The 2019-20 Budget: California's Fiscal Outlook

The 2019-20 Budget: California’s Fiscal Outlook MAC TAYLOR LEGISLATIVE ANALYST NOVEMBER 14, 2018 analysis full gutter 2019-20 BUDGET LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Table of Contents CHAPTER 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 General Fund Condition in 2019-20 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 LAO Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 CHAPTER 2 Budget Condition Under Two Economic Scenarios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Demographic Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 LAO Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 www.lao.ca.gov analysis full gutter 2019-20 BUDGET LEGISLATIVE ANALYST’S OFFICE www.lao.ca.gov (916) 445-4656 Legislative Analyst Mac Taylor State and Local Finance Corrections, Transportation, and Environment Carolyn Chu Anthony Simbol Brian Brown Justin Garosi Ann Hollingsheada Drew Soderborg Seth Kerstein Ross Brown Ryan Miller Rachel Ehlers Lourdes Morales Paul Golaszewski Nick Schroeder Helen Kerstein Brian Uhler Luke Koushmaro Brian Weatherford Anita Lee Shawn Martin Education Caitlin O’Neil Jennifer Kuhn Health and Human Services Ryan Anderson Mark C. Newton Edgar Cabral Ginni Bella Navarre Jason Constantouros Sara Cortez Chas Alamo Kenneth Kapphahn Jackie Barocio Amy Li Ben Johnson Lisa Qing Brian Metzker Paul Steenhausen Ryan Millendez Sonja Petek Ryan Woolsey Administration, Information Services, and Support Sarah Kleinberg Tina McGee Sarah Barkman Izet Arriaga Patt Kregelo Sarah Scanlon Michael Greer Jim Stahley Vu Chu Anthony Lucero Mohammed Mohammed Saeed Rima Seiilova-Olson a General Fund Condition analyst, Fiscal Outlook coordinator. LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Executive Summary The Budget Is in Remarkably Good Shape. It is difficult to overstate how good the budget’s condition is today. Under our estimates of revenues and spending, the state’s constitutional reserve would reach $14.5 billion by the end of 2019-20. In addition, we project the Legislature will have an additional $14.8 billion in resources available to allocate in the 2019-20 budget process. The Legislature can use these funds to build more budget reserves or make new one-time and/or ongoing budget commitments. By historical standards, this surplus is extraordinary. Longer-Term Outlook Is Positive. The nearby figure displays our longer-term General Fund outlook under two different scenarios and assuming current law and policies stay the same. The first scenario shows continuing economic growth and the second shows a recession beginning in 2020-21. If the economy continues to grow, as shown on the left side of the figure, the state has operating surpluses averaging around $4.5 billion per year, but declining over time. In the recession scenario, as shown on the right side, the state has enough reserves to cover its deficits over the outlook period. With More Commitments, Reserves Might Not Fully Cover the Budget Problem. Both of these scenarios assume the Legislature makes no new commitments (such as spending increases or tax reductions) in 2019-20 or later. That is, under these scenarios, the Legislature would use all of the nearly $15 billion in available resources in 2019-20 to build more reserves General Fund Surpluses and Deficits Under Different Scenarios (In Billions) Economic Growth Scenario Recession Scenario $10 5 -5 Operating Surplus Operating Deficit (Covered by Reserves) -10 2018-19 2019-20 2020-21 2021-22 2022-23 2018-19 2019-20 2020-21 2021-22 2022-23 www.lao.ca.gov 1 analysis full gutter 2019-20 BUDGET (reaching a total reserve level of about $30 billion by the end of 2019-20). If the Legislature makes new ongoing commitments in 2019-20, however, reserve levels under a recession scenario would be lower and the state would face higher operating deficits. Depending on the extent of these commitments, reserves might not fully cover a budget problem that emerges during a recession. More Reserves Would Be Needed to Mitigate Reductions to School Funding. In our Fiscal Outlook publications, we assume the state funds schools and community colleges at their minimum level. More explicitly, this means under our assumptions that General Fund spending on K-14 education declines even as the state maintains other programmatic spending using reserves. This assumption is in keeping with the publication’s aim to show spending under current law and policy, which generally has been to fund schools and community colleges at the minimum required level. If instead the Legislature wanted to mitigate the impact on schools and spend above the minimum level, the state’s operating deficits would be larger and more reserves would be needed to cover the budget problem. The State’s Budget Condition Can Change Quickly. Our office has produced a Fiscal Outlook every year since 1995. In dollar terms, the available surplus for 2019-20 is easily the largest our office has ever estimated. As a percent of overall revenues, it is second only to the estimated $10.3 billion surplus in 2001-02, which we projected in November 2000. However, as the state experienced in 2001, these fortunes can change quickly. In the dot-com bust and ensuing recession, state revenues declined precipitously. The very next year, our Fiscal Outlook found the state’s surplus had disappeared, and instead, the budget faced a deficit of $12.4 billion. Legislature Has Unique Opportunity to Prepare for Coming Challenges. In the coming years, the budget will face challenges. The most significant risk to our outlook is the economy, which could slow and result in billions of dollars in revenue losses annually. Decisions outside of the Legislature’s control, for example by the federal government or state retirement systems, also can affect the state budget. The $15 billion surplus we anticipate for 2019-20 gives the Legislature a unique opportunity to prepare for these foreseen—and other unforeseen— challenges still to come. 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Chapter 1 INTRODUCTION Each year, our office publishes the Fiscal Outlook demographic trends that affect California’s out-year in anticipation of the upcoming state budget. The budget situation. goal of this report is to help the Legislature begin Two Important Notes About Report. First, developing the 2019-20 budget. Chapter 1 of this our outlook assesses the state’s General Fund report provides our assessment of the budget condition under current law and policies. We do in the near term. In this chapter, we outline the not attempt to predict how the state or federal economic trends and assumptions that underpin governments will change their policies. Second, our our revenue and expenditure projections for the outlook depends on a set of economic assumptions upcoming year. Chapter 2 provides our longer-term that are subject to uncertainty, particularly in the outlook—through 2022-23—for the state budget. longer run. When economic conditions turn out to Our outlook for the budget relies on two different be different (either better or worse) than what we scenarios: an economic growth scenario and a have displayed here, the budget’s actual revenues recession scenario. In Chapter 2, we also discuss and expenditures also will be different. ECONOMY Our economic outlook is based on the average competition among employers for workers is high. of a collection of forecasts of the U.S. economy This competition typically forces employers to pay from various institutions and professional higher wages to attract new workers. economists, as compiled by Moody’s Analytics Slower Job Growth. The pace of job growth in in September (with an adjustment to the S&P California has slowed consistently each year since 500 in October). This consensus forecast expects 2015. We anticipate that this trend will continue continued growth of the U.S. economy, albeit through 2020. This is consistent with an expected with some slowing in the pace in the coming slowing of national job growth and a limited number years. Based on these expectations, we project of unemployed Californians looking for jobs. continued growth of the California economy. This Housing Weakening. The rate of home price growth, however, will be tempered by slower job growth has slowed consistently throughout 2018. growth and modest weakness in housing. Figure 1 Year-over-year growth dropped from 8.5 percent in (see next page) displays key assumptions of our February to 6.5 percent in September. We anticipate economic outlook. that this trend of slower growth will continue. Our Steady Wage and Salary Growth. We expectation of a slowdown in home price growth anticipate total wages and salaries to continue reflects the rising supply of homes for sale, tighter growing at the same above-average rate as recent mortgage lending, and higher interest rates. years. This strong wage and salary growth is Stock Market Levels Off. After growing rapidly due, in large part, to record low unemployment. between 2014 and 2017, the stock market has been With a limited number of people looking for jobs, up and down throughout 2018. The consensus www.lao.ca.gov 3 analysis full gutter 2019-20 BUDGET Figure 1 Projections of Key Economic Variables Wages and Salaries Payroll Jobs Annual Growth Annual Growth 8% 4% 6 3 4 2 2 1 2014 2015 2016 2017 2018 2019 2020 2014 2015 2016 2017 2018 2019 2020 Home Prices S&P 500 Index Annual Growth 12% 3,000 8 2,600 4 2,200 1,800 2014 2015 2016 2017 2018 2019 2020 2014 2015 2016 2017 2018 2019 2020 expectation is that stock prices will grow much more as made threats of additional tariffs. As of now, slowly moving forward. Earnings of major companies it is unclear what the ultimate outcome of these do not appear to support additional rapid growth in threats will be. Should tariffs cover a broad portion stock prices in the near term. of traded goods, businesses that sell many of their Trade Disputes Create Uncertainties. Over goods to China would be impacted. Consumers the past year, the U.S. and China have entered a and businesses also could face higher prices for trade dispute in which each country has imposed imported goods. These impacts could, in turn, a series of tariffs (taxes on imported goods) on have negative effects on the stock market and the products commonly traded between them, as well broader economy. REVENUES Revenues from California’s three largest taxes— corporation tax—have increased 41 percent since the personal income tax (PIT), sales tax, and 2012-13. PIT revenues have increased 46 percent 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET over that same period. Strong PIT growth is due to increase by 7 percent in 2018, 7.2 percent in higher-than-average wage growth over the period, 2019, but slow to 4.4 percent in 2020 due in especially for high-income earners, and the growth part to constrained growth at the national level. in the stock market. California wage growth from While we project continued growth in capital gains 2012 to 2017 averaged 4 percent (adjusted for revenues in 2018-19, we expect these revenues to inflation), compared to an average of 2.6 percent decline somewhat in 2019-20 due to slow growth from 1993 to 2012. The higher tax rates levied on in the stock market. (More detail on our revenue high-income earners by Propositions 30 and 55 estimates is available in Appendix Figure 1.) (2012 and 2016) further buoyed state revenue from this earnings Figure 2 growth. LAO Near-Term Revenue Outlook Expect Revenue Growth to General Fund (In Millions) Continue in 2019-20. Figure 2 2017-18 2018-19 2019-20 shows our near-term revenue outlook. Consistent with our Personal income tax $93,966 $97,865 $100,985 economic assumptions, General Sales and use tax 25,007 25,870 26,819 Fund revenues continue to increase Corporation tax 12,260 12,728 13,566 Subtotals ($131,233) ($136,463) ($141,369) in 2019-20—by 5.5 percent. Much of the growth is from the Insurance tax $2,575 $2,696 $2,883 PIT. Continued tightening in the Other revenues 1,711 1,762 1,799 labor market should keep upward BSA transfer -4,289 -2,766 -745 pressure on wages and salaries, Other transfers -305 -641 -241 which make up about two-thirds Totals, Revenues and Transfers $130,925 $137,514 $145,065 of taxable income. We expect BSA = Budget Stabilization Account. taxable wages and salaries to EXPENDITURES This section describes major programmatic Colleges. State funding for schools and community spending trends we project for the 2019-20 fiscal colleges is governed largely by Proposition 98, year (including recently passed ballot measures). passed by voters in 1988 and modified in 1990. General Fund spending in three major program The measure establishes a minimum annual areas grow, in some cases moderately, from funding requirement, commonly referred to as 2018-19 to 2019-20: (1) schools and community the minimum guarantee. The state adjusts the colleges, (2) health and human services programs, minimum guarantee each year based on various and (3) employee compensation and state factors including General Fund revenue, per capita retirement programs. However, these areas of personal income, and K-12 student attendance. growth largely are offset by reductions in one-time The state meets the minimum guarantee through spending from 2018-19. Consequently, we estimate a combination of state General Fund and local that General Fund spending growth (under current property tax revenue, with increases in property law and policies) from 2018-19 to 2019-20 will be tax revenue generally reducing General Fund very low. Total spending increases $2.1 billion year costs. The state can provide more funding than over year, a growth rate of 1.5 percent. Proposition 98 requires, though in practice it typically sets funding close to the guarantee. Schools and Community Colleges General Fund Costs Down $640 Million in Proposition 98 Establishes Funding 2018-19. Figure 3 (see next page) shows our Requirements for Schools and Community estimate of school and community college funding www.lao.ca.gov 5 analysis full gutter 2019-20 BUDGET Figure 3 Estimated Changes in School and Community College Funding (In Millions) 2018-19 2019-20 June November November Change From Budget Plan LAO Estimate Change LAO Estimate LAO 2018-19 Total Funding $78,393 $78,325 -$68 $80,765 $2,440 Fund source: General Fund $54,870 $54,230 -$640 $55,447 $1,217 Local property tax 23,523 24,096 572 25,318 1,223 in the current and upcoming year. For 2018-19, total about $480 million would remain for other ongoing K-14 funding is $68 million below the level assumed or one-time initiatives. in the June budget plan. This decrease mainly Health and Human Services (HHS) reflects our estimate of lower community college enrollment, which reduces the cost of funding HHS Spending Increases $1.6 Billion From apportionments. Total General Fund spending 2018-19 to 2019-20. Under our estimates and is down even further, decreasing $640 million assumptions, we project HHS spending would compared with the June estimate. Most of this increase by $1.6 billion (4 percent) between drop is the result of our higher local property tax 2018-19 and 2019-20, driven by cost increases estimates. (General Fund spending in 2017-18 also in three programs (partially offset by reductions in is lower by $471 million due to higher property tax other HHS programs): revenue reported for that year.) • Medi-Cal ($1.4 Billion Increase). Under General Fund Costs Increase $1.2 Billion current law and policy, we estimate that From 2018-19 to 2019-20. For 2019-20, our spending on Medi-Cal would increase outlook assumes the Legislature sets funding equal by $1.4 billion (6.1 percent) in 2019-20. to the minimum guarantee. Under this assumption, The growth is largely explained by (1) our total school and community college funding would assumption that the tax on managed grow to $80.8 billion, an increase of $2.4 billion care organizations (MCO) expires in (3.1 percent) over the 2018-19 funding level. 2019-20, consistent with current law; and The increase in the minimum guarantee is mainly (2) continued projected growth in the cost attributable to growth in state revenues. Of the per participant. However, year-over-year $2.4 billion increase, about half would be covered growth in the program is offset somewhat by by higher property tax revenue and half by state our assumptions that: (1) caseload declines, General Fund. The year-over-year increase in consistent with recent trends; and (2) state property tax revenue mainly reflects our estimate of repayments to the federal government for continued growth in assessed property values. disputed and disallowed claims slow. $2.8 Billion Available for School and • DDS (Over $300 Million Increase). We Community College Programs in 2019-20. estimate spending on the Department After accounting for growth in the guarantee and of Developmental Services (DDS) would backing out various one-time initiatives funded in increase by over $300 million (7.4 percent) 2018-19, we estimate the Legislature would have if current law and policies remain in place in $2.8 billion available for Proposition 98 programs in 2019-20. There are two major reasons for this 2019-20. The state could use this funding to cover increase: (1) growth in caseload and utilization a 3.1 percent statutory cost-of-living-adjustment and (2) the state minimum wage, which is and provide a few other previously scheduled augmentations. After providing these increases, 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET scheduled to increase to $13 per hour on than we anticipate. Second, there are risks that January 1, 2020. we cannot anticipate. In recent years the state has • IHSS (Roughly $100 Million Increase). Under experienced a few large, unexpected cost increases our assumptions, spending on the In-Home in HHS spending, most notably in the Medi-Cal Supportive Services (IHSS) program would program. These unanticipated cost increases have increase by around $100 million in 2019-20. resulted in our prior projections being too low. We Similar to DDS, the major drivers of this cost do not have enough information to know whether increase are related to growing caseload in an unexpected cost increase will occur again in the program, increases in the number of hours 2019-20 and our estimates do not attempt to worked per case, and the state’s scheduled quantify this possibility. increases in the minimum wage. Spending Other Spending growth in IHSS is offset by our assumption that there would be a 7 percent reduction Spending in Employee Compensation and in service hours when the MCO tax expires Retirement Increase $2 Billion in 2019-20. We in 2019-20. Without this assumption, IHSS estimate that General Fund salary and benefit costs spending would grow by roughly $400 million, for current employees across all state departments an over 10 percent increase, year over year. will increase by about $800 million from 2018-19 to 2019-20. Based on existing labor agreements, Comparing our Estimates of HHS Spending most state employees will receive pay increases to the Administration. As Figure 4 shows, the in 2019-20 ranging from 2 percent to 5 percent administration projects HHS spending will increase of pay. Salary increases also increase state costs $3.8 billion in 2019-20, over twice our estimate of for benefits that are paid for as a percentage of the increase. The administration does not display its pay (such as pensions, prefunding retiree health projections of spending at a department level within benefits, Social Security, and Medicare). A large the HHS area, so we do not know all of the sources share of estimated General Fund employee of these differences. Given that Medi-Cal makes up compensation cost increases in 2019-20 are due over half of the agency total, it likely is responsible to provisions of the one-year agreement with for a sizeable portion of this difference. The box on correctional officers—including a 5 percent pay the next page describes our concerns about the increase—ratified earlier this year. Correctional relative lack of detail on these estimates provided officers and their managers represent about by the administration. For 2018-19, we estimate 40 percent of the state’s General Fund payroll HHS spending will be nearly $600 million lower costs. In addition, we estimate that the state’s than the budget assumed in June. This reduction costs for retirement programs (including pension primarily reflects reduced payments to the federal government for disputed claims based on information the state Figure 4 received since the administration’s Comparing LAO and DOF Estimates of projections were developed. HHS Spending Through 2019-20 Uncertainty in These (Dollars in Billions) Estimates. Our expenditure estimates for these HHS programs 2017-18 2018-19 2019-20 depend on our assumptions DOF Estimate (June 2018) $35.5 $39.3 $43.1 about policy, cost, and caseload Year-over-year growth — 3.8 3.8 changes. There are two key Percent growth — 10.6% 9.7% sources of uncertainty in these LAO Estimate (November 2018) $35.5 $38.7 $40.3 assumptions. First, there are Year-over-year growth — 3.2 1.6 uncertainties we know about— Percent growth — 8.9% 4.0% for example, price and caseload HHS = Health and Human Services. growth could be higher or lower www.lao.ca.gov 7 analysis full gutter 2019-20 BUDGET Administration Provides Little Detail in HHS Spending Projections, Creating Challenges and Uncertainty We are concerned that the Legislature does not have adequate information about the administration’s long-term projections for General Fund spending on Health and Human Services (HHS) programs. In other areas of the budget, the Legislature often has better information about the executive branch’s assumptions, methods, and baseline multiyear projections. For example, while our office and the administration regularly have different projections of state revenues, we understand the underlying differences in our respective methodologies that lead to these differences. In HHS, the administration does not make its long-term projections for individual programs available for Legislative review. Not having basic information about the administration’s program-level out-year estimates and projections makes assessing their reasonableness difficult for the Legislature. It also makes it challenging for us to check our own assumptions. As the Legislature begins the 2019-20 budget process, we recommend asking the administration for more detail on its multiyear spending estimates and assumptions in HHS. and health benefits for retired state employees • Infrastructure and Equipment. The budget and pension benefits for teachers) will be about package included $630 million for the State $1 billion higher in 2019-20. Project Infrastructure Fund, $305 million Spending Increases Offset by Significant for deferred maintenance in a variety of One-Time Spending. Under our assumptions, program areas, $170 million for flood control about $3.6 billion in spending commitments made infrastructure, $134 million for voting systems, in the 2018-19 budget do not carry through to and $100 million for kindergarten facilities. 2019-20. (To assess whether or not an item is one • Other Major Items. Other major one-time time, we use the explicit appropriation language spending included $500 million for emergency in the budget package, although this sometimes homeless aid block grants, $200 million for differs with language on legislative intent.) Under hold harmless provisions associated with our assumptions, major one-time spending in ending the SSI/SSP cash out policy, and 2018-19 items include: $105 million in unrestricted funding for the University of California. GENERAL FUND CONDITION IN 2019-20 Figure 5 displays our estimate of the General 2019-20: $14.8 Billion in Available Resources. Fund condition through 2019-20. Under current Under our estimates of revenues and expenditures, law and policies, we estimate 2018-19 will end with discretionary resources at the end of 2018-19 would $9.1 billion in discretionary reserves, an increase grow by $5.7 billion—to $14.8 billion in 2019-20. (In of $7.2 billion over the level assumed at the time this context, “discretionary resources” refers to the the budget was passed in June. There are two estimated end-of-year balance in the Special Fund major reasons for this increase across 2017-18 and for Economic Resources under our assumptions.) 2018-19: (1) revenues are higher by $5.3 billion These surplus resources would be available to and (2) General Fund spending for schools and increase spending, reduce taxes, or increase community colleges is down by about $1.1 billion. reserves. The $5.7 billion increase in available resources is the net result of two major factors: 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET • Total Revenues and Transfers Grow • Required Infrastructure Spending of $7.6 Billion. Under our office’s economic $914 Million. Under our assumptions, in assumptions, revenues grow by $5.1 billion 2019-20, the Constitution would require between 2018-19 and 2019-20. Transfers $914 million to be spent on infrastructure. (which offset revenues) decline year over Under current law, $415 million of this total year, resulting in total growth in revenues and would be dedicated to fund state capital transfers of $7.6 billion overall. outlay and $250 million would be available • General Fund Spending Grows by each for rail infrastructure and affordable $2.1 Billion. From 2018-19 to 2019-20, housing. overall General Fund spending grows only • Required Debt Payments of $1.7 Billion. $2.1 billion. As described in the expenditure In addition, under our revenue estimates, the section, this is the net effect of moderate state would be required to pay an additional growth in schools and community colleges, $1.7 billion toward eligible debts. In our health and human services, and employee outlook, we allocated these funds using compensation and retirement programs, offset recent law and policy. For example, we by reductions in one-time spending from assume $744 million would be used to repay 2018-19. transportation-related loans, consistent with current law. We also assume $268 million Constitutionally Required Reserves, would be used to continue to implement Infrastructure Spending, and Debt Payments. the state’s plan to prefund retiree health Proposition 2 (2014) requires the state to set aside benefits using employer and employee money each year for reserve deposits and debt contributions. That said, the Legislature has payments. (In recent years, the Legislature has some flexibility in these allocations and, in the made additional, optional reserve deposits.) When 2019-20 budget process, could allocate these the state’s constitutional reserve—the Budget funds somewhat differently. Stabilization Account (BSA)—reaches a threshold of 10 percent of General Fund taxes, formula-driven Outlook Assumes Current Law and Policies deposits that would bring the balance above on Budgetary Formulas. All of the estimates in this threshold must be spent on infrastructure. our outlook assume current state policy regarding For 2019-20, we estimate the following Proposition 2. Under alternative interpretations of Proposition 2 requirements: Figure 5 • BSA Reserve Reaches LAO Near-Term Budget Condition $14.5 Billion. Under our revenue projections, the General Fund (In Millions) state would be required 2017-18 2018-19 2019-20 to deposit an additional Prior-year fund balance $5,657 $10,076 $10,281 $745 million into the rainy Revenues and transfers 130,925 137,514 145,065 day fund in 2019-20. Under Expenditures 126,505 137,310 139,373 these assumptions, the fund Ending fund balance $10,076 $10,281 $15,973 would reach $14.5 billion Encumbrances 1,165 1,165 1,165 in 2019-20, 10 percent SFEU balance 8,911 9,116 14,808 of General Fund taxes. Reservesa Consistent with recent state SFEU balance $8,911 $9,116 $14,808 policy, this assumes that Safety net reserve — 200 200 previous years’ optional BSA balance 11,002 13,768 14,513 deposits into the BSA count Total Reserves $19,914 $23,084 $29,521 toward the 10 percent a Reflects the year-end balances in each account under current law and policy. threshold. SFEU = Special Fund for Economic Uncertainties and BSA = Budget Stabilization Account. www.lao.ca.gov 9 analysis full gutter 2019-20 BUDGET Proposition 2, past optional deposits would not instead be deposited into the BSA. The nearby box count toward the BSA threshold, and the amount describes how our outlook treats other statutory dedicated to infrastructure in 2019-20 would and constitutional budget formulas. Assumptions on Other Budget Formulas There are three additional constitutional and statutory budget formulas that may affect spending and revenues in 2019-20. With respect to these formulas, we assume: • Sales Tax Reductions Are Not Triggered. California has two statutes that trigger reductions in the state’s sales tax rate if balances in discretionary reserves reach a certain threshold. The Department of Finance (DOF) is required to make a determination about whether the conditions are met before November 1st of each year. This year’s DOF letter on the sales tax triggers noted that—under the budget act estimates of revenues and reserve balances—the conditions for neither of these triggers were met. Decisions made by the Legislature in the 2019-20 budget process will affect whether the provisions are triggered in November 2019. • Additional Spending for Medi-Cal Is Not Provided. Proposition 55 (2016) extended tax rate increases on high-income earners and created a new budgetary formula that produces increased spending requirements for Medi-Cal under certain conditions. The administration has significant discretion in how to administer these calculations. In 2018-19, the first year of implementation, the administration’s approach resulted in no additional funding for Medi-Cal. Decisions made by the Legislature and the administration in the 2019-20 budget process will affect whether or not the formula results in additional funding requirements for Medi-Cal. • Constitutional Spending Limit Is Not Reached. Under the administration’s June 2018 estimates, the state had several billion dollars of “room” under its spending limit in 2017-18 and 2018-19. While our estimates of tax revenues are higher than those of the administration during these years, we are unable to produce spending limit estimates because our Fiscal Outlook has a General Fund focus whereas the spending limit formulas include special funds. The state budget’s many formulas interact with one another. For example, if decisions made by the administration result in additional spending for Medi-Cal under the provisions of Proposition 55, the likelihood that the state’s sales tax reductions were triggered would be reduced. 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET LAO COMMENTS The Budget Is in Remarkably Good Shape. The State’s Budget Condition Can Change It is difficult to overstate how good the budget’s Quickly. While our current projections suggest the condition is today. For several years, the state state’s economic and budgetary situations are very has consistently increased reserve levels in strong, these fortunes can change quickly. In fact, each subsequent budget. Economic conditions this is precisely what occurred after we published continue to improve: unemployment is low and our Fiscal Outlook at the end of 2000. As a result of wages are growing. Under our estimates of the dot-com bust and ensuing recession in 2001, revenues and spending, the Legislature would have state revenues declined precipitously. The very next $14.8 billion in resources available to allocate in the year, looking to budget year 2002-03, our Fiscal 2019-20 budget process. By historical standards, Outlook found the state’s surplus had disappeared, this surplus is extraordinary. Since 1995, our office and instead, the budget faced a deficit of has produced an outlook of the upcoming year’s $12.4 billion for the upcoming year. In light of these budget condition every year. In dollar terms, the budgetary uncertainties, in the next section, we available surplus for 2019-20 is easily the largest consider how the budget’s multiyear outlook would our office has ever estimated. As a percent of fare under varying economic conditions. overall revenues, it is second only to the estimated $10.3 billion surplus in 2001-02, which we projected in November 2000. www.lao.ca.gov 11 analysis full gutter 2019-20 BUDGET 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Chapter 2 In this chapter, we discuss the condition of the economy is the key source of uncertainty in our budget over the longer term, through 2022-23. budgetary projections.) Second, we discuss the First, we present our estimates of revenues, fiscal implications of statewide demographic trends spending, and the condition of the General Fund that affect the budget now and into the future. under two different economic scenarios. (The BUDGET CONDITION UNDER TWO ECONOMIC SCENARIOS Economy Revenues Economic Assumptions in This Chapter. Our Revenue Situation Assuming Continued spending and revenue projections in this chapter are Economic Growth. Under our growth scenario, based on two different sets of economic conditions: General Fund revenues and transfers grow from $137.5 billion in 2018-19 to $159.3 billion in • Growth Scenario. In this scenario, we assume 2022-23. This represents a moderate 3.8 percent the economy continues to grow. Job growth average annual growth rate over the period. We slows as the economy reaches full employment. attribute this to moderate growth in personal Wage growth overall also slows, but remains income tax (PIT) revenues, which grow just less strong in some industries, such as professional than 3 percent over the period (which is relatively and technical services (for example, lawyers, weak by recent standards). This reflects our engineers, and computer programmers) and in assumptions of: (1) slowing growth in wages the technology sector (for example, software and salaries and (2) a relatively flat stock market. development and data processing). We also Growth in the corporate tax is much stronger at assume a relatively flat stock market. 5.5 percent over the period. We attribute this to • Recession Scenario. In this scenario, we the consensus expectation that corporate profits assume a recession begins in the third quarter continue to grow steadily. (The Appendix contains of calendar year 2020, based on Moody’s more information on our revenue outlook under Analytics “moderate” recession scenario. (This both scenarios.) scenario is not based on a recent historical Revenues in the Recession Scenario. Under example, but rather a model of one possible the recession scenario, revenues would decline recession scenario that Moody’s believes year over year by close to $5 billion in both could materialize in the coming years.) Under 2020-21 and 2021-22, respectively. (Compared to this scenario, GDP drops by 2.25 percent the economic growth scenario, the total revenue over four quarters, starting at the beginning loss would be roughly $46 billion over the outlook of 2020-21. This scenario also assumes period.) Much of these reductions would be driven the S&P 500 declines by one-third over by declines in the PIT. Under our assumption the course of the recession. This recession that the economy starts to recover at the start of scenario is relatively short-lived—the economy 2021-22, revenues grow again in 2022-23. begins to recover at the start of 2021-22. www.lao.ca.gov 13 analysis full gutter 2019-20 BUDGET Scenarios Represent Two of Many Possible and modest growth in revenues over the forecast Outcomes. The scenarios presented in this chapter period. (Overall, school and community college are two of many possible economic outcomes funding—including local property tax revenue— that could occur over the next five years. Our grows at about 3.4 percent per year.) uncertainty about the economy’s condition— Medi-Cal Grows an Average of 5.1 Percent. and therefore revenue performance—increases Medi-Cal, the state’s Medicaid program, accounts throughout the period. Through 2018-19, revenues for 26 percent of overall growth in our outlook. could be a few billion dollars higher or lower than In our growth scenario, spending on Medi-Cal our estimates. In 2019-20, revenues could be increases by an average of 5.1 percent annually. several billions of dollars different. In the out-years Similar to other health and human services of our projections, revenues could be tens of programs, Medi-Cal recently has been growing billions of dollars lower than our recession scenario faster than much of the rest of the budget. This and several billions of dollars above our growth largely has been due to (1) rising caseload and scenario. costs per beneficiary, (2) scheduled reductions in federal funding (as the federal share of costs Spending in for Medi-Cal’s optional expansion population has Economic Growth Scenario declined), and (3) various technical adjustments. The growth we project in Medi-Cal through 2022-23 is This section describes trends in General Fund somewhat lower than recent experience, however. spending assuming the economy continues to There are three main reasons for this: grow. As noted earlier, we assume current law and policies stay in place. • Limited Growth in Caseload Expected. Overall General Fund Spending Grows Recently, Medi-Cal caseload has begun to $19 Billion (3.3 Percent Annually) Over the slowly decline as the economy has continued Outlook Period. Assuming current law and policies to grow. Over the outlook period, we assume stayed in place, we project General Fund spending would Figure 6 increase $19 billion over the period (averaging 3.3 percent Schools and Community Colleges and Medi-Cal per year), as Figure 6 shows. Drive $19 Billion in Projected Spending Growth Together, schools and community colleges and Medi-Cal account for Total 100% 60 percent of this growth. (These 8% All Other (Net) programs also account for well 9% DDS over half of the budget.) 80 10% IHSS Schools and Community Colleges Grow an Average of 13% Retirement 2.9 Percent. The constitutional 60 minimum level of funding for Spending Projected to Grow $19 Billion 26% Medi-Cal 100% schools and community colleges $200 is determined by a set of formulas 40 160 Projected Growth (under the rules of Proposition 98). 120 In our growth scenario, General 20 Schools and 80 2018-19 Spending Level Fund spending on schools and 34% Community Colleges 40 community colleges grows by an average of 2.9 percent over 2018-19 2022-23 the period. This growth rate is relatively low, reflecting slightly DDS = Department of Developmental Services and IHSS = In-Home Supportive Services. negative changes in attendance 14 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET caseload in the program continues a very slow of General Fund costs today, but over the decline initially and is essentially flat in later outlook period is responsible for 10 percent of years, which dampens cost growth. total growth. We can attribute this growth to • Changes in Federal Funding. In recent three major factors: growing caseload in the years, the state share of costs has been program; increases in the number of hours increasing for Medi-Cal’s optional expansion per case; and the state minimum wage, which as a result of scheduled reductions in federal is scheduled to continue increasing over the matching funds. Similarly, in the next couple outlook period. of years, the state’s share of costs for the • Department of Developmental Services Children’s Health Insurance Program also (DDS). DDS also is responsible for about will increase as the federal share declines. 3 percent of General Fund spending today, These increasing state shares have resulted but 9 percent of overall spending growth over in higher-than-otherwise General Fund growth the outlook period. Similar to IHSS, the major rates in these programs. These state costs, reasons for these cost increases are growth however, will stop increasing in 2021-22 in caseload, use of services, and the state when the federal shares reach their scheduled minimum wage. minimums. As a result, the year-to-year Required Spending on Debt and growth rates will subside. Infrastructure. Under the rules of Proposition 2 • Lessening Effects of Technical (2014), the Constitution requires the state to: Adjustments. Finally, our outlook assumes (1) spend minimum amounts on repaying certain that increased spending related to many of the debts, (2) deposit money into reserves, and technical adjustments in recent years are one (3) spend more on infrastructure when reserves time or will be reduced in the future. (Technical reach a certain threshold. These amounts are adjustments include the required repayment determined by a series of formulas. Assuming of federal funds.) These assumptions result in the economy grows and current law and policies lower year-over-year growth in General Fund stay in place, state reserves will have reached spending relative to recent years. their maximum level in 2019-20 under our revenue Three Other Programs Account for Most assumptions. In 2019-20 and the years that follow, of Remaining Growth. Three other—smaller— the state would be required to spend roughly programs account for most of the remaining growth $800 million per year on infrastructure. In addition, over our outlook period. These are: from 2019-20 to 2022-23, the state would be required to spend an average of $1.3 billion per • Retirement Programs. Over the period, the year to pay down certain eligible debts. (In our state’s retirement programs—including pension outlook, we assume an allocation of these funds benefits for retired state employees (CalPERS); using recent law and policy.) pension benefits for teachers (CalSTRS); and other post-employment benefits, namely Spending in Recession Scenario health benefits for retirees—account for This section describes our assumptions and 13 percent of the total increase in underlying estimates on spending in a variety of program areas spending. In CalPERS and CalSTRS, these across the budget in a recession. increases largely reflect the boards’ changes in Lower Spending on Schools and Community assumptions regarding investment returns and Colleges. The formulas determining school and other demographic changes. For retiree health, community college funding tend to result in lower these increases reflect rising health premiums spending when revenues and personal income are and the fact that state retirees are living longer declining and higher spending when the opposite is in retirement. true. In our recession scenario, in which revenues • In-Home Supportive Services (IHSS). The and personal income both decline, the minimum IHSS program accounts for about 3 percent www.lao.ca.gov 15 analysis full gutter 2019-20 BUDGET funding level for K-14 education also declines. • Assume Cost-of-Living Increases Remain We assume the Legislature funds schools and in Place. Consistent with recent practice, community colleges at this lower level (as has we have assumed a variety of programs occurred in past recessions). This means that, in receive cost-of-living adjustments across the our recession scenario, General Fund spending on period. This includes: increases in employee K-14 education declines from a high of $55.6 billion compensation (which we adjust for inflation in 2019-20 to a low of $51.2 billion in 2021-22. after current bargaining agreements expire), (See the Appendix for more detail on these base funding increases for universities, and spending estimates.) discretionary increases for the judicial branch. Lower Spending on Debt and Infrastructure. We do not change these assumptions in the In the recession scenario, we assume the state recession scenario. suspends required deposits into reserves and • Assume Minimum Wage Goes into Effect stops making infrastructure payments (under the as Scheduled. A law passed in 2016 Constitution’s budget emergency rules). Even in (Chapter 4 of 2016 [SB 3, Leno]) increases a budget emergency, however, the state must California’s statewide minimum wage over continue to make required debt payments. As a period of several years. Under the current a result, relative to the growth scenario, state schedule, the minimum wage for most spending on infrastructure would be lower by employees is scheduled to increase to roughly $800 million per year, but the state would $12 per hour on January 1, 2019, to $13 in continue to make debt payments (although, under January 2020, and to $14 in January 2021. the formulas, these required amounts would be a For the purposes of our recession scenario, few hundred million dollars lower). we assume these minimum wage increases Higher Spending on Some Caseload-Driven go into effect as scheduled. (In the event of a Programs. For some programs, caseload increases recession, the Governor has some discretion when the state enters a recession (usually because to pause these increases. For example, if the unemployment increases or wages decline). As Governor paused the increase scheduled to a result, absent policy changes, the state faces occur at the beginning of 2021—so that the higher costs for these programs. Three programs minimum wage remained at $13 per hour in in particular experience quantifiable cost increases 2021—it would save the state, on net, roughly as a result of changes in the economy. They $100 million to $200 million in 2020-21.) are: Medi-Cal; CalWORKs, which provides cash assistance and services to low-income individuals; General Fund Condition and child care. Across these three programs, In this section we show the budget’s bottom line relative to the growth scenario, we estimate the condition under the two economic scenarios. state would face higher costs of roughly $1 billion in General Fund Surpluses Under Growth 2021-22 in the recession scenario (and somewhat Scenario. Figure 7 displays our estimates over the lower cost increases in other years). outlook period of General Fund operating surpluses All Other Program Costs Assumed the Same (the difference between incoming revenues and in Recession Scenarios. Relative to the growth estimated spending). If current law and policies scenario, we keep all other programs’ spending were unchanged (left side of the chart), these levels the same in the recession scenario. We surpluses would average around $4.5 billion per understand that, in a real recession, the Legislature year, declining over time. Figure 7 also shows would change spending in these programs— that—pursuant to the rules of Proposition 2 and particularly those over which the Legislature has under current policy—the state would continue to more control. The aim of this publication, however, make deposits into the state’s Budget Stabilization is to show how the budget would fare assuming Account each year. current policies stayed in place. To be clear, this means we: 16 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Figure 7 General Fund Surpluses Under Economic Growth Scenario (In Billions) Assuming No New Commitments With New Commitmentsa $7 6 BSA Deposit Remaining Operating Surplus 5 4 3 2 1 2018-19 2019-20 2020-21 2021-22 2022-23 2018-19 2019-20 2020-21 2021-22 2022-23 a Assumes Legislature makes an additional $2 billion in one-time and $3 billion in ongoing spending increases or tax reductions in 2019-20. BSA = Budget Stabilization Account. General Fund Operating Surpluses Decline 2019-20 to build more reserves and makes no new With New Commitments. While our outlook commitments.) We also assume the Legislature assumes they remain the same, we know that the funds schools and community colleges at the state’s law and policies will change over this period. minimum level, meaning General Fund spending To that end, for illustrative purposes, the right side would decline year over year, as we described of Figure 7 displays the state’s operating surpluses earlier. In this situation, the state would have plenty if additional commitments were made in 2019-20. of reserves to cover its deficits. In fact, the state In particular, the figure assumes that the Legislature would end the 2022-23 fiscal year with $13.5 billion made an additional $2 billion in one-time and in reserves—enough to cover additional deficits if $3 billion in ongoing commitments (but no the recession were worse or to cover any remaining additional commitments in 2020-21 and beyond). deficits that occurred outside the outlook period. As the figure shows, with these commitments, With More in Commitments, Reserves Would operating surpluses would decline over the outlook Not Fully Cover the Budget Problem. The right period such that they would be gone by the last side of Figure 8 displays the budget’s condition year of the outlook. under the recession scenario if the Legislature In the Recession Scenario, $30 Billion in makes additional commitments in 2019-20. (As Reserves Would Be Sufficient to Cover Deficits. we assumed in the growth scenario, the figure Figure 8 (see next page) displays the budget’s assumes that the Legislature made an additional condition assuming the recession scenario occurs. $2 billion in one-time and $3 billion in ongoing On the left side, we show the budget’s condition commitments.) Under these assumptions, the if the state enters the recession with $30 billion in state would enter the recession in 2020-21 with reserves. (This would mean the Legislature uses $25 billion in reserves and operating deficits would all of the nearly $15 billion in available resources in grow by $3 billion each year. By the end of the www.lao.ca.gov 17 analysis full gutter 2019-20 BUDGET Figure 8 General Fund Condition Under Recession Scenario (In Billions) $30 Billion in Reserves Covers Deficits . . . . . . But With New Commitments, Reserves Would Be Depleted.a $10 5 State enters the recession with -5 $30 billion in reserves. State enters the recession with $25 billion in reserves. -10 Operating Surplus Operating Deficit (Covered by Reserves) Operating Deficit (Not Covered by Reserves) -15 2019-20 2020-21 2021-22 2022-23 2019-20 2020-21 2021-22 2022-23 a Assumes Legislature makes an additional $2 billion in one-time and $3 billion in ongoing spending increases or tax reductions in 2019-20. period, the state would have exhausted its reserves maintains other programmatic spending using and would require solutions—such as spending reserves. This assumption is in keeping with reductions, tax increases, or cost shifts—to cover a the publication’s aim to show spending under $500 million budget problem. current law and policies, which has generally More Reserves Would Be Needed to been to fund schools and community colleges Mitigate Reductions to School Funding. In at the minimum required funding level. If instead our Fiscal Outlook publications, we assume the the Legislature wanted to mitigate the impact on state funds schools and community colleges at schools and spend above the minimum level, the their minimum level. More explicitly, this means, state’s operating deficits would be larger and more under our assumptions, General Fund spending reserves would be needed to cover the budget on K-14 education declines even as the state problem. The nearby box contains more information on reserves and school spending. DEMOGRAPHIC TRENDS California’s Population Is Aging. California’s these natural changes in demographics are offset population is growing older—the average age of or amplified by migration of some groups to and Californians has been increasing and is expected from the state. In recent years, more people left to continue to do so. This is occurring as a result California for other states than moved to the of three distinct trends: (1) birth rates are declining, state from other states. These population losses, (2) baby boomers are now reaching retirement however, have been much lower than historically.) age, and (3) people are living longer. (Some of 18 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Reserves and School Spending Rainy Day Fund Deposits Do Not Affect School Spending. State spending on schools is determined by a series of formulas. These formulas are unaffected by the constitutional requirements for the state to make reserve deposits into its rainy day fund (governed by Proposition 2 [2014]). Consequently, spending on schools is never lower as a result of these reserve deposits. Rather, these deposits result in less revenue available for nonschool programs. As a result, spending on nonschool programs is reduced during the time that reserves are built up. School Reserves. Proposition 2 also established a specific statewide school reserve account (the Public School System Stabilization Account), which is governed by a separate set of formulas. To date, these formulas have not resulted in any deposits being made into the school reserve. As such, school districts do not have dedicated reserves available to cushion the impact of a recession. Growth in Population by Age in the Outlook • Medi-Cal, which provides health insurance Period. Figure 9 shows how our projected change coverage for low-income families, seniors, in population by age group unfolds over our outlook and people with disabilities. In the program, period (2017 through 2023). We expect: (1) the caseload for seniors is expected to increase population of children and young adults to decline, at a rate of 2.7 percent over the next five (2) the population of those in their prime working years (much higher growth than for any other years to remain relatively flat, and (3) the population group). Medi-Cal’s senior caseload carries of seniors to increase significantly. Our projections higher costs for the state on average, resulting for each of these age cohorts are close to the in somewhat higher costs to the program most recent projections made by the Department overall. of Finance (DOF). However, DOF expects the population of children Figure 9 ages 5 to 17 to increase slightly over the period and young adults Expected Growth by Age Cohort, 2017-2023 (ages 18 to 24) to remain nearly constant. Age 75+ Fiscal Effects Age 65-74 We expect each of these three demographic trends to have Age 45-64 distinct effects on the budget. This section examines the fiscal Age 25-44 effects of each of these trends individually and then describes Age 18-24 their likely net effect. Some Cost Increases From Age 5-17 Older Population. We expect the growth in the population of older Age 0-4 Californians to result in somewhat higher costs for some programs. -10 -5 5 10 15 20 25 30 35% In particular, an aging population means higher costs for: www.lao.ca.gov 19 analysis full gutter 2019-20 BUDGET • IHSS provides supportive services to would be much more sensitive to changes in the low-income seniors and people with population of higher-income people than changes disabilities. As such, caseload growth in in the overall working age population. In fact, this program is in part driven by the aging recent data on migration suggest that although population. Additionally, as individuals live California has had net out-migration among most longer, recipients likely will spend more time demographic groups, it has gained among those in the program and require a higher level of with higher incomes ($110,000 per year or more) service. and higher levels of education (graduate degrees). • Retiree Health provides medical benefits Growth in General Fund Costs Declines as to retired state employees. The state is Growth in Population of Children Slows. In paying these benefits in the year they are contrast to programs that largely benefit older used by retirees (although the state also Californians, lower growth in the state’s population is implementing a plan to prefund these of children results in lower cost growth for other benefits for current employees). As more state areas of the budget (particularly, schools). Under employees retire and people live longer, the the rules of Proposition 98, declines in student costs associated with providing their health attendance tend to reduce required funding levels. benefits will continue to increase. Over the next few years, we expect attendance to decline somewhat (although not as much as That said, overall, demographic trends are not the ages 5 to 17 group). This reduces associated the most important determinant of these programs’ school costs. By comparison, if the school-age costs. In IHSS and Medi-Cal, for example, policy population instead grew at the same rate as the changes—such as increases in the state minimum overall population, the state would have to spend wage and the optional expansion of Medi-Cal additional billions of dollars over the outlook period. benefits to a broader group of low-income On Net, Demographic Trends Likely Resulting individuals—result in much larger cost increases in Lower General Fund Spending Growth. The than those attributable to demographic shifts. net effect of an aging population in California has Similarly, for retiree health, another important counterintuitive fiscal effects. Many think the aging determinant of program costs is the trend in population is a major driver of increasing General medical prices. Fund costs, but that view is incomplete. While Somewhat Lower Tax Revenues Possible growth in the population of older Californians likely From Flat Working Age Population. Weak growth means higher costs for some programs, declines of the 45 to 64 age group could hamper growth in in the population of children means much lower state tax revenues because this is the age category growth in costs for other programs. In fact, on net that routinely earns the highest wages and salaries. over the next few years, the state’s demographic That said, this effect must be considered in light trends are likely resulting in lower, not higher, of other demographic shifts in this population. General Fund cost growth. That said, demographic California’s PIT revenues depend, to a large extent, factors have less effect on the state budget than on high-income earners. As a result, revenues policy choices and economic conditions. LAO COMMENTS Consider Target for Overall Level of Reserves. consider its target level of overall reserves as it The budget now has a variety of reserve accounts, builds the budget. In 2019-20, the state will have including some general purpose accounts and nearly $15 billion in its constitutional reserve some program specific accounts, like the ones account. In addition, the Legislature also will be created in 2018-19 for Medi-Cal and CalWORKs. able to use the $15 billion in available resources to Each year we encourage the Legislature to first build more reserves. In this report, we have found 20 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET that a $30 billion reserve would be sufficient to Legislature Has Unique Opportunity to cover the entire budget problem associated with Prepare for Coming Challenges. In the coming Moody’s moderate recession scenario. We also years, the budget likely will face a variety of noted that, with new ongoing commitments in challenges. An obvious example is the economy, 2019-20, a smaller reserve would be insufficient to which could slow. Decisions by the federal fully cover a budget problem. government will affect the state budget, economy, Consider How to Provide Reserves for and tax revenues. Similarly, future decisions by Schools. In addition to general purpose reserves, the state’s retirement systems can change state the state has a separate statewide reserve for costs by billions of dollars—an area of spending schools. However, the school reserve has yet that the Constitution places largely outside of to receive any deposits. Our recession scenario the Legislature’s control. Finally, the state always assumes schools and community colleges are faces the risk of confronting a natural disaster that funded at their constitutional minimum level. That could carry high costs for the people of California is, in our scenario, general purpose reserves are and their government. The $15 billion surplus used solely to maintain nonschool programs. If, we anticipate for 2019-20 gives the Legislature instead, general purpose reserves were used to a unique opportunity to prepare for coming mitigate reductions to schools, additional reserves challenges. As such, we would encourage the would be required to cover larger deficits. This Legislature to allocate a significant portion of the raises basic questions about how the Legislature available resources to one-time purposes and would like to build reserves for schools and the rest building higher reserve levels. of the budget in anticipation of the next recession. www.lao.ca.gov 21 analysis full gutter 2019-20 BUDGET 22 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET APPENDIX Appendix Figure 1 LAO November 2018 Revenue Outlook General Fund (Dollars in Millions) Estimates Outlook Average Annual Growth Scenario 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 Growtha Personal income tax $93,966 $97,865 $100,985 $103,509 $106,278 $109,644 2.9% Sales and use tax 25,007 25,870 26,819 27,753 28,596 29,268 3.1 Corporation tax 12,260 12,728 13,566 14,412 15,111 15,780 5.5 Subtotals ($131,233) ($136,463) ($141,369) ($145,674) ($149,985) ($154,692) (3.2%) Insurance tax $2,575 $2,696 $2,883 $3,007 $3,059 $3,129 3.8% Other revenues 1,711 1,762 1,799 1,802 1,801 1,797 0.5 BSA transfer -4,289 -2,766 -745 -445 -435 -478 -35.5 Other transfers -305 -641 -241 -161 57 202 N/A Totals, Revenues and Transfers $130,925 $137,514 $145,065 $149,877 $154,465 $159,343 3.8% Percent change — 5% 5% 3% 3% 3% — Estimates Outlook Average Annual Recession Scenario 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 Growtha Personal income tax $93,966 $97,865 $100,985 $96,286 $92,446 $96,505 -0.3% Sales and use tax 25,007 25,870 26,819 26,804 26,842 27,775 1.8 Corporation tax 12,260 12,728 13,566 12,363 10,730 13,290 1.1 Subtotals ($131,233) ($136,463) ($141,369) ($135,452) ($130,019) ($137,569) (0.2%) Insurance tax $2,575 $2,696 $2,883 $3,007 $3,059 $3,129 3.8% Other revenues 1,711 1,762 1,799 1,802 1,801 1,797 0.5 BSA transfer -4,289 -2,766 -745 — — — — Other transfers -305 -641 -241 -161 57 202 N/A Totals, Revenues and Transfers $130,925 $137,514 $145,065 $140,100 $134,935 $142,697 0.9% Percent change — 5% 5% -3% -4% 6% — a From 2018-19 to 2022-23. BSA = Budget Stabilization Account. www.lao.ca.gov 23 analysis full gutter 2019-20 BUDGET Appendix Figure 2 Spending Through 2019-20 LAO November 2018 General Fund Estimates (Dollars in Millions) Estimates Outlook Change From 2017-18 2018-19 2019-20 2018-19 Major Education Programs Schools and community collegesa $52,911 $54,230 $55,447 2.2% University of California 3,549 3,729 3,567 -4.3 California State University 3,474 3,655 3,752 2.6 Financial aid 1,188 1,234 1,318 6.8 Child care 1,019 1,378 1,465 6.3 Major Health and Human Services Medi-Cal 20,345 22,563 23,943 6.1 Department of Developmental Services 4,144 4,487 4,819 7.4 In-Home Supportive Services 3,444 3,813 3,897 2.2 SSI/SSP 2,840 2,793 2,800 0.3 Department of State Hospitals 1,485 1,673 1,631 -2.5 CalWORKs 438 201 268 33.3 Major Criminal Justice Programs Corrections and Rehabilitation 11,068 11,630 11,910 2.4 Judiciary 1,743 1,888 2,205 16.8 Debt service on state bonds 5,259 5,532 5,380 -2.8 Other programs 13,598 18,504 16,972 -8.3 Totals $126,505 $137,310 $139,373 1.5% a Reflects the General Fund component of the Proposition 98 minimum guarantee. 24 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Appendix Figure 3 Spending by Major Area Through 2022-23 LAO November 2018 General Fund Estimates(Dollars in Millions) Estimates Outlook Average Annual Growth Scenario 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 Growtha Education Programs Schools and community collegesb $52.9 $54.2 $55.4 $57.1 $58.9 $60.7 2.9% Other education 9.2 10.0 10.1 10.3 10.7 10.9 2.2 Health and Human Services 32.7 35.5 37.4 40.0 42.1 44.3 5.7 Criminal Justice 12.8 13.5 14.1 14.2 14.4 14.6 1.9 Debt service on state bonds 5.3 5.5 5.4 6.0 6.4 6.2 3.0 Other programs 13.6 18.5 17.0 17.6 18.5 19.7 1.5 Totals $126.5 $137.3 $139.4 $145.3 $150.9 $156.4 3.3 Percent change — 8.5% 1.5% 4.2% 3.9% 3.6% — Estimates Outlook Average Annual Recession Scenario 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 Growtha Education Programs Schools and community collegesb $52.9 $54.2 $55.4 $53.2 $51.2 $54.1 — Other education 9.2 10.0 10.1 10.3 10.7 10.9 2.2% Health and Human Services 32.7 35.5 37.4 40.3 42.9 45.2 6.2 Criminal Justice 12.8 13.5 14.1 14.2 14.4 14.6 1.9 Debt service on state bonds 5.3 5.5 5.4 6.0 6.4 6.2 3.0 Other programs 13.6 18.5 17.0 16.5 17.6 18.8 0.4 Totals $126.5 $137.3 $139.4 $140.6 $143.2 $149.9 2.2% Percent change — 8.5% 1.5% 0.9% 1.9% 4.7% — a From 2018-19 to 2022-23. b Reflects the General Fund component of the Proposition 98 minimum guarantee. Note: Program groups are defined to include departments listed in Appendix Figure 2. www.lao.ca.gov 25 analysis full gutter 2019-20 BUDGET 26 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET www.lao.ca.gov 27 analysis full gutter 2019-20 BUDGET LAO PUBLICATIONS The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 28 LEGISLATIVE ANALYST’S OFFICE