The 2020-21 Budget: California's Fiscal Outlook

Projected Annual Growth for Major Revenue Sources 6% 5 4 3 2 1 Projected Annual Growth 14% 12 10 8 6 4 2 )42-3202 ot 12-0202( yadoT htworG detcejorP The 2020-21 Budget: California’s Fiscal Outlook Payroll Jobs Annual Growth Size of bubble indicates program size Growth Scenario 1% Reserve Deposits Operating Surplus 2021 $4 Billion S&P 500 Index Annual Growth 3,323 2020-21 2021-22 2022-23 2023-24 Wages and Salaries 2021 Annual Growth Recession Scenario 2020-21 2021-22 2022-23 2023-24 4% 2021 Operating Deficit Home Prices Covered by Reserves -$7 Billion Annual Growth 5% 2021 GABRIEL PETEK LEGISLATIVE ANALYST NOVEMBER 20, 2019 analysis full gutter 2020-21 BUDGET LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET Table of Contents Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 CHAPTER 1 Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Updates to the 2019-20 Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 The 2020-21 Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 LAO Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 CHAPTER 2 Economic Growth Scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Baseline Expenditure Scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Alternative Expenditure Scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 General Fund Condition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Recession Scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Economy and Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 General Fund Condition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 LAO Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 www.lao.ca.gov iii analysis full gutter LEGISLATIVE ANALYST’S OFFICE www .lao .ca .gov (916) 445-4656 Legislative Analyst Gabriel Petek State and Local Finance Corrections, Transportation, and Carolyn Chu Environment Chas Alamo Anthony Simbol Justin Garosi Brian Brown Ann Hollingsheada Drew Soderborg Seth Kerstein Ross Brown Lourdes Morales Rachel Ehlers Nick Schroeder Frank Jimenez Angela Short Helen Kerstein Brian Uhler Luke Koushmaro Brian Weatherford Anita Lee Shawn Martin Education Caitlin O’Neil Jennifer Pacella Jessica Peters Edgar Cabral Eunice Roh Jason Constantouros Sara Cortez Health and Human Services Kenneth Kapphahn Mark C . Newton Amy Li Ginni Bella Navarre Lisa Qing Ryan Anderson Ned Resnikoff Jackie Barocio Paul Steenhausen Corey Hashida Ben Johnson Brian Metzker Sonja Petek Ryan Woolsey Administration, Information Services, and Support Sarah Kleinberg Tina McGee Sarah Barkman Terry Gough Sarah Scanlon Michael Greer Vu Chu Jim Stahley Mohammed Mohammed Saeed Anthony Lucero Rima Seiilova-Olson a General Fund Condition analyst, Fiscal Outlook coordinator . iv LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET Executive Summary Does the State Have Enough Resources to Pay for Next Year’s Commitments? The first aim of the Fiscal Outlook is to answer whether the state will have sufficient resources to pay for its existing commitments in the upcoming budget year (in this case, 2020-21) . As has been the case in recent years, the answer to this question is yes . Moreover, we find that the budget has an estimated, additional $7 billion surplus available in 2020-21 . (We use the term “surplus” to mean the amount of revenues that exceeds spending under current law and policy .) In the upcoming budget season, the Legislature will allocate this amount between making new budget commitments (like spending increases or tax reductions), paying down debts, and building more reserves . Does the State Have Capacity to Take on New, Ongoing Commitments? Second, the report addresses what share of the $7 billion surplus in 2020-21 is available to be allocated to ongoing purposes (meaning amounts that occur annually) versus one-time purposes (meaning amounts that are spent or saved only in 2020-21) . To address this question, we look at two different expenditure scenarios . We find the state has: • Ongoing Surplus of $3 Billion Under Baseline Expenditure Scenario. In our baseline expenditure scenario, we find the state has an ongoing surplus of around $3 billion . Importantly, this scenario assumes the federal government approves the managed care organization (MCO) tax and the state faces no major disasters over the next few years . (The MCO tax offsets General Fund costs in Medi-Cal but it requires federal approval .) • Ongoing Surplus Drops Below $1 Billion in Alternative Expenditure Scenario. There are a number of risks to the baseline expenditure scenario—including, for example, that the federal government might not approve the MCO tax . In our alternative expenditure scenario, where this and other similarly plausible events—outside the Legislature’s control—occur, we find the state has an ongoing surplus of less than $1 billion . Consequently, assuming the economy continues to grow, the state has capacity to take on new, ongoing commitments . The extent of that capacity depends on how the Legislature views possible risks to the budget like those in our alternative expenditure scenario . If a Recession Begins, Does the State Have Enough Reserves to Cover Revenue Shortfalls? Finally, the Fiscal Outlook assesses whether the state has enough savings—or budget reserves—to cover revenue shortfalls in a recession . We find that the state now is in good shape to weather a recession typical of the post-World War II era . This shows the significant progress California has made in preparing for a downturn . It does not mean, however, that the state is prepared to weather any possible recession . In fact, many of the nation’s post-war recessions www.lao.ca.gov 1 analysis full gutter were milder than more recent recessions have been . Moreover, a recession of similar economic size but with more significant stock market drops would have much larger impacts on the state budget . Comments and Recommendations Budget Is in Good Condition. California’s budget continues to be in a good position . We estimate the Legislature will have a $7 billion surplus available to allocate in the upcoming budget process, and in addition, will build an $18 .3 billion balance in the state’s rainy day fund by the end of 2020-21 . With more than a decade of economic expansion, coupled with deliberate legislative action to put the budget on better footing, the California budget is in good condition . Suggest Caution in Allocating Available Surplus. We think there are reasons for the Legislature to be cautious in allocating the estimated $7 billion surplus . Given the findings of our alternative expenditure scenario—which reflects possible costs to the budget outside of the Legislature’s control—we recommend the Legislature initially plan to dedicate no more than $1 billion of the estimated $7 billion surplus to ongoing purposes in 2020-21 . Moreover, because there are signals suggesting the potential for weaker economic performance than our outlook currently assumes, we suggest the Legislature allocate a significant portion of the surplus toward building reserves and paying down debt . For the remaining surplus, we recommend the Legislature focus on one-time, flexible commitments that can be changed mid-year if economic conditions change . 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET INTRODUCTION Each year, our office publishes the Fiscal Outlook Near-Term Outlook. “Chapter 1” of this report in anticipation of the upcoming state budget provides our assessment of the budget in the near process . In this report, we aim to answer three term (through 2020-21) . In this chapter, we give our questions for lawmakers: assessment of the current condition of the state’s economy and provide our estimates of the budget’s • Does the budget have enough resources condition under these economic projections . available to fund its current commitments in We find that the Legislature would have a nearly the upcoming fiscal year? In recent years, with $7 billion surplus to allocate in 2020-21 under our an expanding economy and growing revenues, economic and revenue assumptions . However, we the answer to this question has been yes . also have concluded that budgetary risks—from • Over the longer term, does the budget have both economic and other sources—are higher this capacity to take on new commitments, such year compared to the recent past . As such, we as spending increases or tax reductions (and think there are reasons for the Legislature to be if so, how much)? Similarly, in general, our cautious in allocating these funds . recent Fiscal Outlooks have identified some Longer-Term Outlook. “Chapter 2” gives our capacity for new commitments . longer-term outlook (through 2023-24) for the • In the event of a recession, would reserves state budget . In this chapter, we address trends be sufficient to cover revenue shortfalls? in revenues and expenditures over this multiyear Increasingly, we have found the state to be period and give our assessment of the budget’s more prepared as it has increased reserve condition under alternative revenue and expenditure levels . scenarios . We find that, in an economic growth scenario, the state has capacity to cover its Our answers to these questions rely on specific current commitments and is in good shape to assumptions about the future of the state economy, weather a recession typical of the post World War II its revenues, and its expenditures . Consequently, era . Based on this analysis, we recommend the our answers are not definitive, but rather reflect Legislature plan to dedicate a sizable portion of our best guidance to the Legislature based on our the $7 billion surplus toward building more reserves professional assessments . and paying down debts, no more than $1 billion to ongoing commitments, and focus the remainder on one-time flexible commitments that can be changed midyear if needed . www.lao.ca.gov 3 analysis full gutter 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET Chapter 1 This chapter mainly focuses on answering the Next, we describe new budgetary developments for first question posed in the Introduction: “Does the current fiscal year (2019-20) that have occurred the budget have capacity to fund its current since the Legislature passed the budget in June . commitments?” The chapter has three parts . Finally, we show our estimate of the condition of First, we describe the economic assumptions that the 2020-21 budget, including various near-term underpin our revenue projections through 2020-21 . revenue and expenditure trends . ECONOMY Economists Anticipate Continued Growth . . . as drops in stock market and real estate prices The consensus among professional economists or changes in relations with trade partners—can (according to a collection of forecasts compiled by be difficult to foresee . That being said, risk to this Moody’s Analytics) is that the U .S . economy will year’s economic outlook has increased compared continue to grow in the coming years, although to other recent years . Certain economic data at a somewhat slower pace than in recent years . points that previously have been key indicators Based on these expectations, we project continued of the state’s economic health have weakened modestly paced growth of the California economy . in 2019 . Specifically—as discussed in the box California is expected to continue to add jobs, but on page 7—weakening can be seen in data on more slowly than in recent years . After slumping housing markets, trade activity, new car sales, and through much of 2019, California’s housing markets business startup funding . This does not necessarily are expected to rebound somewhat, largely mean a broader economic slowdown is imminent in response to falling mortgage interest rates . in the near term . The Federal Reserve recently Figure 1 (see next page) displays key assumptions took actions to stimulate the economy by reducing of our economic outlook . borrowing costs for consumers and businesses . . . . But Risks of a Slowdown Are Higher These actions could help improve the trajectory of Than Normal. Uncertainty is inherent to every the economy . Nonetheless, there likely is greater economic forecast . The state’s economy is complex risk in the economic outlook for 2020-21 than in and major events that shift the economy—such previous budget cycles . UPDATES TO THE 2019-20 BUDGET This report focuses on the 2020-21 budget, revenue and expenditure developments, this which the Legislature will pass in June of 2020 . section provides an update on the budget situation To assess the condition of the 2020-21 budget, for the current year . however, we first examine budgetary changes for Somewhat Higher Revenues. Relative to the 2018-19 and 2019-20 that have occurred since the budget act, we estimate revenues are $1 .6 billion Legislature passed the 2019-20 Budget Act . As higher across 2018-19 and 2019-20 after of this writing, we are now nearly halfway through accounting for mandatory Budget Stabilization the 2019-20 budget . With new information about Account (BSA) reserve deposits (under the rules of www.lao.ca.gov 5 analysis full gutter Proposition 2 [2014]) . These increased revenues $1 .3 billion more in discretionary General Fund largely are due to higher personal income tax (PIT) resources to allocate . collections . (In addition, our estimates of required Assume That Reauthorization of the Managed BSA deposits are lower than those assumed at the Care Organization (MCO) Tax Provides Nearly budget act due to lower estimates of capital gains $900 Million in General Fund Benefit. After revenues .) Of this amount, roughly $250 million is enacting the 2019-20 budget in June, the required to be spent on schools and community Legislature reauthorized the MCO tax in September . colleges (under the rules of Proposition 98 [1988]) . The MCO tax generates General Fund benefit by On net, these factors mean the Legislature has taxing enrollment in managed care organizations and using that revenue to offset General Fund Figure 1 Projections of Key Economic Variables Annual Growth, Except S&P 500 Index Wages and Salaries Payroll Jobs 8% 4% 6 3 4 2 2 1 2014 2015 2016 2017 2018 2019 2020 2021 2014 2015 2016 2017 2018 2019 2020 2021 Home Prices S&P 500 Index 12% 3,400 3,000 8 2,600 4 2,200 1,800 2014 2015 2016 2017 2018 2019 2020 2021 2014 2015 2016 2017 2018 2019 2020 2021 6 LEGISLATIVE ANALYST’S OFFICE 2020-21 BUDGET costs in Medi-Cal . MCOs are reimbursed—in recently released draft guidance that would disallow large part—for this higher tax liability by both the California’s MCO tax, the proposed tax could still federal and state governments . This mechanism gain approval under the existing regulations . We only works, however, with federal approval . Our expect a federal decision on this matter is likely in outlook assumes the federal government does the coming months . approve the MCO tax, improving the budget’s A Few Programs Are Projected to Exhibit bottom line condition in 2019-20 by an additional Lower Caseload Than Initially Anticipated. Costs nearly $900 million . While the federal government associated with some state programs are driven State Fiscal Health Index We created the State Fiscal Health Index to track the strength of economic conditions relevant to the state’s fiscal health . The index combines ten key data points: home prices, home sales, residential and commercial building permits, the S&P 500 stock market index, venture capital funding, unemployment insurance claims, CalFresh claims, port traffic, and new car sales . The index ranges from 0 (representing the lowest level in the last 25 years) to 100 (representing the highest level in the last 25 years) . Both the level of the index and changes in the index from month to month offer information about the state’s fiscal health . When the index is high, revenues tend to be high compared to historical norms . Similarly, when the index is increasing, state revenues are likely to increase over the next 6 to 12 months . On the flipside, a consistent decline in the index over a few months has typically signaled that the state is entering an extended period of revenue weakness . The figure shows the index through September 2019 . The index remained relatively high in September, above 95 percent of months in our historical record . Although the index remains high, it has declined for six straight months . Declines of this duration and magnitude have not been observed since the last recession . Weakening has occurred in housing, trade activity (port traffic), consumer spending (new car sales), and business startup funding (venture capital) . Most other indicators, while not outright declining, have stagnated . More information about the index, as well as monthly updates, can be found on our California Economy & Taxes blog (https://lao .ca .gov/LAOEconTax) . www.lao.ca.gov 7 snoitcelloC xaT gninilceD analysis full gutter State Fiscal Health Index Index Ranging From 0 (Historical Low) to 100 (Historical High) 100 80 60 40 20 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 analysis full gutter at least in part by caseload (program participants) . and Responsibility to Kids (CalWORKs, cash For these programs, the June budget includes an assistance for low-income families)—together assumption of how many people will participate represent just over $24 billion in General Fund in the coming year . If actual caseload turns out spending in 2019-20 . Across these three programs, to be higher (or lower) than initially anticipated, we estimate that if current trends continue, state costs will be higher (or lower) . Using recent costs would be lower by around $450 million in information from state departments, our Fiscal 2019-20 relative to the June budget assumptions . Outlook examines trends in caseload for various Net Improvement of $2.6 Billion in Budget programs relative to budget assumptions . In the Bottom Line Condition. On net, the factors case of three programs, updated data indicate described in this section (coupled with some other lower annual caseload than the budget anticipated . smaller changes) result in an improved budgetary These programs—Medi-Cal (the state’s Medicaid condition of roughly $2 .6 billion in 2019-20 relative program), Cal Grants (financial aid to certain to what was assumed in the June budget package . eligible students), and California Work Opportunity THE 2020-21 BUDGET This section summarizes our projections of Moderate Growth in General Fund Spending revenue and expenditure trends from 2019-20 to on Schools and Community Colleges. General 2020-21 . We then discuss the budget’s overall Fund spending on schools and community colleges condition in 2020-21 under these estimates . As is determined mainly by a set of constitutional is always the case for all of our estimates in this formulas outlined in Proposition 98 . These formulas chapter, actual conditions could differ significantly establish a minimum funding requirement for from what we show here . K-14 education, commonly known as the minimum guarantee . The state meets the guarantee through Major Revenue and a combination of General Fund and local property Expenditure Trends tax revenue . Under our outlook, the state would allocate about 40 percent of General Fund revenue Continued, but Slower, Growth in General toward meeting the guarantee each year of the Fund Revenues. We are projecting revenues to period . With General Fund tax revenue estimated continue to grow from 2019-20 to 2020-21, but to increase nearly $5 .3 billion from 2019-20 to we expect growth in revenues to slow compared to recent years . Figure 2 Year over year, we expect growth in the state’s three major General LAO Near-Term Revenue Outlook Fund revenue sources—PIT, General Fund (In Millions) corporation tax, and sales and use 2018-19 2019-20 2020-21 tax—to be $5 billion, representing a growth rate of 3 .5 percent . This Personal income tax $99,048 $102,288 $105,902 Sales and use tax 26,127 27,108 27,961 is somewhat slower than growth Corporation tax 13,938 13,550 14,134 from these revenues in other recent Subtotals, “Big Three” Revenues ($139,113) ($142,946) ($147,997) years, largely as a result of slowing Insurance tax $2,721 $2,955 $3,051 growth in the PIT—consistent with Other revenues 2,092 2,159 2,534 our projections of slower growth BSA transfer -3,329 -2,050 -2,137 in the state economy in 2020-21 . Other transfers -1,315 -1,851 -78 Figure 2 shows our near-term Totals, Revenues and Transfers $139,281 $144,158 $151,367 outlook for state revenues . BSA = Budget Stabilization Account. 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET 2020-21, our estimate of required General Fund revenues offset only partially by higher required spending on schools and community colleges spending on schools and community colleges; and correspondingly increases by $2 billion . In the (3) low growth in overall expenditures, resulting nearby box, we provide more information on from roughly $5 billion in one-time programmatic changes in the minimum guarantee and the spending amounts in 2019-20 that do not continue implications for K-14 funding . in 2020-21 . If the federal government did not approve the MCO tax, we estimate the available Overall Budget Condition surplus in 2020-21 would be about $4 billion . We Currently Estimate a Nearly $7 Billion Figure 3 (see next page) shows the General Fund Surplus Will Be Available in 2020-21. Our near-term condition under our assumptions and analysis of trends in revenues and expenditures estimates . suggests that the Legislature will have a nearly BSA Balance Reaches $18.3 Billion in $7 billion General Fund surplus available to 2020-21. The state’s largest reserve account is the allocate in the 2020-21 budget process . (The box BSA . It is governed by the rules of Proposition 2 . on page 10 describes what we mean when we When revenues are growing, the state must use the term “surplus” in the Fiscal Outlook .) This annually set aside funds in the BSA until those surplus largely is the result of a number of factors: deposits reach a threshold of 10 percent of (1) the reauthorization—and assumed approval—of General Fund taxes . In addition to these required the MCO tax; (2) continued moderate growth in deposits, in recent years, the Legislature has School and Community College Spending in 2020-21 Under Near-Term Outlook, Proposition 98 Guarantee Grows $3.4 Billion. Our estimate of the minimum guarantee in 2020-21 is $84 .3 billion, an increase of $3 .4 billion (4 .2 percent) over the revised 2019-20 level (see figure below) . The majority of this increase is attributable to growth in General Fund revenue, with the remainder attributable to growth in local property tax revenue . $2.1 Billion Available After Covering Cost-of-Living Adjustment (COLA) and Reserve Deposit. When the minimum guarantee is growing, the state typically funds a statutory COLA for certain school and community college programs . Providing the COLA (estimated at 1 .79 percent) and adjusting for changes in enrollment would cost $1 .1 billion . Under our outlook, formulas in the California Constitution also would require the state to deposit $350 million into the Proposition 98 (1988) reserve . After accounting for these actions and backing out various one-time costs and savings related to 2019-20, $2 .1 billion would remain for other spending priorities in the upcoming budget . Additional $500 Million Available From One-Time Funds. Separate from the increase in the 2020-21 guarantee, we estimate the state has about $500 million available in one-time funds . These funds result from revisions to 2018-19 and Proposition 98 Minimum Guarantee 2019-20 that require the Grows Steadily Under LAO Outlook Estimates state to provide additional (Dollars in Millions) one-time payments to Change From 2019-20 meet the guarantee 2018-19 2019-20 2020-21 Amount Percent in those years . The Legislature could allocate General Fund $54,617 $55,985 $57,963 $1,978 3.5% these funds for any of its Local property tax 23,723 24,886 26,306 1,420 5.7 one-time K-14 priorities . Total Guarantee $78,340 $80,871 $84,269 $3,398 4.2% www.lao.ca.gov 9 analysis full gutter What Do We Mean by “Surplus” in the Fiscal Outlook? One of the goals of the November Fiscal Outlook is to assess how much capacity the budget has to pay for existing and—potentially—new commitments . To answer this question, we compare our projections of revenues to spending under current law and policy . When projected revenues exceed these baseline expenditures, we use the term surplus to describe the difference . (If, instead, we found spending under current law was higher than projected revenues, we would use the phrase “deficit” or “budget problem” to describe the difference .) This surplus is reflected in the 2020-21 ending balance in the Special Fund for Economic Uncertainties (SFEU), shown in figure 3 . (Balances in other state reserves are not included in the surplus because the Legislature—and State Constitution—have already dedicated those funds to that purpose .) Importantly, this balance does not assume how the Legislature might allocate any surplus among other reserve accounts, new one-time or ongoing program commitments, or tax reductions . Once the Legislature does make these allocations, the SFEU balance will change . deposited funds into the BSA on Figure 3 an optional basis . We estimate that, under our revenue estimates LAO Estimate of Near-Term Budget Condition and current policy, the BSA would General Fund (In Millions) reach $18 .3 billion by the end of 2018-19 2019-20 2020-21 2020-21 (see Figure 3) . Of this Prior-year fund balance $11,155 $7,748 $5,378 total, we estimate $15 .2 billion Revenues and transfers 139,281 144,158 151,367 is the “mandatory” portion, Expenditures 142,688 146,529 148,628 deposited subject to the rules of Ending fund balance $7,748 $5,378 $8,116 Proposition 2, and $3 .1 billion is Encumbrances $1,385 $1,385 $1,385 the “optional” balance, over which SFEU balance $6,363 $3,993 $6,731 the Legislature has more control . Reserves Under our estimates, in 2020-21, BSA $14,136 $16,186 $18,323 the mandatory portion of the SFEU 6,363 3,993 6,731 BSA is very close to reaching the Safety net 900 900 900 10 percent threshold referenced Total Reserves $21,399 $21,079 $25,954 earlier . Note: Amounts in this table reflect current law and policy. SFEU = Special Fund for Economic Uncertainties and BSA = Budget Stabilization Account. LAO COMMENTS Budget Is in Good Condition. Under our is smaller than the surpluses allocated by the two estimates of the condition of the budget for most recent budgets . (For comparison, our office 2020-21, the state has sufficient resources to fund estimated the 2018-19 budget allocated a surplus its current commitments . In fact, these estimates of $10 billion and the 2019-20 budget allocated a suggest the budget has a nearly $7 billion surplus surplus of nearly $22 billion) . In addition, under our for the Legislature to allocate in the upcoming estimates, the state would build an $18 .3 billion budget process . While this is not insignificant, it balance in the BSA by the end of 2020-21 . With 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET more than a decade of economic expansion, information .) A cautious approach to allocating this coupled with deliberate legislative action to put the surplus would be to dedicate most—or all—of it budget on better footing, the California budget is in to reserve deposits and one-time purposes . We good condition . think there are reasons to be more cautious this Suggest Caution in Allocating Surplus. The year . There are signals suggesting the economy Legislature will soon begin deliberating about how could be weaker than our 2020-21 outlook to allocate the state’s surplus between building currently assumes . Moreover, as we will discuss more reserves and one-time and ongoing budgetary in “Chapter 2,” the budget’s capacity for more commitments . Our estimates currently suggest ongoing commitments depends—in large part— there will be a $7 billion surplus available for these on a number of factors that are outside of the purposes . (This amount will change in January with Legislature’s control . the Governor’s budget proposal and more available www.lao.ca.gov 11 analysis full gutter 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET Chapter 2 This chapter focuses on answering two economy and stock market are performing . Yet questions posed in the introduction: “What capacity anticipating the health of the state’s economy (and does the state have to take on new budgetary the level of the stock market) is increasingly difficult commitments?” and “Does the state have sufficient the further into the future we look . Revenues can reserves to weather a recession?” We answer be higher or lower by tens of billions of dollars these questions by assessing the budget’s depending on these factors . This report reflects condition through 2023-24 under economic our best guidance to the Legislature at this time, growth and recession scenarios . We examine two but the state economy and budget could be very economic scenarios because California’s revenue different by 2023-24 than what we have presented performance depends, in large part, on how the here . ECONOMIC GROWTH SCENARIO Assumes Continued, Though Slower, Organization of This Section. In the remainder Economic Growth. In our economic growth of this section we describe: (1) our revenue scenario, we assume job growth continues but estimates under this economic growth scenario, at a somewhat slower pace than in recent years . (2) our baseline expenditure scenario, (3) our Wage growth overall also slows, but remains above alternative expenditure scenario, and (4) the average in some high-wage industries, such as budget’s bottom line condition under these different professional and technical services (for example, estimates . lawyers, engineers, and computer programmers) and in the technology sector (for example, software REVENUES development and data processing) . This scenario assumes a relatively flat stock market . Revenue Growth Averages 3.4 Percent Over the Period. Under our growth scenario, General Two Expenditure Scenarios Displayed in This Fund revenues (excluding constitutionally required Section. Economic changes and their ensuing transfers into the state’s reserves) grow from revenue implications are not the only source of $146 billion in 2019-20 to $167 billion in 2023-24 . uncertainty for the Legislature as it considers the This represents a modest 3 .4 percent average longer-term condition of the state budget . Other annual growth rate over the period . The state’s sources of uncertainty include decisions by the three largest tax revenue sources—the PIT, sales voters and federal government, which could leave and use tax, and corporation tax—collectively the budget in better or worse condition by billions are responsible for the vast majority of the overall of dollars over the multiyear period . To illustrate growth . some of this uncertainty within our economic growth scenario, we show two different expenditure Our Projections of Revenue Growth— scenarios: (1) our typical baseline expenditure Particularly in PIT—Have Declined. Figure 4 projections and (2) an alternative scenario that (see next page) compares our projected growth quantifies some risks to state expenditures outside of the three largest taxes from this outlook to our of the Legislature’s control . projections from the Fiscal Outlook published in November 2017 . (In both cases, the growth rates www.lao.ca.gov 13 reflect our projections for the upcoming budget remain in place . Our expenditure projections also year and two subsequent years .) All three revenue provide adjustments to address the impact of sources in the figure are below the line—meaning inflation with the aim of maintaining the purchasing that we are now projecting those revenues to grow power of current legislative commitments . Finally, more slowly than we did two years ago . Growth this scenario does not include any potential—but in PIT, the state’s largest General Fund revenue unpredictable—events with significant costs to the source, has declined most noticeably . This decline state, such as an extraordinarily bad wildfire season largely reflects our assumptions of lower growth in (similar to ones the state has experienced in recent wages and salaries . However, in November 2017, years) . we reflected stock market growth of 1 percent from Overall General Fund Spending Grows Nearly 2018 through 2022 . We now assume stock market $18 Billion (2.9 Percent) Over the Period. If growth of 3 percent from 2020 to 2024 . current law and policies were to stay in place, we project General Fund spending would increase BASELINE $18 billion from 2019-20 to 2023-24 (representing EXPENDITURE SCENARIO average annual growth of 2 .9 percent) . The largest single contributor to this increase is In the baseline expenditure scenario, we constitutionally required spending on schools and make assumptions typical to our Fiscal Outlook community colleges (under the formulas set forth in historically . In particular, this scenario assumes Proposition 98) . In total, K-14 education accounts that current state and federal laws and policies for $7 .1 billion of the increase . Figure 4 Projected Growth for Major Revenue Sources Has Slowed 6% 5 4 3 more slowly. 1 2 Revenues below the line are expected to grow 1 2 3 4 5 6% Projected Growth in November 2017 (2018-19 to 2021-22) 14 LEGISLATIVE ANALYST’S OFFICE )42-3202 ot 12-0202( yadoT htworG detcejorP analysis full gutter Average Annual Growth Size of bubble indicates relative revenue collections ($10 billion) Sales and Use Tax In 2017, we were projecting revenues from Corporation Tax the sales and use tax would grow by 3 .3 percent annually . We are now projecting slower annual growth of 2 .8 percent . Personal Income Tax (PIT) The PIT is the state's largest revenue source and is projected to grow more slowly with slowing wage and salary growth . 2020-21 BUDGET Our Projections of Annual Spending Growth in 2017, our projections of future annual General Also Have Declined Noticeably. Similar to Fund cost growth have slowed from 4 .6 percent to Figure 4, Figure 5 shows how our projections 3 .4 percent . Comparing our current projections to of growth in major state programs has changed prior projections allows us to identify changes in the in the last two years . Circles below the line have underlying trends in program growth . This allows lower projected growth now relative to 2017 . (The us to isolate different causes of changes in the figure includes programs with more than $2 billion budget’s condition . In this case, slower projected in General Fund expenditures, but excludes those growth in General Fund expenditures means the large programs with increases driven mostly budget’s condition is significantly improved over the by discretionary choices, like the University of multiyear period despite slowing revenue growth . California and the California State University .) As the figure shows, in nearly all cases, our projections ALTERNATIVE of spending growth in these areas has slowed . EXPENDITURE SCENARIO This is not the result of one single trend, but rather a variety of demographic, economic, and policy The alternative expenditure scenario described factors . The box on pages 16 and 17 describes in this section begins with the same estimates these trends in greater detail for each of the areas regarding program cost growth as the baseline shown in the figure . scenario, but makes four different assumptions Slowing Expenditure Growth Improves as described below . Importantly, these four Budget’s Condition. Relative to our estimates assumptions reflect possible costs to the state Figure 5 Projected Growth in Most Large State Programs Has Slowed 14% more quickly. 1 1 0 2 ms above are now projected to grow Progra Health Benefits for Retirees 8 Developmental 6 K-14 Education is the single Services largest General Fund expenditure . Medi-Cal 4 State Employee Pensions 2 Teachers’ Pensions CDCR Bond Debt Service 2 4 6 8 10 12 14% Projected Growth in November 2017 (2018-19 to 2021-22) www.lao.ca.gov 15 )42-3202 ot 12-0202( yadoT htworG detcejorP analysis full gutter Average Annual Growth S ($ i 1 z 0 e b o i f ll i b on u ) bble indicates relative program size more slowly. I f I w t t n a H h o o s r S 2 g e t u e 0 e S r l o d r 1 y w i t 7 s g e h , r a a p b o w r n r y s w o e . w 9 j e b T p % e c o y r t o . p d e 7 j r e a d % o c y j t e t o w e o c d v e g te e r I e d o r H x w t S i h p n S e e s 2 c l n i c 0 g t e o 1 h i x t s 7 t t l t y . s ms below are now projected to grow Progra CDCR = California Department of Corrections and Rehabilitation and IHSS = In-Home Supportive Services . analysis full gutter outside of the Legislature’s control . While this recently released draft regulations, California’s scenario is meant to be illustrative, we believe it is MCO tax would not be approved, although the plausible . state could still get approval before the regulations MCO Tax Not Approved by Federal are finalized . This would mean the state would Government. Our baseline expenditure scenario get some or even all of the General Fund benefit assumes the federal government approves the assumed in our baseline expenditure scenario . MCO tax, as described earlier in “Chapter 1” . Under If the federal government does not approve the tax, however, General Fund Medi-Cal costs would Trends in Projected Cost Growth of Major General Fund Programs School and Community College General Fund Spending Growth Declines Slightly. General Fund spending on schools and community colleges mainly is determined by a set of constitutional formulas established by Proposition 98 (1988) . These formulas have a number of inputs, including changes in General Fund revenue, per capita personal income, and student attendance . Compared to November 2017, our projection of out-year annual General Fund cost growth for schools and community colleges has slowed from 3 .5 percent to 2 .8 percent . This decrease mainly reflects our lower General Fund revenue projections . While these changes might not seem substantial, even relatively small shifts in these growth rates can have noticeable implications for the state budget because K-14 education represents a significant share of General Fund spending . Medi-Cal Growth Declines Somewhat. Our projection of annual growth in costs for Medi-Cal, the state’s Medicaid program, slowed from 7 .5 percent in 2017 to 5 .5 percent today . This largely results from three factors . First, pursuant to federal law, the state’s share of cost for major Medi-Cal populations was scheduled to gradually increase before reaching stable levels 2021-22 . Because the vast majority of this increase in state costs has already taken place, remaining associated cost growth in Medi-Cal is lower going forward . Second, our previous projections did not assume reauthorization of the state’s managed care organization (MCO) tax (consistent with then current law), whereas our current projections do . (As explained in “Chapter 1,” the MCO tax reduces General Fund costs for Medi-Cal .) Third, our previous projections assumed significantly higher Medi-Cal caseload than our current projections, which capture recent downward trends in the caseload . CDCR Cost Growth Has Declined Slightly. Cost growth for the California Department of Corrections and Rehabilitation (CDCR) is primarily the net result of two opposing factors . On the one hand, a decline in the inmate population as a result of sentencing changes is lowering state costs by reducing the number of inmates that must be housed in contract prisons . On the other hand, employee compensation costs are growing as the state has approved new labor agreements that increase CDCR employees’ salaries and other elements of compensation . Bond Debt Service Cost Growth Has Declined Substantially. Our projections of growth in General Fund costs for bond debt service has slowed substantially compared to recent projections . One key reason is that we now are assuming a lower interest rate than we have in the last few years on recently issued debt . Facing a consistently low interest rate environment for many years, the State Treasurer has been able to refinance much of the state’s bond debt . Consequently, much of the state’s outstanding debt now carries a lower interest rate resulting in lower annual costs . 16 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET be higher by nearly $7 billion across the entire significant losses of life and property damage . outlook period . As such, lack of approval of the Our baseline scenario accounts for higher costs tax presents a significant risk to the state’s budget associated with fighting forest fires as the state’s condition . fire season has become longer and more severe . State Faces at Least One Major Natural However, the baseline scenario does not attempt Disaster. In recent years, the state has experienced to predict the occurrence of more major fires, for major wildfires that have caused historically example, ones involving significant destruction of many buildings and other structures . To address Developmental Services Growth Has Declined Somewhat. The Department of Developmental Services (DDS) provides individuals with qualifying developmental disabilities with services to meet their needs . For a few years, a major driver of our projected cost growth for DDS has been scheduled increases in minimum wage under state law, which affect a large segment of direct service providers . Because minimum wage increases are scheduled to slow significantly after 2022, annual cost growth in DDS also slows . In-Home Supportive Services (IHSS) Growth Has Increased Slightly. The IHSS program provides personal care and domestic services to low-income individuals to help them remain safely in their own homes and communities . The increase in average annual growth in state IHSS costs between our 2017 and 2019 estimates is largely attributed to policy changes enacted in the 2019-20 budget . For example, the 2019-20 budget continues to fund a restoration of IHSS service hours, which in 2017 we assumed would end in 2019-20 consistent with state law . Additionally, the 2019-20 budget shifted what we assumed to be county costs in 2017 to the state General Fund . California State Teachers’ Retirement System Growth Has Declined Substantially. We expect slower growth in state costs associated with teachers’ pensions for two reasons . One, compensation grew more slowly than we expected over the past few years, consequently, we lowered our estimate for salary growth . Two, the supplemental payments provided by the 2019-20 budget package reduce what the state is required to pay over the next few years . CalPERS Growth Has Declined Substantially. In our prior forecasts, there were two significant factors resulting in substantial increases to state pension contribution rates: (1) in some recent years, actual investment returns were lower than assumed, and (2) the California Public Employees’ Retirement System (CalPERS) board adopted new actuarial assumptions about future investment returns and mortality rates . Both of these factors increased state costs in the near term . Because these factors have been phased in, increases in CalPERS’ projections of state contributions have slowed . Additionally, the state’s supplemental payments—payments above what is required by CalPERS—approved in recent budgets have lowered the state’s contribution rates from what they otherwise were projected to be . Costs of Health Benefits for Retirees Largely Similar. The amount of money the state pays each year toward retired state employees’ health benefits depends on (1) CalPERS health premiums and (2) the number of people receiving the benefit . Because the year-to-year growth in health premiums and enrollment cannot be easily predicted, we rely on past average growth of premiums and enrollment to project costs in the outlook . Our assumptions of future growth have not changed substantially in the past few years . www.lao.ca.gov 17 analysis full gutter the uncertainty associated with these unforeseen, our alternative scenario assumes the scheduled but plausible, events, this alternative scenario federal reductions do not occur in the multiyear assumes the state faces at least one major natural period, leading to around $200 million per year in disaster—like a significant wildfire—during the additional state costs . outlook period . Alternative Scenario Excludes Risks That Education Bond Approved by Voters. In Involve Legislative Decisions. This alternative September, the Legislature passed a measure to scenario excludes changes in the state budget place a $15 billion education facilities bond on that would require a new law or policy by the the 2020 primary ballot . Our baseline expenditure Legislature . We also exclude higher or lower costs scenario does not include the out-year General resulting from the Legislature addressing the Fund costs to pay debt service on any bond debt current issues faced by the state . For example, this issued under this measure because it still requires alternative scenario excludes any potential changes voter approval . If approved, the bond would in state policy related to the state’s energy grid or result in increased General Fund costs of around PG&E bankruptcy proceedings . $500 million in the last year of our outlook . Federal Government Delays Cut to Hospitals GENERAL FUND CONDITION Serving Higher Shares of Medi-Cal and Surpluses Average Around $3 Billion Under Uninsured Patients. Currently, hospitals that serve Baseline Expenditure Scenario. Figure 6 displays a disproportionate share of Medi-Cal and uninsured our estimates of the budget’s capacity for new patients receive supplemental payments funded commitments, assuming the economy continues from dedicated federal funding that is matched by to grow . As the left side of the figure shows, under state and local funds . Under current federal law, our baseline expenditure scenario, the state has the amount of federal funding for these payments operating surpluses averaging around $3 billion is scheduled to be reduced, triggering reductions over the period . (The nearby box describes what in the required amount of state and local matching we mean by the term “operating surplus” in the funds . Our baseline scenario reflects this current Fiscal Outlook.) The key reason the state has law . However, if Congress delays the federal relatively substantial operating surpluses under this reductions—as it has already done in the recent scenario—despite the fact that projected revenue past—state costs would remain higher . As such, growth has slowed compared to recent outlooks— What Do We Mean by “Operating Surplus” and “Operating Deficit” in the Fiscal Outlook? In contrast to the term “surplus” we described in “Chapter 1” (see page 10), which is the amount available to allocate in the budget year (2020-21), an operating surplus reflects resources available over time . An operating surplus occurs when annual revenues exceed expenditures under current law and policy, resulting in an increase to the Special Fund for Economic Uncertainties (SFEU) . An operating deficit occurs when the reverse is true and annual expenditures exceed revenues, causing a decline in the SFEU . When we show operating surpluses under our economic growth scenario it suggests the budget has capacity to take on new ongoing commitments, such as multiyear program expansions or tax reductions . By contrast, our recession scenarios typically display operating deficits . When an operating deficit appears in a recession scenario, the key test of the budget’s fiscal health is whether the state has sufficient reserves to cover these deficits . If not, the Legislature would need to make difficult choices—such as raising taxes; reducing spending; or shifting costs, for instance, to local governments—to balance the budget . 18 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET Figure 6 Ongoing Surpluses Average . . . But Surpluses Decline to Around $3 Billion Under Economic Less Than $1 Billion Under Alternative Expenditure Scenario Growth Baseline Scenario . . . (In Billions) Operating Surplus BSA Deposit $6 $6 5 5 4 4 3 3 2 2 1 1 2020-21 2021-22 2022-23 2023-24 2020-21a 2021-22 2022-23 2023-24 Key Assumptions Key Assumptions Economy continues to grow . Economy continues to grow . MCO tax is approved by federal government . MCO tax is not approved by federal government . State faces no major disasters . State faces at least one major disaster . a In the alternative growth scenario there is a small operating deficit in 2020-21 . BSA = Budget Stabilization Account and MCO = managed care organization . is that we are also projecting slower expenditure (1) the MCO tax is not approved by the federal growth in a variety of programs (as discussed government, (2) the state faces at least one major earlier) . natural disaster over the multiyear period, (3) the Surpluses Decline Below $1 Billion Under education bond is approved by voters, and (4) the Alternative Expenditure Scenario. The right side federal government delays the cut to hospitals of Figure 6 shows how the budget’s condition serving higher shares of Medi-Cal and uninsured would change under the alternative expenditure patients . As the figure shows, operating surpluses scenario described earlier . This scenario is the would still be positive, but would decline below same as our baseline scenario, but assumes: $1 billion over the multiyear period . RECESSION SCENARIO Scenario Assumes California Enters recession starting in January 2021 . If this occurred, Recession in January 2021. This section the Legislature likely would have passed the examines whether there would be sufficient 2020-21 budget (in June 2020) without realizing a reserves to address revenue shortfalls if the state recession was coming . In this case, the $7 billion experienced a typical post World War II (WWII) surplus anticipated in our growth scenario would www.lao.ca.gov 19 analysis full gutter fail to materialize . Consequently, beginning in not perfect . Recessions with similar job losses and early 2021, the Legislature would be revising GDP declines can have different effects on the the 2020-21 budget and trying to anticipate the state budget depending on their underlying causes emerging shortfall for 2021-22 . and the sectors of the economy that are impacted . Organization of this Section. The remainder For example, our recession scenario generally is of this section describes how such a scenario similar in severity to the early 2000s recession . The would play out over the multiyear period . First, early 2000s recession, however, was especially bad we describe the economic conditions assumed for stock prices, which dropped by about one-half in our recession scenario and our estimates of its compared to about 30 percent in our recession revenue implications . Second, we describe how scenario . Stock price fluctuations have an outsized constitutionally driven expenditure programs would impact on state revenues because a large portion be affected by those revenue changes . Finally, we of PIT is collected from higher-income earners who show the budget’s bottom line condition under tend to earn significant income from these sources . these assumptions . As a result, the early 2000s recession had a greater impact on state revenue than what we show in our recession scenario . ECONOMY AND REVENUES Recession Scenario Represents an Average EXPENDITURES of Post-WWII Recessions. The recession scenario displayed in this section roughly averages the Lower Spending on Schools and Community severity of the historical changes in the economic Colleges Offsets $20 Billion of Revenue Losses. conditions that occurred in the dozen recessions The formulas determining school and community following WWII . (These recessions varied college funding tend to result in lower spending substantially in length and severity .) Our recession when revenues and personal income are declining scenario assumes that the unemployment rate in and higher spending when the opposite is true . In California begins to rise in January 2021, eventually our recession scenario, in which revenues decline, peaking at 8 percent, and begins to decline in the minimum funding level for K-14 education also 2022 . Over the course of the recession, the lowest declines . We assume the Legislature funds schools rate of growth in gross domestic product (GDP) and community colleges at this lower level (as has is -0 .6 percent and the S&P 500 loses about occurred in past recessions) . As a result, General 30 percent of its value, dropping to a low of 2200 . Fund spending on K-14 education declines by a few billions of dollars year over year in 2021-22 . Recession Scenario Results in a Roughly Over the course of the recession, required spending $50 Billion Revenue Loss. Under the recession on schools and community colleges is lower— scenario, revenue growth would slow in 2020-21 relative to the growth scenario—by $20 billion, and then decline year over year by close to offsetting revenue losses by a corresponding $8 billion in 2021-22 . Compared to the economic amount . growth scenario, the total revenue loss would be just over $50 billion over the outlook period . Much Lower Debt and Infrastructure Spending of these reductions would be driven by declines in Requirements Offset Additional $7 Billion of the PIT . Under our assumption that the economy Revenue Losses. Proposition 2 (2014) requires starts to recover in 2022, revenues grow slowly in the state to make annual deposits into reserves, 2022-23 and more robustly in 2023-24 . additional payments toward certain state debts, and—under certain conditions—spend more funds Unique Conditions of Future Recession Will on infrastructure . In the recession scenario, we Result in Different Revenue Implications. In assume the state suspends required deposits into general, more severe recessions have greater fiscal reserves and stops making infrastructure payments implications for the state, but this relationship is (under the Constitution’s budget emergency rules) . 20 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET We also assume the state’s required debt payments colleges at their constitutional minimum level . More decline consistent with the constitutional formulas . explicitly, this means, under our assumptions, As a result, relative to the growth scenario, the General Fund spending on K-14 education declines state’s revenue losses are offset by nearly $7 billion even as the state maintains other programmatic in lower Proposition 2 requirements over the period . spending using reserves . This assumption is consistent with the publication’s aim to show GENERAL FUND CONDITION spending under current law and policies, which generally has been to fund schools and community In the Recession Scenario, Reserves Are colleges at the minimum required funding level . Sufficient to Cover Deficits. Figure 7 displays the If instead the Legislature wanted to mitigate the budget’s condition under our recession scenario . impact on schools and spend above the minimum These estimates assume a number of automatic level, the state’s operating deficits would be program expenditure suspensions are not larger . In this recession scenario, however, there operative . (These suspensions are discussed more would be nearly enough reserves to hold spending later .) The left side of the figure shows the annual on schools and community colleges flat from operating deficits in the recession scenario . (Refer 2020-21 to 2022-23 . In 2023-24, General Fund to the box on page 18 for more information on how spending on schools and community colleges we use the term “operating deficit .”) The right side would begin to grow again under the constitutional of the figure shows how much in total reserves funding formulas . remain at the end of each year in the scenario . As More Reserves Available With Suspensions. the figure shows, the state enters the recession The 2019-20 budget package made a number with nearly $23 billion in reserves and uses most of of ongoing program augmentations subject to the balance to cover billions of dollars of operating suspension on December 31, 2021 if the budget deficits . At the end of 2023-24, the state still could is not projected to collect sufficient revenues to have about $5 billion in reserves remaining . fund them . (These suspensions are described Reserves Would Be Nearly Sufficient to Hold in more detail in the box on page 22 .) Under School and Community College General Fund current law, the suspensions would be operative Spending Flat. In our Fiscal Outlook publications, in our recession scenario, meaning expenditures we assume the state funds schools and community would be lower by nearly $1 billion in 2021-22 Figure 7 Without Significant New Spending, California Could Weather a Typical Post-WWII Recession Scenario Assumes Automatic Program Suspensions Are Not Operative (In Billions) 2020-21 2021-22 2022-23 2023-24 Reserves Remaining $10 $20 -$2 2020-21 -4 2021-22 Portion of reserves -6 2022-23 used to cover Operating Deficit operating deficits . (Covered by Reserves) 2023-24 -8 Amount of reserves remaining -10 at the end of recession scenario . www.lao.ca.gov 21 analysis full gutter 2020-21 BUDGET and nearly $2 billion in 2022-23 . (We assume the be lower than we showed in Figure 7 and the state same language is operative for 2023-24, although would have over $9 billion in reserves remaining at the law does not state this .) Figure 8 shows the the end of 2023-24 . implications for the budget: operating deficits would Figure 8 If Program Suspensions Are Operative, Even More Reserves Would Remain in 2023-24 Scenario Assumes Automatic Program Suspensions Are Operative (In Billions) 2020-21 2021-22 2022-23 2023-24 Reserves Remaining $10 20 -$2 2020-21 -4 2021-22 Portion of reserves -6 2022-23 used to cover operating deficits . Operating Deficit (Covered by Reserves) 2023-24 -8 Even more reserves remain -10 at end of recession scenario if suspensions are not operative . Some Expenditure Amounts Are Subject to Suspension Suspension Language in State Law. The 2019-20 budget package made a number of ongoing expenditures subject to suspension on December 31, 2021 . In these cases, statute directs the Department of Finance (DOF) to calculate whether General Fund revenues will exceed General Fund expenditures—without suspensions—in 2021-22 and 2022-23 . If DOF determines revenues do exceed expenditures, then the programs’ ongoing expenses will continue . If not, expenditures across nearly a dozen different programs are automatically suspended . The cost of not suspending these augmentations is $850 million in 2021-22 (a half-year effect) and $1 .7 billion in 2022-23 . Suspensions Cannot Be Partially Operative Under Current Law. Under the statute, if the budget does not have sufficient resources to pay for all expenditures without suspensions, the suspensions become operative for all affected programs . This means that, even if the budget has the capacity to pay for some of the affected programs, under current law, none of those expenditures would continue . Calculation Excludes Entering Fund Balance. In some cases, the budget might have sufficient resources to pay for the expenditures subject to suspension (without using dedicated reserves), but the suspensions would still be operative . That is because the calculation considers only projected revenues from each individual fiscal year and not resources carried over from prior years (in the entering fund balance) . 22 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET LAO COMMENTS California Is in Good Shape to Weather scenario, the state has $3 billion for new ongoing a Recession Typical of Post-WWII Era. This commitments . Importantly, this scenario assumes report assess whether the budget has sufficient the federal government approves the MCO tax and reserves to cover revenue shortfalls in the event the state faces no major disasters over the next of a typical post-WWII recession . We found the few years . In a plausible alternative expenditure state has sufficient reserves to cover operating scenario, where these conditions do not hold, deficits under such a recession, even assuming the the state has less than $1 billion for new ongoing downturn began midway through the budget year . commitments . This is an important marker of budgetary strength . . . But Recommend Caution in Allocating and shows the significant progress California has Surplus. Given the findings of our alternative made in preparing for a recession . The state now expenditure scenario—which reflects possible is in good shape to weather a recession typical of costs to the budget outside of the Legislature’s the post-WWII era . This does not mean, however, control—we recommend the Legislature initially that the state is prepared to weather any possible plan to dedicate no more than $1 billion of the recession . In fact, many of the nation’s post-WWII estimated $7 billion surplus to ongoing purposes in recessions were milder than more recent recessions 2020-21 . (Later in the budget season, when there have been . Moreover, a recession of similar is additional information about federal and voter economic size but with more significant stock decisions, there could be more ongoing capacity market drops would have much larger impacts on available .) Moreover, because there are signals the state budget . suggesting the potential for weaker economic Economic Growth Scenario Shows State performance than our outlook currently assumes, Has Capacity for New Commitments . . . we suggest the Legislature allocate a significant In “Chapter 1” we estimated that the budget portion of the surplus toward building reserves has $7 billion to allocate in 2020-21, indicative and paying down debt . For the remaining surplus, of a good budget condition . In “Chapter 2,” we we recommend the Legislature focus on one-time, assessed how much of that $7 billion surplus flexible commitments that can be changed midyear would be available for ongoing purposes under two if economic conditions change for the worse . expenditure scenarios . In our baseline expenditure www.lao.ca.gov 23 analysis full gutter 24 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET APPENDIX Appendix Figure 1 LAO November 2019 Revenue Outlook General Fund (In Millions) Growth Scenario 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 Personal income tax $99,048 $102,288 $105,902 $109,378 $112,031 $114,383 Sales and use tax 26,127 27,108 27,961 28,849 29,714 30,414 Corporation tax 13,938 13,550 14,134 14,660 15,292 16,022 Subtotals, “Big Three” Revenues ($139,113) ($142,946) ($147,997) ($152,886) ($157,038) ($160,819) Insurance tax $2,721 $2,955 $3,051 $3,152 $3,251 $3,330 Other revenues 2,092 2,159 2,534 2,601 2,642 2,678 BSA transfer -3,329 -2,050 -2,137 -531 -429 -389 Other transfers -1,315 -1,851 -78 276 288 291 Totals, Revenues and Transfers $139,281 $144,158 $151,367 $158,385 $162,790 $166,730 Recession Scenario 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 Personal income tax $99,048 $102,288 $101,840 $94,139 $95,300 $106,267 Sales and use tax 26,127 27,108 27,805 27,360 27,846 29,657 Corporation tax 13,938 13,550 13,899 13,619 13,089 15,111 Subtotals, “Big Three” Revenues ($139,113) ($142,946) ($143,544) ($135,119) ($136,235) ($151,035) $2,721 Insurance tax $2,955 $3,051 $3,152 $3,251 $3,330 Other revenues 2,092 2,159 2,534 2,601 2,642 2,678 BSA Transfer -3,329 -2,050 -1,641 — — — Other transfers -1,315 -1,851 -78 276 288 291 Totals, Revenues and Transfers $139,281 $144,158 $147,410 $141,148 $142,417 $157,334 BSA = Budget Stabilization Account. www.lao.ca.gov 25 analysis full gutter Appendix Figure 2 Spending Through 2020‑21 LAO Baseline Expenditure Estimates (In Millions) Estimates Outlook Change From 2018‑19 2019‑20 2020‑21 2019‑20 Major Education Programs Schools and community collegesa $54,617 $55,985 $57,963 3.5% University of California 3,743 3,938 3,955 0.4 California State University 3,811 4,302 4,188 -2.7 Financial aid 1,198 1,602 1,535 -4.2 Child care 1,370 2,042 1,997 -2.2 Major Health and Human Services Programs Medi-Cal $19,680 $22,015 $23,532 6.9% Department of Developmental Services 4,487 5,031 5,561 10.5 In-Home Supportive Services 3,777 4,493 5,116 13.9 SSI/SSP 2,760 2,733 2,730 -0.1 Department of State Hospitals 1,727 1,770 1,808 2.1 CalWORKs 298 453 577 27.4 Major Criminal Justice Programs Corrections and Rehabilitation $11,821 $12,223 $12,147 -0.6% Judiciary 1,928 2,161 2,183 1.0 Debt service on state bonds $5,358 $5,313 $5,742 8.1 Other programs $26,111 $22,466 $19,593 ‑12.8 Totals $142,688 $146,529 $148,628 1.4% a Reflects the General Fund component of the Proposition 98 minimum guarantee. SSI/SSP = Supplemental Security Income/State Supplementary Payment. 26 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET Appendix Figure 3 Spending by Major Area Through 2023-24 LAO Growth Scenario, Baseline Expenditure Estimates (In Millions) Estimates Outlook Average Annual 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 Growtha Education Programs Schools and community collegesb $54.6 $56.0 $58.0 $59.9 $61.5 $63.1 3.0% Other major education programs 10.1 11.9 11.7 12.4 13.0 13.7 3.5 Health and Human Services 32.7 36.5 39.3 40.9 43.1 46.0 6.0 Criminal Justice 13.7 14.4 14.3 14.4 14.6 14.9 0.8 Debt service on state bonds 5.4 5.3 5.7 6.0 5.7 5.8 2.4 Other programs 26.1 22.5 19.6 21.8 21.1 21.0 -1.6 Totals $142.7 $146.5 $148.6 $155.3 $159.1 $164.5 2.9% Percent Change 2.7% 1.4% 4.5% 2.4% 3.4% a From 2019-20 to 2023-24. b Reflects 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 27 analysis full gutter 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