The 2024-25 Budget: Overview of the Governor's Budget

2024-25 BUDGET The 2024-25 Budget: Overview of the Governor’s Budget GABRIEL PETEK | LEGISLATIVE ANALYST JANUARY 2024 www.lao.ca.gov 1 2024-25 BUDGET 2 LEGISLATIVE ANALYST’S OFFICE 2024-25 BUDGET Executive Summary Why Do Budget Problem Estimates Differ? A budget problem is inherently a point-in-time estimate that reflects information available at the time of development, forecasts of future revenues and spending, and assumptions about the extent to which changes in costs are due to current policy (that is, whether or not they are “baseline changes”). When changes in costs do not occur automatically under current policy, we count them as budget solutions or augmentations. We take this approach in order to provide the Legislature visibility into the full scope of the administration’s choices. What Is Our Estimate of the Budget Problem Under the Governor’s Budget? We estimate the administration solved a budget problem of $58 billion. Our estimate of the Governor’s budget deficit is larger than the administration’s estimate ($38 billion) largely due to differences in what we consider to be baseline changes. The largest of these changes impacts schools and community colleges. Specifically, the administration defines a $15 billion reduction to school and community college spending—relative to the enacted level in 2023—as a baseline change. How Does the Governor Propose to Solve the Budget Problem? The Governor’s budget solutions focus on spending. Spending-related solutions (including both school and community college spending and other spending) total $41 billion and represent nearly three-quarters of the total solutions. In addition, the Governor’s budget includes $13 billion in reserve withdrawals, which represent nearly one-quarter of the total; $4 billion in cost shifts; and about $400 million in revenue-related solutions. Assessing the Governor’s Approach. The Governor’s budget revenue projection is $15 billion higher than our Fiscal Outlook. This revenue estimate is plausible, but optimistic. On the spending side, there are strengths and weaknesses to the Governor’s approach. In particular, the Governor’s reserve withdrawal is reasonable, and we think focusing on spending-related solutions is warranted. However, some significant spending-related solutions pose challenges. The budget lacks a plan for implementing proposed reductions to schools and community colleges, and some other solutions are unlikely to yield the anticipated savings. Further, the state faces significant deficits in the coming years, likely necessitating difficult decisions in the future, such as reductions to core services and/or revenue increases. Crafting the Legislature’s Budget. Overall, the Governor’s budget runs the risk of understating the degree of fiscal pressure facing the state in the future. The Legislature likely will face more difficult choices next year. To mitigate these challenges, we recommend the Legislature develop this year’s budget with a focus on future years. Specifically, we suggest the Legislature: (1)plan for lower revenues, (2) maintain a similar reserve withdrawal, (3) develop a plan for school and community college funding, (4) maximize reductions in one-time spending, and (5) apply a higher bar for any discretionary proposals and contain ongoing service level. www.lao.ca.gov 3 2024-25 BUDGET 4 LEGISLATIVE ANALYST’S OFFICE 2024-25 BUDGET INTRODUCTION On January 10, 2024, Governor Newsom on our initial review as of January 12. In the presented his proposed state budget to the coming weeks, we will analyze the plan in more California Legislature. In this report, we provide detail and release many additional issue-specific a brief summary of the Governor’s budget based budget analyses. WHAT IS THE BUDGET PROBLEM? A budget problem—also called a deficit— college spending—relative to the enacted level in arises when resources for the upcoming budget 2023—as a baseline change. As we explained in are insufficient to cover the costs of currently our report The 2024-25 Budget: California’s Fiscal authorized services. In the Governor’s budget, Outlook, these adjustments would not be automatic the administration estimated that the state faces under current law—they would require proactive a budget problem of $38 billion. In December, our choices by the Legislature—and therefore we office pegged the budget problem at $68 billion. count them as policy choices. Similarly, across the The difference between these estimates is narrower rest of the budget, we estimate the administration than these topline numbers might suggest. scores about $5 billion in other budget solutions A budget problem is inherently a point-in-time as baseline changes. This includes, for example, estimate that reflects information available at the $1.6 billion in spending delays for competitive time of development, forecasts of future revenues transit grant funds, a change in the General and spending, and assumptions about the extent Child Care budgeting methodology that results to which changes in costs are due to current policy in nearly $900 million in savings over the budget (that is, whether or not they are “baseline changes”). window, and a change in the distribution of funds When changes in costs do not occur automatically in the school facilities program that delays nearly under current policy, we count them as budget $700 million in spending until after 2024-25. solutions or augmentations. We take this approach If these actions were all counted as policy choices, in order to provide the Legislature visibility into rather than baseline changes, the resulting budget the full scope of the administration’s choices. problem would be $58 billion. This section walks through the sources of our We Estimate the Net Difference Between differences with the administration and how those LAO and Administration Budget Problems Is differences impact the budget problem estimate. About $10 Billion. The right side of Figure 1 shows We Estimate the Administration Solved the differences between our estimate of the a Larger Budget Problem—$58 Billion. administration’s budget problem versus our own While the Governor cited a budget problem of December 2023 estimate. The key difference $38 billion, we estimate the administration solved here is related to our offices’ respective revenue a budget problem of $58 billion. Our estimate of forecasts—the Governor’s are about $15 billion the Governor’s budget deficit is larger than the higher. Offsetting these higher revenues are administration’s largely due to differences in what some other changes. For example, the Governor we consider to be baseline changes. As the left side sets aside $3.4 billion for unexpected costs and of Figure 1 on the next page shows, we estimate proposes over $2 billion in new discretionary the administration counts about $21 billion in proposals. Both of these choices make the budget budget solutions as baseline changes. The largest problem larger and necessitate additional budget of these changes impacts schools and community solutions by these amounts. (We will provide tables colleges. Specifically, the administration defines of all of the Governor’s proposed solutions and a $15 billion reduction to school and community discretionary actions in forthcoming Appendices.) www.lao.ca.gov 5 2024-25 BUDGET Figure 1 We Estimate the Governor ...Roughly $10 Billion Lower Than Solved a $58 Billion Budget Problem… Our Fiscal Outlook Estimate (In Billions) -$10 -$10 Administration's Estimate -20 of the Budget Problem -20 Our Estimate of the Our Estimate of the LAO -30 Governor's Budget -30 Governor's Budget Fiscal Outlook Problem Problem Budget Problem -40 -40 -50 -50 LAO Lower K-14 Education Revenues -60 All Other -60 Budget Solutions -70 Counted as Baseline -70 Other Adjustments -80 -80 (For Example, SFEU Balance, Discretionary Proposals) SFEU = Special Fund for Economic Uncertainties. HOW DOES THE GOVERNOR PROPOSE ADDRESSING THE BUDGET PROBLEM? Figure 2 summarizes the budget solutions Governor’s spending-related solutions are one-time that this section describes in detail. The and temporary, rather than ongoing. The remainder Governor’s budget solutions focus on spending. of this section describes each of these types in turn. Spending-related solutions (including both school Reductions. Under our definition, a spending and community college spending and other reduction occurs when the Governor proposes spending) total $41 billion and represent nearly the state spend less money than what has three-quarters of the total solutions. In addition, the been established under current law or policy. Governor’s budget includes $13 billion in reserve More colloquially, these are spending cuts. withdrawals, which represent nearly one-quarter The Governor’s budget includes $8 billion of the total; $4 billion in cost shifts; and about in spending-related reductions. The largest $400 million in revenue-related solutions. include: a nearly $800 million reduction to state departments’ operation budgets, proposed to be Spending-Related Solutions allocated through departments’ vacancy rates; The Governor’s budget includes $26 billion about $500 million in savings to continue an in spending-related budget solutions (excluding existing two-week delay in Medi-Cal payments; a schools and community colleges). These solutions $500 million reduction to the school facilities aid can be categorized into four types: reductions, program; and a $350 million reduction to legislative delays, fund shifts, and reversions. Nearly all of the district projects. 6 LEGISLATIVE ANALYST’S OFFICE 2024-25 BUDGET Figure 2 How the Governor Addresses a $58 Billion Budget Problem Revenue Related Cost Shifts Reduction Reserve Withdrawals Other Spending-Related Delay Solutions School and Community College Spending (Proposition 98) Fund Shift Reversion Delays. We define a delay as an expenditure and local agencies will already be well underway reduction that occurs in the budget window in planning, financing, and beginning to implement (2022-23 through 2024-25), but has an associated these projects, not providing this funding in future expenditure increase in a future year of the years would cause disruptions. multiyear window (2025-26 through 2027-28). Fund Shifts. Fund shifts are budget solutions That is, the Governor proposes moving the that use other fund sources—for example, special spending to a future year. About $8 billion of the funds—to pay for a cost typically incurred by the Governor’s spending-related solutions are delays. General Fund. These shifts displace spending As a result, proposed spending is higher by that these special funds otherwise would have $5 billion in 2025-26, nearly $2 billion in 2026-27, supported. As a result, we consider these to be and roughly $1 billion in 2027-28. Given our and the a type of spending-related solution because they administration’s forecasts of the budget condition typically result in lower overall state spending, in future years, the state likely cannot afford inclusive of all funds. We estimate the Governor’s this spending. Although these delayed amounts budget includes $6 billion in fund shifts. This would be subject to future budget conditions includes: using nearly $4 billion in revenue from the and legislative decisions, some delays create managed care organization tax to offset General a relatively strong obligation or expectation on Fund costs in Medi-Cal and shifting $1.8 billion in the state. For example, the Governor proposes costs for multiple programs from the General Fund reverting and delaying provision of about $2.7 billion to the Greenhouse Gas Reduction Fund. in previously appropriated funding that already Reversions. Costs for state programs has been committed for specific state and local sometimes come in lower than the amount that was transportation projects. Because state departments appropriated. This often occurs, for example, when www.lao.ca.gov 7 2024-25 BUDGET the state overestimates uptake in a new program Although the Governor has not officially declared a or as a routine matter in programs where spending budget emergency for 2024-25 (or any other year in is uncertain due to factors like caseload. When the budget window), we agree that the conditions actual state costs are below budgeted amounts, a for a declaration exist. After a budget emergency is reversion occurs after a period of time—typically, declared, the state can withdraw up to half of the three years. The reversion returns the unspent constitutional balance of the BSA. (The Legislature funds to the General Fund. In this year’s budget, the also can withdraw the entire “discretionary” balance Governor proposes accelerating some reversions of the BSA at any time, which are amounts that that would have otherwise occurred in the future were deposited into the fund on top of Proposition 2 and proposes proactively reverting certain funds requirements.) The Governor proposes withdrawing that otherwise are continuously appropriated (which half of the BSA’s constitutional balance, $10.2 billion, has the effect of realizing savings from the unspent and the entire discretionary balance, $1.8 billion. funds that would not otherwise occur). While not all Safety Net Reserve. The Governor also of these amounts represent lower state spending proposes withdrawing the entire balance of the over the long term, they do result in savings Safety Net Reserve—$900 million. Withdrawing today at a cost in the future. As a result, we count the entire balance of the Safety Net Reserve may them as spending-related solutions. We estimate not be consistent with legislative intent. The Safety the proposed budget includes about $3 billion Net Reserve was designed to help cover costs in reversions. of increasing caseload in Medi-Cal and the California Work Opportunity and Responsibility School and to Kids (CalWORKs) program in the event of an Community College Spending economic downturn. Although caseloads under $15 Billion in Lower Spending on Schools and the Governor’s budget are higher than anticipated Community Colleges. The California Constitution in June, economic conditions likely do not yet sets a minimum annual funding requirement for match what the Legislature envisioned when it schools and community colleges (otherwise known created the reserve. Moreover, the administration as Proposition 98 [1988]). The state meets this proposes ongoing reductions to CalWORKs despite requirement through a combination of General Fund withdrawing these reserves. Withdrawing the spending and local property tax revenue. Due to entirety of this reserve may not be consistent with its the large decline in General Fund revenues, the original design. constitutionally required General Fund spending Cost Shifts level is down $15.2 billion relative to the estimates in the June budget. The Governor proposes to reduce The Governor’s budget includes about $4 billion school and community college spending to this in cost shifts. We define cost shifts as budget lower level (we describe the specific reductions in actions that achieve savings in the present, but the next section). result in a binding obligation or higher cost for the state in a future year. In that way, these actions Reserve Withdrawals can be similar to borrowing, but are often not Budget Stabilization Account. Proposition 2 explicitly structured as such. For example, major (2014) governs deposits into and withdrawals from categories of cost shifts in the Governor’s budget the state’s general-purpose constitutional reserve— include proposals to: defer one month of state the Budget Stabilization Account (BSA). Under employee payroll from June to July, which results in these rules, the state can make withdrawals from $1.6 billion in one-time savings; redirect a $1.3 billion the constitutionally required balance of the BSA in supplemental pension payment made under the a fiscal emergency, which occurs when estimated requirements of Proposition 2 for actuarially required resources for the upcoming year are insufficient contributions to the California Public Employee to cover the costs of the previous three enacted Retirement System, and $1.2 billion in special budgets, adjusted for inflation and population. fund loans. 8 LEGISLATIVE ANALYST’S OFFICE 2024-25 BUDGET Revenue-Related Solutions businesses’ ability to reduce their tax bill by counting previous losses against their current We estimate the Governor’s budget includes income. This would generate about $300 million in about $400 million in revenue-related solutions. additional revenue in 2024-25. For example, the Governor proposes narrowing BUDGET CONDITION In this section, we describe the overall condition of the General Figure 3 Fund budget after accounting for General Fund Condition Summary the Governor’s budget proposals (In Millions) and solutions. We also describe the condition of the school and 2022-23 2023-24 2024-25 community college budget. Revised Revised Proposed Prior-year fund balance $61,737 $42,078 $8,030 General Fund Budget Revenues and transfers 180,416 196,859 214,699 Figure 3 shows the General Expenditures 200,075 230,908 208,718 Ending fund balance $42,078 $8,030 $14,010 Fund condition based on the Encumbrances 10,569 10,569 10,569 Governor’s proposals and using SFEU balance 31,509 -2,539 3,441 the administration’s estimates Reserves and assumptions. BSA $21,708 $23,132 $11,106 SFEU 31,509 -2,539 3,441 Under Governor’s Budget, Safety net 900 900 — Reserves Would Total $14.5 Billion Total Reserves $54,117 $21,493 $14,547 by End of 2024-25. Under the BSA = Budget Stabilization Account and SFEU = Special Fund for Economic Uncertainties. Governor’s budget, general purpose reserves would total $14.5 billion by Figure 4 the end of 2024-25. (In addition, the state would have $3.9 billion in the State Faces Significant Operating Deficits Proposition 98 Reserve, available (In Billions) only for school and community college programs.) The remaining 2024-25 2025-26 2026-27 2027-28 balance of the BSA—$11 billion— would likely be available to address -$10 a budget problem next year in the very likely event that it occurs. -20 Administration Plans for Significant Future Budget -30 Deficits. The Governor’s budget -40 includes estimates of multiyear revenues and spending. Under the -50 administration’s projections, the LAO Budget Problem LAO Ongoing Deficits state faces operating deficits of -60 DOF Budget Problem (LAO Estimate) DOF Ongoing Deficits $37 billion in 2025-26, $30 billion -70 in 2026-27, and $28 billion in 2027-28. (As shown in Figure 4, -80 these deficits are very similar to our DOF = Department of Finance. www.lao.ca.gov 9 2024-25 BUDGET December projections of the budget’s position— Fund spending on school and community college although our estimates were based on current law programs in 2022-23 by $8 billion. The budget and policy, not the Governor’s budget proposals.) does not specify how the state will implement this Although these future deficits are smaller than the reduction, but indicates the state will make the current one, they are still quite significant. Moreover, reduction in a way that avoids impacting school and the state is likely to face these deficits with fewer community college budgets. We also understand options—such as one-time spending reductions and that as part of this action, the state would make reserves. As such, future deficits are likely to require supplemental payments totaling $8 billion over a more difficult decisions, like ongoing spending cuts five-year period (from 2025-26 through 2029-30). and revenue increases. (Separate from this proposal, the budget scores $1.1 billion in lower baseline spending in 2022-23.) School and Proposes Discretionary Withdrawal From Community College Budget Proposition 98 Reserve. The Proposition 98 Funding for Schools and Community Colleges Reserve is a statewide reserve account for school Down $14.3 Billion Over Budget Window. and community college funding. The Governor Compared with the estimates included in the proposes to make a discretionary withdrawal of June 2023 budget plan, the administration estimates $5.7 billion from this account to help cover costs for the constitutional minimum funding level for schools existing school and community college programs and community colleges is down $14.3 billion over in 2023-24 and 2024-25. After accounting for the the 2022-23 through 2024-25 period. This downward discretionary withdrawal and a few other automatic revision consists of a $15.2 billion reduction in adjustments, the remaining balance in the reserve required General Fund spending, partially offset would be $3.9 billion. by a $903 million increase in local property tax Funds Augmentations in a Few Areas. revenue. Most of the reduction—$9.1 billion—is The most notable ongoing augmentation is a attributable to 2022-23, with the remainder divided 0.76 percent statutory cost-of-living adjustment about evenly between 2023-24 and 2024-25. (COLA) for existing school and community college The Governor proposes to reduce funding to the programs. The most notable one-time proposal is lower constitutional level through a combination of $500 million for a second round of grants funding spending reductions and discretionary withdrawals zero-emission school buses. The budget also from the Proposition 98 Reserve. These reductions proposes smaller increases related to the educator also free up funding for a few smaller augmentations. workforce, education technology, and community Assumes $8 Billion in Lower Spending in college nursing programs. 2022-23. The budget proposes to reduce General ASSESSING THE GOVERNOR’S APPROACH Revenues Optimistic but Plausible. current year, we are yet to see clear signs of such California entered a revenue and economic a rebound. Income tax withholding is up only downturn last fiscal year. State tax revenues fell 2 percent. Sales tax collections are down slightly. 20 percent. The number of unemployed workers In the relatively important collections month of in California increased by 200,000. A key question December, corporation tax collections posted for this budget is: to what extent and for how long double digit declines. Unemployment continues will this downturn persist? The Governor’s budget to tick up consistently each month. One potential assumes a quick return to growth, projecting reason for optimism is the rebound in stock prices an 8 percent increase in tax revenues in the that occurred over the last year, especially in the current fiscal year. While possible, we think this spring of 2023. Stock market rallies, however, assumption is optimistic. Halfway through the can reverse as quickly as they start. Further, the 10 LEGISLATIVE ANALYST’S OFFICE 2024-25 BUDGET relationship between stock price gains and state core service level. There are some solutions, revenues is complex. Any two similar stock market however, that may not yield the savings required to rallies can have significantly different impacts on balance the budget. For example, across-the-board state revenues. reductions—like the proposal to allocate general Reserve Withdrawals Generally Reasonable. funding cuts to departments based on their The Governor proposes withdrawing roughly half of vacancy rates—historically have not generated the the BSA and the entire Safety Net Reserve to help initially assumed savings. In addition, as discussed solve the budget problem. While the administration earlier, some proposed solutions increase future likely could withdraw the entire balance of the BSA budget pressure and shift fiscal risk to other under the rules of Proposition 2 (for example, if the entities. In addition to the transportation example Governor declared a budget emergency for multiple provided earlier, the administration suggests years in the budget window), maintaining a sizeable the University of California and California State balance in the BSA is prudent given the continued University could use delayed payments as collateral budget problems likely for future years. against borrowing. Not only would this proposal increase the pressure on the state to provide these Budget Lacks Plan for Implementing payments next year—despite continued deficits— Proposed Reductions in School and Community but it also would shift fiscal risk to these entities College Spending. The largest source of savings in the event the state does not ultimately make within the Governor’s school and community these payments. college spending package is a proposed reduction of $8 billion in 2022-23 funding. The administration, Despite Spending-Related Solutions, however, has not explained how its proposal Governor’s Budget Likely Unsustainable in could achieve $8 billion in savings, given the Future Years. The state faces significant operating administration also indicates the proposal would deficits in the coming years, which are the result not impact school and community college budgets. of lower revenue estimates, as well as increased The Legislature will need significantly more cost pressures. These deficits are somewhat information before it can assess the proposal— compounded by the Governor’s budget proposals including its potential effects on the state budget to delay spending to future years and add billions after 2024-25. The Legislature also may want to in new discretionary proposals. State revenues consider alternative solutions, such as making in the out-years would need to exceed the additional withdrawals from the Proposition 98 administration’s forecast by roughly $50 billion per Reserve, funding fewer augmentations, or making year in order to sustain the spending proposed by targeted reductions to existing programs. the Governor’s budget. While our multiyear revenue forecast is somewhat above the administration, it Governor’s Spending-Related Solutions is well below amount needed to close the deficits. Warranted, but Some Solutions Could Pose Thus, while it may be reasonable to expect some Challenges. The administration proposes upside to the administration’s multiyear revenues, spending-related solutions (excluding school and it is unlikely this upside will resolve the out community college spending) of $26 billion. This is year deficits. a good start to solving the budget problem as these reductions largely do not impact the state’s ongoing CRAFTING THE LEGISLATURE’S BUDGET Overall, the Governor’s budget runs the risk of In particular, most of the recommendations we understating the degree of fiscal pressure facing make here would mitigate some of the need the state in the future. The Legislature likely will face for even more difficult decisions in the future, more difficult choices next year. To mitigate these such as reductions to core services and/or challenges, we recommend the Legislature develop revenue increases. this year’s budget with a focus on future years. www.lao.ca.gov 11 2024-25 BUDGET Plan for Lower Revenues. By May, we will Maximize One-Time Spending Reductions. be much closer to resolving the question of how The Governor’s budget includes $26 billion in much (if at all) revenues will rebound in the current spending-related solutions (excluding school and fiscal year. While many outcomes are possible, community college solutions). While the Governor’s our assessment of the current evidence suggests budget likely reflects pulling back most recently the resolution of this question likely will result in approved one-time and temporary spending, we the administration revising down their revenue are still assessing whether any additional such estimates in May. Should this occur, it would appropriations remain. To the extent they do, necessitate additional budget solutions. We advise we recommend the Legislature assess whether the Legislature to begin to consider now what those additional pull backs could be achieved, including solutions could be. in the current year. Maximizing one-time spending Maintain Similar Reserve Withdrawal. We reductions allows the Legislature to minimize the advise the Legislature to use no more in reserves use of other budget tools—like reserves—that than proposed by the Governor—currently about likely will be needed in future years. To ensure half of general-purpose reserves. Given the state these one-time savings can be realized, the is likely to continue to face significant budget Legislature may wish to consider early action on problems in the coming years, depleting reserves current-year appropriations. now would make reductions to ongoing programs Apply High Bar for Any Discretionary and/or ongoing revenue increases more likely. Proposals and Contain Ongoing Service Develop Plan for School and Community Level. The Governor’s budget includes roughly College Funding. Given the lack of clarity in the $2 billion in discretionary proposals for 2024-25. Governor’s proposal, the Legislature may want to To balance the budget, these discretionary develop its own plan for addressing school and proposals require additional reductions to community college funding. As we describe in already approved expenditures. Consequently, our Fiscal Outlook, the Legislature could use the we recommend the Legislature set a very high existing balance in the Proposition 98 Reserve threshold for approving these new proposals. to help cover spending above the constitutional Specifically, the Legislature would need to view minimum in 2022-23. This approach would these new proposals as preferable to already allow the state to reduce spending in 2022-23 approved spending. We also recommend the with no immediate effect on schools and Legislature avoid growing the ongoing service level community colleges. by assessing whether to continue approved, but not yet implemented, programs. LAO PUBLICATIONS This report was prepared by Ann Hollingshead, with contributions from analysts 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. 12 LEGISLATIVE ANALYST’S OFFICE