The 2020-21 Budget: Initial Comments on the Governor’s May Revision

The 2020-21 Budget: Initial Comments on the Governor’s May Revision GABRIEL PETEK LEGISLATIVE ANALYST May 2020 analysis full gutter 2020-21 BUDGET LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET Executive Summary Administration Estimates State Faces $54.3 Billion Budget Problem. The administration’s estimate of the budget problem is the result of a combination of factors. Most notably, it anticipates revenues will be lower across 2018-19, 2019-20, and 2020-21 by $41 billion. The administration also anticipates the budget will face higher costs in direct response to the coronavirus disease 2019 (COVID-19) public health emergency and indirect costs in light of worsening economic conditions. Budget Assumes $8.6 Billion in Direct COVID-19 Related Expenditures. State costs to respond to COVID-19 span a number of program areas, including education, public health, homelessness, and corrections. One of the largest areas of proposed expenditures is a $2.9 billion COVID-19 contingency fund that would be available to the administration to respond to the public health crisis. How Does the Administration Solve the Budget Problem? The Governor makes a number of proposed solutions across a wide range of areas to solve the budget problem. These solutions are summarized in the figure below. Of these solutions, roughly $15 billion would be unwound if sufficient federal assistance were provided. How the Governor Proposes Solving a $54.3 Billion Budget Problem (In Billions) Total Budget Problem—$54.3 Billion $0 Use Federal Funding -10 Shift Costs -20 Reduce Spending -30 Adjust K-14 -40 Education Spending Increase Revenues -50 Use Reserves Make Baseline Adjustments -60 www.lao.ca.gov 1 analysis full gutter 2020-21 BUDGET With Mitigating Actions, 2020-21 School Funding Is Similar to 2019-20 Levels. One of the program areas that the Governor uses to solve the budget problem is reducing General Fund spending on schools and community colleges to the minimum level required under the State Constitution. This action provides a budget solution of $15.2 billion. However, the Governor also proposes a number of mitigating actions—like payment deferrals and federal funding—that offset the effect of this reduction on school funding. After accounting for these mitigating actions, K-12 funding is about flat on a year-over-year basis. In addition, the Governor proposes creating a new ongoing obligation for schools equal to 1.5 percent of General Fund revenues starting in 2021-22. LAO Comments. We conclude this report with our initial comments on this budget package. Our comments fall into a few different areas. • Budget Solutions. The Governor takes a reasonably balanced approach in his proposed solutions without relying excessively on any one type of solution. While the Governor proposes some targeted spending reductions, others—like 10 percent reductions to universities and state employee compensation—are less targeted. We recommend the Legislature take a more surgical approach where possible. • Multiyear Budget Condition. Although the state now faces a sizeable multiyear budget deficit, the Governor makes a serious effort to address this challenge. However, the Governor’s multiyear plan has some weaknesses. First, the proposal to create a significant, new ongoing obligation to schools contributes to the state’s multiyear operating deficit and limits future legislative flexibility. Second, some of the Governor’s cost shift proposals— specifically those on pensions—shift costs to future years and, in one case, could set a dangerous precedent. • Federal Assistance. Along with the Governor, legislative leaders have already been pursuing new federal assistance, which is warranted. We suggest leaders request that such assistance be made flexible. However, even if new, flexible federal aid materializes, significant budget problems likely would reemerge in a few years. If the state receives significant federal aid, we would suggest the Legislature reconsider the structure of the budget in its entirety. • Legislative Authority and Oversight. In a number of areas across the budget, the Governor makes proposals that raise serious concerns about the Legislature’s role in future decisions. We are very troubled by the degree of authority that the administration is requesting that lawmakers delegate. We urge the Legislature to resolutely guard its constitutional role and authority. 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET On May 14, 2020, Governor Newsom presented the plan in more detail and provide additional a revised state budget proposal to the Legislature. comments in hearing testimony and online.) We (This annual proposed revised budget is called the begin with an overview of the overall budget “May Revision.”) In stark contrast to the January condition under the May Revision estimates and budget proposal—which anticipated the state proposals. Then we describe the major actions the would have a surplus to allocate for 2020-21— Governor took to close an estimated $54 billion the public health emergency associated with the budget gap. We conclude with our initial comments coronavirus disease 2019 (COVID-19) pandemic on this budget package. and ensuing severe economic consequences have The information presented in this report is based resulted in profoundly negative conditions for the on our best understanding of administration actions upcoming budget. as of Saturday, May 16, 2020. In many areas of the In this report, we provide a summary of the budget, our understanding of the administration’s Governor’s revised budget, focusing on the state’s proposals will continue to evolve as we receive General Fund—the budget’s main operating more information. account. (In the coming days, we will analyze OVERVIEW OF BUDGET CONDITION The Budget Problem that the May Revision proposes additional direct COVID-19 related spending in two categories: Administration Estimates State Faces $54.3 Billion Budget Problem. The administration • Additional Direct Response Expenditures estimates the state faces a budget problem of of $3.5 Billion. We understand that the $54.3 billion relative to their January estimates. administration proposes an additional This is the result of a combination of factors. $3.5 billion in direct COVID-19-related Most notably, it anticipates revenues will be lower expenditures. We have not yet received across the budget window by $41 billion. The information about how the administration administration also anticipates the budget will would spend this funding or which state face higher costs in both direct response to the departments would receive it. COVID-19 public health emergency and indirect • Unallocated COVID-19-Related response as caseload-driven program costs are Contingency Fund of $2.9 Billion. higher in light of worsening economic conditions. The administration also proposes the We describe these costs in more detail in the Legislature set aside $2.9 billion in a remainder of this section. (Earlier this month, our fund that the Governor could access for office estimated the budget problem would range future COVID-19-related expenses. The between $18 billion and $31 billion depending administration has proposed using control on the severity of the economic recession. For section language to expend these funds for more information about how the budget situation any purpose related to the COVID-19 state of has changed since January see our LAO Spring emergency with a 72-hour notification to the Outlook.) Joint Legislative Budget Committee. $8.6 Billion in Direct COVID-19-Related In total, under the May Revision, the state would Expenditures. State costs to respond to COVID-19 spend $8.6 billion on direct COVID-19-related span a number of program areas, including expenditures, as Figure 1 (see next page) shows. education, public health, homelessness, and Importantly, the administration assumes that the corrections. In addition to the roughly $2 billion in federal government ultimately will reimburse the existing COVID-19-related expenditures the state state for an estimated 75 percent of these costs has already incurred, we currently understand www.lao.ca.gov 3 analysis full gutter 2020-21 BUDGET under the federal disaster declarations—meaning Figure 1 the net cost to the state would be $2.1 billion. Direct COVID-19 Related Funding in the (These reimbursements are reflected in the May Revision administration’s revenue estimates.) (In Billions) Higher Costs Related to Caseload in Safety Net Programs. The administration anticipates Amount caseload-related costs across the state’s safety Funding Already Expended net programs—including Medi-Cal, California Work Authorized under Control Section 36 $0.8 Opportunity and Responsibility to Kids (CalWORKs), Authorized under DREOA 1.4 and CalFresh—to increase significantly. While we Funding Proposed in the May Revision are still working to understand the administration’s Direct responses expenditures (2019-20) $2.1 estimates for these programs, they include a Direct response expenditures (2020-21) 1.4 9.2 percent year-over-year increase in Medi-Cal COVID-19 contingency fund 2.9 enrollees, 51.1 percent increase in CalFresh Total $8.6 participation, and an unprecedented 75.6 percent COVID-19 = coronoavirus disease 2019 and DREOA = Disaster increase in CalWORKs participating families. Response-Emergency Operations Account. General Fund Condition Figure 2 After Solutions, General Fund Would Have a Nearly $2 Billion Ending Balance. The Governor General Fund Condition proposes $54.3 billion in solutions—which we Under Governor’s May Revision describe in the next section—to balance the General Fund (In Millions) budget. After solutions, the General Fund would 2019-20 2020-21 end 2020-21 with an estimated $1.9 billion ending Prior-year fund balance $11,280 $1,619 balance, shown as the Special Fund for Economic Revenues and transfers 136,837 137,417 Uncertainties (SFEU) balance in Figure 2. (The Expenditures 146,497 133,902 enacted balance of the SFEU for the budget year Ending fund balance $1,619 $5,135 cannot be below zero. This reserve generally is Encumbrances 3,175 3,175 used for the state to respond to disasters, such as SFEU balance -$1,556 $1,960 a fire, and provides a small buffer against some of Reserves the uncertainty inherent in budget estimates.) BSA balance $16,156 $8,350 Administration’s Multiyear Budget Condition SFEU —a 1,960 Reflects Continued Structural Deficit. In our Safety Net Reserve 900 450 Spring Fiscal Outlook, we noted that the state’s Totals $17,056 $10,760 a newly emergent fiscal challenges are unlikely to Negative SFEU excluded from total reserves balance. dissipate quickly and will extend well beyond the SFEU = Special Fund for Economic Uncertainties and BSA = Budget Stabilization Account. end of the public health crisis. This also is true in the administration’s multiyear budget projections, even after accounting for solutions proposed this year. Under its projections, the state would face a relatively small budget problem of around $5 billion in 2021-22, growing to around $16 billion by 2023-24. 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET HOW DOES THE ADMINISTRATION SOLVE THE BUDGET PROBLEM? Figure 3 summarizes the budget solutions that Solutions Include $15 Billion Subject to this section describes in detail. Specifically, to Federal “Triggers.” The administration proposes solve the budget problem the Governor: (1) makes making nearly $15 billion in one-time and ongoing baseline adjustments, which do not involve choices spending reductions subject to federal “trigger” about changes to current law (12 percent); (2) uses language. Figure 4 (see next page) shows more reserves (15 percent); (3) increases revenues detail on the Governor’s proposed solutions, (8 percent); (4) adjusts K-14 education spending including those subject to the federal trigger. (Our (28 percent); (5) reduces spending (19 percent); estimate of the amount subject to the triggers (6) shifts costs (11 percent); and (7) uses federal differs from the administration’s figure somewhat funds (7 percent). (Our categorization of these because the administration’s total excludes one amounts is somewhat different than how the loan-related item that is also contingent on the administration organized them.) Of the total, the triggers.) Under the trigger language, if the federal administration proposes $15 billion in ongoing government passes legislation that provides solutions (of this $8.1 billion are Proposition 98 at least $14 billion in funding to the state, the General Fund). The ongoing solutions are entirely administration would have authority to temporarily spending-related. restore all of the programs that were reduced. We Figure 3 How the Governor Proposes Solving a $54.3 Billion Budget Problem (In Billions) Total Budget Problem—$54.3 Billion $0 Use Federal Funding -10 Shift Costs -20 Reduce Spending -30 Adjust K-14 -40 Education Spending Increase Revenues -50 Use Reserves Make Baseline Adjustments -60 www.lao.ca.gov 5 analysis full gutter 2020-21 BUDGET discuss the spending reductions subject to this government’s share of cost for state Medicaid provision in more detail below. programs until the end of the national public health emergency declaration. We estimate the MAKE BASELINE ADJUSTMENTS administration’s assumptions result in General Fund savings of $5.5 billion across three programs: There are two “baseline” adjustments to the Medi-Cal, IHSS, and some developmental services Governor’s projection of the budget deficit. These programs. Of this, the administration scores are adjustments that do not require changes to $4.3 billion as budget solutions (the remainder current law to implement. offsets the budget problem in their baseline Receive $4.3 Billion in Federal Funding for calculations). Medicaid Programs. Congress recently approved Remove or Modify $2.1 Billion in January a temporary 6.2 percent increase in the federal Proposals. The Governor’s proposed January Figure 4 How the Administration Proposes Solving a $54.3 Billion Budget Problem (In Billions) Subject to Trigger Not Subject to Trigger Totals Make Baseline Adjustments Account for higher federal Medicaid funding — $4.3 $4.3 Remove or modify January proposals — 2.1 2.1 Use Reserves Make BSA withdrawal — 7.8 7.8 Make Safety Net Reserve withdrawal — 0.5 0.5 Increase Revenues Suspend net operating losses — 1.8 1.8 Limit business incentive tax credits — 2.0 2.0 Interaction between the two above items — 0.6 0.6 Adjust K-14 Education Spending Provide funding at the minimum guarantee $8.1 7.1 15.2 Reduce Spending Make flat 10 percent reductions 3.6 1.4 4.9 Make targeted reductions 2.3 3.2 5.6 Shift Costs Make special fund loans 0.9 2.0 2.9 Shift pension costs — 1.7 1.7 Convert capital financing to lease revenue bonds — 0.8 0.8 Transfer special fund balances — 0.4 0.4 Use Federal Funding Use Coronavirus Relief Fund — 3.8 3.8 Use CCDBG funds 0.1 0.1 Totals $14.9 $39.4 $54.3 BSA = Budget Stabilization Account and CCDBG = Child Care and Development Block Grant. 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET budget estimated the state would have a moderate in a year, it generates a NOL equal to the surplus for 2020-21, which the Governor proposed amount by which their expenses exceed allocating to a variety of new spending proposals. their revenues. The corporation can then The Governor withdraws or modifies most of these deduct the NOL from its taxable income in proposals, reducing the budget problem. Based on subsequent years, reducing their taxes in information the administration provided to us, we those years. estimate the associated savings of withdrawing or • Limit Business Tax Credits. Businesses may modifying these proposals is $2.1 billion, including not claim more than $5 million in tax credits roughly $900 million in ongoing savings. per year in 2020, 2021, and 2022. Tax credits reduce a business’s tax bill directly, on a USES RESERVES dollar-for-dollar basis. The largest business tax credit is the research and development Administration Proposes Withdrawing credit. $8.3 Billion in Reserves. The state’s largest general purpose reserve is the Budget In addition, the administration proposes two Stabilization Account (BSA), which is governed by actions to increase sales tax compliance on used constitutional rules under Proposition 2 (2014). car purchases; however, they do not count these as The state also has the Safety Net Reserve, which budget solutions. was created to provide additional reserves for certain caseload-driven programs. Under the ADJUSTS SCHOOL AND administration’s estimates, the state would begin COMMUNITY COLLEGE SPENDING the 2020-21 fiscal year with $17.1 billion across these two reserve accounts. The administration Budget Year proposes using roughly half of that total to address the budget problem in 2020-21. Reduces General Fund Spending to Minimum $10.7 Billion in Reserves Would Remain at Level. Proposition 98 (1988) determines the the End of 2020-21. Under the administration’s minimum amount the state must spend on schools estimates and proposals, the state would end and community colleges each year through a 2020-21 with $10.7 billion in reserves. This combination of General Fund and local property includes a balance of nearly $2 billion in the SFEU. tax revenue. The Governor’s estimates of General The administration has a multiyear plan to use Fund revenue are down significantly over the the remaining BSA and Safety Net reserves over 2018-19 through 2020-21 period, resulting in a three years—using about $6 billion in 2021-22 and drop to the minimum funding level for schools $3 billion in 2022-23. and community colleges. The Governor proposes to reduce funding to the lower level, resulting INCREASES REVENUES in General Fund savings of $16.5 billion. (The administration classifies about $15.2 billion of Increases Revenues by $4.4 Billion From this total as “budget solution” related with the Taxes on Businesses. The Governor’s budget remaining difference largely the result of technical solutions in the May Revision include two actions adjustments.) Local property tax revenues also that the administration estimates would increase drop by roughly $1 billion, resulting in a total tax revenues by $4.4 billion in 2020-21. They are: Proposition 98 decrease of $17.5 billion. With Mitigating Actions, 2020-21 School • Suspend Net Operating Loss Deductions. Funding Is Similar to 2019-20 Levels. To bring Corporations that have net income over state spending down to the minimum guarantee, $1 million would not be allowed to use net the May Revision includes $6 billion in reductions operating loss (NOL) deductions to reduce to existing K-12 education programs (subject to their taxes in 2020, 2021, or 2022. When a the trigger reductions) and $5.3 billion in payment corporation’s expenses exceed its revenue www.lao.ca.gov 7 analysis full gutter 2020-21 BUDGET deferrals. (When the state defers payments to trigger reductions) and $662 million in payment schools from one fiscal year to the next, the deferrals, with the remainder largely associated state can reduce spending while allowing school with rescinding January proposals. (Typically a districts to continue operating a larger program payment deferral does not impact programs.) In by borrowing or using cash reserves.) Most of the contrast to schools, federal relief funding allotted remainder is associated with rescinding January for community colleges is not a significant source proposals. The proposed programmatic reductions of aid to offset state funding reductions for the also are mitigated by $5.8 billion in one-time federal colleges. Even with some mitigating actions funding for schools in 2020-21. This amount (including the budget relief mentioned below), includes $4.4 billion for districts to implement college funding per student still declines from strategies to mitigate the effects of learning loss 2019-20 to 2020-21. during school closures. The net fiscal effect of Governor Also Proposes Supplanting Pension these proposed actions is shown in Figure 5. When Payments for Schools and Community Colleges. accounting for these additional measures, K-12 The 2019-20 budget included two supplemental funding is about flat on a year-over-year basis, pension payments—one to the California State with federal funds and payment deferrals offsetting Teachers’ Retirement System (CalSTRS) and one the reduction in Proposition 98 funding. (If the to the California Public Employees Retirement reductions are triggered off, overall funding would System (CalPERS)—that would reduce district increase on a year-over-year basis.) pension contribution rates over the next few Community College Funding Set to Decline decades. Although subject to some uncertainty Despite Mitigating Actions. Of the $17.5 billion these payments could have yielded savings of more drop in the minimum guarantee, about $2 billion is than $5 billion over the next few decades for school attributable to the community colleges. The May districts and more than $0.5 billion for community Revision addresses this drop with $1 billion in cuts colleges. The Governor proposes repurposing to community college programs (subject to the these payments to supplant school and community Figure 5 Deferred Payments and Federal Funds Offset Reductions in K-12 Funding Funding for K-12 Schools (In Billions) $80 70 60 50 40 Other Fundsa 30 Deferred Payments 20 Federal Relief Funds Proposition 98 Funds 10 2019-20 Enacted 2019-20 May Revision 2020-21 May Revision a Consists of settle-up payments and one-time fund swaps. 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET college contributions to CalSTRS and CalPERS for increase and then makes a 10 percent reduction. 2020-21 and 2021-22. This would result in savings (In this case, the former is not part of the “trigger” of around $2.1 billion for school districts and reduction, but the latter is.) Second, the Governor $0.2 billion for community colleges in 2020-21 and proposes flat rate cuts for the Department of 2021-22, but would forgo the remaining savings Developmental Services and child care. Third, over the next few decades. the Governor anticipates savings of $900 million in 2020-21 across a variety of departments from Multiyear unspecified efficiencies. Overall, these reductions Creates Supplemental Obligation to Increase result in $4.9 billion in savings (of which $3.6 billion School and Community College Funding. The is subject to the triggers). May Revision proposes to create a new multiyear Proposes Targeted Reductions Totaling payment obligation to supplement the funding $5.6 Billion. In program areas across the rest schools and community colleges receive under of the budget, the Governor proposes making Proposition 98. The total obligation would be targeted reductions to certain programs or benefit $13 billion—the administration’s estimate of the levels. For example, the Governor proposes additional funding schools and community colleges reverting a number of augmentations planned would have received if their Proposition 98 funding in 2019-20, such as $200 million for the infill had continued to grow in 2019-20 and 2020-21. infrastructure development grant program for The state would make annual payments toward housing and $300 million for kindergarten facilities this obligation beginning in 2021-22. The payments grants. Overall, these targeted reductions result would equal 1.5 percent of General Fund revenue in $5.6 billion in savings (of which $2.3 billion is and could be allocated for any school or community subject to the triggers). college program. The May Revision also proposes to recalibrate the Proposition 98 formulas so that SHIFTS COSTS a portion of these supplemental payments would increase school and community college funding Makes $3.3 Billion in Special Fund Loans and on a permanent basis. Specifically, the state Transfers. In past recessions, the state made loans would increase the share of General Fund revenue from other state accounts, known as special funds, required to be spent on schools and community to the General Fund to address budget problems. colleges from 38 percent to 40 percent. (We The administration proposes making $2 billion in estimate that this recalibration would make roughly loans from 57 separate special funds to the General the first $2.5 billion of the supplemental payments Fund. Over 90 percent of these loans are less than permanent.) $100 million. The administration also proposes control section language that would lend special fund savings from lower employee compensation in REDUCES SPENDING 2020-21 to the General Fund. The administration Proposes Flat Reductions Resulting in estimates this would yield about $1 billion in loans. $4.9 Billion in Lower Spending. The Governor (We count these as a trigger reduction because proposes a number of flat reductions across the employee compensation reductions are tied to programs or rates in a few different areas. First, in the triggers.) Finally, the administration proposes three program areas—universities, judicial branch, transferring about $400 million in special fund and employee compensation—the Governor balances to the General Fund—amounts that would proposes making a flat, 10 percent reduction. (The not be repaid. Governor also proposes similar reductions in other Shifts $1.7 Billion in Pension-Related Costs. areas of the budget, but the associated savings are The Governor makes a few pension-related smaller.) For example, for General Fund support to proposals that shift costs. First, the both university systems, the Governor withdraws 2019-20 budget made a supplemental pension his January proposal to provide a 5 percent base payment of $2.5 billion to CalPERS. The state www.lao.ca.gov 9 analysis full gutter 2020-21 BUDGET would have realized savings over the next few costs of these projects and then repay those bonds decades, eventually resulting in an estimated gross with interest over time. This results in savings of savings of $5.9 billion. The Governor proposes roughly $800 million in 2020-21, but higher debt repurposing this supplemental payment to supplant service costs over time. state General Fund contributions to CalPERS this year. This would result in savings of $2.4 billion, USES FEDERAL FUNDS which the administration scores over multiple years including 2021-22. However, it means the Coronavirus Relief Fund (CRF) Provides state would forgo the remaining savings over Funding for COVID-19-Related Expenditures. the next few decades. Second, the Governor Congress recently established the CRF to provide proposes suspending CalSTRS’ ability to increase money to state, local, tribal, and territorial the state’s contribution rate from 2020-21 to governments for “necessary expenditures 2023-24. Currently, CalSTRS can only increase (or incurred due to the public health emergency with decrease) the state’s rate by 0.5 percent per year respect to the Coronavirus Disease 2019” that (equivalent to $169 million in 2020-21). Instead, are incurred between March 1 and December 30, the administration proposes to provide offsetting 2020. California’s state government is eligible for payments using other required debt payments. $9.5 billion from the CRF. Guidance from the U.S. Finally, the administration proposes eliminating a Department of the Treasury outlines the eligible $265 million supplemental payment to CalPERS uses of these funds. planned for 2020-21 under current law and shifting Administration Proposes Using $3.8 Billion a $243 million pension payment to Proposition 2 in CRF to Address Budget Problem. The debt payments. May Revision assumes the state can use Shifts Roughly $800 million in Costs to Lease $3.8 billion of the total CRF funding to offset Revenue Bonds (LRBs). Recent budgets have underlying state costs. This includes $2.6 billion set aside General Fund monies to pay for some to address increased CalWORKs caseload from capital outlay projects. For example, the state March 1 to December 30, 2020, $750 million for has set aside nearly $1 billion in the State Project homelessness, and $405 million in other areas such Infrastructure Fund for the renovation of the State as public safety and public health. (We currently Capitol Annex and the construction of a new office have very little information about what is included building near the State Capitol. The Governor in the final category.) The administration proposes proposes converting this and other projects to LRB to remit the remaining CRF funds to schools financing. Under this proposal, the state would ($4 billion), counties ($1.3 billion), and cities borrow from the bond market to pay the upfront ($450 million). LAO COMMENTS Budget Solutions asserting its own priorities, as it constructs the state’s budget. Mix of Solutions Reasonably Well-Balanced. Proposed Revenue Solutions Are a In our Spring Fiscal Outlook, we recommended Reasonable Starting Point for Deliberations, the Legislature use a mix of all the tools at its but Have Limitations. Should the Legislature disposal to solve the 2020-21 budget problem. wish to include revenue actions in its mix of The Governor has taken this approach, using a solutions, the May Revision proposals are worth balanced mix of proposed solutions across a variety consideration. The state suspended NOLs and of types and areas. Doing this, the Governor does limited business tax credits during prior recessions. not rely excessively on any one type of solution. We These actions generally are considered somewhat recommend the Legislature take a similar approach, 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET less burdensome on taxpayers than other actions ongoing reductions, the Governor makes choices like increasing tax rates. This is because they that reduce the ongoing budget gap. Some of largely would change the timing of tax payments these choices—like closing two prisons in the (causing payments to be made sooner than they near future—are prudent given the circumstances. otherwise would) but would not significantly Other decisions—like reductions to programs increase the total amount of taxes businesses and services—are painful but necessary to close pay over the next several years. That being said, the budget’s multiyear deficits. We support the the proposed actions also have some drawbacks. Governor’s decision to make ongoing solutions a Most importantly, predicting the amount of revenue key feature of his proposed budget and urge the generated from these solutions is more difficult than Legislature to take a similar approach. In particular, some alternatives due to the inherent complexity the Governor’s May Revision includes $15 billion of corporation tax filings. Counting on a certain in ongoing solutions—we recommend the ultimate amount of revenues from these solutions to fix the budget package include no less than this amount. budget problem is somewhat risky. Compounding …But Creates Significant New, Ongoing this risk, our preliminary review suggests that the Obligation. Under the administration’s current administration’s estimates for the revenue solutions projections, the supplemental payments to schools may be too high. and community colleges would total $10.1 billion Some Spending Reductions Are Targeted, over the 2021-22 through 2023-24 period. Others Less so. The Governor proposes spending (Of this amount, $5.7 billion is related to the reductions across a wide array of program 1.5 percent payments and $4.4 billion is related areas. (Many of these reductions would be to recalibrating the Proposition 98 formulas.) temporarily “triggered off” in the event of more These payments contribute directly to the state’s federal assistance.) In many cases, the Governor multiyear operating deficit, making it even more takes a targeted approach to reductions. In difficult for the Legislature to balance future some of these cases, the Governor’s proposals budgets. In addition, the existing Proposition 98 avoid compounding the public health crisis or formulas provide for increases in school funding associated personal economic challenges facing tied to growth in General Fund revenue and local Californians. For example, the Governor does not property tax revenue. Under the administration’s reduce CalWORKs grants or recent expansions revenue assumptions, Proposition 98 would already to the Earned Income Tax Credit. The Governor require increases in per-pupil funding averaging also proposes targeted and relatively limited 5 percent per year over the multiyear period, while reductions to Medi-Cal and corrections. In other still requiring reductions to much of the rest of areas, however, the Governor proposes blunter the budget. If the Legislature wishes to provide reductions. For example, the Governor proposes schools with additional funding beyond this level, a flat 10 percent reduction to universities, judicial it could make that decision as part of annual branch, and state employee compensation. While budget deliberations. Enacting a new formula limits significant reductions are necessary given the legislative discretion and flexibility. severity of the budget crisis, we recommend the Pension Proposals Also Shift Costs to Future Legislature take a more surgical approach where Years. As we described earlier, the Governor possible. In the coming days and weeks, we will makes pension-related proposals that achieve help identify alternative solutions where available. short-term savings but result in higher costs in the future. Given the magnitude of the budget Multiyear Budget Condition problem, some degree of cost shifts are tolerable. Governor Makes Progress in Addressing However, the plan to suspend increases to the Multiyear Condition... Similar to our office, the state’s CalSTRS rate is short-sighted and weakens administration’s multiyear budget projections reflect the funding plan adopted in 2014. Unlike with continued economic and budgetary pain for the CalPERS, which can require the state to make state. Nonetheless, by proposing a number of certain payments, CalSTRS’ authority is much more www.lao.ca.gov 11 analysis full gutter 2020-21 BUDGET limited. Reducing CalSTRS’ statutory authority to Legislative Authority and Oversight raise rates now sets a dangerous precedent for Governor Continues to Propose Significant future years, opening the door to further changes Policy Changes That Require More Time that could erode the health of the system. for Legislative Consideration. In addition to Continuing to Seek More Federal Assistance budgetary actions, the Governor’s January budget Warranted... The extent of the budget problem proposal included a number of accompanying identified not only for 2020-21, but also future changes to policy. While some have been amended years, is substantial. Without federal assistance, or withdrawn, the Governor continues to propose the Governor proposes the state make sizeable and a number of these policy changes in the May ongoing reductions to education, health and human Revision. This includes, for example, a number of services, state employee compensation, and many proposals to create new or reorganize existing state other areas. Moreover, while reserves and other departments—such as the Department of Business budgetary maneuvers can mitigate these reductions Oversight and the Department of Better Jobs and in the near term, additional reductions will be Higher Wages. Given the Legislature’s reduced necessary in future years. Along with the Governor, capacity to hold hearings in recent months, legislative leaders have already been pursuing new lawmakers have not had time to carefully consider federal assistance, which is warranted. We suggest these proposals. The Governor now asks that the leaders request that any assistance made available Legislature examine and approve these changes— be flexible. Given the significant ongoing effects of alongside a complicated and difficult budget—in this crisis, the state requires assistance that can a compressed period of time. We recommend be used to address not only this year’s budget the Legislature defer some of these choices and deficit, but also future deficits that will result from consider them instead in the policy process or in continued economic and budgetary hardship as a the next budget cycle. result of the COVID-19 public health emergency. Several Administration Proposals Sideline ...But Budget Structure Would Still Need Legislative Authority. In a number of areas across to Be Reconsidered if Federal Assistance the budget, the Governor makes proposals that Materialized. As noted earlier, the Governor’s raise serious concerns about the Legislature’s May Revision would undo the majority of ongoing role in future decisions. This includes, for spending reductions if additional federal assistance example, the Governor’s creation of a new were received. Even if flexible funding materializes, COVID-19 contingency fund and a number of however, it likely would only be available for a year examples of budget bill language that delegate or two. Consequently, significant budget problems increased authority to the administration. In some likely would reemerge in a few years. Should cases, we have received only limited information additional federal assistance become available, we about how the proposals would be implemented. In suggest the Legislature reconsider the structure of many cases, we are very troubled by the degree of the budget using all available tools. Doing so would authority that the administration is requesting that allow the state to phase in spending reductions the Legislature delegate. more slowly, mitigating the negative economic consequences of pulling back spending too quickly. 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET CONCLUSION The Governor has presented a budget to the challenges. Nonetheless, the budget plan has some Legislature that addresses a $54.3 billion budget weaknesses, which we suggest the Legislature problem. Despite the state’s historic reserve address as it adopts the fiscal plan for the state. levels and good budgetary position entering the However, perhaps more importantly, in a number of recession, the dramatic change in the state’s areas across the budget, the administration asks economic circumstances has already meant the that the Legislature delegate significant authority to state must make difficult decisions. In response, the the executive branch. In these cases, we urge the Governor has presented a plan that puts forward Legislature to jealously guard its constitutional role a balanced mix of solutions and makes a serious and authority. effort to address the state’s ongoing budgetary www.lao.ca.gov 13 analysis full gutter 2020-21 BUDGET LAO PUBLICATIONS This report was prepared by Ann Hollingshead, with contributions from others across the office, and reviewed by Carolyn Chu and Anthony Simbol. 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