains, the example, to support the establishment of a new state will be required to contribute more money to program—and between special funds. pay for current and future pension costs as well Funds’ Cash Held Together in PMIA. The funds as a larger unfunded liability. As a result of this described above all are separate in a budgetary and other assumption changes, average employer sense, but not on a cash basis. That is, the actual contribution rates are projected to rise over the cash associated with the General Fund and next few years. most other state funds is pooled together in the Employer Contributions Paid From Each state’s portion of the PMIA. The PMIA effectively Fund. The General Fund and nearly all other funds functions as a central checking account, receiving have some payroll costs to employ state workers, all revenues and paying all expenses associated and therefore also have associated pension costs. with the various budgetary funds. (The PMIA also Each fund pays employer contributions to CalPERS holds funds on behalf of cities, counties, and based on its own state payroll costs. Some funds— other local entities in the spearate Local Agency like the Motor Vehicle Account—primarily support Investment Fund.) Over the last six months, the operations performed by state employees (such as daily balance in the PMIA has averaged roughly registering vehicles), and therefore have relatively $72 billion. The State Treasurer’s Office manages high associated state pension costs. Other funds— the PMIA, generally investing the money in low-risk such as the Mental Health Services Fund—primarily instruments with short-term maturity schedules. pass funding through to local governments and In February 2018, the average return on these therefore have low associated state pension investments was 1.4 percent. costs. When employer contribution rates rise, the associated costs to each fund also rise. Retirement Liabilities Proposition 2 State Pensions Funded From Three Sources. The state provides pension benefits to retired state Key Provisions Regarding Debt Repayments. and California State University employees through Proposition 2 requires the state to make the CalPERS pension system. CalPERS pensions minimum annual payments toward certain are funded from three sources: investment eligible debts through 2029-30. (It also contains gains, employer contributions, and employee certain requirements related to the state’s rainy contributions. Investment gains pay for about day fund.) A formula determines the required two-thirds of current benefits, while employer and minimum payments, which can vary significantly employee contributions pay for the remainder. with fluctuations in revenues, particularly those State Pension Plan Has Significant Unfunded from capital gains. Over the next few years, the Liability. Like many other pension systems around administration estimates Proposition 2 debt the country, CalPERS has an unfunded liability. repayments will vary from $1.3 billion to $1.5 billion Unfunded liabilities occur when assets on hand each year, but these requirements could be are less than the estimated cost of benefits earned hundreds of millions of dollars higher or lower to date. For 2015-16, CalPERS estimates the depending primarily on the future performance of unfunded liability is $60 billion. The state bears the the stock market. cost of this unfunded liability, which it is addressing Current Plan for Debt Repayments. While there is no overarching statutory plan in place for future www.lao.ca.gov 3 analysis full gutter 2018-19 BUDGET Proposition 2 debt repayments, the Legislature and post Long-Term Capacity for Debt Payments Under Governor have agreed—in some cases, informally, Proposition 2.) and, in a few cases, in state law—to prioritize Interest on Proposition 2 Debts. Some certain debts that involve multiyear commitments. Proposition 2 debts carry no interest, such as settle In addition to the CalPERS loan repayments under up. Other Proposition 2 debts carry interest but discussion in this report, Proposition 2 is being the rates tend to be quite low. For instance, most used to repay special fund loans to the General special fund loans carry a fixed interest rate equal Fund, to repay certain amounts owed to schools to the investment earnings rate of the PMIA on the and community colleges (called “settle up”), and to day the loan was made. (In recent years, this rate prefund retiree health benefits. (We discuss these has averaged 0.5 percent, although it has risen in uses in our December 21, 2017 budget and policy recent months.) OVERVIEW OF CALPERS BORROWING PLAN This section provides an overview of the otherwise. Finally, funds that accrue these benefits CalPERS borrowing plan as enacted by the are to repay the loan to the PMIA with interest. 2017-18 budget package and described in a Plan Very Likely to Save the State Money. subsequent analysis provided by the administration The aim of this plan is to save the state money to the Legislature on September 28, 2017. (We over the next few decades by slowing the pace refer to this as the “September report.”) at which the state’s annual pension contributions CalPERS Borrowing Plan Enacted in 2017-18. rise. The precise amount of savings will depend on As part of the 2017-18 budget package, SB 84 many factors, including actual investment returns approved the Governor’s May Revision proposal over the next few decades. An actuarial analysis by to borrow $6 billion from the PMIA to make a CalPERS in the September report suggests that, one-time supplemental payment to CalPERS. State under the median scenario, the loan would save the pension contributions will continue to rise over the state $3.1 billion over the next 20 years. Under the next several years due to the recent changes in projections, these savings would begin to accrue the pension plan’s investment assumptions, but in 2019-20 and then grow over time. The growth this supplemental payment will reduce the state’s in savings is faster in the next few years and then pension contributions below what they would be slows in the early to mid-2020s. otherwise. State Has Already Transferred $4 Billion. How the Plan Works. Figure 1 shows how this Senate Bill 84 authorizes DOF to determine borrowing plan is meant to work. Under the plan, the timing of the $6 billion to be transferred the State Controller transfers $6 billion from the from the PMIA to CalPERS. In a letter dated PMIA to CalPERS, which CalPERS then invests to October 2, 2017, DOF directed the State Controller help pay down the unfunded liability. Over the next to transfer the $6 billion in three installments of few years, funds that pay pension costs (including $2 billion each on October 31, 2017, January the General Fund, other state funds, and federal 16, 2018, and April 17, 2018. These amounts were funds) accrue benefits through lower employer scheduled throughout the 2017-18 fiscal year to contributions costs relative to what they would be minimize disruption to the state’s cash resources in the PMIA. 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2018-19 BUDGET REPAYING THE LOAN In this section, we first describe the legislative have issues making repayments), and later be requirements for repaying the loan, as well as reimbursed. initial decisions made regarding the repayments by SB 84 Requires Tracking of Payments by DOF, as outlined in the September report. We then Fund. In addition to requiring that DOF ensure each describe the administration’s repayment plan for fund pays its share of the loan, SB 84 requires 2018-19. DOF to develop a tracking mechanism for these repayments and maintain records of payments Legislative Requirements and Initial made by each fund. Senate Bill 84 also requires Administrative Decisions DOF to make public some of these records. In particular, SB 84 states that DOF shall “include Loan to Be Repaid by 2030 or Sooner. Senate in the published fund condition statement of Bill 84 stipulates that the principal and interest the applicable funds and accounts, the amount payments of the loan must be fully repaid on or determined to be the share of the loan principal and before June 30, 2030. Senate Bill 84, however, interest due and payment from each fund for the gives the administration discretion to determine fiscal year.” the timing of the repayments. The administration indicated in its September report that it plans to General Fund’s Share of Loan Initially repay the loan over an eight-year period—that is, Calculated at About 60 Percent but Revised by June 30, 2025. to Half. Senate Bill 84 gives DOF the authority to set the methodology for calculating the amount Interest Costs to Add to Repayment Amount. to be repaid by each fund. In its May proposal, Under SB 84, interest on the loan is calculated the administration indicated that it expected the quarterly using the two-year United States General Fund’s share of the total $7 billion loan Treasury rate for the prior calendar year. In 2017, this rate averaged 1.4 percent. In the September report, the Figure 1 administration estimated interest costs will add roughly $1 billion to How the CalPERS Borrowing Plan Works the $6 billion principal repayment, bringing the total loan repayment to $7 billion. Repayment Costs to Be PMIA Allocated Across Funds. Under SB 84, each fund, including the General Fund, is to pay its Principal and proportionate share of the loan Supplemental Payment Interest Repayments principal and interest. As an example, if a particular fund represents 5 percent of CalPERS’ state employer contributions each General Fund Other State Funds CalPERS year, it would repay 5 percent Federal Funds Benefit (Lower Rates) of the loan over its lifetime. Senate Bill 84 also authorizes the General Fund to advance money on behalf of other state funds (for example, if those funds PMIA = Pooled Money Investment Account. www.lao.ca.gov 5 analysis full gutter 2018-19 BUDGET repayment to be 61.5 percent ($4.4 billion), while are to repay their shares using their own available all other funds (including federal funds) would resources beginning in 2018-19. (The reason repay the remaining 38.5 percent ($2.5 billion). In other funds did not begin repayments in 2017-18 the September report, however, the administration was to allow time for DOF to develop a system indicated it had identified payroll data that more for allocating repayment costs across the other accurately reflects underlying pension costs funds.) In the September report, DOF developed a paid by the General Fund and other funds. As a set repayment schedule for other funds. As shown result, it revised the General Fund’s share of total in Figure 2, relative to 2018-19, repayment costs repayments down to 49.1 percent ($3.4 billion) for other funds would nearly double by 2021-22, and the other funds’ share up to 50.9 percent triple by 2022-23, and quadruple by 2023-24. (The ($3.6 billion). administration, however, has indicated that it could General Fund Repayments to Vary With revisit this schedule in the future.) Available Proposition 2. Senate Bill 84 stated the Interest Costs Not Distributed According to Legislature’s intent to repay the General Fund’s Different Repayment Schedules. Though the share of the loan from Proposition 2 annual debt administration sets different repayment schedules requirements. The 2017-18 budget package made for the General Fund versus other state funds, it an initial General Fund repayment of $146 million does not allocate interest costs accordingly. Thus, from Proposition 2. In the September report, under the administration’s approach, if the General DOF indicated it plans for future General Fund Fund ends up paying faster than anticipated, the repayments to vary depending on the availability of interest savings are distributed across all funds Proposition 2 funds. rather than just to the General Fund. (This is Other Funds to Repay According to Set contrary to SB 84’s provision that each fund pay its Schedule. Other funds (including federal funds) proportionate share of the interest costs.) Figure 2 Other Funds' Loan Repayments Will Increase Substantially in Future Years (In Millions) $1,000 900 800 700 600 500 400 300 200 100 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2018-19 BUDGET Governor’s Repayment Plan for • Statutory Limits. Some funds, particularly 2018-19 bond funds, have limits on their administrative expenditures. Because the loan repayment Repays $475 Million From the General costs would have caused a few funds to Fund. For 2018-19, the administration proposes exceed their caps, DOF exempted these fund the General Fund repay $475 million from from repayments. Proposition 2 debt requirements. This is the • Other Reasons. A dozen other state funds amount of Proposition 2 funds available given were exempt for various technical reasons. other commitments and priorities (such as For instance, funds that function solely to prefunding retiree health benefits). This amount is pass through monies to another fund were nearly $300 million more than anticipated in June exempt, as were a few funds that paid 2017. (This is mostly due to higher estimated pension costs in the past but were recently Proposition 2 requirements and lower costs of abolished. one other debt repaid within Proposition 2.) The proposed amount for repayment is likely to change Shifts the Associated $8.5 Million in Costs again in May when the administration updates its to Other Funds in Two Ways. For those funds estimate of overall Proposition 2 debt requirements. relieved from making part or all of their repayment Repays $200 Million From Other State Funds. in 2018-19, the administration shifts the costs to The administration also plans $200 million in other funds using a two-step approach: repayments from other funds (excluding federal • Shifts Some Repayment Costs to funds) in 2018-19. This amount is based on the Funds Within the Same Department. repayment plan outlined in the September report. The administration indicates that—when The $200 million is distributed among other state possible—it shifted costs between funds that funds proportional to their pension costs, except as have the same administering department. For discussed below. example, DOF shifted about $1 million in costs Relieves About 40 Funds From Making from the Waste Discharge Permit Fund to the $8.5 Million in Repayments in 2018-19. The Underground Storage Tank Cleanup Fund. administration relieves about 40 funds (10 percent Both of these funds are operated by the State of state funds) from making part or, in most Water Resources Control Board. We estimate cases, all of their repayment on a one-time basis about $4.4 million in loan repayment costs in 2018-19. (The administration has not made from 25 funds were shifted in this manner. any commitments about these funds in future • Shifts Some Repayment Costs to All Other years.) Altogether, we estimate the relieved loan Funds. In cases where repayment costs could repayment costs to total about $8.5 million. As not be shifted to another fund administered described below, these costs are shifted to other by the same department, the administration funds in 2018-19 so that overall repayments from distributed the costs evenly to all other all other state funds remain at the planned level funds. We estimate about $4.2 million in loan of $200 million. The administration cites various repayment costs from 17 funds were shifted in reasons for relieving these repayments, including: this manner. The largest of these cost shifts, • Structural Deficits. Some funds have ongoing from the State Parks Recreation Fund, was expenditures exceeding their available $2.3 million. revenues, creating a structural deficit. As Based on our own evaluation of information Figure 3 on the next page shows, according provided by the administration, we estimate that to DOF, 18 funds have such a deficit and these shifts resulted in more than 100 funds having thus are unable to absorb their share of the their loan repayment amount increased by more loan repayment costs (totaling $5 million) in than 3 percent and 11 funds having their repayment 2018-19. amount increased by 50 percent or more. The www.lao.ca.gov 7 analysis full gutter 2018-19 BUDGET administration has indicated to us that they plan to increases the scheduled repayments in the first use this process again in future years to cover the year. The administration states that, together, costs of funds that are unable to pay. these changes avoid steep ramp ups in costs in Tracks These Shifted Costs Internally. The the next few years. It also indicates that it took this administration is tracking the cost shifts internally, approach at the request of the fund’s administrator, not through publicly accessible budget documents. the Department of Motor Vehicles. (Under the Thus, the fund condition statements produced by administration’s approach, the higher interest costs DOF in 2018-19 reflect a fund’s total repayment, that result from this modification accrue to all inclusive of any shifts from other funds, with no funds, not just the MVA.) designation about those shifts. Funds that owe Excludes All Federal Fund Repayments. repayments but have shifted their costs to other The Governor’s 2018-19 repayment plan notably funds have no indication of these shifts either. excludes all repayments from federal funds— Sets Up Alternative Payment Schedule totaling $24 million under the administration’s for One Fund. The administration uses the method. (Other funds do not cover these costs set repayment schedule for other state funds in 2018-19.) This is because federal rules may outlined in the September report, with one not allow the state to use federal funds for exception: the Motor Vehicle Account (MVA). these purposes—however, the administration is A fund with significant state operations costs, requesting approval from a federal negotiator to do the MVA owes one of the largest shares of the so. In the nearby box, we discuss some of the fiscal loan repayment. The administration changes the implications regarding the uncertainty over whether repayment schedule for this fund in two ways. the state can use federal funds to repay the loan. First, it extends the repayment schedule out to 2029-30 (rather than 2024-25). Second, it slightly Figure 3 Loan Repayment Cost Shifts for Funds With Structural Deficits (In Thousands) Fund With Structural Deficit . . . Costs Shifted to . . . Amount State Parks and Recreation Fund All Other State Funds $2,255 Waste Discharge Permit Fund Underground Storage Tank Cleanup Fund 1,094 Public Safety Communications Revolving Fund All Other State Funds 709 DNA Identification Fund Fingerprint Fees Account 476 Collins-Dugan California Conservation Corps Reimbursement Account All Other State Funds 166 Drug and Device Safety Fund Radiation Control Fund 85 State Trial Court Improvement and Modernization Fund Trial Court Trust Fund 70 State Certified Unified Program Agency Account Lead-Acid Battery Cleanup Fund 24 Timber Tax Fund All Other State Funds 20 California Fire and Arson Training Fund All Other State Funds 17 Driving-Under-the-Influence Program Licensing Trust Fund Hospital Quality Assurance Revenue Fund 17 Victim - Witness Assistance Fund State Penalty Fund 8 Sale of Tobacco to Minors Control Account Radiation Control Fund 6 Registered Environmental Health Specialist Fund Radiation Control Fund 5 Medical Marijuana Program Fund Health Statistics Special Fund 5 Professional Forester Registration Fund All Other State Funds 3 Sea Otter Fund, California All Other State Funds 2 Winter Recreation Fund All Other State Funds 1 Totals $4,965 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2018-19 BUDGET ASSESSMENT In this section, we assess the administration’s Method for Identifying Costs by Fund. repayment approach. While we think some aspects As noted earlier, in the September report the of the administration’s plan are reasonable, we administration revised its methodology for have serious concerns that certain elements are identifying pension costs by fund in order to not consistent with the requirements the Legislature calculate each fund’s share of loan. This changed established in SB 84. Accordingly, we also the General Fund’s share of the overall loan from recommend a modified approach that comports 61 percent to 49 percent (and shifted approximately with the legislation. $1 billion in costs from the General Fund to other state and federal funds). However, we think Basic Elements of the the new methodology is reasonable overall and Plan Reasonable better reflects underlying pension costs than the administration’s method in May 2017. Below, we describe why we think the basic Priority Placed on CalPERS Loan Within elements of the administration’s plan are Proposition 2. In 2018-19, the administration reasonable. Uncertainty Over Using Federal Funds to Repay the Loan Federal Government May Not Allow the State to Use Federal Funds to Repay the Loan. Most federal funding to California, for various purposes from health to transportation, are deposited into a single account: the Federal Trust Fund. It is not yet clear whether the federal government will allow monies from the Federal Trust Fund to be directly expended on the loan repayments. This is because the California Public Employees’ Retirement System (CalPERS) loan repayments are not part of the CalPERS’ “actuarially required contribution,” and so federal rules may not allow the state to use federal funds for these purposes. The administration is requesting approval from a federal negotiator to do so. Under the administration’s current methodology, we estimate that the Federal Trust Fund and other smaller federal funds will owe nearly $400 million in repayments over the lifetime of the loan. Federal Decision Could Have Different Fiscal Implications. In some cases, a decision by the federal government in either direction will not affect the amount of federal funding provided to the state. For example, some federal grants are provided in a lump sum and would not change even if the federal government disallowed the state from spending federal monies on the loan repayment. (In these situations, the state would have to redirect other funds to cover these costs but could use the freed up federal funding for other allowable purposes.) There could be other cases, however, where the state receives federal funding based on its costs, including those for personnel. In these cases, the state could receive more or less federal funding depending on whether the loan repayment is deemed an allowable personnel cost. (In these situations, if these costs are not allowed, the state would bear the loan repayment cost.) Administration Has Not Yet Considered How to Cover Costs. The administration’s 2018-19 repayment plan does not address these federal costs at this time, while the state waits for a decision from the federal government. If the federal government rejects the state’s request, then the administration indicates it would consider options for covering the loan repayment costs associated with federal funds. It could take different approaches for different programs funded through the Federal Trust Fund. For example, in some cases, the administration might want to use General Fund resources, but in others, it might shift the costs to other state funds where a sufficient nexus exists. www.lao.ca.gov 9 analysis full gutter 2018-19 BUDGET places a high priority on repaying the CalPERS that other fund administrators concerned about the loan by using about a third of the Proposition 2 costs in 2018-19, however, simply requested to debt requirement for this purpose. In the past, our be relieved from the costs, rather than considering office has recommended the Legislature prioritize ways to spread the costs out over time to make high-interest debts within Proposition 2. While the them more manageable. (Fund administrators interest accruing on the CalPERS loan repayments may not have been aware they could request is low by most standards, it is actually somewhat alternative repayment schedules, as our discussion higher than most other current Proposition 2 debt with departments revealed that some fund priorities. Moreover, because the interest rate on administrators were unaware of the future costs, or the CalPERS loan is tied to the two-year Treasury even the upcoming year’s costs, associated with rate, it will likely rise in coming years. As long as the loan.) the Legislature continues to maintain its current Cost Shifts Across Funds. The administration’s uses of Proposition 2, we think it should place a decision to shift $8.5 million in costs among other high priority on repaying the CalPERS loan. state funds raises both policy and legal concerns Overall Special Fund Repayment Structure. because a sufficient nexus between the funds does Under the administration’s schedule, other state not appear to exist in many cases. Most notably, in funds’ repayments will ramp up significantly over cases where costs are shifted from one fund to all the next few years. Also, as we noted earlier, other funds, a nexus almost certainly does not exist funds will not experience most of the full benefit between all the funds involved. A nexus might also of the loan, in terms of slower growth in employer be lacking in cases where costs are shifted from contributions, until the early to mid-2020s. As such, one fund to another fund administered by the same this might create a situation where, in the short run, department. For instance, as discussed earlier, the costs of the loan are higher than the benefits, the administration shifts costs between two funds potentially placing pressure on a fund’s finances. administered by the State Water Resources Control We therefore concur with the administration’s Board. Yet these two funds serve different purposes approach of setting a base repayment schedule for and have entirely different fee payers. funds that increases over time. Cost Shifts Are Not Tracked Publicly. Despite SB 84’s directive that DOF publish in fund Some Features Raise condition statements the amount determined to Serious Concerns be the cost of the loan that is due and payable, the administration only publishes the total amount There are some specific choices in the of repayments, which in some cases is more or administration’s loan repayment approach that raise less than a fund’s proportional share. As such, serious concerns. Most notably, some elements of the administration’s approach lacks transparency the plan are inconsistent with directions given in because the shifts are only being tracked internally statute. For example, the plan shifts costs between and not through publicly accessible budget funds without any public acknowledgement of documents. As described in the nearby box, in a these cost shifts. We describe these issues in more recent report to the Legislature, the administration detail below. (In general, it is our understanding also failed to acknowledge these fund shifts. that the administration has made these choices to improve the administrative ease of making the loan Interest Cost Allocations. Senate Bill 84 directs repayments.) the administration to ensure that all funds pay their proportionate shares of the principal and interest Lack of More Fund-Specific Repayment of the loan. The administration, however, has Schedules. For all funds except one (the MVA), the decided not to allocate interest costs by fund. This administration imposes the set repayment schedule results in an implicit shifting of costs among funds. in 2018-19. Funds other than the MVA, however, For instance, the General Fund is repaying nearly might also benefit from a different repayment $300 million more in 2018-19 than anticipated in schedule, depending on their specific fiscal and June 2017. All else equal, this could reduce interest programmatic conditions. Our understanding is 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2018-19 BUDGET costs to the General Fund by about $50 million could lead to tens or even hundreds of millions over the lifetime of the loan. (Any future shifts that of dollars in principal and interest costs being accelerate General Fund payments could result in distributed inappropriately across funds. tens of millions of dollars, or over a hundred million Recommended Approach dollars, more in General Fund savings.) Yet, under the administration’s approach and despite direction Overview of the Recommended Approach. in SB 84, these savings are distributed to all funds, In this section, we recommend an approach not just the General Fund. Conversely, by extending to repaying the loan that would modify the its repayment period, the MVA is increasing interest administration’s plan. This recommended approach: costs on the loan repayment, yet these costs (1) is consistent with statute, (2) allocates costs are distributed across all funds instead of being appropriately and publicly, and (3) provides attributed solely to the MVA. incentives to create more cost-effective Issues This Year Have Larger Out-Year outcomes. Below, we describe each feature of the Implications. If the administration maintains its recommended alternative in more detail. approach in future years, the issues described Customize Repayment Schedules as Needed. above will be exacerbated as the costs of repaying Under our alternative, DOF would first communicate the loan double, triple, and quadruple. In particular, the set repayment schedule with each fund the costs shifted between funds likely will increase administrator and then direct the administrator to as funds face larger repayment costs. Also, as the analyze the effects of the loan repayment on the repayment costs increase, more funds are likely fund over the coming years. (For small funds this to face difficulty with repayment, resulting in even analysis could be very straightforward, but for larger more shifts. As such, the administration’s approach funds, more complex.) The fund administrator could Recent Report From the Administration Legislature Requested Additional Information on Funds With Issues Repaying. In addition to the September report required by statute, the Joint Legislative Budget Committee (JLBC) requested two further reports from the administration with additional information on the borrowing plan. These reports were due one month before the final two $2 billion transfers were scheduled (in January and April 2018, respectively). In its request for information, the JLBC asked for a “projection of special fund costs and list of special funds that would potentially have problems repaying the loan as scheduled.” Department of Finance (DOF) Responded That All Funds Have Sufficient Balances to Pay Assessments. The JLBC received the second of these reports from the administration on March 16, 2018. This report states: “we anticipate all funds to have sufficient balances to pay their assessments.” However, as we note in this report, about 40 funds are not making repayments in 2018-19 under the administration’s own schedule. Of these, 18 are not making repayments because they face structural deficits. (Representatives of the administration note they are interpreting the JLBC’s question to mean a list of funds that face issues with cash flow problems, not budgetary problems. There is no mention of this interpretation in the report to the JLBC.) DOF’s Statements Obscure Cost Shifts Across Funds. As noted in this report, DOF’s cost shifts involve no public tracking system that would allow members of the Legislature or the public to compare a fund’s assessments to the amount paid. DOF provides no additional context or explanation about these cost shifts in its public budget documents. As a result, without additional information, its March 2018 report would likely have given members of the Legislature the false impression that all funds are repaying their assessments in 2018-19. www.lao.ca.gov 11 analysis full gutter 2018-19 BUDGET then request (and justify) a customized repayment be feasible, the state could consider using the schedule. For example, fund administrators could General Fund to make the repayment on the fund’s request an extended repayment period, as was behalf.) This would ensure the state is following the done by the Department of Motor Vehicles for the directives under SB 84. MVA. Funds facing better budgetary conditions may Track Interest Costs by Fund. Under our prefer to pay more sooner, avoiding a steep ramp alternative, interest costs would be tracked for up in costs, while those with structural imbalances each fund based on its own repayment schedule. may choose to repay more later. In addition to fulfilling legislative requirements, Use Loans Rather Than Cost Shifts. For some this approach has a couple of advantages. First, funds, a longer repayment schedule alone may it attributes the costs of the loan by fund more not be sufficient to help them manage their loan accurately. (In particular, it would ensure the repayments. In these cases, DOF could use loans General Fund benefits from lower interest costs from the General Fund (or possibly other funds) if it repays its share of the loan more quickly than to cover the repayment costs. These loans would other funds.) Second, it creates a strong incentive be repaid with interest and tracked in publicly for funds that have the ability to repay more quickly accessible state budget documents, including to do so. This would lower the state’s overall costs fund condition statements. (For funds facing associated with the loan. severe fiscal constraints where a loan might not LAO PUBLICATIONS This report was prepared by Ann Hollingshead and reviewed by Paul Golaszewski. 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. 12 LEGISLATIVE ANALYST’S OFFICE