The 2019-20 Budget: May Revision Multiyear Budget Outlook

The 2019-20 Budget: May Revision Multiyear Budget Outlook GABRIEL PETEK LEGISLATIVE ANALYST MAY 17, 2019 analysis full gutter 2019-20 BUDGET LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Executive Summary This report presents our office’s independent assessment of the condition of the state General Fund budget through 2022-23 assuming the economy continues to grow and all of the Governor’s May Revision spending proposals are adopted. Multiyear Budget Condition Is Positive. Under our multiyear outlook assumptions, the state budget has the capacity to pay for the Governor’s May Revision proposals and still has an operating surplus—which could be available to respond to unanticipated cost increases, build additional reserves, or make additional commitments. In fact, although the Governor proposes to “sunset” four major categories of program expenditures (such as provider rate increases in Medi-Cal), our outlook suggests this action is not necessary to balance the budget. The figure below shows our projections of the budget’s operating surpluses with and without the Governor’s proposed sunsets. As the right side of the figure shows, under our revenue assumptions, operating surpluses persist even without the Governor’s proposed sunsets. Recent Budgets Focused on Building Reserves to Prepare for Future. In this report, we also analyze how well the Governor’s proposed budget prepares the state for future budgetary challenges—such as a recession. Recently enacted budgets have focused on building reserves as the primary strategy for preparing the budget for the future. They also have focused new discretionary spending proposals on one-time, rather than ongoing, purposes. For example, in 2016-17 and 2018-19, the Legislature committed roughly half of the budget’s estimated surplus to increasing reserves. These budgets also committed a relatively small amount of new resources to ongoing spending. (This comparison excludes 2017-18 because the state faced a Operating Surpluses Under . . .Surpluses Persist LAO Economic Growth Scenario. . . Without Proposed Sunsets (In Billions) $6 $6 BSA Deposit BSA Deposit 5 5 Remaining Operating Surplus Remaining Operating Surplus 4 4 3 3 2 2 1 1 2019-20 2020-21 2021-22 2022-23 2019-20 2020-21 2021-22 2022-23 BSA = Budget Stabilization Account. Note: Reflects our office’s estimates of revenues and expenditures under the Governor’s May Revision proposals. www.lao.ca.gov 1 analysis full gutter 2019-20 BUDGET small budget problem—or a “deficit”—in January of that year, meaning there was no comparable surplus for 2017-18.) Governor Places a Much Lower Emphasis on Building More Discretionary Reserves . . . In his proposed budget, the Governor’s revenue estimates indicate the state has a much larger available surplus to allocate compared to recent years. In both dollar and percentage terms, however, the Governor allocates much less of this surplus to building more discretionary reserves. Moreover, the Governor proposes allocating more available funding, in dollar terms, to new ongoing spending commitments. Specifically, as shown in the figure below, he proposes new ongoing spending of $3.4 billion (growing to $4.4 billion upon full implementation), compared to recent levels of $300 million and $1.3 billion in 2016-17 and 2018-19. . . . And Instead Focuses on Paying Down State Debt. The Governor has stated that one of the primary objectives of his budget is to better prepare the state for a future challenge. To accomplish this, the Governor proposes to pay down state debts (which he refers to as a plan to build budget resilience). In particular, the Governor proposes allocating $9.5 billion of available discretionary resources to repaying state debts, including paying down pension liabilities, repaying outstanding loans to state special funds, undoing two budgetary deferrals, and paying obligations to schools and community colleges. We Recommend the Legislature Maintain Its Recent Practice to Focus on Reserves. We agree with the Governor that the state’s remarkable surplus represents a unique opportunity to prepare the budget for the future. We also agree that using a portion of the surplus to address some of the state’s outstanding debt is prudent. However, we think the state’s plan for responding to a recession should focus—first and foremost—on building budget reserves. Building reserves is the most reliable and effective method for preparing the budget for a downturn. As such, we recommend the Legislature dedicate a larger portion of the surplus to discretionary reserves, as it has done in recent budgets. Governor Proposes Using Smaller Share of Surplus for Reserves(cid:31)Compared to Recent Enacted Budgets (In Billions) 2019-20 (Proposed) Portion of one-time spending proposed for paying down debts 2018-19 (Enacted) 2016-17 (Enacted) 5 10 15 20 $25 Reserves One-Time or Temporary Spendinga Ongoing Spending Note: This comparison excludes 2017-18 because the state faced a small budget problem—or “deficit”—in January of that year, meaning there is no comparable surplus for 2017-18. 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET This report presents our office’s independent The first section of this report analyzes the assessment of the condition of the state General near-term budget condition under our revenue Fund budget through 2022-23 under the estimates and those of the administration. The Governor’s May Revision proposals. As is our second section analyses how the budget would fare practice at the May Revision, our assessment under our estimates of revenues and expenditures is based on: (1) one set of economic conditions assuming the economy continues to grow. The third (in this outlook, a continued growth scenario), section analyzes the extent to which the Governor’s (2) implementation of the Governor’s policy May Revision proposals prepare the budget for a proposals, and (3) our own estimates of the future future budget problem. costs of state programs. NEAR-TERM BUDGET CONDITION Under Our Estimates, Figure 1 2019-20 Ends With Nearly $1 Billion Higher Surplus. Comparing LAO and DOF Near-Term General Fund Budget Figure 1 compares our office’s Outlooks bottom-line estimates of the (In Millions) budget’s condition to the LAO DOF administration’s estimates. Relative 2018-19 2019-20 2018-19 2019-20 to the Department of Finance Revised Proposed Revised Proposed (DOF), we estimate 2019-20 would Prior-year fund balance $11,213 $6,561 $11,419 $6,224 end with $961 million more in Revenues and transfers 138,388 144,478 138,046 143,839 the Special Fund for Economic Expenditures 143,039 147,048 143,241 147,033 Uncertainties (SFEU). The Ending fund balance $6,561 $3,991 $6,224 $3,031 SFEU—the state’s discretionary Encumbrances $1,385 $1,385 $1,385 $1,385 reserve—represents the difference SFEU balance 5,176 2,606 4,839 1,646 between state spending and DOF = Department of Finance and SFEU = Special Fund for Economic Uncertainties. state resources for a given fiscal year. The key reason our SFEU balance is higher is that our estimates of revenues Figure 2 are somewhat higher than the administration’s estimates. Consequently, under our assessment, Comparing Total Reserve Balances the Legislature has a roughly $22 billion Under LAO and DOF Budget Outlooks surplus available to allocate in 2019-20, rather (In Millions) than the roughly $21 billion surplus under the Reserves at End of 2019-20 LAO DOF administration’s estimates. BSA balance $16,372 $16,515 Total Reserves. Figure 2 compares how the SFEU balance 2,606 1,646 state’s total reserve balances would differ under Safety Net Reserve balance 900 900 the LAO and DOF estimates of revenues (assuming School reserve balance 313 389 all of the Governor’s May Revision proposals are Total Reserves $20,191 $19,450 in place). Total reserve balances under our office’s DOF = Department of Finance; BSA = Budget Stabilization Account; revenue estimates would be about $20.2 billion and SFEU = Special Fund for Economic Uncertainties. at the end of 2019-20, compared to $19.5 billion under the Governor’s estimates. This difference is the net result of four factors: www.lao.ca.gov 3 analysis full gutter 2019-20 BUDGET • Slightly Lower Budget Stabilization estimates, the SFEU balance would be about Account (BSA) Balance. The BSA is the $1 billion higher at the end of 2019-20 than it state’s general purpose constitutional would be under the Governor’s estimates. reserve. Proposition 2 (2014) outlines a • Unchanged Safety Net Reserve. The set of complicated formulas that require 2018-19 budget created the Safety Net minimum deposits into the BSA each year. Reserve to set aside funds for future costs of (The formulas also require the state to pay two programs—California Work Opportunity down a certain amount of eligible debts each and Responsibility to Kids (CalWORKs) and year.) In addition to these required deposits, Medi-Cal—in the event of a recession. The the state is permitted to make additional Governor proposes depositing $700 million optional deposits into the account. Under into this account to bring its total balance to our estimates of revenues—particularly lower $900 million. estimates of capital gains revenues—the BSA • Slightly Lower School Reserve. In addition balance would be nearly $150 million lower at to creating new rules for depositing funds the end of 2019-20 than under the Governor’s into the BSA, Proposition 2 established a revenue estimates. specific statewide school reserve (the Public • Higher SFEU Balance. The state’s other School System Stabilization Account). This primary general purpose reserve account school reserve is governed by a separate is the SFEU. Unlike the BSA, which has set of formulas. Under our estimates of restrictions on withdrawals, the Legislature revenues, the deposit into the school reserve has wide discretion to use the funds in the would be $76 million lower than under the SFEU. As described above, under our revenue administration’s estimates. LONGER-TERM BUDGET CONDITION To evaluate the effect of the administration’s Governor’s May Revision proposals and still have a policy proposals on the state’s fiscal condition couple billions of dollars annually to build additional over the next few years, both our office and the reserves or make additional commitments. These administration produce a multiyear budget outlook surpluses are significantly larger than those in May. Both of these outlooks assume the economy displayed by the administration in its multiyear continues to grow, although we have differences in estimates. The administration’s estimates of the our respective approaches to and conclusions about operating surplus are in the hundreds of millions what that growth could look like. In this section, of dollars. There are two major factors that drive we present our longer-term budget outlook under these differences: (1) our office’s higher estimates our set of economic assumptions and compare our of revenues (particularly in the out years) and (2) our estimates to the administration’s forecast. office’s lower estimates of spending on health and Operating Surpluses Assuming Economic human services programs. Growth. The left side of Figure 3 displays our Surpluses Are Lower Assuming No Sunsets. office’s outlook for the General Fund. The top part Importantly, the left side of Figure 3 includes of each bar shows our projection of the annual the Governor’s proposal to sunset four major BSA deposit. The bottom part of each bar shows categories of program expenditures in 2021 and the annual operating surplus (the amount by 2022. The Governor’s sunset proposals are to: which projected revenues exceed expenditures (1) use Proposition 56 (2016) funding for General or the annual change in the SFEU). This indicates Fund cost increases in Medi-Cal, (2) make the that—under this set of economic assumptions— restoration of In-Home Supportive Services service the state’s budget has the capacity to pay for the hours temporary, (3) make new insurance subsidies 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET temporary, and (4) make new supplemental rate models, this fairly positive economic picture increases for developmental services providers would result in moderate revenue growth over temporary. Absent these sunsets, a structural the period. deficit would emerge under his policy plans and • Lower Growth in General Fund Spending revenue estimates. The right side of Figure 3 on Schools and Community Colleges. shows the budget’s multiyear condition, under our Under the rules of Proposition 98 (1988), the estimates, if the Legislature chose not to implement state must provide a minimum funding level these sunsets. As the figure shows, our estimates to schools and community colleges each of the budget’s condition suggest the state has the year. This minimum level is met through a capacity to implement the Governor’s May Revision combination of General Fund spending and proposals without sun setting these program local property tax revenue. In the past couple expenditures. of years, we have revised our projections Positive General Fund Situation Reflects a of growth for the General Fund share of Number of Factors. This budgetary outlook is the minimum funding level downward. positive. It is the result of three important factors For example, in our May 2017 outlook, and assumptions: we estimated General Fund growth would average 3.6 percent per year over the • Continued Economic and Revenue outlook period. Our May 2018 outlook, we Growth. The budget surpluses displayed in estimated annual growth of 3.4 percent. This Figure 3 rely on a specific economic scenario. May, we estimate General Fund spending That economic scenario assumes U.S. gross on schools and community colleges would domestic product grows at nearly 2 percent grow 2.9 percent over the outlook period. annually over the next five years, wages and This primarily reflects slower projected growth salaries continue to grow above 3 percent in General Fund revenue and faster growth annually, the stock market remains mostly flat, in local property tax revenue compared to and many other conditions persist. Under our Figure 3 Operating Surpluses Under . . .Surpluses Are Lower LAO Economic Growth Scenario. . . Without Proposed Sunsets (In Billions) $6 $6 BSA Deposit BSA Deposit 5 5 Remaining Operating Surplus Remaining Operating Surplus 4 4 3 3 2 2 1 1 2019-20 2020-21 2021-22 2022-23 2019-20 2020-21 2021-22 2022-23 BSA = Budget Stabilization Account. Note: Reflects our office’s estimates of revenues and expenditures under the Governor’s May Revision proposals. www.lao.ca.gov 5 analysis full gutter 2019-20 BUDGET previous outlooks. This slower growth in Hill fires that occurred in November 2018 or school spending contributes to the budget’s the Tubbs wildfire in October 2017. Such an better condition. (Overall growth in funding for occurrence could occur, however, and the schools and community colleges—including associated state costs would be hundreds of local property tax revenues—would be higher millions or even a billion dollars. than 3 percent under our outlook.) • Unexpected Cost Increases. This outlook • Lower Growth in Medi-Cal. The Governor’s provides the Legislature with our best estimate proposed budgets in both January and May of future costs based on currently available reflected significantly lower Medi-Cal costs data. We do not build in an assumption about than had been anticipated by recent budgets unexpected costs. In recent years, however, and administration estimates. Under our unexpected costs have occurred and been outlook, a portion of this baseline adjustment sizable. For example, the 2017-18 budget results in lower ongoing costs to the Medi-Cal reflected a $1.8 billion unexpected cost program. This improves the budget’s multiyear increase in the Medi-Cal program due to condition by hundreds of millions of dollars a one-time retroactive payment of drug relative to our previous estimates. rebates and an administrative error. (That said, the state also sometimes revises LAO Comments costs downward—as the administration did with Medi-Cal costs this year—and such Budget Outlook Continues to Be Positive. downward revisions would result in a budget Our office produces a multiyear assessment of the condition that is better than what we have state’s budget condition twice annually. For several currently displayed.) years, these outlooks have indicated the budget picture is positive and this assessment continues Our Multiyear Outlook Does Not Reflect to hold today. As this analysis has shown, the Intent for Future Augmentations. The operating Governor’s approach to focus new spending surpluses in this section reflect no additional commitments on one-time purposes, rather than budget commitments after 2019-20. That is, ongoing ones, contributes to a budget picture that we assume no additional program or benefit reflects operating surpluses assuming the economy expansions occur after this budget is passed. In continues to grow. That said, the economic picture some cases, however, the Legislature has signaled can change quickly. If the growth of California’s that it intends to make additional programmatic economy slows in the coming years, the budget commitments. For example, the 2018-19 budget picture will be very different from what we have package included statutory intent language stating displayed here. the Legislature’s goal to increase CalWORKs State Faces a Number of Cost Pressures Not grants to ensure participating families’ incomes are Reflected in This Analysis. Our multiyear budget above 50 percent of the federal poverty level by analyses often emphasize the risks the state 2020-21. The Governor also has stated he intends could face in a recession or economic slowdown. to propose further program augmentations. For However, even under the precise economic example, in this budget, the Governor has noted conditions assumed in this outlook, we think the his goal for providing universal preschool to all budget could face unexpected cost increases (and children in California and has proposed funding lower surpluses) than we are currently displaying. to develop a plan to achieve this goal (including There are a number of reasons this could occur, revenue options). Future augmentations (if not fully including: offset by new revenues) would reduce the operating surpluses we display here. • Disaster(s). Our outlook assumes the state Recommend the Legislature Maintain Some faces no major disaster in the coming years, Operating Surplus Capacity for Future Years. such as an earthquake or catastrophic The Governor’s May Revision proposes new wildfire, similar to the Camp, Woolsey, and 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET ongoing spending while treating some existing this case, assuming the sunsets are not enacted. programmatic commitments and cost pressures— Moreover, given the various unexpected cost such as provider payment increases in Medi-Cal increases the state could face in the future, we and developmental services—as temporary. suggest the Legislature build positive operating Given these programs have been priorities of surpluses into its planning estimates. Given these the Legislature in recent years, we do not think considerations, we recommend the Legislature the Legislature should take this approach. In adopt a final budget package with a level of building its multiyear plans and assumptions, ongoing spending that is no higher than currently we recommend the Legislature use estimates of proposed by the Governor (in 2019-20 this level of ongoing spending that reflect the full cost pressures ongoing spending is $3.4 billion—projected to grow associated with the budget’s commitments—in to $4.4 billion—upon full implementation). PREPARING THE BUDGET FOR THE FUTURE Throughout this budget process—as in recent from temporary shortfalls, delaying or mitigating the years—there has been significant discussion about need for the Legislature to make difficult choices, whether the state budget is prepared to weather a including spending reductions and tax increases. In recession. In our previous work (Building Reserves recent years, when significant resources have been to Prepare for a Recession and The 2019-20 available, the Legislature has focused on building Budget: California’s Fiscal Outlook), we estimated more reserves to prepare the budget for the future. the state would need between $20 billion and . . . And Focused New Commitments on $40 billion in reserves to avoid major spending One-Time Purposes. One-time programmatic reductions, tax increases, or cost shifts in a spending also benefits the budget in the event of recession. The Governor has stated that one of the a budget problem. One-time spending has one of primary objectives of his budget is to better prepare the benefits of reserves (it reduces the size of a the state for such a future challenge. To do this, future budget problem) but not the other benefit the administration uses a substantial portion of of reserves (holding money available to spend the expected surplus to pay down state debts and on programs in the future). In recent budgets, liabilities. In February, we offered the Legislature the Legislature has focused new spending alternative debt and liability payment options that commitments on one-time purposes and generally would provide greater General Fund benefits. (More limited the amount of new increases in ongoing information about our alternative options can be spending. found in The 2019-20: Structuring the Budget: Figure 4 (see next page) shows how recent Reserves, Debt and Liabilities.) However, in that budgets have allocated available discretionary report we did not assess whether the Governor’s resources (the “surplus”). In 2016-17, we estimate approach accomplishes this stated objective. In the Legislature had $7.3 billion available for this section, we analyze how well the Governor’s new discretionary spending increases and in budget proposals prepare the budget to weather a 2018-19 nearly $10 billion available. In each of recession. these budgets, the Legislature committed roughly half of the surplus to increasing reserves. These How Recent Budgets Have Prepared budgets also committed a relatively small amount of for Future Challenges new resources to ongoing spending—$300 million Recent Budgets Have Focused on Building and $1.2 billion, respectively. (This comparison Reserves to Prepare for the Future . . . Budget excludes 2017-18 because the state faced a small reserves are monies set aside for future use, like a budget problem—or a deficit—in January of that household’s savings account that is dedicated to year, meaning there is no comparable surplus for emergencies. Reserves help insulate the budget 2017-18.) www.lao.ca.gov 7 analysis full gutter 2019-20 BUDGET Figure 4 How Recent Budgets Have Allocated a Surplus (In Billions) How the 2016-17 Budget Allocated $7.3 Billion How the 2018-19 Budget Allocated $9.9 Billion in Available Discretionary Resources in Available Discretionary Resources $0.7 $1.3 $4.8 $3.8 $2.9 $3.8 Reserves One-Time or Temporary Spending Ongoing Spending Note: This comparison excludes 2017-18 because the state faced a small budget problem—or “deficit”—in January of that year, meaning there is no comparable surplus for 2017-18. The Governor’s New Approach to total balance in the SFEU and optional reserve Preparing the Budget deposits (which includes optional deposits into the BSA, as well as any deposit into the Safety Governor Places a Much Lower Emphasis Net Reserve). Mandatory reserve deposits on Building More Discretionary Reserves . . . (under the rules of Proposition 2), however, We estimate the Governor’s May Revision had a also increase total state reserves. (Generally, significant budget surplus of nearly $21 billion. mandatory reserve deposits are higher when Figure 5 shows how the Governor allocates that revenues estimated for the upcoming fiscal year surplus and compares the proposed allocation are higher.) Figure 6 compares recent budgets’ to recent enacted budgets. As the figure shows, constitutionally required reserve deposits to in both numerical and proportional terms, the the 2019-20 May Revision estimate. As the Governor allocates a much smaller share of figure shows, while the Governor is proposing discretionary resources to reserves than previous significantly less in discretionary reserve deposits budgets enacted. In dollar terms, the Governor for 2019-20 compared to other recent budgets, the proposes much more one-time and ongoing Governor’s budget does include a slightly larger spending. That said, within one-time or temporary mandatory reserve deposit. This is largely because spending, the Governor allocates $9.5 billion to the Governor anticipates more revenues for the paying down state debts (which we discuss in upcoming fiscal year, particularly revenues from greater detail later in this brief). capital gains. . . . But Required Reserve Deposits Instead of Building Discretionary Reserves, Are Somewhat Higher. In Figures 4 and 5, Governor Focuses on Paying Down State discretionary reserves have two components: the Debt. The Governor proposes to pay down state 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Figure 5 Governor Proposes Using Smaller Share of Surplus for Reserves(cid:31)Compared to Recent Enacted Budgets (In Billions) 2019-20 (Proposed) Portion of one-time spending proposed for paying down debts 2018-19 (Enacted) 2016-17 (Enacted) 5 10 15 20 $25 Reserves One-time or Temporary Spendinga Ongoing spending Note: This comparison excludes 2017-18 because the state faced a small budget problem—or “deficit”—in January of that year, meaning there is no comparable surplus for 2017-18. Figure 6 Reserve Deposits in Recently Enacted Budgets (In Billions) $3.0 2018-19 (Enacted) Discretionary Reserve Deposits Mandatory Reserve Deposits 2.5 2019-20 2018-19 2016-17 (Proposed) (Enacted) (Enacted) 2.0 2016-17 2018-19 (Enacted) 2019-20 (Enacted) (Proposed) 1.5 2016-17 (Enacted) 1.0 2019-20 (Proposed) 0.5 Total SFEU Balancea Optional Reserve Deposits BSA Transferb a For 2018-19 and earlier, reflects the planned end of year SFEU balance at the time of budget act. b Reflects the planned BSA transfer for the initial budget year deposit. SFEU = Special Fund for Economic Uncertainties and BSA = Budget Stabilization Account. Note: This comparison excludes 2017-18 because the state faced a small budget problem—or “deficit”—in January of that year, meaning there is no comparable surplus for 2017-18. www.lao.ca.gov 9 analysis full gutter 2019-20 BUDGET debts to improve the budget’s condition (which proposals changed somewhat under the May he refers to as a plan to build budget resilience). Revision, the major proposals are largely In particular, the Governor proposes allocating unchanged. We described these proposals in depth $9.5 billion of available discretionary resources to in our report The 2019-20 Budget: Structuring the repaying state debts. The Governor also allocates Budget: Reserves, Debt and Liabilities. We also $2.2 billion in constitutionally required debt summarize them—and their potential benefits—in payments under the rules of Proposition 2. While the nearby box. Proposition 2 determines the minimum amount that LAO Comments must be spent on debt payments, the measure gives the Legislature flexibility on how to allocate Compared to recent budgets, which have those payments (among eligible uses). Figure 7 focused on building reserves as the primary summarizes how the administration proposes mechanism to prepare the budget for the future, allocating these payments. (In addition to the the Governor emphasizes paying down debts. payments described above, the 2019-20 budget We summarize our assessment of whether these will repay additional billions of dollars in debt, such proposals better prepare the budget for addressing as debt service on bonds, on a mandatory basis. a future budget problem in Figure 8 (see page 12). We do not include these annual, mandatory debt Some of the Governor’s Approach Makes repayments in our description of the Governor’s Sense . . . Some of the proposed debt repayments debt package.) improve the budget’s bottom-line condition and Proposed Debt Package Largely the Same we believe those are good ideas. Most notably, as January. The only new debt proposal in the the proposed supplemental payment to the May Revision is to pay $25 million toward the California Public Employees’ Retirement System University of California Retirement Plan unfunded will reduce the system’s unfunded liability and result liability. While the amount and composition— in significant state savings over time, which has Proposition 2 or discretionary—of other debt benefits for the state budget. (Our recent analysis on this proposal recommended Figure 7 modifications, but we recommend Governor’s Debt and Liability Repayment Proposals in the Legislature approve this payment in its final budget 2019-20 May Revision package.) While the supplemental (In Millions) California State Teachers’ Proposition 2 Retirement System payment for Debt Payments districts’ unfunded liability does Liability Type . . . Liability Owed by . . . Discretionary (Mandatory) not directly lower state costs, Retirement Liabilities reducing schools’ costs could CalPERS State $3,000 — put their budgets in better shape CalSTRS State — $1,117 to withstand future challenges. CalSTRS School districts 2,300 — Given the state’s interest in school OPEB State — 260 UCRP Universities 25 — districts’ financial health, we do not have concerns with this proposal. Budgetary Liabilities Pension deferral State 707 — . . . However, Much of the Payroll deferral State 973 — Governor’s Approach Does Special fund loans State 1,283 — Not Help the Budget Address Weight fee loans State 886 — a Future Problem. Whereas Settle up State 297 390 paying down unfunded pension CalPERS borrowing plan State — 390 liabilities better positions the state Totals $9,471 $2,157 for addressing a future budget OPEB = other post-employment benefits and UCRP = University of California Retirement Plan. problem, other proposals do not 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET have that effect. In particular, repaying special of last resort. Moreover, as described in the fund loans and undoing two budgetary deferrals nearby box, the state’s capacity to borrow from only have benefit if the state anticipates using special funds might be more constrained than their these borrowing mechanisms to address a budget balances would indicate. problem again in the future. This approach could Paying off the state’s remaining settle up to be problematic, however, as special fund borrowing schools also does not help the state address a could result in negative impacts to those programs. future budget problem. Settle-up payments do not While the state has used these practices in past reduce costs in the long term, nor do they create recessions, we believe they should be a measure more cash reserves for the future. Instead, paying Major Features of The Governor’s Debt Package Key Components of the Governor’s Debt Package. The Governor’s debt repayment package has a number of notable features. In particular it includes payments toward: • CalPERS. The California Public Employees’ Retirement System (CalPERS) is the state employee pension system. The state of California has full responsibility for CalPERS’ $59 billion unfunded liability. The Governor proposes paying down an additional $3 billion of this unfunded liability. We estimate the state would save about $90 million annually beginning in 2020-21 as a result. (These savings would grow over time.) • CalSTRS. The California State Teachers’ Retirement System (CalSTRS) is the pension system for California’s teachers. Under state law, the state has responsibility for roughly one-third of CalSTRS’ $104 billion unfunded liability and school districts and community colleges share responsibility for the other two-thirds of the liability. The Governor proposes using $2.3 billion to pay down a share of the districts’ CalSTRS unfunded liability and $1.1 billion to pay down the state’s share of the liability. CalSTRS estimates the districts’ payments would reduce their costs by a total of $6.7 billion over the next three decades— reducing districts’ annual contributions by about 0.4 percent of payroll. Whether or not the state would achieve savings over the next few decades from paying down a portion of the state’s share of the unfunded liability is less certain. • Pension and Payroll Deferrals. To address budgetary shortfalls in the past, the state has made various accounting adjustments to push costs into different fiscal years, providing a significant temporary budgetary benefit. These are called deferrals. The Governor proposes reversing two of the state’s outstanding deferrals: (1) a payroll deferral, in which the state employee payroll for June is dated July 1, and (2) a pension deferral, in which the fourth-quarter payment to CalPERS due at the end of June is paid in early July. The cost to undo these actions is $1.7 billion. • Special Fund Loans. As one of many actions it took in the 2000s to address its budget problems, the state loaned amounts to the General Fund from other state accounts, particularly special funds. The state has been repaying these loans since the end of the Great Recession and the Governor proposes repaying all remaining outstanding special fund loans at a cost of $2.2 billion. (This figure includes “weight fee loans” as a type of special fund loan.) • Settle Up. A settle-up obligation to schools and community colleges is created when their constitutional minimum spending requirement ends up higher than estimated in the enacted budget. The Governor proposes repaying all outstanding settle up in the 2019-20 budget. www.lao.ca.gov 11 analysis full gutter 2019-20 BUDGET Figure 8 Summary of Assessments of Governor’s Debt Package Key Budgetary Advantage for Does This Proposal Allow the State to Governor’s Proposal State or Other Entity Address a Future Budget Problem? Pays down CalPERS unfunded liability Saves state money over the long term Yes—Provides significant budgetary savings. Recommend Legislature approve this payment. Pays down CalSTRS school district Saves districts and UC money over the Somewhat—Could improve districts’ and universities’ and UCRP unfunded liability long term financial health, making these entities better prepared for reductions in General Fund spending. Pays down CalSTRS state unfunded Saves state money over the long term Somewhat—Likely will achieve savings, but has a lower liability chance of doing so over the next few decades compared to CalPERS payment. Undoes budgetary deferrals Improves state budgetary and Yes—Allows state to take action again in the future; accounting practices however, building more reserves would be a more efficient way to achieve the same goal. Repays outstanding special fund loans In some cases, allows fund to expand Somewhat—Might allow state to borrow again, but funds’ services for fee payers future capacity for lending might be more constrained than in the past. Repays outstanding settle up Supports additional school spending No—This action removes the option to provide schools more this year funding during a fiscal downturn. UCRP = University of California Retirement Plan. remaining settle up now reduces the solutions the budget for the future. We also agree that using available to the state to mitigate reductions in a portion of the surplus to address some of the school funding in the event of a fiscal downturn. state’s outstanding debt is prudent. However, we Rather than pay off the remaining settle up this think the state’s plan for responding to a recession year, the state could wait to provide the funding should focus—first and foremost—on building in a year when schools are facing little, or no, budget reserves. Building reserves is the most increase in funding. Taking this approach could reliable and effective method for preparing the enable schools to maintain ongoing programs that budget for a downturn. As such, we recommend otherwise would be reduced. the Legislature dedicate a larger portion of the We Recommend the Legislature Maintain surplus to discretionary reserves, as it has done in Its Recent Practice to Focus on Reserves. We recent budgets. agree with the Governor that the state’s remarkable surplus represents a unique opportunity to prepare 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET How Much of Special Fund Balances Are Available for Borrowing? State Has Repaid Billions of Dollars in Special Fund Loans to the General Fund. During the dot-com bust and Great Recession, the state borrowed from special funds to help address the General Fund’s budget problems. Since the end of the Great Recession, the state has repaid billions of dollars of these special fund loans. In recent years the state also has built significant reserve balances in its special funds—as of the Governor’s budget, the projected balance of special fund reserves was $17 billion at the end of 2019-20. To What Extent Are These Special Fund Balances Borrowable? While special fund reserves in aggregate are significant, not all of this amount is borrowable from a legal perspective or advisable to borrow from a policy perspective. Based on our preliminary analysis, there are several reasons for this: • Some Funds Are Not Legally Borrowable. In recent years, constitutional amendments have prohibited the state from borrowing from most transportation accounts. Major transportation accounts represent over $5 billion of the special funds’ total reserve balance of $17 billion. • Some Funds Have Built Large Balances to Maintain Operations. In some cases, special funds face volatile or declining revenue sources. These funds have built large balances in order to smooth expenditures in future years when revenues may be lower than today. For example, the Healthcare Treatment Fund, with a balance of $300 million, receives revenues from taxes on tobacco products. Because tobacco consumption (and associated revenue) is expected to continue to decline in the coming years, the fund has a significant balance in order to maintain current expenditure levels. • Some Funds Have Been Allocated, but Not Yet Encumbered. The Greenhouse Gas Reduction Fund (GGRF) receives auction revenues from the state’s cap-and-trade program and reflects a fund balance of about $1.3 billion. Under both our and the administration’s estimates of the Governor’s expenditure proposals for the fund, however, GGRF would have an unencumbered balance of less than $100 million available at the end of 2019-20. • Some Funds Faces Structural Deficits. Many funds have positive reserve balances, but nonetheless face structural deficits. For example, as of the Governor’s Budget, the Motor Vehicle Account had a balance of over $300 million, but faces a structural deficit for future years. Likewise, the Immediate and Critical Needs Account (ICNA), which was created to finance the construction of a number of new courts, has a balance of about $300 million, but might not have sufficient resources in the future to fund its originally planned projects. (In fact, a key reason ICNA faces these structural issues is that a significant portion of ICNA resources were transferred to the General Fund during the fiscal downturn.) Borrowing from these funds again is possible, but would further exacerbate their existing budgetary problems. www.lao.ca.gov 13 analysis full gutter 2019-20 BUDGET CONCLUSION The Governor’s January budget proposal and emphasizes paying down debts. We believe some May Revision have reflected a somewhat different of the Governor’s debt package has merit, but approach to fiscal management compared to also note that the state has not yet reached the recently enacted budgets. First, relative to recent lower end of our advised range of reserves. Given budgets, the Governor proposes a higher level the extraordinary level of resources now available, of ongoing spending. Specifically, the Governor we think the Legislature should stay on its current proposes new, ongoing discretionary spending course, continuing to focus on building reserves as of $3.4 billion in 2019-20 (excluding the sunsets the primary mechanism for preparing the budget for described below). This is much higher than recently the future. enacted levels of $300 million and $1.3 billion. The Governor’s budget reflects an extraordinary Coupled with these new ongoing spending surplus of $22 billion, but it is the Legislature’s proposals, the Governor suggests making some constitutional authority to ultimately determine ongoing expenditures temporary in order to the allocation of that surplus in the enacted address a budget problem that would otherwise budget. As the Legislature sets about its final materialize under his administration’s own multiyear budget deliberations, we have the following estimates. Under our estimates of revenues and recommendations. First, we recommend the expenditures, however, these sunsets would not be Legislature adopt a final budget package with a necessary. Given these programs reflect ongoing level of new ongoing spending that is no higher services and have been recent legislative priorities, than the level currently proposed by the Governor. we do not think the Legislature should take this Second, we recommend the Legislature reject the approach. Governor’s plan to make ongoing augmentations Second, the Governor proposes a shift in temporary in order to address the multiyear budget the state’s approach to preparing for the future, condition. Rather, we think the state budget should namely a recession, but also other unforeseen accurately reflect the true ongoing costs associated challenges, such as a natural disaster. While past with its budget year commitments. Finally, we budgets emphasized building more reserves as recommend the Legislature build more reserves the primary means of preparation, the Governor than currently proposed by the Governor. LAO PUBLICATIONS This report was prepared by Ann Hollingshead, with assistance from analysts across the office, and reviewed by Carolyn Chu. 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. 14 LEGISLATIVE ANALYST’S OFFICE