The 2023-24 Budget: Multiyear Budget Outlook

2023-24 BUDGET The 2023-24 Budget: Multiyear Budget Outlook GABRIEL PETEK | LEGISLATIVE ANALYST | MAY 2023 KEY TAKEAWAYS Very Unlikely the State Will Be Able to Afford the May Revision Spending Levels. Under our estimates, the state faces operating deficits throughout the multiyear window, meaning revenues would need to come in above our projections for the budget to be balanced. While the revenues required to balance the budget are optimistic, but plausible, in the budget window, they are improbable in the out-years. For example, to eliminate the operating deficit in 2024-25, revenues would need to be roughly $30 billion higher than our forecast. Our analysis suggests that level of revenue is very unlikely—there is less than a one-in-six chance the state can afford the May Revision spending level across the five-year period. This means that, if the Legislature adopts the Governor’s May Revision proposals, the state very likely will face more budget problems over the next few years. Multiyear One-Time and Temporary Spending Commitments No Longer Affordable. In 2021-22 and 2022-23, the Legislature committed to future one-time and temporary spending in 2023-24 and beyond. Most of this spending no longer appears to be affordable. While the May Revision makes several billion dollars in spending reductions, it maintains $11 billion in one-time and temporary spending in 2023-24. We recommend this spending be reduced further (from $11 billion to roughly $4 billion) and out-year one-time and temporary spending be eliminated entirely, as explained further below. Combination of Reserves and Reduced One-Time Spending Extends Budget Capacity for State to Sustain Core, Ongoing Programs. Under our outlook, reserves would cover nearly half of the projected multiyear deficits while reducing $18 billion of one-time and temporary spending would cover an additional third. The remainder—$12 billion, shown on the far right of the figure—would need to be addressed with other solutions, like revenue increases, cost shifts, and other spending reductions. Taken together, reducing spending and using reserves give the Legislature a few years to align revenues and spending as the economic picture unfolds. Combination of Reserves and Reduced One-Time Spending Extends Budget Capacity for State to Sustain Core, Ongoing Programs (In Billions) Reducing One-Time and Reserves Cover Nearly Half of Projected Deficits Temporary Spending Shrinks Future Deficits -5 -5 -10 -10 -15 -15 -20 -20 -$25 -$25 2023-24 2024-25 2025-26 2026-27 2023-24 2024-25 2025-26 2026-27 Remaining Budget Problem Budget Problems Covered by Reserves www.lao.ca.gov 1 2023-24 BUDGET INTRODUCTION This brief presents our office’s independent May Revision policies were adopted. The first assessment of the condition of the state General section of the brief presents our analysis of the Fund budget through 2026-27 under our forecast of budget condition under these assumptions. revenues and spending, assuming the Governor’s The second section provides our comments. ANALYSIS Budget Problem $6 Billion Larger in the 2024-25 budget process. (This would add to the 2023-24 Under LAO Estimates. Under our double-digit budget problem for 2024-25 already office’s projections, and assuming the Governor’s projected under both our and the administration’s May Revision policies were adopted, the budget estimates, as we describe below.) problem for this year is $34.5 billion—$6.2 billion LAO Spending Estimates Over $10 Billion higher than our estimate under the administration’s Higher Than the Administration by 2026-27. projections. There are two key, partially offsetting, By 2026-27, our estimate of General Fund reasons for this roughly $6 billion difference: spending (excluding spending on schools and • Lower Revenues. Across the budget window community colleges) is $10 billion higher than the (2021-22 through 2023-24), our revenue administration’s estimate. At an agency level, the projections are $11 billion lower than the single largest contributor to this difference is Health administration’s estimates. We discuss our and Human Services (HHS). Across all programs economic and revenue outlook in greater in this agency (including, for example, Medi-Cal, detail here: The 2023-24 Budget: May In-Home Supportive Services, developmental Revenue Outlook. Lower revenues result in services, and child care), our estimates are a larger budget problem. $6 billion higher than the administration’s projection by 2026-27. Between 2023-24 and 2026-27, • Lower Constitutional Requirements. HHS programs grow at an average annual rate of Coupled with our lower revenue estimates, 5.5 percent under our projections, compared to we also estimate that spending on 3.4 percent under the administration’s estimates. constitutional requirements is correspondingly Remaining programs—including employee lower by $4.8 billion. (Lower spending partially compensation, pensions, and higher education— offsets the increase in the budget problem.) are responsible for the remaining $4 billion in These requirements are based on formulas difference in that year. As we have commented that tend to increase spending when revenues in the past, our office has little insight into the grow and reduce spending when revenues components of, or assumptions underlying, the decline. These formulas include spending administration’s projections in HHS. As a result, on schools and community colleges (under we cannot identify the precise source of these Proposition 98 [1988]), as well as debt differences—or the comparative reliability of our payments and reserve deposits (under the respective estimates—with confidence. rules of Proposition 2 [2014]). General Fund Spending on Schools and If the Legislature adopts the administration’s Community Colleges Grows Moderately Under revenue estimates—and does not solve the LAO Revenues. Under our outlook, Proposition 98 additional budget problem we identify above— General Fund spending on schools and community we anticipate there will be a revenue shortfall in colleges is $89 billion in 2026-27—nearly $12 billion 2023-24. As a result, the Legislature would need to above our projected 2023-24 level and $5 billion address this additional budget problem as part of higher than the administration’s projection for 2 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET 2026-27. Both of these figures are attributable to our office’s projections of the state’s budget growth in revenue and the Proposition 98 formula condition compared to the administration’s that reserves a minimum percentage of that revenue estimates. As the figure shows, both of our offices (just under 40 percent) for school and community project the state will have operating deficits (budget college programs. A small portion of the increase problems) over the multiyear period. The operating relative to 2023-24 (about $1.5 billion) reflects the deficits under our forecast are slightly larger— continuing expansion of transitional kindergarten ranging from $14 billion to $20 billion—compared to in 2024-25 and 2025-26. (The June 2021 budget those under the administration’s forecast—ranging plan contained an agreement to make all four-year from $14 billion to $17 billion. There are three olds eligible for transitional kindergarten by 2025-26 reasons for these differences (some offsetting): and required the state to adjust the Proposition 98 (1) our revenue estimates are somewhat higher than requirement upward for the associated costs.) the administration in the out-years, particularly in When combined with slightly smaller increases in 2026-27; (2) our higher revenue estimates result the local property tax portion of Proposition 98, in higher spending on schools and community overall growth in school and community college colleges; and (3) as noted above, our estimate funding would average around 4.6 percent annually. of spending on all other programs is higher than Operating Deficits Average $18 Billion the administration’s projections over the period, Annually Under LAO Estimates. Figure 1 shows reaching a difference of $10 billion by 2026-27. Figure 1 Operating Deficits Somewhat Larger Under LAO Projections (In Billions) -5 -5 Additional budget problem under -10 LAO revenues -10 -15 -15 -20 -20 LAO Projected Operating Deficits Administration Projected Operating Deficits -$25 -$25 2023-24 2024-25 2025-26 2026-27 2023-24 2024-25 2025-26 2026-27 www.lao.ca.gov 3 2023-24 BUDGET Very Unlikely the State Will Be Figure 2 Able to Afford the May Revision Spending Levels. While both our and Very Unlikely State Can Afford the the administration’s forecasts suggest May Revision Spending Level the state faces operating deficits, Total Revenue (In Billions) revenues could differ substantially from these estimates. Figure 2 displays the $280 distribution of the most likely revenue The shaded area shows how far outcomes over the multiyear (in light revenues could deviate from our Revenues Needed to Support 260 main forecast. Outcomes beyond May Revision Spending Level purple). As seen in the figure, while the the shaded area are possible, but revenues most likely will fall in the revenues required to balance the budget 240 shaded area. (in green) are optimistic, but plausible, in the budget window, they are improbable 220 in the out-years. For example, to eliminate the operating deficit in 2024-25, revenues 200 LAO Forecast would need to be roughly $30 billion higher than our forecast (in dark purple). 180 Our analysis suggests that level of revenue is very unlikely—there is less than 160 a one-in-six chance the state can afford 2021-22 2022-23 2023-24 2024-25 2025-26 2026-27 the May Revision spending level across the five-year period. This means that, if the Legislature adopts the Governor’s May Revision proposals, the state very likely will face more budget problems over the next few years. COMMENTS Multiyear One-Time and Temporary Proposed Spending Delays Are Likely Spending Commitments No Longer Affordable. Unaffordable. This year, the Governor proposes In budget-related legislation, the Legislature often delaying some spending planned for 2023-24 to commits to future spending augmentations. In future years. We find it is very unlikely that future 2022-23, for example, the Legislature committed budgets will have the capacity to accommodate tens of billions of dollars to one-time and temporary all of the out-year spending planned under the spending in 2023-24 and later. Establishing future Governor’s May Revision, including the proposed spending commitments allows the Legislature to spending delays. As a result, we recommend the exert its priorities in future budgets in advance of Legislature ensure high-priority, one-time spending new proposals from the Governor. However, these is included in this year’s budget because future commitments should be understood to be subject one-time spending is unlikely to be affordable. to change due to the uncertainty surrounding Reserves Cover Nearly Half of Projected revenue projections. Most of this spending no Cumulative Budget Problems Over the longer appears to be affordable. Under our Multiyear. Under our estimates, the state would revenues, we recommend one-time spending have $22 billion in general purpose reserves that it in 2023-24 be reduced further (from $11 billion could use to cover the deficits shown in Figure 1. to roughly $4 billion) and out-year one-time and (This would include $21.7 billion in the Budget temporary spending be eliminated entirely, as Stabilization Account and $450 million in the explained further below. 4 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET Safety Net Reserve.) Cumulatively, deficits would Combination of Reserves and Reduced be $52 billion over the period, meaning the state One-Time Spending Extends Budget Capacity could cover nearly half of the projected deficits for State to Sustain Core, Ongoing Programs. using reserves alone, as shown on the left side of Taken together, reducing spending and using Figure 3. As reserves are not sufficient cover the reserves give the Legislature a few years to align full projected budget problems under our forecast, revenues and spending as the economic picture the Legislature would need to use other options (for unfolds. Using only one or the other would mean example, spending reductions, revenue increases, the Legislature would need to make more difficult or cost shifts) to address the remaining $30 billion decisions—like cuts to core programs or revenue in deficits. Reducing one-time and temporary increases—at least one year earlier. Although spending would address an additional $18 billion. revenue estimates are subject to uncertainty, The remainder—$12 billion, shown on the far right revenues are very unlikely to grow sufficiently to in Figure 3—would need to be addressed with cover planned spending. Consequently, we advise other solutions. the Legislature to begin to address future budget problems by reducing additional one-time spending as part of this year’s budget process. Figure 3 Combination of Reserves and Reduced One-Time Spending Extends Budget Capacity for State to Sustain Core, Ongoing Programs (In Billions) Reducing One-Time and Reserves Cover Nearly Half of Projected Deficits Temporary Spending Shrinks Future Deficits -5 -5 -10 -10 -15 -15 -20 -20 -$25 -$25 2023-24 2024-25 2025-26 2026-27 2023-24 2024-25 2025-26 2026-27 Remaining Budget Problem Budget Problems Covered by Reserves www.lao.ca.gov 5 2023-24 BUDGET 6 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET www.lao.ca.gov 7 2023-24 BUDGET 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