The 2025-26 Budget: Cap-and-Trade Expenditure Plan

2025-26 BUDGET The 2025-26 Budget: Cap-and-Trade Expenditure Plan GABRIEL PETEK | LEGISLATIVE ANALYST | FEBRUARY 2025 SUMMARY The Governor proposes roughly $1.8 billion in discretionary cap-and-trade expenditures in 2025-26. The Governor’s plan funds a number of programs and activities that were initially to be supported with the General Fund, but then were shifted to the Greenhouse Gas Reduction Fund (GGRF) through the 2024-25 budget process in order to address the multiyear budget problem. Additionally, the Governor proposes two new fund shifts in the budget year to help reduce pressure on the Motor Vehicle Account (MVA), which faces insolvency in 2025-26 absent corrective action. We find that while the proposed fund shifts present trade-offs, the Governor’s GGRF proposal for 2025-26 largely adheres to the expenditure plan the Legislature agreed to as part of the 2024-25 budget package. However, GGRF revenues are subject to substantial uncertainty and are trending lower than forecasted as of the middle of the 2024-25 fiscal year. To the extent these somewhat lower revenue patterns persist, the Legislature may need to make modifications to the GGRF expenditure plan for 2025-26. Should they further weaken, modifications to 2024-25 GGRF spending may also be necessary. Moreover, to the extent that the General Fund condition worsens, the Legislature could be faced with making ongoing reductions to base programs. If that were to occur, the Legislature might want to consider using this fund source as a tool to help preserve its highest-priority activities—which may differ from those in the current plan. Accordingly, we recommend that the Legislature closely monitor GGRF and General Fund revenues and be prepared to adjust expenditure plans as necessary. Background quarterly auctions have generated an average of $1.1 billion in revenue, with annual amounts Expenditures for Most Cap-and-Trade averaging $4.4 billion. Under current law, most Auction Revenues Are Directed by Statute. GGRF is allocated to specific programs, as The California Air Resources Board (CARB) holds shown in Figure 1. The remaining revenue is quarterly cap-and-trade auctions. The revenues available for appropriation by the Legislature for from these auctions are deposited into GGRF discretionary spending programs, as well as to and generally are allocated to climate-related cover state administrative costs, through the annual programs. Over the past three years, individual budget process. Figure 1 Continuous Appropriations and Other Statutorily Required GGRF Appropriations Program Department Appropriation Amount High-speed rail project HSRA 25 percent of annual revenues Affordable Housing and Sustainable Communities Program SGC 20 percent of annual revenues TIRCP CalSTA 10 percent of annual revenues Low Carbon Transit Operations Program Caltrans 5 percent of annual revenues Healthy and resilient forest activities CalFire $200 million Safe and Affordable Drinking Water Program SWRCB 5 percent of annual revenues (up to $130 million) Manufacturing tax credit N/A Roughly $100-$140 million State Responsibility Area fee backfill CalFire Roughly $70-$90 million GGRF = Greenhouse Gas Reduction Fund; HSRA = High-Speed Rail Authority; SGC = Strategic Growth Council; TIRCP = Transit and Intercity Rail Capital Program; CalSTA = California State Transportation Agency; Caltrans = California Department of Transportation; CalFire = California Department of Forestry and Fire Prevention; SWRCB = State Water Resources and Control Board; and N/A = not applicable. www.lao.ca.gov 1 2025-26 BUDGET Past Two Budget Agreements Included revenues for specific purposes. This contrasts Plans for Spending Out-Year Discretionary with the historical practice of allocating funding GGRF. The past two budget agreements—2023-24 on a year-by-year basis. As shown in Figure 2, and 2024-25—not only appropriated GGRF to the bulk of the agreed-upon planned GGRF discretionary programs for those respective spending would backfill reductions to expenditures budget years, but also included plans to dedicate that were previously planned to be made from a large share of out-year discretionary GGRF the General Fund for a wide variety of activities. Figure 2 Discretionary Greenhouse Gas Reduction Fund Expenditure Plan as of 2024-25 Budget Act (In Millions) Program Department 2024-25 2025-26 2026-27 2027-28 2028-29 Fund Shifts From General Fund $2,434 $1,504 $1,314 $1,089 $650 Climate Packages $1,371 $1,051 $952 $989 — Drinking water/wastewater projects (Water) SWRCB $225 $30 — — — Drayage trucks & infrastructure (ZEV) CEC 157a — — — — Flood projects (Water) DWR 126 — — — — ZEV fueling infrastructure grants (ZEV) CEC 120a — — $99 — Habitat restoration projects (NBA) DWR 103 — — — — Streamflow Enhancement Program (Water) WCB 101 — — — — Demand side grid support (Energy) CEC 75 75 — — — Clean trucks/buses/off-road equipment (ZEV) CEC 71a — — — — Protecting wildlife (NBA) WCB 70 — — — — Emerging opportunities (ZEV) CARB 53 — — — — Fire prevention grants (Wildfire) CalFire 40 — — 42 — Transit buses & infrastructure (ZEV) CEC 29a — — — — Ocean protection activities (Coastal) OPC 28 — 37 — — Extreme heat/community resilience (Extreme heat) OPR 25 — — — — Equitable Building Decarbonization (Energy) CEC 25 — — 93 — Long duration storage (Energy) CEC 23a 26 — — — Carbon removal innovation (Energy) CEC 20a — — — — Prescribed fire pilot; monitoring & research (Wildfire) CalFire 26 — — — — Wetlands restoration (NBA) CDFW 17 — — — Livestock methane reduction (Agriculture) CDFA 17 7 — — — Climate Action Corps (Community Resilience) OPR 9 9 9 9 — Salton Sea activities (Water) DWR 7 — — — — ZEV programs (ZEV) CEC — 385 299 387 — ZEV programs (ZEV) CARB — 215 301 213 — Distributed Electricity Backup Assets (Energy) CEC — 200 180 — — Hydrogen grants (Energy) CEC 5 34 — — — Oroville pump storage (Energy) DWR — 30 100 100 — Watershed climate resilience (Water) WCB — 15 — — — Water recycling/groundwater cleanup (Water) SWRCB — 15 — — — Tribal engagement (Wildfire) CalFire — 10 — — — SWEEP (Water) CDFA — — 21 — — Environmental justice grants (Community Resilience) CalEPA — — 5 — — Unit fire prevention projects (Wildfire) CalFire — — — 26 — Regional Forest and Fire Capacity (Wildfire) DOC — — — 20 — Transportation and Other Environmental Programs $1,063 $453 $363 $100 $650 Competitive and formula-based TIRCP CalSTA $958a $368 $20 — — Vulnerable community toxic cleanup DTSC 65 — 43 — — Diablo Canyon land conservation Various 40 10 50 $50 — CERIP CEC — 50 150 50 $650 Highways to Boulevards Caltrans — 25 50 — — Oil well plug/abandonment DOC — — 50 — — (Continued) 2 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET Program Department 2024-25 2025-26 2026-27 2027-28 2028-29 Non-Fund Shifts $315 $278 $480 $710 $275 AB 617—Community Air Protection CARB $250 $250 $250 $250 $250 Zero Emission Transit Capital Program CalSTA — — 230 460 — Salton Sea activities Various 65 3 — — — Community renewable energy CPUC — 25 — — 25 Totals $2,750 $1,783 $1,794 $1,799 $925 a Includes funding scored in 2023-24. SWRCB = State Water Resources Control Board; ZEV = zero-emission vehicles; CEC = California Energy Commission; DWR = Department of Water Resources; NBA = nature-based activities; WCB = Wildlife Conservation Board; SWEEP = State Water Efficiency and Enhancement Program; CARB = California Air Resources Board; CalFire = California Department of Forestry and Fire Protection; OPC = Ocean Protection Council; OPR = Governor’s Office of Planning and Research; CDFW = California Department of Fish and Wildlife; CDFA = California Department of Food and Agriculture; CalEPA = California Environmental Protection Agency; DOC = Department of Conservation; TIRCP = Transit and Intercity Rail Capital Program; CalSTA = California State Transportation Agency; DTSC = Department of Toxic Substances Control; CERIP = Clean Energy Reliability Investment Plan; Caltrans = California Department of Transportation; and CPUC = California Public Utilities Commission. These actions were taken with the intent of sustaining previous Figure 3 multiyear spending commitments Governor’s Proposed 2025-26 Cap-and-Trade while achieving General Fund Expenditure Plan savings in response to the deficit (In Millions) and worsening budget condition. Proposed in Governor’s Proposal Department 2025-26 Budget Governor Proposes Continuous Appropriationsa $2,576 $1.8 Billion Discretionary High-speed rail project HSRA $936 Spending in 2025-26. As shown Affordable Housing and Sustainable SGC 749 in Figure 3, the Governor proposes Communities Program TIRCP CalSTA 374 spending $4.8 billion from GGRF Healthy and resilient forests activities CalFire 200 in 2025-26. Of this amount, the Low Carbon Transit Operations Program CalTrans 187 proposal provides $2.6 billion Safe and Affordable Drinking Water Program SWRCB 130 for continuous appropriations, Other Existing Statutory Commitments $346 $346 million for other existing Manufacturing tax credit N/A $141 statutory commitments, and Baseline operations Various 117 State Responsibility Area fee backfill CalFire 88 $1.8 billion for discretionary spending. Almost all of the Discretionary Appropriations $1,832 2024-25 Budget Agreement $1,783 proposed 2025-26 discretionary Fund shifts from General Fund (climate packages) Various $1,504 spending would be used to Non-fund shifts Various 278 implement agreements that New Proposals $49 were part of the 2024-25 budget Motor Vehicle Account offset CARB $81 package, as detailed in Figure 2. CERIP CEC -32b Based on the administration’s Total $4,754 revenue assumptions and a Based on Governor’s revenue assumption of $4.2 billion in 2025-26. b Governor proposes shifting $32 million of planned spending on CERIP from GGRF to Proposition 4. proposed expenditures, it HSRA = High Speed Rail Authority; SGC = Strategic Growth Council; TIRCP = Transit and Intercity estimates GGRF would maintain a Rail Capital Program; CalSTA = California State Transportation Agency; CalFire = California balance (also known as a reserve) Department of Forestry and Fire Prevention; SWRCB = State Water Resources and Control Board; N/A = not applicable; CARB = California Air Resources Board; CERIP = Clean Energy Reliability of roughly $160 million at the end Investment Plan; and CEC = California Energy Commission. of 2025-26. www.lao.ca.gov 3 2025-26 BUDGET Adds Two Proposed Fund Shifts Aimed at Assessment Supporting MVA. The Governor proposes two Governor’s Proposal Maintains Agreed-Upon modifications to the cap-and-trade expenditure Expenditure Plan. We find the Governor’s plan agreed to as part of the 2024-25 budget. GGRF proposal to be largely consistent with Both are GGRF-related fund shifts with the goal the expenditure plan agreed to in 2024-25. (The of supporting CARB activities typically funded one relatively small modification is related to the by MVA. (As we discuss in our February 2025 proposed fund shift for CERIP.) Assuming GGRF publication, The 2025-26 Budget: Transportation revenues are adequate and the Legislature’s Proposals, MVA continues to be structurally priorities remain unchanged, maintaining these imbalanced and faces insolvency in the previous spending plans is both reasonable and budget year absent corrective action.) The two appropriate. However, should the budget condition proposals include: or prioritization of potential activities change, the • Clean Energy Reliability Investment Plan Legislature may want to revisit these intentions. (CERIP) Fund Shift ($32 Million Shift From Using GGRF to Backfill MVA Comes With GGRF to Proposition 4). The Governor Trade-Offs. The proposed fund shifts come with proposes shifting $32 million of planned notable trade-offs, as we discuss in further detail spending to implement CERIP from GGRF to in The 2025-26 Budget: Transportation Proposals. Proposition 4. (The Legislature established For example, a key advantage is that they allow CERIP in 2022 to support various activities the state to continue to keep MVA balanced in aimed at helping the state reach its clean 2025-26 without raising vehicle fees or reducing energy goals.) Along with this proposed service levels. However, some key disadvantages fund shift, the Governor would designate include that (1) the amount shifted to Proposition 4 the funding specifically for the Demand Side results in the bond funds being used to sustain Grid Support Program. (Previous budget existing commitments rather than to enhance agreements included intent to provide GGRF the state’s climate efforts, (2) using unallocated for CERIP-related activities in 2025-26 projected discretionary GGRF revenues for this but deferred decisions on which specific purpose means they are not available for other activities would be funded to future budget purposes, and (3) sustaining the proposed level of deliberations.) This proposal would reduce expenditures from GGRF in 2025-26 may be difficult pressure on GGRF by $32 million in 2025-26. if revenues fail to strengthen, as discussed below. (Please see our February 2025 report, The 2024-25 GGRF Revenues Are Coming in 2025-26 Budget: Proposition 4 Spending Plan, Below Projections. The Department of Finance for further discussion of these shifts.) (DOF) estimates future GGRF revenues based • MVA Offset ($81 Million Shift From GGRF on an average of actual allowance prices from to MVA). The Governor proposes to transfer auctions that occurred in the previous calendar a total of $81 million from GGRF to MVA in year. In general, we find this methodology to 2025-26. This consists of the $32 million that be a reasonable approach. However, the past would be “freed up” by the CERIP fund shift two auctions have reflected some weakening in discussed above, along with $49 million from allowance prices compared to the auctions that projected additional unallocated discretionary took place during the prior year. Specifically, GGRF revenues. These transfers would pay for DOF projected 2024-25 auction prices of about the costs of CARB’s Mobile Source Program, $38 per allowance, but actual prices at the first two which is intended to reduce emissions from quarterly auctions of the fiscal year were roughly on- and off-road mobile sources. (Separately, $31. Accordingly, as shown in Figure 4, GGRF the Governor also proposes to transfer revenues in 2024-25 have been somewhat lower $85 million from CARB’s Air Pollution Control than the administration’s projections last spring Fund to further address MVA shortfalls.) that formed the basis of the 2024-25 Budget Act’s GGRF spending package. 4 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET Figure 4 Recent Quarterly GGRF Auction Revenues Underperformed Projections (In Millions) $1,600 Actual Revenues 1,400 DOF Revenue Projectionª 1,200 1,000 800 600 400 200 Nov-20 Feb-21 May-21 Aug-21 Nov-21 Feb-22 May-22 Aug-22 Nov-22 Feb-23 May-23 Aug-23 Nov-23 Feb-24 May-24 Aug-24 Nov-24 a DOF forecast as of the 2024-25 Budget Act. GGRF = Greenhouse Gas Reduction Fund and DOF = Department of Finance. If Revenue Trends Continue at Modest sufficient to fund existing statutory commitments Decline, Planned Current-Year Expenditures and the budget-year spending plan agreed to in the Likely Still Feasible… Two auctions remain in 2024-25 budget package. Specifically, we estimate the 2024-25 fiscal year—February and May. We that if the allowance prices seen at the past two estimate that even if allowance prices continue auctions persist throughout 2025-26, in adopting to trail the 2024-25 Budget Act’s assumptions, the final budget plan the Legislature and Governor if they remain at comparable levels to the past would need to reduce the Governor’s proposed two auctions (roughly $31), GGRF likely will be 2025-26 expenditures by nearly $200 million to able to continue to support the expenditures that prevent a negative fund balance for GGRF at currently are planned for 2024-25. This is in part the end of the fiscal year. Since GGRF revenues because many of the continuous appropriations are subject to substantial uncertainty, as we are calculated as a percentage of GGRF revenues discuss in greater detail below, revenues could and thus automatically adjust downward when be notably higher or lower than recent trends. revenues decline. However, should allowance Further declines in revenues compared to what prices decline more steeply than occurred in the has been the case thus far would necessitate August and November 2024 auctions, modifications additional reductions to planned expenditures, to planned expenditures for 2024-25 could whereas increases in revenues could potentially potentially be necessary. DOF could address such result in additional monies becoming available for a circumstance through Control Section 15.14 of the discretionary purposes. annual budget act, which provides a mechanism Substantial and Increasing Degree of for DOF to make midyear reductions if auction Uncertainty Around GGRF Revenues. Predicting revenues are insufficient to support discretionary how the cap-and-trade market will behave and GGRF spending at the budgeted levels. forecasting corresponding GGRF revenues are …But Revisiting GGRF Spending Plan for always subject to some uncertainty. However, 2025-26 Could Be Necessary Depending a couple of factors may contribute to more on February and May Auction Results. If the uncertainty than usual for this exercise over the somewhat lower allowance prices that the state next several years. The Legislature may want to has experienced over the past two auctions persist keep these uncertainties in mind as it makes its into 2025-26, we estimate that revenues may not be GGRF budgeting decisions. In particular: www.lao.ca.gov 5 2025-26 BUDGET • CARB Considering Cap-and-Trade $10 billion annually over the next few years. To the Program Changes. CARB has indicated extent the state’s budget condition weakens in the that it intends to begin a rulemaking coming months, the Legislature could consider process for potential amendments to the modifying its GGRF spending plan. For example, cap-and-trade program that would influence if revenue declines result in the state facing a allowance prices. These include potential large budget problem that necessitates cuts to changes to the number of allowances the ongoing programs, the Legislature could consider state makes available and the allocation of forestalling those reductions by redirecting GGRF to those allowances. help sustain higher-priority activities. • 2030 Expiration of Statutory Authorization. Recommendations Before the Legislature last extended the statutory authorization for the cap-and-trade Monitor Auctions and General Fund Condition program in 2017, revenues from GGRF Over Coming Months. Given the growing uncertainty around cap-and-trade revenues, we began to decline due to investor uncertainty recommend the Legislature continue to closely about the status of the program. Should monitor quarterly auctions to assess how revenues considerable uncertainty about the fate of the are materializing. To the extent that revenues from program exist as its next statutory end-date the February and May 2025 auctions deviate from approaches (2030), a similar downward projections, the 2025-26 GGRF spending levels pressure on revenues could emerge. may not be able to support the plans included in the • Linkage With Washington State. CARB 2024-25 budget agreement. has indicated that it is discussing linking Additionally, we recommend that the Legislature California’s cap-and-trade program with the consider updated information on the condition program in Washington state. Such action of the General Fund as it becomes available over could affect allowance prices in both states as the coming months before it finalizes its GGRF they come into alignment. spending plan. In the event that the General Fund Revisiting Spending Plan Also Could Make condition deteriorates notably, the Legislature could Sense if Budget Condition Worsens. As of consider redirecting GGRF as a tool to help sustain January 2025, both our office and DOF projected its highest-priority activities. that the state’s General Fund will be roughly Adopt GGRF Spending Plan Consistent With balanced in 2025-26 under the Governor’s budget Legislative Priorities. Ultimately, once the picture proposal. However, various factors could change is clearer regarding GGRF revenues as well as over the coming months that could affect the the General Fund condition, we recommend the condition of the state’s General Fund. For example, Legislature adopt a GGRF expenditure plan that if the costs of responding to and recovering from is consistent with its intent and priorities. This will the January 2025 wildfires that affected the Los include assessing strategies for supporting the Angeles region are higher than anticipated or state MVA and the programs that account historically has revenues come in lower than projected, the state’s supported, and the degree to which the Legislature budget condition could worsen. Additionally, our is comfortable with the trade-offs associated with office and DOF project out-year deficits of over the Governor’s proposed fund shifts. 6 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET www.lao.ca.gov 7 2025-26 BUDGET LAO PUBLICATIONS This report was prepared by Helen Kerstein, and reviewed by Rachel Ehlers and Ross Brown. 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