The 2023-24 Budget: Initial Comments on the Governor's May Revision

2023-24 BUDGET The 2023-24 Budget: Initial Comments on the Governor’s May Revision GABRIEL PETEK | LEGISLATIVE ANALYST | MAY 2023 KEY TAKEAWAYS Governor’s May Revision Solves a $28 Billion Budget Problem. The figure below summarizes the budget solutions that the Governor proposes using to address the $28.3 billion budget problem. As the figure shows, while the January Governor’s budget focused primarily on spending solutions, the May Revision solves much of the additional budget problem by shifting more costs and increasing revenues. That said, spending solutions still represent about half of the total proposals. Total budget solutions proposed in the May Revision (including those maintained from Governor’s budget) are: $15.1 billion in spending reductions and delays, $9.1 billion in cost shifts, $3.7 billion in revenue increases and shifts, and $450 million in reserve withdrawals. Although Revenues Are Always Uncertain, May Revision Predicated on Optimistic Estimates. The administration points out that there is elevated uncertainty in this year’s revenue outlook. Significant revenue uncertainty, however, is not unique to this year. Due to economic unknowns, policy changes, and other potential disruptions, revenues forecasts are always uncertain. This year, as always, we advise adopting the best possible revenue estimate based on all available economic and revenue data. We do not view revenue uncertainties as a cause for inaction or a reason to adopt optimistic revenue assumptions. Based on our assessment, there is a roughly two-thirds chance revenues will come in below May Revision estimates. As such, while we consider the May Revision revenues plausible, adopting them would present considerable downside risk. Adopting Administration’s Revenue Estimates Sets Up Difficult January. Under our revenues, and after accounting for constitutional spending requirements, the budget problem for 2023-24 is $6.2 billion larger than the administration’s estimates. The state currently has $11 billion in one-time or temporary spending planned for 2023-24—amounts that could be reduced to address this larger budget problem. Doing so now—in response to our lower revenue projections—would be better than waiting until next year for a few reasons. Once the new fiscal year begins, state departments will begin obligating and distributing these funds as planned. As such, midyear pullbacks would need to be based on what money has gone out How the May Revision the door instead of the state’s priorities. Addresses a $28 Billion Budget Problem This approach could be particularly (In Billions) disruptive to program participants who would have planned on receiving the Revenue Increases Reserve funds. Moreover, the administration $30 and Shifts Withdrawal will have an information advantage—it 25 Cost Shifts knows better what money has or has not been dispersed—making it more 20 Spending Reductions challenging for the Legislature to exert and Delays $28 Billion 15 Budget its preferences in response. While Problem using some reserves at that time could 10 be reasonable, the Legislature could May Revision still face difficult decisions to ensure 5 Governor's Budget the budget is on sound fiscal footing in future years. www.lao.ca.gov 1 2023-24 BUDGET INTRODUCTION On May 12, 2023, Governor Newsom In the coming days, we will analyze the plan in presented a revised state budget proposal to more detail and provide additional comments in the Legislature. (This annual proposed revised hearing testimony. The information presented in budget is called the “May Revision.”) In this brief, this brief is based on our best understanding of we provide a summary of and comments on the administration’s proposals as of May 13, 2023. the Governor’s revised budget, focusing on the In many areas of the budget, our understanding will overall condition and structure of the state General continue to evolve as we receive more information. Fund—the budget’s main operating account. $28 BILLION BUDGET PROBLEM In this section, we present our estimates of estimates included an assumption about the costs the budget problem the Governor addressed in of inflation in future years that was not current law. the May Revision budget proposal. Importantly, We explained those differences in more detail in the estimates in this section are predicated on our report, The 2023-24 Budget: Overview of the the administration’s revenue projections. As we Governor’s Budget. discuss later in this report, the administration’s Budget Problem Increased $10.4 Billion revenue projections are optimistic. Under our own Since January. We estimate that, under the projections, the budget problem would be larger. administration’s policies and assumptions, the What Is a Budget Problem? A budget budget problem grew by $10.4 billion since problem—also called a deficit—occurs when the administration’s January projections in the resources are insufficient to cover the costs of Governor’s budget. There are a range of factors, currently authorized services. Under the State some offsetting, that contribute to the growing Constitution, a budget problem must be solved, budget problem. They are: for example, by increasing revenues or reducing • Revenues Lower by $9.4 Billion. spending. Due to a deteriorating revenue picture The administration’s baseline revenue relative to expectations from June 2022, both our estimates (that is, excluding constitutionally office and the administration have anticipated the required reserve deposits and policy choices) state faces a budget problem in the 2023-24 budget are lower by $8.4 billion across the three-year process. (The budget problem is calculated across budget window compared to January the budget window—that is, the three fiscal years estimates. (The total also includes about under review in the budget process. In this case, $1 billion in revenue adjustments attributable those years are: 2021-22, 2022-23, and 2023-24.) to 2020-21 and earlier.) This increases the size of the budget problem. THE BUDGET PROBLEM • Constitutional Requirements Lower by We Estimate the Governor Solved a $2.7 Billion. Reflecting these lower revenue $28.3 Billion Budget Problem in the May estimates, the administration’s estimates of Revision. Our estimate of the budget problem General Fund constitutional requirements is slightly lower than the $31.5 billion figure (including school and community college cited by the administration. The reasons for our spending, reserve deposits, and debt differences are generally the same as those we payments) are lower by $2.7 billion. This cited at the Governor’s budget, including the partially offsets the revenue decrease cost of certain assumptions and policies that the described above, reducing the size of the administration included in the baseline, but had not budget problem. been adopted. For example, the administration’s 2 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET • Spending and Other Adjustments Increase • New Discretionary Spending of Over Budget Problem by $2.7 Billion. Across $700 Million. We estimate the Governor the budget, baseline spending (meaning, proposed additional discretionary spending spending under current law) is higher than of over $700 million in the May Revision. Governor’s budget estimates by $2.7 billion. This adds to the $2.2 billion in discretionary Some of the contributors to this increase spending proposed in January for a total of include baseline costs in Medi-Cal and $2.9 billion. A forthcoming appendix also In-Home Supportive Services. Higher provides a list of these proposals, which baseline spending increases the size of the increase the size of the budget problem. The budget problem. nearby box includes more information on how we categorize adjustments for universities, courts, and employee compensation. Adjustments for Universities, Courts, and Employee Compensation We define discretionary spending as new spending not required under current law or policy. We generally do not assume annual cost increases for inflation and other cost pressures, except where the Legislature has a practice of enacting them. Programs for which the Legislature generally has provided these increases include: universities, employee compensation, and courts. In these cases, as long as the administration’s proposed increase is consistent with our estimate of underlying cost pressures, we do not consider the augmentation to be discretionary. For example, the Governor proposes $443 million to provide 5 percent base General Fund increases for the universities, which we do not include in the forthcoming Appendix on discretionary spending. That said, to address the budget problem, the Legislature could choose to provide a lower amount for universities and other similar items. HOW THE GOVERNOR PROPOSES SOLVING Figure 1 THE BUDGET PROBLEM How the May Revision The State Constitution requires the Addresses a $28 Billion Budget Problem Legislature to enact a balanced budget, (In Billions) which means the Governor must propose solutions when the administration estimates Revenue Increases Reserve $30 the state faces a deficit. The state has and Shifts Withdrawal many types of solutions—or options— 25 Cost Shifts for addressing a budget problem, but the most important include: reserve 20 Spending Reductions withdrawals, spending reductions, revenue and Delays $28 Billion 15 Budget increases, and cost shifts (for example, Problem between funds). 10 Figure 1 summarizes the budget May Revision 5 Governor's Budget solutions that the Governor proposes using to address the $28.3 billion budget problem. As the figure shows, while the January Governor’s budget focused primarily on spending solutions, the May Revision solves www.lao.ca.gov 3 2023-24 BUDGET much of the additional budget problem by shifting proposes delaying: $550 million in grants for early more costs and increasing revenues. That said, education facilities from 2023-24 to 2024-25 and spending solutions still represent about half of the $550 million for broadband last-mile project grants total proposals. Total budget solutions proposed from 2023-24 to future years. To the extent budget in the May Revision (including those that persisted problems persist—as we anticipate is likely—the from the Governor’s budget) are: $15.1 billion in Legislature will have to revisit these and other spending reductions and delays, $9.1 billion in spending augmentations again. cost shifts, $3.7 billion in revenue increases and $5.1 Billion in Reductions. We define a shifts, and $450 million in reserve withdrawals. spending reduction as the elimination of an The remainder of this section describes each of augmentation previously approved under current these components in more detail. (In this figure law or policy. The May Revision includes $5.1 billion and throughout the report, some of the estimates in reductions, the largest of which is withdrawing cited here for the Governor’s budget might not a discretionary principal payment on state’s match estimates provided in our Overview of the unemployment insurance loan (which otherwise is Governor’s Budget, published in January. In these paid by employers’ payroll taxes). The May Revision cases, our understanding of the proposals has also includes a proposal to delay providing ongoing evolved since we published that report.) General Fund for financial assistance to Covered California enrollees, freeing up $304 million. About $15.1 Billion one-third of the Governor’s spending solutions Spending-Related Solutions are reductions. The Governor’s May Revision includes $3.7 Billion in Reductions Subject to Trigger $15.1 billion in spending-related budget solutions, Reduction. The May Revision proposes making a slight increase relative to the Governor’s one-quarter of all spending-related solutions budget. That said, although spending reductions subject to trigger restoration language. Under increased on net, the May Revision also withdraws this proposed language, program spending that some spending reductions proposed in January. otherwise would have occurred in 2023-24 would For example, the May Revision retracts the not be allocated as part of the June budget act. proposed reduction to the Court Appointed However, if in January 2024 the administration Special Advocate program and proposes using estimates there are sufficient resources available an alternative fund source for a portion of the to fund these expenditures, those programs would Behavioral Bridge Housing program, rather than a be restored halfway through the fiscal year. Many General Fund delay. of the spending solutions in natural resources The May Revision spending proposals can be and environment, transportation, and housing categorized into three types: reductions, delays, and homelessness are subject to this trigger and reductions subject to trigger restoration. Nearly restoration language. That said, our revenue all of these solutions would apply to one-time and estimates suggest it is unlikely that these trigger temporary spending. The forthcoming appendix restorations can be afforded in 2023-24. As such, provides a list of these proposed solutions. The the Legislature should consider these solutions as remainder of this section describes each of these spending reductions. types in turn. $9.1 Billion Cost Shifts $6.3 Billion in Delays. We define a delay as an expenditure reduction proposed for the We estimate the May Revision includes budget window (2021-22 through 2023-24) with $9.1 billion in cost shifts, a $6 billion increase an associated cost increase in a future year of relative to January. Cost shifts occur when the state the multiyear (2024-25 through 2026-27). That is, moves costs between entities, fund sources, or the spending would be moved to a future year. across fiscal years. For example, shifting spending Less than half of the Governor’s spending-related from the General Fund to special funds or, as has solutions are delays. For example, the Governor been done in prior budgets, shifting costs from 4 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET the state to local governments. Major cost shift to be used to draw down federal funding to support proposals in the May Revision include: (1) $2 billion Medi-Cal. We estimate that, in 2023-24 specifically, in loans from special funds (and other state funds) the MCO tax proposal would provide $3.5 billion to to the General Fund; (2) a shift of $1.1 billion in costs address the budget problem. In addition, the May for zero-emission vehicles from the General Fund Revision proposes reverting $200 million in unspent to the Greenhouse Gas Reduction Fund; (3) early funds associated with the Middle Class Tax Refund reversion of unspent funds in General Child Care to the General Fund. (as estimated by the Department of Finance) and $450 Million Reserves California Work Opportunity and Responsibility to Kids (CalWORKs); and (4) shifts in a variety of Uses $450 Million From the Safety Net capital outlay projects from General Fund cash to Reserve. The 2018-19 budget created the Safety bonds, for example for climate projects, student Net Reserve to set aside funds for future costs housing, and clean energy projects. (Bonds of two programs—CalWORKs and Medi-Cal— associated with the climate projects and clean in the event of a recession. Absent policy energy would require voter approval to move changes, these programs typically experience forward.) While swapping bonds for General Fund increased expenditures during a recession when is a reasonable response to weakening fiscal unemployment increases and program caseloads conditions, the merits of the individual projects rises. The reserve has a balance of $900 million proposed warrant scrutiny, especially given that and the May Revision proposes using half of that to with higher interest rates, the related debt servicing address the budget problem in 2023-24. costs will be higher into the future. The forthcoming Maintains State’s Constitutional Reserves. appendix provides a full list of these proposed The state has two main constitutional reserve cost shifts. accounts: the Budget Stabilization Account (BSA), which can help address a budget problem, $3.7 Billion Revenue-Related Solutions and the School Reserve, which can supplement The May Revision includes $3.7 billion in otherwise required spending on schools and revenue-related solutions, an increase of community colleges (and cannot help address the $3.4 billion from January. The main proposal in this budget problem). In order for the state to make area is a renewal and increase in a tax on health discretionary withdrawals from either of these insurance plans known as the managed care accounts, the Governor must declare a budget organization (MCO) tax. Under the proposal, the tax emergency. Although a budget emergency is likely would last from April 2023 through December 2026 available, the Governor does not propose using and be used to maintain and augment support for funds from either the BSA or the School Reserve in Medi-Cal, the state’s Medicaid program. The tax the May Revision. also requires approval from the federal government www.lao.ca.gov 5 2023-24 BUDGET MAY REVISION BUDGET CONDITION In this section, we describe the overall address the budget problem. As a result, under condition of the General Fund budget after the administration’s estimates and assumptions, accounting for the May Revision proposals general purpose reserves would total $26.5 billion and solutions. We also describe the condition by the end of 2023-24. In addition, the state would of the school and community college budget. have $10.7 billion in the School Reserve, available As is the case in the previous section, all of the only for school and community college programs. estimates and figures here are predicated on the In both cases, the state would have reached the administration’s revenue projections. constitutional maximum for the accounts. Budget Condition Expected to Continue to General Fund Budget Deteriorate. Under the administration’s estimates Figure 2 shows the General Fund condition and assumptions, the budget condition would under the May Revision. The state would end worsen in future years. Specifically, under these 2023-24 with $3.8 billion in the Special Fund estimates, the state faces operating deficits of for Economic Uncertainties (SFEU). The SFEU around $15 billion in each year of the outlook is the state’s operating reserve and essentially (2024-25 through 2026-27). Cumulatively, these functions like an end-of-year balance. The State deficits would compound such that the state would Constitution’s balanced budget provision prohibits have a negative $41 billion balance in the SFEU by the state from enacting a negative SFEU balance 2026-27. As such, these operating deficits represent for the upcoming fiscal year, in this case, 2023-24. future budget problems the Legislature would While historically the state mostly has enacted need to address. The budget condition will look SFEU balances between $1 billion and $4 billion, different under our revenue estimates, however. the Legislature can choose to set the balance at any We will address the budget’s multiyear condition in level above zero. greater detail in our forthcoming report, The 2023-24 Under May Revision, Reserves Would Total Budget: Multiyear Budget Outlook. $26.5 Billion by End of 2023-24. As mentioned School and Community College Budget earlier, the Governor’s May Revision does not propose using any constitutional reserves to Proposition 98 Minimum Guarantee Down Over Budget Window. The State Figure 2 Constitution sets a minimum annual funding requirement for schools General Fund Condition Summary and community colleges. The (In Millions) minimum guarantee is met with a combination of General Fund 2021-22 2022-23 2023-24 Revised Revised Proposed and local property tax revenue. Compared with the estimates Prior-year fund balance $40,057 $55,462 $24,118 Revenues and transfers 232,537 205,129 209,054 included in the June 2022 budget Expenditures 217,133 236,472 224,101 plan, the administration revises its Ending fund balance $55,462 $24,118 $9,072 estimates of the minimum guarantee Encumbrances $5,272 $5,272 $5,272 up $317 million in 2021-22 and SFEU Balance $50,190 $18,846 $3,800 down $3.6 billion in 2022-23. Reserves For 2023-24, the administration BSA $21,708 $22,252 $22,252 estimates the minimum guarantee SFEU 50,190 18,846 3,800 is $106.8 billion—$3.5 billion below Safety net 900 900 450 the 2022-23 level enacted last June. Total Reserves $72,798 $41,998 $26,502 SFEU = Special Fund for Economic Uncertainties and BSA = Budget Stabilization Account. 6 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET The net decrease over the period is primarily for existing programs. Compared with the June attributable to lower General Fund revenue 2022 budget plan, it also includes a net increase of estimates, somewhat offset by higher local $1.1 billion in constitutionally required deposits into property tax revenue. the School Reserve, as well as a few new ongoing Includes Additional Ongoing Spending, and one-time initiatives. To cover these increases Makes Reductions to Previous One-Time and avoid spending more than the guarantee, the Augmentations. Despite the drop in the May Revision proposes $5.1 billion in reductions to guarantee, the May Revision proposes to provide several one-time grants approved last year. an 8.22 percent statutory cost-of-living adjustment COMMENTS Administration Maintains Some Spending discretionary proposals without prejudice, unless Augmentations Using Safety Net Reserve and they address an immediate safety or health issue. Budget Borrowing. Although the administration In most cases, doing so would not impact current proposes about $15 billion in spending-related services provided by the state. solutions in its budget proposal, the administration Revenues Estimates Are Always Uncertain. still maintains significant one-time or temporary The administration points out that there is elevated spending augmentations slated for 2023-24. uncertainty in this year’s revenue outlook. To support this spending, at least in part, the Significant revenue uncertainty, however, is not administration uses about $2.5 billion in special unique to this year. Due to economic unknowns, fund loans and reserve withdrawals. Using these policy changes, and other potential disruptions, funds now means the state will not have them to revenues forecasts are always uncertain. This year, support core programs later in the likely event that as always, we advise adopting the best possible budget problems persist. In order to minimize the revenue estimate based on all available economic likelihood of future reductions to core programs, the and revenue data. We do not view revenue Legislature could reduce more one-time spending uncertainties as a cause for inaction or a reason to instead of using these reserves and special adopt optimistic revenue assumptions. fund loans. Adopting Administration’s Revenue Estimates May Revision Predicated on Optimistic Sets Up Difficult January. We advise the Revenues. Across 2021-22 to 2023-24, our Legislature to adopt our revenue estimates, which tax revenue estimates are $11 billion lower than are less likely to result in unanticipated shortfalls in the administration’s May Revision estimates. the future. Adopting the administration’s revenue We discuss our revenue estimates in greater detail estimates, by contrast, would mean there is a here: The 2023-24 Budget: May Revenue Outlook. two-in-three chance that the state’s shortfall will Based on our assessment, there is a roughly grow, necessitating more budget solutions in next two-thirds chance revenues will come in below year’s budget. For example, under our revenues, May Revision estimates. As such, while we consider and after accounting for constitutional spending the May Revision revenues plausible, adopting them requirements, the budget problem for 2023-24 would present considerable downside risk. is $6.2 billion larger than the administration’s Budget Problem Magnified by New estimates. This would add to the administration’s Proposals. The May Revision includes $2.9 billion already planned deficit for 2024-25 of $14 billion. in new, discretionary spending proposals. Put another way, adopting the Governor’s plan sets These proposals add to the budget problem dollar the Legislature up for another double-digit budget for dollar, necessitating spending reductions and problem, involving even more difficult budget other budget solutions. Given the budget problem, decisions, next year. we recommend the Legislature reject all new www.lao.ca.gov 7 2023-24 BUDGET Spending Reductions for 2023-24 Will need to be based on what money has gone out the Be More Challenging Next Year. The state door instead of the state’s priorities. This approach currently has $11 billion in one-time or temporary could be particularly disruptive to program spending planned for 2023-24—amounts that participants who would have planned on receiving appeared affordable when they were enacted the funds. Moreover, the administration will have in previous years, but appear less so today. If an information advantage—it knows better what budget problems persist, as is likely, pulling money has or has not been dispersed—making back more of this spending will be necessary, at it more challenging for the Legislature to exert least in part. Doing so now—in response to our its preferences in response. While using some lower revenue projections—would be better than reserves at that time could be reasonable, the waiting until next year for a few reasons. Once Legislature could still face difficult decisions to the new fiscal year begins, state departments ensure the budget is on sound fiscal footing in will begin obligating and distributing these funds future years. as planned.As such, midyear pullbacks would 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. 8 LEGISLATIVE ANALYST’S OFFICE