The 2024-25 Budget: The Governor’s Proposition 98 Funding Maneuver

2024-25 BUDGET The 2024-25 Budget: The Governor’s Proposition 98 Funding Maneuver GABRIEL PETEK | LEGISLATIVE ANALYST | FEBRUARY 2024 SUMMARY In this brief, we evaluate the Governor’s novel proposal to allow schools to keep $8 billion of cash disbursements above the minimum requirement without recognizing the budgetary impact of those payments. We first provide some background information on how the state’s budget and cash positions differ as well as some basic information about school finance. We then describe this proposed funding maneuver. Finally, we assess the proposal and provide our recommendation on it. (The administration very recently released the trailer bill language associated with this proposal. We did not receive this language in time to review it for this analysis. However, this analysis reflects our best understanding of the proposal, which was confirmed by the administration. We will provide additional analyses as necessary as we review the proposed statutory language.) Bottom Line. This proposed maneuver is bad fiscal policy. It sets a problematic precedent for the state and creates a binding obligation that will worsen out-year deficits and require more difficult decisions in the future. The state could maintain school and community college spending in a number of other ways. We strongly recommend that the Legislature reject the administration’s proposal. BACKGROUND State Fiscal Basics Governor’s budget. Despite this significant deficit, there is a good chance that the administration’s The Legislature Plans the State’s Budget and revenue projections are too low and the state the Administration Manages the State’s Cash. will face an even larger budget problem in May. Through the annual budget process, the Legislature Further, under both our and the administration’s creates a plan for General Fund spending based forecasts, the state will need to solve large deficits on its resources available (most notably, projected in future years—averaging around $30 billion each revenues). This is the state’s budget. After this plan year for the next three years. is put into law, the executive branch executes it on a cash basis. That is, on a daily basis, the state’s tax State’s Cash Position Is Currently Very agencies collect revenues, the State Controller pays Strong. Despite this weak budget position, the the state’s bills, and the State Treasurer invests any state’s cash position is currently very strong. of the state’s cash that is currently unused. We have Even though revenue projections have declined described how the state’s cash management substantially, the administration projects the system works in earlier publications, including: General Fund would still have a small cash surplus Managing California’s Cash and An Update on the at the end of the current year. Further, under the State’s Cash Management Situation. same projections, the state would end this year with nearly $100 billion in unused borrowable resources Budget Position Is Currently Weak. After a (balances in other state funds). These funds would couple years of surpluses, the state faced a deficit be available to cover any cash deficits that could last year and continues to face deficits now and occur in subsequent months. into future years. We estimate the administration addressed a $58 billion budget problem in the www.lao.ca.gov 1 2024-25 BUDGET Why Is There a Difference? The reason that the Minimum Funding Level for K-14 Education Has state’s budget and cash positions have diverged is, in Declined Substantially for 2022-23. Typically, the large part, due to undistributed funds. While all of the budget process does not involve large changes in monies in the State Treasury are committed in some revenue in the prior year (in this case, 2022-23). This is sense—usually to an expenditure or reserve, including because prior-year taxes usually have been filed and an ending fund balance—some of those funds have associated revenues collected by April of any given not yet been disbursed. There are many reasons why year. Due to the state conforming to federal tax filing this can occur. Currently, for example, the state: (1) has extensions, however, the Legislature only gained a sizeable balances in its reserve accounts, including complete picture of 2022-23 tax collections late in the Budget Stabilization Account and Proposition 98 2023—after the fiscal year already ended. Those data Reserve; (2) has many special funds that are carrying showed a severe revenue decline, with total income large balances; and (3) has allocated large sums tax collections down 25 percent. A decline of this to expenditures that take years to disburse, like magnitude is unprecedented for the prior fiscal year. It infrastructure projects. That said, if the state’s budget also results in an unprecedented prior-year reduction position remains weak, the state’s cash position will to the minimum funding requirement for schools and erode as well. community colleges. General Fund Payments to Schools School and Community College Significantly Above Revised Proposition 98 Funding (Proposition 98) Requirement for 2022-23. Throughout 2022-23, State Constitution Establishes a Minimum the State Controller distributed funds to schools and Funding Level for Schools and Community community colleges based on program expenditure Colleges. The California Constitution sets a levels the state initially approved in June 2022 and minimum annual funding requirement for schools later modified in June 2023. These expenditure levels and community colleges (otherwise known as aligned with the estimates of the minimum funding Proposition 98 [1988]). Each year’s minimum funding requirement at the time the state approved them. requirement is established using a set of formulas. The As a result of the state’s revenue decline for that state meets this requirement through a combination year, however, these disbursements now exceed of General Fund spending and local property tax the revised estimate of the minimum requirement by revenue. Under these formulas, General Fund approximately $8 billion. The state would need to take spending on K-14 education tends to increase when legislative action to revise these payments in light of revenues grow and decrease when revenues decline. the lower minimum requirement. GOVERNOR’S PROPOSAL Governor’s Budget Proposes Not Recognizing Expenditure Would “Accrue” to the Future the Expenditures Above the Minimum Instead. The Governor’s budget does not address Requirement, Despite Allowing Schools to Keep the misalignment between the state’s cash and the Funding. The Governor’s budget proposes budget positions until future years. Starting in no changes to the funds that have already been 2025-26, the administration would recognize the distributed for 2022-23 on a cash basis—that is, those budgetary costs in increments of $1.6 billion annually payments would not be offset or recouped and K-14 for five years. The payments would be scored outside districts would not be expected to make any changes of the state’s Proposition 98 requirements, meaning in their local budgets. At the same time, however, they would add to the state’s projected deficits in in order to score budgetary savings, the Governor those years. These payments would bring the state’s proposes to delay recognizing these payments in cash and budget documents back into alignment. its budget documents. In essence, this maneuver generates short-term budgetary savings by creating a misalignment between the state’s cash position and its budget. 2 LEGISLATIVE ANALYST’S OFFICE 2024-25 BUDGET LAO ASSESSMENT Creates a New Type of Budget Solution: Therefore, this proposal is fundamentally different Effectively an Interest-Free Loan From the than other kinds of spending delays proposed State’s Cash Resources. Under this proposed by the administration.) The state currently faces maneuver, the state would generate budget savings deficits of around $30 billion per year for the next by not recognizing a budgetary expenditure, few years. Given that the state will need to deploy despite the fact that the cash has gone out the most of its budget tools to address this year’s door. Although it is not technically a loan, the best deficit, these future budget problems are likely way to conceptually understand this proposal is going to require even more difficult decisions, that the state would make an interest-free loan to including ongoing cuts to state programs and/or itself using its own cash resources. In short: the revenue increases. The future payments on this unacknowledged $8 billion in cash disbursements maneuver would exacerbate these problems, likely in 2022-23 create an outstanding “principal” due requiring the Legislature to make even more difficult from the state’s cash resources. The state would decisions as soon as next year. Moreover, the cost make “repayments” on this principle balance of this maneuver would be outside of funding for beginning in 2025-26 as it acknowledges the schools and community colleges. All other state cash disbursement on a budgetary basis. In total, General Fund programs would bear these costs. the repayments would equal the principal such Sets a Problematic Precedent. While that there would be no interest payments. While borrowing to finance a year-end deficit is the state does sometimes shift costs between unconstitutional, the state is permitted to shift time periods as a type budget solution—as is its own funds and costs—that is, to internally the case with deferrals—this specific maneuver borrow—to balance the budget. Such cost shifts is unprecedented. include, for example, budgetary deferrals (for Obfuscates Budget’s True Condition. We example, the payroll deferral) and special fund have major concerns about this proposal from a loans. Similar to this proposed maneuver, these transparency perspective. The proposal would tools create long-term obligations in exchange for create a new budgetary obligation on the state that short-term budgetary relief and some do so by is virtually invisible in budget and cash documents creating discrepancies between cash and budget as currently produced by the Department of documents. However, this particular maneuver is Finance and State Controller. Further, although new and sets a problematic precedent. It would this maneuver is clearly a proposal that requires likely create an expectation that the state would legislative approval, the administration treats it continue to use maneuvers like this to pay for as an “automatic” change in its depiction of the spending in the presence of budget deficits. state’s budget condition. This has the effect of: Even more concerning, in effect, the state’s cash (1) reducing the size of the budget problem on position represents the only upper bound to which paper, and (2) obscuring the proposed solution the state could use a maneuver like this. As long in the documents presented to the Legislature as as there is sufficient cash in the treasury, the state part of the Governor’s budget. (We explained this could defer the recognition of almost any amount dynamic further in our report: The 2024-25 Budget: of budgetary expenditure. Eventually, however, the Overview of the Governor’s Budget.) bill comes due—the state cannot defer incurred Creates Binding Obligation That Magnifies costs forever. At that time, like under this proposal, Structural Deficit, Likely Requiring More Cuts the Legislature likely would have to make other to Other Programs in the Future. The repayments spending cuts to repay the “loans.” on this maneuver would represent a new, binding obligation on the state. (Although the precise timing of these repayments would be up to the Legislature, the payments would have to occur eventually. www.lao.ca.gov 3 2024-25 BUDGET LAO RECOMMENDATION Strongly Recommend Rejecting Governor’s In our report, The 2024-25 Budget: Proposition 98 Proposal. This proposed maneuver is bad K-12 Education Analysis, we set forward some fiscal policy, sets a problematic precedent, and alternative options that would allow the state to creates a binding obligation on the state that maintain school funding while achieving budgetary will worsen out-year deficits and require more savings in 2022-23, but without the problematic difficult decisions. We strongly recommend downsides of this specific proposal. that the Legislature reject the proposal. LAO PUBLICATIONS This report was prepared by Ann Hollingshead, with assistance from Kenneth Kapphahn and Edgar Cabral, 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. 4 LEGISLATIVE ANALYST’S OFFICE