The 2022-23 Budget: Initial Comments on the State Appropriations Limit Proposal

The 2022-23 Budget: Initial Comments on the State Appropriations Limit Proposal FEBRUARY 2022 Summary. The state appropriations limit (SAL) appropriations limit on the state and most types constrains how the Legislature can use revenues of local governments. (These limits also are that exceed a specific threshold. Given recent referred to as “Gann limits” in reference to one of revenue growth, the SAL has become an important the measure’s coauthors, Paul Gann.) The limits consideration in the state budget process and will later were amended by Proposition 111, which was continue to constrain the Legislature’s choices in passed by voters in 1990. For more information this year’s budget process. This post provides our about the history of the appropriations limit, office’s initial analysis on and comments about the see our previous reports, including: The State Governor’s proposals to address SAL requirements Appropriations Limit. in the 2022-23 Governor’s Budget. How the Formula Works. Each year the state must compare the appropriations limit to HOW DOES THE SAL WORK? appropriations subject to the limit. As shown in In the late 1970s, voters passed Proposition 4 Step 1 of Figure 1, this year’s limit is calculated (1979), which added Article XIIIB to the State by adjusting last year’s limit for a growth factor Constitution. Article XIIIB established an that includes economic and population growth. Figure 1 How the State Appropriations Limit (SAL) Works Step 1 Determine the Limit Prior-Year Limit SAL Growth Factor Adjustment includes COLA Step 2 and Change in Population Determine Appropriations Subject to the Limit Proceeds of Taxes Appropriations Subject to the Limit Exclusionsa Step 3 Determine the “Room” If proceeds of taxes (after exclusions) are below the limit over a two-year period, do nothing. “Room” If proceeds of taxes (after exclusions) are above the limit over a two-year period, there are excess revenues. a Exclusions are appropriations that are not counted towards the state appropriations limit. For example, spending on capital outlay is excluded. COLA = cost-of-living adjustment. 2022-23 Budget Series 1 As shown in Step 2, appropriations subject to the be room under the limit, across 2020-21 and limit are determined by taking all proceeds of taxes 2021-22, of $16.9 billion. At Governor’s budget, and subtracting excluded spending. In Step 3, under the administration’s updated revenue the state compares appropriations subject to the estimates and budget proposals, there are excess limit to the limit itself. If appropriations subject to revenues of $2.6 billion across these years—a net the limit are less than the limit, there is “room.” $19.5 billion change in the state’s SAL position. If appropriations subject to the limit exceed the (These requirements also differ somewhat from the limit (on net) over any two-year period, there are requirements our office estimated in the November excess revenues. Fiscal Outlook. We describe these changes in more How Does the Legislature Meet the detail in the nearby box.) As shown in Figure 2, this Constitutional Requirements Under the SAL? change has the following components: As implied by Figure 1, if appropriations • Higher Revenues. Across the two years, subject to the limit are expected to exceed the SAL revenues are higher by $22.5 billion limit, the Legislature can: (1) lower proceeds consistent with strong revenue collections of taxes, (2) increase exclusions, or (3) split the across all three major tax sources. (SAL excess revenues between additional school revenues include both General Fund and and community college district spending and special tax revenues. General Fund SAL taxpayer rebates. (Exclusions include: subventions revenues differ slightly from total General to local governments, capital outlay projects, debt Fund revenues because not all revenues are service, federal and court mandates, and certain proceeds of taxes.) kinds of emergency spending.) • More Exclusions. Across the two years, exclusions are higher by about $3 billion, HOW HAVE SAL although this change masks significant REQUIREMENTS CHANGED? variation in exclusions occurring both up and down. A key difference is the administration’s Prior Year (2020-21) and higher estimate of qualified capital outlay, Current Year (2021-22) which increased mainly due to some technical When the 2021-22 Budget Act was enacted scoring issues. in June 2021, the state anticipated there would How Do These SAL Requirements Compare to Our Fiscal Outlook? Prior Year and Current Year. In our November Fiscal Outlook, we estimated the state would have $14 billion in state appropriations limit (SAL) requirements to address across 2020-21 and 2021-22, compared to the administration’s estimate of $2.6 billion. There are two major reasons for the difference (in addition to many other smaller differences). First, the administration’s SAL revenue estimates (excluding proposals) are lower than ours by about $6 billion across 2020-21 and 2021-22. Second, the Governor’s budget proposes reallocating over $3 billion in transportation funds, which count as exclusions, which our office assumed would revert to the General Fund. Budget Year. In our November Fiscal Outlook, we estimated the state would have $12 billion in SAL requirements to address in 2022-23. The administration shows room of $5.7 billion. The key reason for this difference is that our estimates did not make any assumptions about how the surplus would be allocated. The Governor’s budget, by contrast, proposes allocations for the surplus, including to purposes that meet SAL requirements, such as additional spending on capital outlay and reductions in tax revenues. (We discuss these specific proposals in greater detail below.) In addition, some of our assumptions are different. For example, the administration’s tax revenue estimates (excluding policy proposals) are lower than ours by $3 billion in 2022-23. 2022-23 Budget Series 2 • Appropriations Limit Unchanged. Finally, the appropriations limit itself is unchanged. Figure 2 The state does not revisit its estimate of the Comparing SAL Estimates, Budget Act limit after the budget has been passed. to Governor’s Budget (In Millions) WHAT ARE THE SAL REQUIREMENTS UNDER THE 2020-21 2021-22 GOVERNOR’S BUDGET? SAL Revenues and Transfers Budget Act $208,667 $207,919 Some Proposals Help Address Requirements... Governor’s budget 215,221 223,906 The Governor’s budget includes proposals—both Difference -$6,554 -$15,987 revenue reductions and spending increases— Exclusions that help the state address its SAL requirements. Budget Act -$79,158 -$112,739 In particular, these include: Governor’s budget -80,363 -114,604 Difference $1,205 $1,865 • $17 Billion in Proposals Using the General Appropriations Limit Fund Surplus. The Governor’s budget Budget Act $115,860 $125,695 allocates a surplus of $29 billion across a Governor’s budget 115,860 125,695 variety of program areas. These proposals Difference — — include $16.9 billion in discretionary Net Effect -$5,349 -$14,122 proposals across 2021-22 and 2022-23— Two Year Total -$19,471 both revenue and spending—that address SAL = state appropriations limit. SAL requirements. Figure 3, shows the major excludable spending proposals in the Figure 3 Major SAL Excludable Governor’s Budget Spending Proposals (In Millions) Department Proposal 2021-22 2022-23 Secretary for Transportation Agency Transportation Infrastructure Package $3,500 — Secretary for Transportation Agency Supply Chain Resilience — $600 Department of Transportation Transportation Infrastructure Package 800 600 School Facilities Aid Program Funding for School Facilities Program — 1,250 Energy Commission Clean energy and building decarbonization — 545 State Hospitals Implement IST waitlist workgroup solution — 350 Department of Water Resources Drought response activities — 250 Energy Commission Zero-emission vehicle programs — 250 HCD Infill Infrastructure Grant Program — 225 CDCR Ironwood State Prison HVAC Project Conversion to General Fund — 182 California Military Department Sacramento: Consolidated Headquarters Complex Bonds to Cash — 159 Various Departments Contingency funding for unspecified activities — 155 CalFire Various capital outlay — 120 OES California Disaster Assistance Act Adjustment — 114 Department of General Services Facilities Management Division Deferred Maintenance — 101 California State University Deferred maintenance and energy efficiency projects — 100 University of California Deferred maintenance and energy efficiency projects — 100 Department of Water Resources Oroville pump storage and energy reliability support — 100 BSCC County Operated Juvenile Facility Grants — 100 Note: Includes proposals using General Fund surplus monies greater than $100 million. For a complete list of all proposals, see: https://lao.ca.gov/ reports/2022/4492/Overview-Appendix-011422.pdf. SAL = state appropriations limit; IST = Incompetent to Stand Trial; HCD = Department of Housing and Community Development; CDCR = California Department of Corrections and Rehabilitation; HVAC = heating, ventilation, and air conditioning; CalFire = California Department of Forestry and Fire Protection; and OES = Governor’s Office of Emergency Services. 2022-23 Budget Series 3 Governor’s budget. (For a complete listing of • Proposition 98 (Spending on Schools and the Governor’s budget spending proposals, Community Colleges) Increases by $0.40. including the amount of SAL exclusions, The Proposition 98 (1988) formulas determine see: https://lao.ca.gov/reports/2022/4492/ the minimum amount the state must spend on Overview-Appendix-011422.pdf.) schools and community colleges each year. • $2.2 Billion in Proposals Using Discretionary Under current conditions, the Proposition 98 Proposition 98 Funds. The Constitution formulas require the state to spend about sets a minimum annual funding requirement $0.40 on new school spending for each for schools and community colleges. After $1 in new revenues. setting aside funding for statutory cost-of-living • Proposition 2 (Debt Payments and Reserve adjustments and other planned program Deposits) Requirements Increase between expansions, the Governor’s budget includes $0.15 and $0.20. The Proposition 2 (2014) nearly $13 billion in discretionary spending formulas require the state to set aside proposals to meet the constitutionally required minimum amounts each year for reserves funding level for schools and community and debt payments. In general, an additional colleges. Of this total, the proposals include $1 of revenue above expectations likely means $2.2 billion in discretionary proposals that an increase in Proposition 2 requirements address SAL requirements. of between $0.15 and $0.20, although they can be as high as $0.30 in strong stock …But Excess Revenues Remain Outstanding. market years. After accounting for revenue reductions and excluded spending, the Governor’s budget estimates This Year, Each $1 Increase in Current-Year there would be $2.6 billion in excess revenues from Tax Revenues Also Will Result in $1 in Additional 2020-21 and 2021-22. The Governor’s budget does SAL Requirements. This year, additional not set aside a portion of the surplus to meet this revenues will result in even more constitutional requirement. (The constitution allows the state two requirements. In particular, each $1 of additional years to address this requirement.) revenue estimated in either 2020-21 and/or 2021-22 also will increase SAL requirements by WHAT HAPPENS TO THE SAL IF $1. While some of the additional spending required REVENUE ESTIMATES CHANGE? by Propositions 98 and 2 could be excluded from the SAL, it is not a requirement. Depending on Revenue estimates change throughout the fiscal various spending choices made, the constitutional year and the Governor’s May Revision will reflect requirements of Propositions 4, 98, and 2 largely new revenue estimates that incorporate the latest should be considered additive. collected data—particularly from the key revenue Each Additional $1 in Revenue Could month, April. This section describes how updated Increase Requirements by $1.60 or So. revenue estimates are likely to affect the state’s The bottom line of the factors above is that, for SAL position—and, by extension, the surplus. each additional $1 revenue collected (especially in Typically, Each $1 in Unanticipated the current year), total constitutional requirements Revenues Results in $0.40 in Additional Surplus. could increase by around $1.60. Counterintuitively, When the state has a surplus, an additional $1 of the dynamics are such this year that if revenues unanticipated revenues typically would result in exceed expectations, Legislative flexibility over the about $0.40 of additional surplus—although this can surplus could decrease substantially. vary widely depending on specific conditions like stock market performance and school attendance. The state’s surplus does not increase by $1 for each $1 in additional revenues because of the state’s constitutional requirements, which require the state to allocate revenues to particular uses. Specifically, for each $1 in unanticipated revenues: 2022-23 Budget Series 4 LAO COMMENTS surplus. Specifically, under this example, the Legislature would need to allocate $10 billion to SAL Requirements meeting the SAL requirements after meeting the Likely to Be Higher in May requirements of Propositions 98 and 2. Consequently, there likely would be far fewer non-excluded We Expect Current-Year Revenues to Be proposals than are included in the Governor’s Higher Than the Governor Anticipates. According budget. Figure 4 shows the major Governor’s budget to our most recent “Big Three” revenue outlook spending proposals not excluded from the SAL. update, there is a 90 percent chance that revenues will exceed Governor’s budget projections for the Other, Difficult to Predict, Factors Also Will current year (2021-22). The most likely outcome is Influence the SAL Requirements. That said, many that 2021-22 revenues will exceed expectations by other factors also will change between now and $5 billion to $20 billion. May. For example, special fund tax revenues could be higher or lower, “baseline” exclusions (spending Some Currently Non-Excluded Spending Likely on exclusions under current law) could be higher Needs to Be Reduced at May Revision. If revenues or lower, and the limit itself will change in response exceed expectations by $10 billion in 2021-22, for to new data released in the spring. As a result, the example, it could mean constitutional requirements actual change in the SAL requirements will be higher increase by $15.5 billion to $17 billion. As a result, or lower than the specific change in General Fund despite significantly higher revenues, the Legislature tax revenue. would have only limited discretion over this additional Figure 4 Major Governor’s Budget Spending Proposals Not Excluded From SAL (In Millions) Department Proposal Amount Health Care Services Bridge housing through Behavioral Health Continuum Infrastructure Program $1,000 EDD UI Trust Fund loan repayment 1,000 BCH Agency Encampment Resolution Grants Program 500 CalFire Staffing and operational enhancements 400 Health Care Services Undo delay in end-of-year fee-for-service provider payment processing 309 Health Care Access and Information Provide funding for care economy workforce development 271 Energy Commission Clean energy and building decarbonizationa 266 Cal Fire Various forest health and resilience proposals 243 Public Health Public health IT systems 235 Health Care Services Payments to encourage equity and practice transformation 200 Air Resources Board Zero-emission vehicle programa 160 Franchise Tax Board Enterprise Data to Revenue Project, Phase 2 151 GO-Biz Small business grants 150 CDCR Integrated Substance Use Disorder Treatment Program Expansion 127 CDE State Preschool rate increase for students with disabilities 111 Workforce Development Board Establish new HRTPs in health and human service careers 110 Judicial Branch Promote Trial Court Fiscal Equity 100 University of California Seed and matching grants for applied research 100 Department of Conservation Oil well abandonment & remediation 100 a Partial exclusions. Note: Includes proposals using General Fund surplus monies greater than $100 million. For a complete list of all proposals, see: https://lao.ca.gov/ reports/2022/4492/Overview-Appendix-011422.pdf. SAL = state appropriations limit; EDD = Employment Development Department; UI = Unemployment Insurance; BCH Agency = Secretary for Business, Consumer Services, and Housing Agency; CalFire = California Department of Forestry and Fire Protection; IT = information technology; GO-Biz = Governor ’s Office of Business and Economic Development; CDCR = California Department of Corrections and Rehabilitation; CDE = California Department of Education; HRTP = High Road Training Partnership; and BSCC = Board of State and Community Corrections. 2022-23 Budget Series 5 Options for Legislative Consideration governments or amend the definition of subvention in order to count more funding Two Different Approaches to Addressing provided at the local level. SAL Requirements. Given the dynamics described above, the state very likely will face higher SAL • Spend More on Infrastructure. requirements at the May Revision. The Legislature The Constitution allows expenditures on has two different options to address these, which capital outlay projects to be excluded from can be implemented separately or in tandem. appropriations subject to the limit. Statute First, the state can take a preemptive approach. defines capital outlay as: “an appropriation for Through the iterative budget process, the state can a fixed asset (including land and construction) lower revenues and/or spend more on excluded with a useful life of 10 or more years and a purposes, using a variety of fund sources. This value which equals or exceeds one hundred approach lowers appropriations subject to the limit thousand dollars ($100,000).” The state and reduces the potential for excess revenues. could spend more on infrastructure-related Second, the Legislature can choose to address purposes from a variety of fund sources, any remaining excess revenues through taxpayer including General Fund, Proposition 98 rebates and additional payments to schools and General Fund, and/or some tax-revenue community colleges. We discuss each of these supported special funds. options in turn below. • Spend More on Emergencies. Address SAL Requirements Preemptively. The Constitution also allows expenditures A preemptive approach involves different options, on emergencies to be excluded from primarily using surplus funds, but other funds (such appropriations subject to the limit. However, as Proposition 98 spending) also can be used. This those expenditures must meet three specific alternative can include one, or any combination, conditions. The spending must be: (1) related of the following: to an emergency declaration by the Governor, (2) approved by a two-thirds vote of the • Lower Tax Revenues. In order to reduce tax Legislature, and (3) dedicated to an account revenues for tax year 2021, the Legislature for expenditures relating to that emergency. most likely would need to act very soon, but We think that some existing Governor’s the state also could lower revenues for 2022 budget proposals—such as the proposal to in the coming months. There are many options repay the Unemployment Insurance loan from for tax reductions, including: broad-based the federal government—could be excluded rebates, targeted rebates, and expansions as long as the funding was approved with a of tax credits and programs like the Earned two-thirds vote. Income Tax Credit. Compared to waiting to address excess revenues, this option would Excess Revenues Must Be Allocated to afford the state more flexibility in designing the School Payments and Taxpayer Rebates. reductions. One advantage of this approach The Legislature could meet any remaining is that lowering tax revenues reduces some SAL requirements by splitting excess revenues constitutionally required spending (described between taxpayer rebates and payments to schools above) that otherwise would be required in and community colleges The Constitution gives the addition to meeting the SAL’s requirements. state two years to make these payments, and so the • Provide More Subventions to Local costs could be funded in the 2023-24 budget. That Governments. Under the Constitution and said, if this is the Legislature’s preferred approach, statute, subventions—funding provided to we recommend setting aside funding to pay for local governments on an unrestricted basis— these costs this year. There is no guarantee that are excluded from the SAL and counted, next year’s budget will have a surplus and, indeed, instead, at the local level. The state could could face even more SAL requirements. Setting provide more unrestricted funding to local aside the money now will ensure the state has the resources to pay for these obligations. 2022-23 Budget Series 6 Recommend the Legislature Make a Plan This decision will have significant spending Before the May Revision for Addressing the implications. For instance, if the Legislature wishes Requirements. Regardless of which approach the to meet the SAL’s requirements through excluded Legislature decides to pursue, given the complexity spending, we recommend determining how to of this budget situation, the high likelihood SAL allocate that spending now. Moreover, regardless requirements will increase, and the difficult of how the Legislature wishes to meet the SAL’s trade-offs at hand, we recommend the Legislature requirements, there likely will be significantly less make a plan for how it wishes to approach funding available for non-excluded purposes. As potential requirements in May. We recommend the such, we recommend the Legislature determine Legislature first determine how it wishes to meet the its priorities for non-excluded spending. Although SAL’s requirements. the Legislature does not need to finalize its budget now, determining the architecture of its preferred approach will increase its flexibility. 2022-23 Budget Series 7 LAO PUBLICATIONS This post was prepared by Ann Hollingshead and reviewed by Carolyn Chu. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. 2022-23 Budget Series 8