The 2024-25 Budget: Cap-and-Trade Expenditure Plan

2024-25 BUDGET The 2024-25 Budget: Cap-and-Trade Expenditure Plan GABRIEL PETEK | LEGISLATIVE ANALYST | FEBRUARY 2024 SUMMARY The Governor proposes a roughly $2.3 billion discretionary cap-and-trade expenditure plan. The plan would dedicate most of this funding for fund shifts to backfill General Fund reductions, including $557 million proposed for early action in the current year. The proposal also includes an intention to commit a significant amount of out-year Greenhouse Gas Reduction Fund (GGRF) revenues to backfill future spending for activities related to zero-emission vehicles (ZEVs) that previous budget agreements had initially planned to provide from the General Fund. We find the Governor’s overall approach of using GGRF primarily to achieve General Fund solutions to be sensible, but the Legislature ultimately could choose a different package of programs to protect. Moreover, if the General Fund condition continues to deteriorate and the Legislature has to consider making ongoing reductions to base programs, it may want to consider using GGRF to preserve more urgent and ongoing needs rather than backfilling spending for one-time discretionary activities. We recommend the Legislature adopt a GGRF spending plan that reflects its priorities and maximizes General Fund savings. We also recommend the Legislature minimize its out-year GGRF commitments. Retaining its traditional flexibility over these future funds will leave the Legislature better positioned to respond should other priorities emerge, especially in light of projected General Fund deficits over the next couple of years. While we believe more GGRF revenues ultimately might be available for discretionary expenditures in 2024-25, considerable uncertainty exists around these estimates. With this uncertainty in mind, we recommend the Legislature continue to closely monitor quarterly cap-and-trade auctions to assess how revenues are materializing and set its annual GGRF spending levels accordingly for both the budget year and future years. For 2024-25, this could mean spending at somewhat higher levels than proposed by the Governor, but as the potential for volatility grows in the out-years, a more conservative spending approach in the future could be prudent. Background The remaining revenue is available for appropriation by the Legislature through the annual budget for Cap-and-Trade Auction Revenue. other ongoing funding commitments (such as state Revenues from quarterly cap-and-trade auctions administrative costs and statutory transfers) as well are deposited into GGRF and the funds generally as discretionary spending priorities. are allocated to climate-related programs. Over the past three years, individual quarterly auctions have Governor’s Proposal generated an average of $1.1 billion in revenue, Proposes $2.3 Billion in Discretionary with annual amounts averaging $4.2 billion. Spending. The Governor assumes the state will Under current law, about 65 percent of auction have about $5.1 billion in GGRF monies available to revenue is continuously appropriated to certain spend in 2024-25. This total includes (1) unallocated projects and programs, including for the state’s revenues from higher-than-anticipated proceeds high-speed rail project, affordable housing, transit, the state received in the August 2023 auction, and safe drinking water. In addition, $200 million (2) short-term investment proceeds earned on is continuously appropriated each year for prior-year funds before they were spent, and forest health and wildfire prevention activities. www.lao.ca.gov 1 2024-25 BUDGET (3) anticipated revenues from 2024-25 auctions and • California Department of Forestry and investment earnings. Of this amount, as shown in Fire Protection Fire Prevention Grants Figure 1, the proposal commits $2.5 billion ($81 Million). The budget also would reduce for continuous appropriations; $2.3 billion General Fund and instead provide GGRF for for discretionary spending; and $284 million the fire prevention grants program, which for other existing commitments, including both aims to reduce the risk of wildfires to baseline operations. homes and communities and reduce carbon Includes $557 Million emissions from forest fires. Proposed for Early Action, Figure 1 Primarily for ZEV Activities. The budget proposes spending Governor’s Proposed 2024-25 Cap-and-Trade $557 million of available GGRF Spending Plan revenues in 2023-24, primarily (In Millions) for activities included in the multiyear ZEV package that was Department Funding part of recent budget agreements. Continuous Appropriations $2,518 The Governor proposes that High-speed rail project HSRA $912 the Legislature take early action Affordable Housing and Sustainable Communities SGC 729 and use these funds to achieve TIRCP CalSTA 365 Healthy and resilient forests CalFire 200 current-year General Fund savings Low Carbon Transit Operations Program CARB 182 through the following fund shifts: Safe and Affordable Drinking Water Program SWRCB 130 • ZEV Activities ($476 Million). Other Existing Commitments $284 Baseline Operations Various $100 The Governor proposes Manufacturing tax credit N/A 97 shifting current-year funding State Responsibility Area fee backfill CalFire 87 from the General Fund to Discretionary Appropriations $2,279 GGRF for four programs Early Action Fund Shifts (2023-24) $557 adopted as part of the ZEV ZEV fueling infrastructure grants (ZEV package) CEC $219 package in recent budgets, all Drayage trucks and infrastructure (ZEV package) CEC 157 Fire prevention grants CalFire 81 administered by the California Clean trucks, buses, off-road equipment (ZEV package) CEC 71 Energy Commission (CEC): Transit buses and infrastructure (ZEV package) CEC 29 ZEV fueling infrastructure Budget-Year Fund Shifts (2024-25) $1,242 grants ($219 million); drayage TIRCP and other transportation programs CalSTA $791 trucks and infrastructure Energy package activities CEC 144 Extreme heat package activities CNRA/SGC 94 ($157 million); clean trucks, Wildfire package activities Various 81 buses, and off-road Oil well plug and abandonment DOC 50 equipment ($71 million); Coastal resilience package activities CNRA 37 and transit buses and Livestock methane reduction program CDFA 24 Water and drought package activities CDFA 21 infrastructure ($29 million). The administration has Other Discretionary Spending $480 AB 617 CARB $250 directed CEC to pause its Zero-Emission Transit Capital Program CalSTA 230 spending of authorized Total $5,081 General Fund for these HSRA = High Speed Rail Authority; SGC = Strategic Growth Council; TIRCP = Transit programs to avoid and Intercity Rail Capital Program; CalSTA = California State Transportation Agency; CalFire = California Department of Forestry and Fire Prevention; CARB = California Air Resources eroding these potential Board; SWRCB = State Water Resources Control Board; N/A = not available; ZEV = zero-emission vehicle; CEC = California Energy Commission; CNRA = California Natural Resources Agency; current-year savings. DOC = Department of Conservation; CDFA = California Department of Food and Agriculture; and AB 617 = Assembly Bill 617 Community Air Protection Program. 2 LEGISLATIVE ANALYST’S OFFICE 2024-25 BUDGET Uses Discretionary Funds Primarily to Swap Commits $3.5 Billion in Out-Year GGRF. Out Planned General Fund Spending. As shown Reflecting actions agreed to as part of the 2023-24 in Figure 1, similar to the proposed current-year fund budget package, the Governor’s proposal commits swaps, the Governor uses most of the remaining out-year discretionary GGRF for various programs. discretionary spending ($1.2 billion) to backfill Specifically, as shown in Figure 2 and consistent General Fund reductions in 2024-25 for various with the 2023-24 budget agreement with the programs, including those related to transportation Legislature, the Governor’s proposal includes intent as well as activities included in a number of climate to commit funding annually for the ZEV package budget packages. (We discuss these specific and the Zero-Emission Transit Capital Program from proposals and programs in our companion 2025-26 through 2026-27. The figure also shows publications, The 2024-25 Budget: Crafting the new $600 million the Governor is proposing Climate, Resources, and Environmental Budget to provide for ZEV programs in 2027-28 (reflecting Solutions and The 2024-25 Budget: Transportation the proposed delay from the budget year) as well Budget Solutions.) The two main exceptions to this as a new proposed intention to provide annual approach are $250 million for the AB 617 Community appropriations of $250 million for the AB 617 Air Protection program and $230 million for the program through 2029-30. Zero-Emission Transit Capital Program administered Assessment by the California State Transportation Agency. The former is a program initiated through Chapter 136 of Use of GGRF to Achieve General Fund 2017 (AB 617, C. Garcia) to monitor and reduce air Savings Has Merit, but Legislature Could pollution in vulnerable communities. This program Choose an Alternative Mix. Given the General has received regular support from GGRF over the Fund deficit, the Governor’s proposal to use most past several years. The latter is a new program discretionary GGRF to achieve General Fund initiated in the 2023-24 budget intended to provide savings and sustain some program activities makes four years of formula funding to transit agencies sense. However, the Legislature could adopt this which they can use to support zero-emission buses same strategy in a somewhat different way to align and related infrastructure and/or to cover their with its priorities. Specifically, it could achieve the operating expenses. same amount of savings as the Governor through directing GGRF funds to backfill a different mix Delays $600 Million in Planned GGRF Funding. of General Fund reductions. For example, the The Governor proposes to delay $600 million in Governor proposes using a total of $1.8 billion planned GGRF spending for the ZEV package from from GGRF to backfill essentially all the proposed 2024-25 to 2027-28. This delay frees up this funding General Fund reductions to the ZEV package across in 2024-25, making an additional $600 million the next three years, but only $37 million in 2024-25 available for achieving budget solutions through to sustain a mere 8 percent of the proposed other General Fund reductions and backfills. reductions to certain coastal resilience activities that This $600 million is part of the $2.3 billion in had been included in previous budget agreements. resources used for discretionary spending. Figure 2 Governor’s Proposed Out-Year GGRF Commitments (In Millions) Program Department 2025-26 2026-27 2027-28 2028-29 2029-30 Totals AB 617 CARB $250 $250 $250 $250 $250 $1,250 ZEV package CARB 215 301 213 — — 729 CEC 385 299 387 — — 1,071 Zero-Emission Transit Capital CalSTA 230 230 — — — 460 Totals $1,080 $1,080 $850 $250 $250 $3,510 GGRF = Greenhouse Gas Reduction Fund; AB 617 = Assembly Bill 617 Community Air Protection Program; CARB = California Air Resources Board; ZEV = zero-emission vehicle; CEC = California Energy Commission; and CalSTA = California State Transportation Agency. www.lao.ca.gov 3 2024-25 BUDGET Based on its highest priorities, the Legislature could find that it has higher priorities for GGRF could choose a different allocation. The Legislature revenues than sustaining planned one-time has flexibility around how it is able to direct GGRF program expansions. While nothing precludes revenues because the program was authorized in it from revisiting these spending intentions a way that is akin to a tax, meaning the funds can in a future year, leaving them in its multiyear legally be used for broad purposes. Moreover, if the spending plan for now could set unrealistic General Fund condition continues to deteriorate expectations and make redirecting the and the Legislature has to consider making ongoing funds in the coming years more challenging. reductions to base programs, it may want to In contrast, holding off on making spending prioritize GGRF monies differently. Specifically, commitments until it has more information the Legislature may need to consider using these about the budget situation it faces in each funds to preserve more urgent and ongoing needs given fiscal year would preserve more rather than backfilling spending for one-time flexibility for the Legislature to target available discretionary activities. discretionary GGRF funds to its pressing and Extensive Reliance on Out-Year GGRF Makes emerging priorities. Assumptions About Future State Priorities • Uncertainty Around Future Revenues. and Revenues. While the state dedicates a share As we discuss below, considerable of annual GGRF revenues to recurring ongoing uncertainty exists around how much GGRF activities (such as the high-speed rail project, revenue will be available in future years. sustainable housing and transit programs, and A precipitous drop in these revenues could activities to improve drinking water quality and jeopardize not only planned out-year ZEV availability), it generally has maintained about and Zero-Emission Transit Capital Program 35 percent for discretionary spending decisions spending but also other longstanding state agreed upon by the Legislature and Governor priorities for which the state has historically as part of each year’s budget negotiations. relied upon this funding source—raising The 2023-24 budget package broke with historical further questions about the wisdom of practice somewhat by including plans to dedicate committing these additional funds so many a notable share of out-year discretionary GGRF years in advance. revenues for specific purposes rather than deferring Legislature Could Revisit Existing Statutory that decision to future legislative and administration Commitments if Its Priorities Have Changed. negotiations, including $600 million annually for Besides revisiting whether it wants to maintain three years beginning in 2024-25 to backfill General out-year, limited-term discretionary commitments Fund reductions within the ZEV package. As noted for ZEV activities and other programs, the above, the Governor’s proposal includes $3.5 billion Legislature also could reconsider the degree to in out-year GGRF discretionary spending which both current continuous appropriations commitments. While this approach allows the (which receive about 65 percent of total GGRF state to maintain long-term intended ZEV spending revenues) and ongoing discretionary spending plans and save General Fund, it does raise two commitments continue to be consistent with key concerns: its current priorities. Most of the continuous • Limits Legislative Flexibility to Respond to appropriations were established as part of the Potential Changes in Out-Year Priorities. 2014-15 budget, and legislative priorities may have Given the projected budget deficits in the changed over the last decade. Particularly in the coming years, the Legislature could face context of the General Fund deficit and proposed some very difficult choices around its spending reductions to other programs, the expenditures—including a potential need to Legislature can consider all GGRF expenditures “on reduce General Fund support for core ongoing the table” and within its purview for reevaluation programs. In such a case, the Legislature and potential modification. 4 LEGISLATIVE ANALYST’S OFFICE 2024-25 BUDGET Administration’s New Revenue Estimate these estimates. The Legislature will be able Methodology Less Conservative, Likely More to incorporate additional information from the Accurate. As part of developing its annual budget February and May 2024 auctions before it needs to proposal, each year the Department of Finance make its final budget decisions for 2024-25. (DOF) estimates how much revenue it believes Increasing Degree of Uncertainty will be generated for GGRF at cap-and-trade Around Revenues. A couple of factors may auctions in the coming fiscal year. This estimate contribute to more volatility than usual for forms the basis for the Governor’s annual GGRF cap-and-trade revenues over the next several spending plan. DOF recently changed the years. The Legislature may want to keep these methodology it uses to calculate this projection. uncertainties in mind as it makes its GGRF Prior to spring 2023, the administration based its budgeting decisions for 2024-25 and in the estimates on an assumption that all cap-and-trade coming years. allowances would sell at the auction floor price. • California Air Resources Board (CARB) This methodology resulted in DOF regularly Considering Cap-and-Trade Program underestimating revenues quite notably, as Changes. CARB is in the process allowances have sold well above the floor price of considering amendments to the for the last several years. (In contrast, our office cap-and-trade program that would influence historically has developed cap-and-trade revenue allowance prices. These include potential estimates based on an assumption of stable changes to the emissions cap, the number allowance prices. In recent years, this approach of allowances the state makes available, and has led our projections of annual discretionary the allocation of those allowances. Scenarios GGRF revenues to exceed the Governor’s by that CARB has presented suggest allowance several hundreds of millions of dollars—and also auction prices will increase, which likely would has resulted in our estimates more closely aligning mean more revenues for GGRF. However, with actual auction results, as compared to the the way in which CARB makes changes to its administration’s projections.) DOF’s new approach allocation of allowances (such as modifying uses an average of actual allowance prices from the mix of allowances given away for free auctions that occurred in the previous calendar to certain industries like utilities versus year. For 2024-25, this new approach has resulted the number sold at the state-run auctions) in the administration basing its spending plan on ultimately will determine the impacts on prices higher estimates compared to its previous practice. and state revenues. We believe DOF’s new approach is likely to yield • 2030 Expiration. Before the Legislature last more accurate revenue predictions. extended the statutory authorization for the We Estimate More GGRF Could Be Available cap-and-trade program in 2018, revenues for Discretionary Spending, but Projections from GGRF began to decline due to investor Carry Considerable Uncertainty. Even with uncertainty about the status of the program. DOF’s new approach, we believe the administration Should considerable uncertainty about the still could be underestimating the amount of fate of the program exist as its next statutory GGRF revenue that cap-and-trade auctions will end-date approaches (2030), a similar change generate in 2024-25. Our conclusion is based on in revenue trends could reemerge. Such recent auction trends, in which allowance prices volatility related to reauthorization questions have been trending upward (as of this writing). is not likely to be a significant risk this year, Should these trends continue, the state could but could develop over the next several years have additional GGRF to spend in both the current closer to 2030. and budget years compared to the Governor’s proposal—perhaps including several hundreds of millions of dollars more for discretionary spending. However, considerable uncertainty exists around www.lao.ca.gov 5 2024-25 BUDGET Recommendations flexibility over the use of these funds in upcoming years should other priorities emerge. This is Adopt GGRF Spending Plan That Focuses on especially important in this fiscal environment, Legislative Priorities and Maximizes General where the budget situation is expected to be Fund Solutions. We recommend the Legislature difficult for the next few years. As such, we adopt the Governor’s overall strategy of using recommend that—for now—the Legislature consider GGRF to help backfill General Fund reductions for both reducing planned out-year GGRF funding that certain programs. This approach allows the state to has not yet been appropriated, and reducing rather achieve necessary budget savings while continuing than delaying GGRF expenditures and revisiting important activities. However, we recommend the them in a future year when it has a better sense of Legislature adopt a GGRF spending package that its available fiscal resources and highest spending ultimately preserves funding for its highest-priority priorities. This would help avoid creating spending activities, which may represent a different mix expectations that the state may not be able to fulfill. from that proposed by the Governor. For example, instead of prioritizing GGRF to sustain nearly all of Monitor Auctions and Adopt Spending Levels the original intended funding for ZEV activities, the That Reflect Evolving Revenue Trends. Given Legislature could redirect some of those funds to the growing uncertainty around cap-and-trade protect some additional funding for other program revenues, we recommend the Legislature continue areas proposed for deeper reductions, especially to closely monitor quarterly auctions to assess how given the significant amount of federal funds revenues are materializing and set its annual GGRF available for ZEVs. Depending on how quickly and spending levels accordingly. For 2024-25, this will severely the General Fund condition worsens, the mean incorporating the results of the February and Legislature also could consider using GGRF to May 2024 auctions. (The results from February backfill General Fund reductions to core ongoing were not yet available at the time of this writing.) programs rather than to sustain discretionary If allowance prices continue to trend upward at that one-time climate and environment spending. point, the Legislature could have some additional In addition, the Legislature could consider revisiting comfort in potentially adopting a plan that spends GGRF continuous appropriations and ongoing at a slightly higher level than the Governor’s spending commitments, most of which were proposal. For future years, the Legislature may established in 2014-15. The Legislature’s highest want to adopt a more conservative approach with priorities may now be different. its GGRF spending assumptions, given the growing uncertainty around allowance prices and potential Minimize Out-Year GGRF Commitments. for revenue volatility. As discussed above, avoiding The state faces considerable uncertainty about making significant out-year GGRF commitments future GGRF revenues due to the factors mentioned is another tool that can help preserve legislative above. In addition, committing out-year GGRF flexibility to respond to unknown and evolving future funds, while useful to provide some assurance revenue trends. regarding future programs, limits legislative 6 LEGISLATIVE ANALYST’S OFFICE 2024-25 BUDGET www.lao.ca.gov 7 2024-25 BUDGET LAO PUBLICATIONS This report was prepared by Sarah Cornett and reviewed by Rachel Ehlers. 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