The 2022-23 Budget: Initial Comments on the Governor's May Revision

The 2022-23 Budget: Initial Comments on the Governor’s May Revision Key Takeaways Governor Allocates $52 Billion Overall General Fund Surplus in May Revision. Reflecting extraordinary revenue growth for a second year in a row, we estimate the Governor had a $52 billion General Fund surplus to allocate in the May Revision. In addition, under the administration’s revenue estimates, the Governor had a $33.5 billion surplus within the school and community college budget to allocate to discretionary purposes. Across these two surpluses, the Governor allocates $40 billion to meet the state’s constitutional requirements under the state appropriations limit (SAL). The largest categories of spending from the overall General Fund surplus are for natural resources and transportation programs. May Revision Sets Up Fiscal Cliff for 2023-24. While the administration meets the SAL requirements across the prior and current year, the Governor leaves $3.4 billion in unaddressed SAL requirements in 2022-23. Moreover, we estimate the state would face an additional SAL requirement of over $20 billion in 2023-24. The Governor’s May Revision does not have a plan to address this roughly $25 billion requirement. As a result, the state would very likely face a significant budget problem next year, which could require reductions to programs. Recession Risk Heightened. Predicting precisely when the next recession will occur is not possible. However, certain economic indicators historically have offered warning signs that a recession is on the horizon. Many of these indicators currently suggest a heightened risk of a recession within two years. Recommend Increasing Reserves. We strongly recommend the Legislature consider building more reserves than proposed by the Governor in the May Revision. Additional reserves can help the state address either future SAL requirements or a budget problem resulting from a recession. We recommend taking a fiscally prudent approach, which would be to identify several billion dollars in non-excluded spending and instead dedicate those funds to reserves. GABRIEL PETEK | LEGISLATIVE ANALYST MAY 2022 INTRODUCTION On May 13, 2022, Governor Newsom presented testimony and online. The information presented a revised state budget proposal to the Legislature. in this brief is based on our best understanding (This annual proposed revised budget is called the of the administration’s proposals as of 11:00 AM, “May Revision.”) In this brief, we provide a summary May 14, 2022. In many areas of the budget, this of the Governor’s revised budget, focusing on the understanding will continue to evolve as we receive overall condition and structure of the state General more information. We only plan to update this brief Fund—the budget’s main operating account. In the for very significant changes (that is, those greater coming days, we will analyze the plan in more than $500 million). detail and provide additional comments in hearing BUDGET CONDITION Figure 1 shows the General Fund condition requires the state to allocate a certain share of based on the Governor’s proposals and using the revenues for spending on schools and community administration’s estimates and assumptions. colleges; and Proposition 2 (2014) requires the state to set aside some revenues—particularly Changes in Budget Condition capital gains revenues—to build reserves, pay Since Governor’s Budget down state debts, and in some cases, spend Revenues Higher by Nearly $57 Billion more on infrastructure. Reflecting the higher Compared to Governor’s Budget. Revenue revenue estimates, and including policy changes, growth over the last two years has been the May Revision reflects higher constitutionally extraordinary. Following growth of nearly 30 percent required spending on K-14 education of in 2020-21, revenues are projected to grow by $21 billion across the budget window. In addition, almost 20 percent in 2021-22. Reflecting these Proposition 2 reserve requirements are higher unprecedented collections, the by $2.4 billion while debt payments are lower by May Revision assumes revenues (excluding Budget Stabilization Figure 1 Account [BSA] transfers) will General Fund Condition Summary be $57 billion higher than the (In Millions) Governor’s budget over the budget window. Our office’s revenue 2020-21 2021-22 2022-23 estimates are very similar to these Revised Revised Proposed estimates (only about $450 million Prior-year fund balance $5,889 $37,699 $15,425 higher over the budget window). Revenues and transfers 194,575 226,956 219,632 Expenditures 162,765 249,229 227,364 Constitutional Requirements Ending fund balance $37,699 $15,425 $7,694 Higher by $23 Billion. The State Constitution has three Encumbrances $4,276 $4,276 $4,276 major voter initiatives that require SFEU balance $33,423 $11,149 $3,418 the Legislature to spend some Reserves revenues in specific ways. BSA $14,643 $20,325 $23,283 Specifically, Proposition 4 (1979) SFEU 33,423 11,149 3,418 Safety net 900 900 900 constrains how the state can spend Total Reserves $48,966 $32,374 $27,601 revenues that exceed a specific SFEU = Special Fund for Economic Uncertainties and BSA = Budget Stabilization Account. threshold; Proposition 98 (1988) 2 LEGISLATIVE ANALYST’S OFFICE 2022-23 BUDGET $500 million due to changes in the components of Under Governor’s Proposals, General estimated revenues. (We discuss Proposition 4, and Purpose Reserves Remain Below its impact on the surplus, in a subsequent section.) Pre-Pandemic Levels as a Share of Budget. Baseline Spending Higher by $11 Billion. As Figure 2 shows, the state’s general-purpose Across the rest of the budget, other baseline reserves increased steadily after 2014-15, when costs are higher by $11 billion. This is primarily the Proposition 2 was passed by voters. In 2019-20, result of early legislative action, including adopting the state made its first withdrawal from the $5.7 billion in a variety of revenue reductions— BSA under the rules of Proposition 2 and the such as the restoration of net operating loss balance declined substantially. Since 2019-20, deductions—and $2.7 billion for rental assistance. reserves have grown in dollar terms as the state has continued to make new deposits into the Reserves Under BSA as required by the Constitution. Nonetheless, Governor’s May Revision under the Governor’s May Revision, general purpose reserves as a share of nonschool General Purpose Reserves Reach Nearly spending would reach 17 percent by the end $28 Billion. The bottom of Figure 1 shows of 2022-23, still below the pre-pandemic share general purpose reserves planned for the end of 20 percent. In contrast, the Proposition 98 of 2022-23 under the administration’s estimates Reserve has increased from zero in 2019-20 to and assumptions. Under the Governor’s May $9.5 billion—or nearly 9 percent of school and Revision, the state would end 2022-23 with community college funding—under the Governor’s $27.6 billion in general purpose reserves. This total May Revision estimates for 2022-23. includes $23.3 billion in the BSA, the state’s main constitutional reserve governed by Proposition 2; $3.4 billion in the Special Fund for Economic Uncertainties (SFEU), the Figure 2 state’s main discretionary reserve; and $900 million in the Safety General Purpose Reserves Have Net Reserve. Not Quite Reached Pre-Pandemic Share of Budget Proposition 98 Reserve Reaches $9.5 Billion. In addition, 25% a General Purpose Reserves the Proposition 98 Reserve, b School Reserves which is dedicated to school and 20 community college spending, would reach $9.5 billion under 15 the Governor’s May Revision. We do not include this reserve in 10 general purpose reserves because withdrawals supplement the 5 constitutional minimum spending level for K-14 education and therefore do not help the state 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 address future budget problems. However, this reserve does benefit a General purpose reserves (including BSA and Safety Net Reserve) as a share of the non-school budget. Excludes Special Fund for Economic Uncertainties (SFEU) because the graphic shows actual, rather than enacted, schools because it mitigates the levels. Actual SFEU balances vary widely depending on fluctuations in revenues and spending. funding reductions that occur when b Proposition 98 (school) reserves as a share of overall school budget. the constitutional minimum drops. www.lao.ca.gov 3 THE SURPLUS Figure 3 displays the major spending decisions OVERALL GENERAL FUND that the Governor made in allocating state SURPLUS discretionary funds (including proposals carried While the Governor’s May Revision provides forward from January). It includes: (1) the $34 billion a starting point for legislative deliberation, the in spending choices using the overall General Fund Legislature ultimately will craft the final budget surplus (this figure excludes reserve deposits, tax package for the 2022-23 fiscal year. In that process, refunds, and debt payments, which are shown the Legislature will make its own determination instead in Figure 4) and (2) the $33 billion surplus about how to allocate funds available. One of within the school and community college budget. the goals of this brief is to help the Legislature As the figure shows, schools and community determine how much capacity the budget has colleges would receive the largest spending for new augmentations so that it has the most allocations reflecting the significant growth in flexibility to exercise its discretion. To achieve this, Proposition 98. The remainder of this section we estimate the available General Fund surplus: discusses the major components of each of these the amount of revenue available for new spending funding amounts. commitments after paying for the costs of programs under current law. (If, instead, we found spending under current law was higher than projected Figure 3 Major Discretionary Spending Choices in 2022-23 May Revision $33 Billion Surplus Within School and Community College Budget; $34 Billion in Overall General Fund Surplus Spending Proposals (In Billions) Schools and Community Collegesa Resources and Environment Transportation Other Health Human Services School Facilities One Time or Temporary Housing and Homelessness Ongoing Criminal Justice Higher Education Workforce Development 5 10 15 20 25 30 $35 a Includes General Fund and local property tax revenue. 4 LEGISLATIVE ANALYST’S OFFICE 2022-23 BUDGET revenues, we would use the phrase “deficit” or General Fund surplus, to reduce revenues. “budget problem” to describe the difference.) (Of this total, 97 percent would be one time This year, the concept of the surplus is more or temporary.) In particular, this category complicated because the state appropriations limit includes the Governor’s $11.5 billion proposal (SAL), under the rules of Proposition 4, constrains to provide tax refunds to vehicle owners how the Legislature can allocate revenues that in California. exceed a specific threshold. We describe the • $3 Billion to Reserves. The Governor limitations the SAL places on how the Legislature proposes the Legislature enact a year-end can allocate the surplus in the next section. balance in the SFEU of $3.4 billion. The We Estimate the Governor Allocated an Legislature can choose to set the SFEU Overall General Fund Surplus of $52 Billion balance at any level above zero. However, in the May Revision. We estimate the Governor recent budgets have enacted SFEU had a $52 billion surplus to allocate in the 2022-23 balances around $2 billion to $4 billion, May Revision, an increase of $23 billion over the which the state uses to cover costs for $29 billion surplus we estimated was available in unanticipated expenditures. January. The figure is very similar to the $49 billion • $2 Billion to Ongoing Spending Increases. discretionary General Fund surplus identified The Governor’s spending proposals include by the administration, although some of our $2.4 billion in ongoing spending, about offices’ specific assumptions are different. (In the 5 percent of the surplus. That said, under coming days, we will publish tables enumerating the administration’s estimates, the ongoing the specific proposals in the May Revision by costs of the Governor’s budget proposals program area.) would grow significantly over time, totaling How the Governor Allocates the $52 Billion $7.4 billion by 2025-26. The largest of Overall General Fund Surplus. Figure 4 shows these include $1.8 billion (in 2025-26) for how the Governor proposes allocating the overall the proposed expansion of Medi-Cal to General Fund surplus. Overall, we estimate 95 percent are Figure 4 devoted to one-time or temporary purposes and 5 percent are How the Governor Allocates a $52 Billion Overall ongoing. Specifically, the Governor General Fund Surplus in the 2022-23 May Revision proposes allocating: • $32 Billion to One-Time or Temporary Spending on Programmatic Expansions. The Governor proposes Revenue Reductions spending about 60 percent and Tax Refunds of the overall General Fund surplus, or $32 billion, on a one-time or temporary basis for a variety of programmatic SFEU Balance One-Time or expansions. (We define Temporary temporary to mean three Spending Debt and years or fewer.) Loan Payments • $12 Billion to Revenue Reductions and Tax Ongoing Spending Refunds. The Governor proposes using $12 billion, SFEU = Special Fund for Economic Uncertainties. about 24 percent of the overall www.lao.ca.gov 5 all income-eligible Californians and nearly commitments. For simplicity, we refer to this $600 million for a State Supplementary amount as the “surplus” within the school and Payment grant increase, according to community college budget. This amount is separate administration estimates. (In the next week or from the overall General Fund surplus and must so, we will issue our estimates of the cost of be allocated for school and community college ongoing proposals.) programs (or deposited into the Proposition 98 • $2 Billion to Pay Off Debts and Liabilities. Reserve). Under the Constitution, the Legislature Each year, the state pays many billions can appropriate more than this amount (by of dollars towards debts and liabilities. increasing funding above the minimum guarantee) (Under the Governor’s May Revision, for or less (by suspending the guarantee with a example, the state would make $3.4 billion two-thirds vote of each house). in constitutionally required debt payments How the Governor Proposes Allocating the under Proposition 2, as well as other routine Surplus Within the K-14 Education Budget. debt payments made by the state, such as After setting aside funding for statutory COLAs and annual actuarially required contributions to other planned program expansions, the Governor’s the state’s pension systems, debt service on budget includes $33.5 billion in discretionary state bonds, and the state’s plan to prefund spending proposals to meet the minimum retiree health.) In addition to these routine required funding level for schools and community payments, the Governor proposes the colleges. As Figure 5 shows, the Governor Legislature use $2 billion in overall General proposes allocating $11.6 billion for ongoing Fund surplus funds to repay state debts program increases and $21.9 billion for one-time and liabilities. This includes $1.3 billion for purposes. The largest one-time augmentation converting some projects currently funded is for $8.75 billion in discretionary block by lease revenue bonds to cash and repaying grants—$8 billion for schools and $750 million for around $600 million in special fund loans to community colleges—that would be distributed on the General Fund. a per-student basis. SURPLUS WITHIN SCHOOL AND COMMUNITY COLLEGE BUDGET Figure 5 Total state spending on schools and community Governor’s Major Spending Choices for colleges is determined mainly by a set of Schools and Community Colleges constitutional formulas set forth in Proposition 98. These formulas establish a minimum funding requirement for K-14 education, commonly known as the minimum guarantee. The state meets the guarantee through a combination of General Fund and local property tax revenue. The Legislature, in Ongoing turn, decides how to allocate this funding among Other One Time specific school and community college programs. Many factors affect the costs of these programs, including changes in student attendance and One-Time statutory cost-of-living adjustments (COLAs). Discretionary Grants When the guarantee exceeds the cost of existing programs, the difference is available for new 6 LEGISLATIVE ANALYST’S OFFICE 2022-23 BUDGET THE STATE APPROPRIATIONS LIMIT The SAL limits how the state can use revenues The Constitution also allows the state two that exceed a certain limit. When revenues are additional years to make these payments. expected to exceed the limit before the state makes SAL Requirements Now Significantly Impact its discretionary budget choices, it has a SAL Budget Choices. In the past, our office generally requirement. (In other words, a SAL requirement did not issue reports on the administration’s is the amount of revenue the state is required approach to meeting SAL requirements because to allocate in ways that meet its constitutional the limit did not impact budget choices. In the requirements under Proposition 4.) Specifically, SAL past few years, however, the SAL has become a requirements can only be met with: major feature in budget architecture and places • Tax Reductions or Tax Refunds. The first constraints on the use of surplus funds. The reason way the Legislature can allocate revenues the SAL is now a major feature of the budget is due in order to comply with the SAL is to reduce to revenue growth exceeding growth in the limit. proceeds of taxes, for example, by reducing We discuss this dynamic in our report, The State tax rates, increasing tax credits, or returning Appropriations Limit. funds to taxpayers through tax refunds. Governor Allocates $35 Billion in Overall • Excluded Spending. Second, the Legislature Surplus to Address SAL Requirements. The can spend more on excluded purposes. Governor’s May Revision includes $35 billion Categories of excluded spending include: in discretionary General Fund proposals that subventions to local governments, debt meet SAL requirements across 2021-22 and service, federal and court mandates, capital 2022-23. (This reflects 68 percent of the overall outlay, and emergency spending. For some surplus.) Figure 6 shows the distribution of these exclusions, like federal and court mandates, proposals by type of SAL requirement. As the legislative decisions play a limited role in increasing or Figure 6 decreasing the excluded spending. But for other How the Governor Allocates $35 Billion in Overall exclusions, like subventions General Fund Surplus to SAL Requirements to local governments and spending on capital outlay projects, the Legislature has Revenue Reductions much more discretion. and Tax Refunds • Excess Revenues Split Between Tax Refunds and Tax Refunds School Spending. Finally, the Legislature can follow the provisions of Section 2 Capital Outlay of Article XIIIB of the Constitution. Specifically, if appropriations subject to the limit exceed the limit on net Revenue Reductions across two years, the state Excluded Federal and Emergency Spending must allocate the excess Court Mandates equally between taxpayer refunds and additional education spending. SAL = state appropriations limit. www.lao.ca.gov 7 figure shows, about two-thirds of the proposals the May Revision, which result in slightly lower SAL are for excluded spending, including nearly half requirements across the budget window.) of the overall proposals going to capital outlay Governor Also Allocates $5.1 Billion Within projects. (Importantly, the definition of capital K-14 Education Surplus for SAL-Excluded outlay under the SAL is more expansive than the Spending. In addition to the $35 billion in SAL typical definition in the budget.) These capital exclusions that use the overall General Fund outlay proposals include, for example, $2.2 billion surplus, the Governor proposes using $5.1 billion for school facilities, $2 billion for the transportation from the surplus within the school and community infrastructure package, and nearly $2 billion for college budget for SAL-excluded purposes. The the strategic energy reliability reserve. About largest component is $3.2 billion for deferred one-third of the SAL-related proposals are for maintenance ($1.7 billion for schools and revenue reductions and tax refunds, including the $1.5 billion for community colleges). Governor’s $11.5 billion tax refund proposal for May Revision SAL Estimates. Figure 7 shows vehicle owners. (The nearby box also describes the state’s final SAL position after accounting for the Governor’s changes to the SAL calculation in all of the May Revision proposals. As the figure Governor’s Proposed Administrative and Statutory Changes to the SAL Calculation The Governor proposes two changes to the state appropriations limit (SAL) calculation, which both lower requirements across the budget window. Taken together, these changes result in lower SAL requirements by nearly $3 billion in 2022-23. Specifically, the administration: • Counts More School District Capital Outlay Exclusions. School districts, like local governments and the state, have their own appropriations limits. State law requires most school districts to set aside a portion of their general purpose funding for the ongoing and major maintenance of their facilities. Districts currently set aside approximately $2.2 billion per year related to this requirement. These funds meet the definition of capital outlay for SAL purposes, and so the administration’s SAL calculations propose school districts exclude this spending from their limits. Because of the way school district limits interact with the state’s limit, excluding this spending results in dollar-for-dollar reductions in appropriations subject to the limit at the state level. • Counts Certain IT Project Costs as Excluded. The May Revision identifies information technology (IT) project costs totaling $227 million General Fund in 2021-22 and $447 million General Fund in 2022-23 as SAL excludable. The administration did not previously categorize these costs as excludable, but recently developed a methodology to exclude certain IT expenditures. Generally, the administration’s methodology considers development and implementation costs for approved IT projects to be SAL excludable, but does not exclude other costs to plan projects or maintain and operate IT systems from the limit. We find the administration’s changes reasonable, but suggest the Legislature direct the administration to exclude additional IT expenditures, including costs for planning, maintaining, and operating certain systems. 8 LEGISLATIVE ANALYST’S OFFICE 2022-23 BUDGET shows, 2020-21 would end with Figure 7 “negative room” (appropriations SAL Estimates in the 2022-23 May Revision subject to the limit above the limit) of $17 billion. However, 2021-22 (In Billions) would have room of $19 billion. 2020-21 2021-22 2022-23 Because the state’s SAL position is considered on net over two SAL Revenues and Transfers $216 $256 $252 fiscal years, these two years Exclusions -83 -150 -113 have roughly $2 billion in room Appropriations Subject to the Limit $133 $106 $139 Limit $116 $126 $136 remaining. However, at the same Room/Negative Room -17 19 -3 time, the Governor’s May Revision Excess Revenues? No leaves $3.4 billion in unaddressed SAL = state appropriations limit. SAL requirements in 2022-23. BUDGET STRUCTURE COMMENTS Recession Risk Heightened. Predicting precisely when the next Figure 8 recession will occur is not possible. However, certain economic Economic Indicators Point to Elevated Recession Risk indicators historically have offered warning signs that a recession Below, we compare the current values of four economic indicators to normal time periods as is on the horizon. As shown in well as years leading into past recessions. The data covers the seven recessions since 1973. Figure 8, many of these indicators Rising Inflation | California Inflation Relative to Prior Three Years currently suggest a heightened Normal Before Recessions Now risk of a recession within two years. High inflation and tight labor 0% 1% 4% markets suggest an overheated economy is struggling to find Tight Labor Markets | California Unemployment Rate avenues for further expansion, an Before observation seemingly supported Recessions Now Normal by a decline in real gross domestic product in the first quarter of 2022. 5.1% 5.3% 6.5% Home sales have declined as mortgage rates have risen rapidly. Slowing Home Sales | Annual Change in U.S. New Home Sales Consumer sentiment has fallen to Now Before Recessions Normal levels typically seen only during recessions. Changes in prices --99%% -6% 4% of certain U.S. treasury bonds suggest financial markets may be Falling Consumer Sentiment | Annual Change in Consumer Sentiment Index pessimistic about the economic outlook. In the last five decades, Now Before Recessions Normal a similar collection of economic conditions has occurred six times. -21% -3% 1% Each of those six times a recession has occurred within two years (and often sooner). www.lao.ca.gov 9 Economic Conditions Weigh on Revenue would have a budget problem of roughly $25 billion Outlook. Past experience does not guarantee that in next year’s budget process. Importantly, the state we are heading for a recession. In our assessment, cannot “grow its way out” of this kind of budget however, the risk of a recession is high enough to problem. As we have discussed previously, for warrant a downward adjustment to our revenue each $1 in revenues the state collects above the outlook. As a result, we forecast stagnant revenues limit, it must allocate about $1.60 in constitutional in the out-years. The administration, in contrast, requirements. This means that if revenues are anticipates somewhat more growth, resulting in higher than the Governor’s budget anticipates, the their estimates exceeding ours by around $13 billion state will be in an even worse fiscal position. (For by 2025-26. In the context of the uncertainty reference, see: The 2022-23 Governor’s Budget: surrounding these out-year estimates, however, Initial Comments on the State Appropriations a difference of $13 billion is still relatively minor. Limit Proposal.) The key distinction between our office and the Recommend Increasing Reserves to Address administration is how much each of us insures Likely Fiscal Cliff. The vast majority of the against the risk of a recession during the forecast Governor’s discretionary budget augmentations period. Whereas we reflect an elevated risk of a are one time or temporary. Maintaining a focus on recession, this is less true of the administration. limited-term funding is essential to the budget’s As such, while we think the administration’s ongoing health. However, this approach alone estimates generally are reasonable, they do carry is unlikely to be sufficient to stave off future a higher risk of the state facing a shortfall in the budget problems. That is because, as we have next few years. (We discuss these issues and our discussed here, the state faces dual risks to its revenue estimates in our post, The 2022-23 May bottom line condition. The risk of a recession is Revision: May Revenue Outlook.) heightened, meaning revenue growth could be May Revision Leaves $3.4 Billion in slower than the Governor anticipates, resulting in Unaddressed SAL Requirements… Under the budgetary imbalance. But even if revenue growth Governor’s May Revision, the state would have continues as the administration expects, under our $3.4 billion in unaddressed SAL requirements in estimates, the state would face roughly $25 billion 2022-23. We strongly urge the Legislature against in SAL requirements next year that would result enacting a budget that leaves unaddressed SAL in a corresponding budget problem. This amount requirements. The Legislature either could allocate approaches the entire balance of the state’s more resources to purposes that meet the SAL’s general purpose reserves for 2022-23. If revenues requirements or save funds to meet the requirement grow faster than that, the problem likely would be, next year. The nearby box discusses an example of counterintuitively, even worse. We will issue our how the Legislature can avoid leaving a budget-year multiyear assessment of the budget’s condition in SAL requirement unaddressed. the coming week or so, and that report will offer …And Sets Up a Fiscal Cliff as Early as more insights into the ranges of possible budget 2023-24. Although the unaddressed 2022-23 SAL outcomes the state faces in the near future. In the requirement is relatively small, because the SAL is meantime, we strongly recommend the Legislature calculated over two years, the 2022-23 requirement consider building more reserves than proposed must be considered alongside the state’s 2023-24 by the Governor in the May Revision. Additional SAL position. Our estimates suggest the May reserves can help the state either address future Revision sets the state up for a significant budget SAL requirements or a budget problem resulting problem as soon as next year. Specifically, from a recession. under our estimates of the Governor’s revenue assumptions and spending proposals, the state would face an additional SAL requirement of over $20 billion in 2023-24, but have a surplus of only $1.6 billion in that year. This means that the state 10 LEGISLATIVE ANALYST’S OFFICE 2022-23 BUDGET Example of How to Address the Remaining SAL Requirement Within the Governor’s May Revision revenue estimates and the state appropriations limit (SAL) framework, the Legislature has some options for addressing the $3.4 billion unaddressed SAL requirement in 2022-23. For example, the Legislature can: • Spend More Proposition 98 (1988) General Fund on Excluded Capital Outlay. Spending more Proposition 98 funding on capital outlay (or other excluded spending) would results in dollar-for-dollar reductions in appropriations subject to the limit at the state level because of the way school district limits interact with the state’s limit. For schools, the Legislature has several promising options. Most notably, it could allocate more funding for Transitional Kindergarten facilities to support the upcoming expansion of that program, increase funding for deferred maintenance beyond the amount included in the May Revision, or provide an infusion for the School Facility Program (either in addition to or in-lieu of the amount from the overall General Fund surplus). Each of these options could support facility improvements that would benefit students and programs for many years. The Legislature could fund these options by reducing spending on the Governor’s proposed discretionary grants or other proposals it deems less essential. • Swap Certain Greenhouse Gas Reduction Fund (GGRF) and General Fund Expenditures. The administration’s 2022-23 GGRF expenditure plan provides over $1.7 billion for projects that likely would qualify as capital outlay under the SAL, including high-speed rail, transit projects, and incentives for heavy-duty vehicles. (Cap-and-trade auction revenues that make up the GGRF are not counted as proceeds of taxes under the SAL.) The administration also proposes to use at least this amount of General Fund on climate-related projects that are not SAL excludable. Should it wish to fund the same or a very similar mix of programs as the Governor, the Legislature could swap the fund sources for these climate-related activities—use General Fund for the capital outlay projects and GGRF for the non-excludable projects. This would reduce overall General Fund spending subject to the limit and help meet nearly $2 billion of the unaddressed requirement in 2022-23. • Reject Some Proposals That Do Not Meet SAL Requirements. Finally, the Legislature can reject some of the Governor’s proposals that do not meet a SAL requirement and instead spend those funds on SAL-related requirements, as listed on page 7. SURPLUS ALLOCATION CONSIDERATIONS This brief focuses on our assessment of the but leaves $3.5 billion in unaddressed requirements Governor’s May Revision budget structure and in 2022-23. We recommend the Legislature address provides our guidance to the Legislature on budget all SAL requirements. For example, it could make architecture. The remainder of the piece provides statutory changes to the SAL or allocate more of our guidance to the Legislature on allocating the surplus to SAL-excluded purposes. If the latter, the surplus with a focus on legislative flexibility, we recommend the Legislature allocate no less effectiveness, and sustainability. than $44 billion to meeting SAL requirements (using Address All SAL Requirements. In total, either the General Fund surplus and/or the surplus the administration allocates $40 billion on a within the school and community college budget). discretionary basis to meeting SAL requirements, www.lao.ca.gov 11 2022-23 BUDGET Determine Allocation Among Options for refunds now, they may be better targeted to those Meeting SAL Requirements. The administration with the least resources or those most in need. allocates 56 percent of its SAL requirements Similarly, the Legislature can think about to capital outlay, 29 percent to tax refunds and modifying the Governor’s infrastructure proposals revenue reductions, and 12 percent to emergency to focus on its highest priorities. Drought, energy spending. The Legislature can choose any reliability, and wildfire response are areas worthy allocation among: excluded spending (such as of state attention. However, the Legislature will capital outlay, subventions to local governments, want to evaluate whether the Governor’s specific and emergency spending), tax refunds and revenue proposals are the most effective ways at addressing reductions, and excess revenue tax refunds these challenges. For example, in constructing its and school payments. In crafting its budget, we own energy package, the Legislature might want recommend the Legislature consider how its policy to consider (1) how much funding to dedicate to goals could align with each of these categories of address potential near-term electricity shortages allowable uses. as compared to initiatives to build longer-term Assess Best Use Within Each Category reliability, (2) how to balance activities that rely on of Excluded Spending. The majority of the fossil fuels to address reliability concerns against administration’s excluded spending proposals those that better align with its climate and pollution would be allocated to (1) tax refunds and goals, and (3) where state expenditures might (2) transportation, natural resources, and maximize California’s eligibility and competitiveness energy-related capital outlay. While the Legislature for drawing down additional federal funds. has indicated interest in both of these areas, we The Legislature also could assess whether recommend the Legislature consider whether the the administration’s hospital and nursing facility approaches offered by the administration would be retention payments proposal would be likely effective. Do the proposals address a well-defined to address attrition. Our understanding of the problem with a policy strategy that has been proposal is that payments would be conditioned evaluated and found to be effective? Did recent on prior employment, rather than continued budgets make similar augmentations that may have employment in the future. Therefore, whether these helped address pressing needs? Do state and local payments would be an effective retention strategy is entities have the capacity to spend the funds on unclear. Alternative approaches could be warranted effective projects and activities in a timely manner? to reduce staffing turnover. For example, how could tax refunds be Evaluate Whether Disbursing Funding Over structured to be most effective? With an expanding Multiple Years Would Be Preferable to All at economy and extensive federal government Once. Under the rules of the SAL, the Legislature intervention over the last two years, many could appropriate funds this year to a specific Californians—although certainly not all—have excluded purpose and disperse those funds over seen their incomes, savings, and wealth rise. multiple years. The advantage of this approach Unemployment rates have fallen rapidly and job is that it could allow the Legislature to allocate openings outnumber available workers. In turn, a significant amount of resources to a particular rising incomes and wealth have come along with need (or set of needs) now, but would allow the rising prices, which increase the hardships of benefits of that appropriation to be spread over those who have not benefited from the economic many years. Moreover, with mounting signs rebound. Under such conditions, immediate, that the economy is approaching the peak of its broad-based refunds may not be the best current expansionary cycle, delaying the infusion approach. Delaying payments of refunds for a of these fiscal resources to when conditions most period of time while setting aside funds to help likely have softened could enhance the economic support Californians should the current economic benefit of this policy. This also could help address expansion begin to wane could provide more administrative capacity challenges associated with effective relief. If the Legislature wants to provide large, one-time allocations. 12 LEGISLATIVE ANALYST’S OFFICE 2022-23 BUDGET Identify Any Missed Opportunities. The May Weigh Trade-Off Between Reserves and Revision proposes a number of new initiatives. Non-Excluded Spending. Our analysis suggests While these may be meritorious, we recommend the state government cannot expand on an ongoing Legislature consider whether there are (1) existing basis without risking significant budget problems in programs addressing problems that should be just a few years. Specifically, under our assessment considered as a higher priority or (2) other issues of the Governor’s May Revision, the state would that should be addressed more immediately. For face a roughly $25 billion budget problem next instance, the May Revision proposes establishing year. Setting aside additional reserves now new centers at the universities, but provides no would help mitigate that problem. In the event of augmentation for addressing the universities’ a downturn, our scenario analysis has indicated deferred maintenance. Similarly, the administration that substantially larger problems are plausible. proposes new housing programs that likely could Therefore, the Legislature must weigh how much of be folded into existing programs like Homekey. the surplus should be dedicated to reserves versus Doing so could make existing programs more other purposes. The Legislature also could evaluate flexible while also reducing the need for additional whether there are existing program expenditures administrative capacity. The administration also to suspend in order to dedicate additional funds to proposes shifting funding from the Department reserves or new augmentations. We recommend of Public Health to the Office of Planning and taking a fiscally prudent approach, which would be Research for pandemic-related communications. to identify several billion dollars in non-excluded Shifting this responsibility—while the pandemic spending and instead dedicate those funds remains ongoing—could delay the dissemination to reserves. of important information on vaccines and other public health measures. Moreover, this shift could result in duplication and mixed messaging. Avoiding these outcomes has been one of the lessons learned during the pandemic. Lastly, beyond the constitutional requirements of Proposition 2, the administration includes very few proposals to help the state prepare for the next downturn now. (Most of the administration’s proposals to increase reserves and pay down debt are scored in the out-years. That is, after 2022-23.) www.lao.ca.gov 13 14 LEGISLATIVE ANALYST’S OFFICE 2022-23 BUDGET www.lao.ca.gov 15 LAO PUBLICATIONS This report was prepared by Ann Hollingshead with contributions from staff across the office, and reviewed by Carolyn Chu. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, California 95814. 16 LEGISLATIVE ANALYST’S OFFICE