Understanding $100 Billion in Spending Growth: Causes and Fiscal Implications

analysis full 2026-27 BUDGET UNDERSTANDING $100 BILLION IN SPENDING GROWTH: CAUSES AND FISCAL IMPLICATIONS GABRIEL PETEK | LEGISLATIVE ANALYST | APRIL 2026 www.lao.ca.gov 1 analysis full AN LAO REPORT 2 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT Executive Summary State Faces Deficits. Both our office and the administration have estimated the state faces structural deficits ranging from $20 billion to $30 billion annually. While recent revenue gains— driven by a strong stock market and investor enthusiasm surrounding artificial intelligence—have buoyed the state’s near-term budget picture, long-term imbalance will likely persist without significant policy changes. This Report Assesses Causes and Fiscal Implications of Spending Growth. Since 2019-20, General Fund spending has grown just over $100 billion—from $146 billion in 2019-20 to $248 billion under the Governor’s budget proposal for 2026-27. This report assesses the causes and fiscal implications of this growth in order to inform decision-making going forward. Overall, Majority of Growth Attributed to Sustaining Services and a Handful of Programs. In this report, we find that about 70 percent of this spending growth went to sustaining services that already existed in 2019-20 while 30 percent went to expanding or creating new services since that time. Programmatically, a substantial majority of the growth— across sustaining and expanding services—is attributable to higher spending on schools and community colleges ($37 billion), Medi-Cal ($25 billion), Department of Developmental Services ($8 billion), In-Home Supportive Services ($8 billion), child care ($4 billion), and universities ($3 billion, which is categorized as local assistance in this report). K-14 Education Spending Saw More Service Expansions Than the Rest of the Budget. Outside of spending on K-14 education, a substantial majority of cost growth has supported existing programs rather than creating new services. In contrast, K-14 funding growth has been more evenly split. Specifically, we estimate that about half of K-14 education spending growth sustained existing services, while the other half funded expansions and new programs. The figure below summarizes these differences. Difficult Decisions Ahead. The persistence of the state’s To What Extent Did Cost Increases Sustain or deficits strongly suggests the Expand Services Across the Budget? balance of the state’s spending (In Billions) commitments and revenues is not sustainable. In retrospect, the $50 state could not afford to sustain its 45 existing services while funding the Sustain Existing Services 40 chosen suite of expansions and 35 Expand or Create New Services new programs under the same tax 30 revenue structure. Further, as we 25 describe in this report, due to the 20 15 state’s constitutional limitations 10 on how it can spend tax revenues, 5 addressing these deficits will likely require at least some—if not Local Assistance K-14 Education State Operations significant—spending reductions. In short, in the years ahead, policymakers will have difficult decisions to make. www.lao.ca.gov 3 analysis full AN LAO REPORT 4 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT INTRODUCTION General Fund spending has grown just over picture, long-term imbalance will likely persist $100 billion since the COVID-19 pandemic—from without significant policy changes. Addressing $146 billion in 2019-20 to $248 billion under these structural imbalances will require difficult the Governor’s budget proposal for 2026-27. decisions, including spending reductions that could This report aims to assess the drivers of that be significant. growth. Specifically, we examine the extent to This report proceeds in three parts. First, we which underlying cost pressures versus program begin with a discussion of the underlying structure expansions caused state spending to increase over of the state budget and its design. We also describe this period. This analysis is particularly important how state General Fund spending is organized and given the current fiscal outlook. Both our office the analytical approach for this analysis. Second, and the administration have estimated the state we present our analysis of cost growth for three faces structural deficits ranging from $20 billion to types of state spending: (1) local assistance, $30 billion annually. While recent revenue gains— (2) K-14 education, and (3) state operations. driven by a strong stock market and investor Last, we discuss takeaways from our analysis and enthusiasm surrounding artificial intelligence— their implications for solving the structural deficit. have buoyed the state’s near-term budget ORGANIZATION OF GENERAL FUND SPENDING Categories of General Fund Spending provide services to the public, such as fire suppression or emergency response, and To assess the extent to which the budget’s administrative or oversight functions, such growth reflects expanding or creating new services as tax administration and the treasury. It also versus sustaining existing services we need includes personnel and operating costs for to distinguish between different types of spending. We have organized this report into three main categories of General Fund Figure 1 spending: state operations, local assistance, Categories of State Spending and Proposition 98 (1988) (K-14 education (In Billions) spending). These are summarized below and in Figure 1. Local Assistance $200 General Fund Budget Organized Into State Operations and Local Assistance. State budget documents produced by the About half of local 150 assistance spending administration broadly categorize nearly is Proposition 98 all General Fund spending into two main categories (with a small third category 100 for capital outlay, which is not included in this analysis): State Operations All other A small share of 50 local assistance state operations • State Operations. Includes expenditures All other costs are state operations Proposition 98 for the administration and direct delivery of programs by state government employees. This category covers both operational functions that directly www.lao.ca.gov 5 analysis full AN LAO REPORT state departments and state-run institutions, tax revenue, so it can fluctuate annually. Although as well as state-level payments like bond growth in the minimum funding level for K-14 debt service. education has a direct relationship with General • Local Assistance. Includes payments, Fund revenues, the condition of the Proposition 98 grants, and other support provided to local budget can differ substantially from the condition governments and other entities that administer of the rest of the budget. Most Proposition 98 or support public programs. For example, this spending is local assistance, provided to districts includes payments to healthcare providers, and colleges to manage independently. In short, grants to local governments, and direct Proposition 98 creates a constitutionally protected payments to individuals. For the purposes slice of the budget that functions separately from of this report, we also classify funding to the the rest of state spending, both in terms of how it University of California (UC) and California is calculated and how it is allocated, and for this State University (CSU) as “local assistance,” reason, this report treats this spending differently even though it is technically categorized than the rest of the General Fund. as state operations. We treat them as local Drivers of Cost Increases assistance because: (1) the state provides Our assessment also requires assigning funding one main allocation to each system, which changes to different types of budget actions. In they manage independently—unlike typical this section, we describe the drivers of state costs state operations where the state exclusively over time: the underlying reasons for growth and provides targeted funding for specific the mechanisms through which that growth occurs. purposes such as salaries or leases, and (This discussion applies to spending outside of (2) the Governor and Legislature do not Proposition 98, which is governed by constitutional set compensation levels for UC and CSU formulas and operates differently.) The drivers of employees (system governing boards make those decisions). cost increases are also summarized in Figures 2 and 3. Proposition 98 Creates a “Budget Within Spending Increases Since 2019-20. This a Budget.” Proposition 98 creates a “budget analysis focuses on cost increases that have within the budget” by establishing a minimum occurred since 2019-20. We selected that year as level of funding that the state must provide each a “pre-pandemic” baseline—most of that fiscal year year to K-12 schools and community colleges (K-14 education). From the annual Figure 2 funding level determined by Reasons for and Mechanisms of Cost Increases Proposition 98, the Legislature then determines how to allocate these resources Sustain Existing Expand or Create New Services and Supports Services and Supports among various K-14 education programs. In practical terms, Cost changes under Automatic this means that a portion of existing law the state’s overall budget is effectively earmarked for Legislative action is Legislative action required to sustain Discretionary education, and those funds services expands services are generally not available for other programs. This funding Other entities, like is determined by formulas voters or the federal Other entities government, require External require action to based on multiple inputs, action to sustain expand services services including state General Fund revenues and local property 6 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT Figure 3 Examples of Reasons for and Mechanisms of Cost Increases Sustaining Existing Services and Supports Mechanism Description Examples Automatic Cost changes occur under existing law, based on changing • IHSS caseload changes. conditions, like changes in caseload, utilization, or price. • Medi-Cal per enrollee costs. • Child care provider COLAs. Discretionary Legislative changes are required to sustain existing services in • University base increases at or below inflation. response to changes in prices or demand. • General Salary Increases. • Developmental services rate increases. External Cost changes to sustain services are required by other entities, such as voters or the federal government. Expanding or Creating New Services and Supports Mechanism Description Examples Discretionary Discretionary choices enacted by the Legislature to expand • Expanding eligibility for Medi-Cal. services or supports. • Increasing child care slots. External Service expansions are required by other entities, such voters • Federal requirements to modernize IT or the federal government. IHSS = In-Home Supportive Services; COLA = cost-of-living adjustment; and IT = information technology. occurred before the pandemic and it predates most • Sustaining Existing Services and Supports. of the major federal and state spending changes Leaving a program’s funding level unchanged that followed. However, in the nearby box, using year to year typically results in an erosion of 2019-20 as the starting point means certain cost its service. To sustain an existing service level, increases are categorized differently than would be funding increases are necessary to respond the case had a different base year been chosen. to inflation, changes in the eligible population, Reasons State Spending Grows. State and the intensity of program use. Sustaining spending can increase for different reasons, services also can mean maintaining services depending on the underlying goal of that increase. in line with current standards of care, including In particular, spending can either grow due to: incorporating advancements in technology. Effects of the Starting Fiscal Year There Is No Perfect Starting Point. Starting our analysis in 2019-20 allows us to assess the growth in the state budget prior to most of the significant budgetary effects of the COVID-19 pandemic. That said, other baseline years would have been reasonable to select. By starting with 2019-20, our analysis takes any policies already enacted before July 1, 2019 as given and any new policy enacted after this date as discretionary. As a result, any changes in cost due to eligibility, benefit levels, or services associated with these prior policy choices is categorized as automatic changes to sustain existing services. An example of this effect is state minimum wage. Chapter 4 of 2016 (SB 3, Leno) phased in gradual increases in the state minimum wage, reaching $15.50 per hour in 2023 (and adjusted for inflation thereafter). A rising minimum wage affects a number of state programs indirectly and some programs directly, like In-Home Supportive Services provider wages. As a result of starting our analysis in 2019-20, all increases in cost due to the minimum wage are considered automatic. www.lao.ca.gov 7 analysis full AN LAO REPORT For example, in health care, improved “sustaining” or “expanding” requires judgment and diagnostic tools and treatments can increase introduces uncertainty into this analysis. costs and improve participants’ standard of Mechanism of Spending Growth. From the care even when the underlying program has perspective of the Legislature, costs can also not changed. increase through different mechanisms. Those are: • Expanding or Creating New Services and • Automatic. Some cost increases occur under Supports. Increases can also occur as a existing law, based on changing conditions, result of policy decisions to expand or create like changes in caseload, utilization, or price. new services or supports. New services and In these cases, the law provides a mechanism supports can include: expanding eligibility for the administration to align program costs to populations not previously eligible, with actual service demand—such as when enhancing benefits, broadening the scope more participants qualify for a program than of services, or reducing the rate paid by expected or when participants use more program participants. services than projected. These changes do Uncertainty in This Analysis. Although not require legislative action (but do involve conceptually distinct, sometimes differentiating administrative action). between actions taken to sustain existing services • Discretionary. Other program cost changes versus expand them is difficult in practice. For require legislative action regardless of the instance, some funding changes—such as provider underlying driver of those costs. For example, rate increases—do not directly increase services to sometimes a change to law is required to beneficiaries but instead raise payments to support respond to inflation or changes in demand. service delivery. When enacted episodically and Under our definition of discretionary, in excess of inflation, however, they can result legislative action is always required to expand in greater utilization of services, functioning like or create new services or supports. program enhancements. In addition, some funding • Externally Required. In other cases, cost adjustments—like a particular base increase increases are mandated by outside entities, for UC or CSU—could be aimed at maintaining including the federal government, voters, or purchasing power, but, at other times, a base courts. For example, federal policy changes increase might exceed inflation, include enrollment may shift costs to the state, or voter-approved growth expectations, or be linked with performance initiatives may require additional spending on expectations. As a result, categorizing spending as specific programs. LOCAL ASSISTANCE ($58 BILLION) State local assistance costs (including UC and is also approximately $58 billion.) These estimates CSU but excluding K-14 education) have grown also exclude one-time and temporary spending by $58 billion since 2019-20. This reflects what authorized between these two points in time and we would term “base” increases. That is, to avoid therefore reflect only ongoing spending at the distortions from temporary fluctuations in either beginning and end of the period. 2019-20 or 2026-27, we have adjusted growth in each program to reflect underlying (base) GROWTH BY DRIVER OF COSTS program changes, excluding one-time funding This section examines growth in local assistance and one-time fund shifts from the end points. by underlying reason—sustaining existing services (That said, adjusting programs for one-time shifts versus expanding or creating new services—and by does not substantially change the picture: the mechanism—automatic, discretionary, or external. unadjusted change between 2019-20 and 2026-27 Figure 4 shows that automatic growth to sustain 8 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT We estimate that about Figure 4 two-thirds of the nearly What Drove the Nearly $60 Billion Increase in Local Assistance? $60 billion increase in local assistance is 2019-20 to 2026-27 attributable to these automatic changes. Some External Requirements That Sustain Service Levels key examples of automatic External Requirements That Change Service Levels increases that sustain the state’s service level include: (1) caseload and utilization in developmental Discretionary Choices that services, which has Expand or Create New grown notably over the Services or Support last ten years, driven in part by the diagnosis of qualifying intellectual and developmental disabilities Discretionary Choices Automatic Cost Increases That That Sustain the among California residents; State’s Service Level Sustain the State’s Service Level (2) Medi-Cal managed care capitation rates, which have increased in response to rising health care costs and utilization; (3) a statutory cost-of-living adjustment (COLA) for child care providers; and (4) In-Home Supportive Services (IHSS) caseload, which has grown the state’s service level accounts for most—nearly in part due to demographic two-thirds—of the total growth in local assistance changes. As described in the box on page 7, by spending. Discretionary decisions that sustain choosing 2019-20 as our starting fiscal year, all existing service levels account for 15 percent. policy choices up to that point to adjust program Discretionary decisions that expand or create new costs are included in this category. (In addition to services or supports account for about 20 percent this report, our office published a series of budget of growth. External sources of growth—such as analysis reports and briefs which provide more federal actions and voter-approved measures— detail on many of these program-specific issues.) account for less than 5 percent. Discretionary Choices to Automatic Increases to Sustain Services Sustain Services In many cases, the Legislature must act to Most State Budget Growth Has Come sustain service levels because those programs From Automatic Changes to Sustain Existing have limited mechanisms for automatic increases to Services and Supports. By our definition, cost account for underlying cost growth. In these cases, increases that occur automatically under current the Legislature is providing a discretionary increase, law reflect the cost of sustaining existing service but it is targeted to maintaining the purchasing levels. (State law does not provide for automatic power of the existing service, for example through adjustments that expand programs beyond COLAs, rate adjustments, or increases to a grant. growth in inflation or underlying demand/eligibility.) www.lao.ca.gov 9 analysis full AN LAO REPORT For the purposes of this report, we define rates. Consistent with these broader trends, sustaining the state’s service level as funding key state-cost-relevant indicators experienced sufficient to cover inflation and demographic elevated growth. For example, annual growth in growth in the eligible population since 2019-20. the California Construction Cost Index, published Costs above this level are defined as expanding by the Department of General Services (DGS) services or supports. and reflective of capital outlay costs, peaked at Discretionary Choices to Sustain Services 13.4 percent in 2021 and remained above 9 percent Accounted for $7 Billion in Cost Growth. in 2022 and 2023—well above its five-year average Overall, we have found that about $7 billion in cost of 3.1 percent. Similarly, the California Necessities growth—or 15 percent of total local assistance—is Index, which tracks price changes for basic goods attributable to discretionary choices to sustain such as food and clothing and is relevant to human the state’s service level. Key examples include services programs, grew by 6.6 percent in 2021 the Legislature’s decisions to: (1) update the rate compared to a five-year average of 3.6 percent. structure for developmental services using a Discretionary Choices to Expand or commissioned rate study (we count the majority of Create New Services or Support these rate increases as sustaining services given that they were largely in line with inflation since Since 2019-20, the Legislature has enacted 2019-20), (2) increase reimbursement rates for child roughly $12 billion in discretionary choices that care providers, (3) increase average spending on expand or create new services and supports. (This supportive services in California Work Opportunity estimate accounts for budget reductions enacted and Responsibility to Kids (CalWORKs) roughly in in recent years and those proposed in the 2026-27 line with inflation, (4) increase Cal Grant awards at Governor’s Budget.) These choices represent about UC and CSU to align with higher tuition charges, 20 percent of local assistance growth over the and (5) provide unrestricted base increases for UC period (meaning roughly 80 percent of increases and CSU that cover inflation (portions exceeding have sustained existing services rather than created inflation are treated as service expansions). new ones). Major actions in this category include: Many Choices to Sustain Costs Were (1) expansion of comprehensive Medi-Cal coverage Responding to Long-Term Cost Pressures… to undocumented immigrants; (2) expansion Several legislative actions to sustain services since of child care slots; (3) a 10 percent increase in 2019-20 addressed not only current cost pressures CalWORKs grants, provided on top of other grant but also long-standing ones. For instance, some increases funded from realignment funding (which programs had not received cost adjustments roughly kept pace with inflation relative to 2019-20 for many years prior to 2019-20 or had been levels); and (4) expanded eligibility for Middle Class reduced in response to budget deficits in the Great Scholarships (MCS) to include students who also Recession. For example, prior to the 2021-22 rate receive Cal Grant awards. update, developmental services rates had not been External Requirements increased since at least the early 2000s. Similarly, A small share of total growth—about $2 billion, or the State Supplementary Payment grants had not less than 5 percent—is attributable to requirements been increased for many years despite rising cost from external entities such as the federal of living and the Legislature enacted grant increases government, voters, and courts. For example, to catch up with those cost pressures. under HR 1, the federal government is providing …At a Time of High Inflation. After decades of $1.4 billion less in funding for health services to relatively low inflation, prices for many goods and people with unsatisfactory immigration status. The services began rising rapidly in 2021, reflecting Governor proposes mitigating roughly half of this supply chain disruptions and strong demand. cost by reducing coverage for certain populations Inflation peaked in mid-2022 and began to that gained this status under HR 1, such as moderate in 2023 as supply conditions improved refugees and asylees. and the Federal Reserve increased interest 10 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT GROWTH BY MAJOR services to individuals with intellectual and developmental disabilities; IHSS, which provides PROGRAM AREA supports to eligible aged, blind, and disabled Figure 5 shows total growth in local assistance individuals who cannot remain safely in their homes (including UC and CSU, but excluding K-14 without assistance; child care; the universities, education) by program area. As the figure including UC and CSU; California State Teachers’ shows, a handful of programs are responsible Retirement System; CalWORKs; and financial aid for the vast majority of the nearly $60 billion in programs. The remainder of this section provides growth. Specifically, these are: Medi-Cal, the further detail on programmatic growth among these state’s Medicaid program; the Department of major programs. Developmental Services (DDS), which provides Figure 5 Which Programs Drove the Nearly $60 Billion Increase in Local Assistance? DDS IHSS CalSTRS CSAC UC DSS County SSI/SSP Admin. CalWORKs CWS DPH Other DSS SIB Judicial Medi-Cal Child Care CSU Branch CDE DDS = Department of Developmental Services; IHSS = In-Home Supportive Services; CSAC = California Student Aid Commission; DSS = Department of Social Services; CWS = Child Welfare Services; DPH = Department of Public Health; CDE = California Department of Education; and SIB = Scholarshare Investment Board. www.lao.ca.gov 11 analysis full AN LAO REPORT Medi-Cal Spending Largely Grew Due to in 2019-20, and an adjustment to exclude the Higher Costs Per Enrollee. Ongoing General Governor’s 2026-27 IHSS budget proposals, base Fund spending in Medi-Cal grew by $25 billion costs in IHSS grew by $8 billion from 2019-20 to over the period—around 40 percent of the growth 2026-27. The three primary drivers of this increase in local assistance spending. This growth reflects were: (1) caseload growth, accounting for roughly adjustments to account for certain one-time 50 percent of the total; (2) growth in the cost per amounts, such as a temporary enhancement in hour of care—including minimum wage increases federal matching funds in 2019-20 that helped and locally negotiated wages and benefits above offset a portion of General Fund spending. We the minimum—accounting for roughly 40 percent; estimate around 75 percent of the growth is and (3) growth in hours per case, representing the result of automatic increases and most of roughly 10 percent. State costs for county the remainder from expansions adopted by the administration of IHSS have increased over this Legislature. As we noted in our publication The period, although counties do not receive a COLA 2026-27 Budget: Medi-Cal Analysis, most of these from the state. Overall, nearly all cost growth in increases are from growth in the cost per Medi-Cal IHSS reflects sustaining services. enrollee, rather than from enrolling more people Child Care Costs Grew Because of Legislative in Medi-Cal. For example, the cost per Medi-Cal Choices to Expand Slots and Reimbursement enrollee has grown as a result of higher provider Rates. From 2019-20 to 2026-27, General Fund rates and pharmacy costs. Overall, about two-thirds child care costs grew by $3.7 billion, primarily of Medi-Cal cost growth reflected sustaining due to legislative choices to expand and sustain services, versus one-third for increasing services. services. The largest components of this Developmental Services Costs Grew Mainly growth were slot expansions and increases in Response to Caseload and Utilization in reimbursement rates. Additional growth Increases. Base costs in developmental services resulted from statutory COLAs and increases increased by about $8.4 billion over this period, in the CalWORKs child care caseload over this largely due to changes that occurred automatically period. During the same years, non-General under existing law. Specifically, we estimate that Fund spending on child care increased by nearly roughly $5.6 billion of this increase resulted from $200 million, partially offsetting General Fund DDS caseload growth—driven by the diagnosis of costs. Overall, about half of cost growth in child qualifying intellectual and developmental disabilities care reflects about half sustaining services and half among California residents—and higher utilization. increasing services. A smaller share, about $2.2 billion, reflected UC Costs Grew Largely Due to Base legislative actions to sustain DDS services. A key Increases That Slightly Exceeded Inflation. component of this category was the implementation Costs for UC grew by $1.7 billion from 2019-20 to of service provider rate reform beginning in 2026-27. Over this period, the state provided UC 2021-22, based on a commissioned study of with unrestricted base General Fund increases service provider costs, which aimed to make rate in all but one year (2020-21), along with targeted setting more consistent statewide after several ongoing increases in some years. Taken together, years of piecemeal rate reductions and restorations. these General Fund increases exceeded inflation The smallest share of the total increase, roughly over the period. Whereas about $1.1 billion $500 million, resulted from legislative actions (70 percent of the spending growth) reflects that expanded services above existing levels. 2019-20 costs adjusted for inflation, about Overall, about 90 percent of cost growth in DDS $250 million (15 percent) reflects General Fund reflected sustaining services, versus 10 percent for increases beyond inflation. Of the $250 million, the increasing services. bulk is attributable to new or expanded targeted IHSS Costs Higher Due to Caseload and programs. The remainder of the spending growth Growth in Cost of Care. After an adjustment is due to enrollment increases. UC’s resident to account for a temporary increase in federal undergraduate enrollment in 2026-27 was matching funds that offset General Fund costs approximately 22,000 students (11 percent) higher 12 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT than in 2019-20, with an associated cost increase CSAC Costs Primarily Grew Due to Eligibility of about $280 million. While we attribute some of Expansions and Award Amounts. Between this enrollment growth to underlying demographic 2019-20 and 2026-27, California Student trends (that is, sustaining access), we attribute most Aid Commission (CSAC) base costs grew by to growth beyond those demographic trends (that $1.4 billion. About half of this growth reflects is, expanding access). Overall, about 70 percent legislative actions to expand eligibility. Specifically, of cost growth in UC reflects sustaining services, the Legislature expanded eligibility for the MCS versus 30 percent for increasing services. program and created the California Community CSU Costs Also Grew Largely Due to Base College Expanded Entitlement program to broaden Increases That Slightly Exceeded Inflation. Cal Grant access. Beyond expanded eligibility, Between 2019-20 and 2026-27, costs grew by about 25 percent of CSAC spending growth is $1.5 billion for CSU. As with UC, the state provided attributable to increases in certain Cal Grant CSU with unrestricted base General Fund increases awards in response to tuition increases at UC and in all but one year (2020-21) of the period, along CSU. The remaining growth in CSAC spending with targeted ongoing increases in some years. results from underlying caseload increases, largely Taken together, these General Fund increases linked to higher education enrollment trends. somewhat exceeded inflation over the period. CalWORKs Cost Growth Driven Largely by Whereas about $1.3 billion (80 percent of the Higher Spending Per Person. After an adjustment spending growth) reflects 2019-20 costs adjusted to account for a net zero funding shift involving the for inflation, about $234 million (15 percent) reflects Cal Grant program, base General Fund spending General Fund increases beyond inflation. Of the in CalWORKs grew $969 million from 2019-20 $234 million, the bulk is attributable to new or to 2026-27. The major drivers of this growth expanded targeted programs. The small remainder include: (1) a 10 percent grant increase, which was of spending growth is due to enrollment increases. provided on top of a cumulative 21.5 percent grant CSU’s resident undergraduate enrollment in increase covered by realignment funds under a 2026-27 was approximately 5,200 students statutory mechanism (that primarily restored prior, (1.5 percent) higher than in 2019-20, with an recession-era reductions); (2) growth in the average associated cost increase of $52 million. Given cost per person on employment services, which is underlying demographic trends declined over roughly consistent with inflation; and (3) cost shifts this period, we attribute all enrollment growth to due to realignment adjustments and the availability expanding access rather than sustaining access. of federal Temporary Assistance for Needy Overall, about 80 percent of cost growth in CSU Families funds. reflects sustaining services, versus 20 percent increasing services. K-14 EDUCATION ($37 BILLION) Long-Term Growth in K-14 Costs Driven by meets the Proposition 98 funding requirement Constitutional Formula Requirements, Rather through a combination of state General Fund and Than Legislative Choices. Proposition 98 local property tax revenue. Though the Legislature establishes a minimum funding level each year can fund above or below the minimum guarantee, for schools and community colleges, commonly it typically funds at the calculated level. As a known as the minimum guarantee. The state result, the overall K-14 funding level is typically calculates the guarantee using a set of formulas determined by the operation of these formulas, that take into account certain inputs, such as rather than legislative decisions about specific K-14 state General Fund revenue, local property tax program costs. revenue, and K-12 student attendance. The state www.lao.ca.gov 13 analysis full AN LAO REPORT Increases in K-14 Education Are Externally Adjusting for Growth in Base Amount, Driven. In other sections, we attribute spending $31 Billion in General Fund Ongoing Cost growth to “automatic” changes that occur under Increases. Similar to our treatment of local law and “external” changes required by other assistance earlier in this report, we first adjust entities, versus “discretionary” choices by the this growth for base increases. That is, to avoid Legislature. In contrast, for K-14 education, virtually distortions from temporary fluctuations in either all funding growth from 2019-20 through 2026-27 is 2019-20 or 2026-27, we exclude one-time funding mechanically driven by the Proposition 98 formulas and one-time fund shifts from the end points. After themselves—essentially meaning the entire total making these adjustments, we assume that base increase is “externally driven” in the language of the General Fund spending growth in Proposition 98 is rest of this report. $31 billion. Legislative Decisions Allocate Funding About Half of K-14 Base Growth Supported Between Sustaining and Expanding Services. Sustaining Existing Services. Across both K-12 Although Proposition 98 determines the overall level education and community colleges, we estimate of funding to schools and community colleges, the that 56 percent of spending increases were used Legislature retains discretion over how available to sustain existing services, while 44 percent was Proposition 98 funds are allocated. This means used to expand services or create new services. that, within the guaranteed funding level, the Applying these percentages to the growth in base Legislature decides whether to use additional General Fund spending implies: resources to sustain services or expand them. • $17.6 Billion for Sustaining Services. For Majority of Growth in Proposition 98 school and community college districts, Spending Is Attributed to the General Fund. sustaining costs mainly includes providing Between 2019-20 and 2026-27, total Proposition 98 COLAs and other base augmentations for spending—including both General Fund and existing programs. These adjustments help local property tax revenue—grew $46 billion, districts address rising costs, including while General Fund Proposition 98 spending salary and benefit costs. For schools, these grew $35 billion. General Fund and local property adjustments also have helped offset the fiscal tax revenues are effectively fungible within the effects of declining attendance. guarantee. To calculate how Proposition 98 General • $13.8 Billion for Expanding Services. In Fund growth was spent over the period, we first K-12 education, expansions include initiatives estimate how funding growth (excluding one-time such as a new after school program, the funding and fund shifts) was allocated between expansion of transitional kindergarten to all sustaining and expanding services. We then four-year olds, and the arts education program apply that growth proportionally to the General approved by voters through Proposition 28 Fund component. This means that the increases (2022). For community colleges, expansions described below do not tie to overall changes in include increases beyond inflation in general Proposition 98 spending. purpose funding, along with new and expanded categorical programs for purposes such as basic needs centers, student financial aid, and part-time faculty health insurance. 14 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT STATE OPERATIONS ($9 BILLION) This section examines increases in state is that department’s vacancy rate.) Using limited operations costs, which support state-delivered data, we estimate that these factors contributed services, including oversight and accountability roughly equally to cost growth over the period. functions. These activities include departments Specifically, about half of the increase in total that administer and oversee state grant programs, employee compensation appears to be associated collect taxes and fees, and perform statewide with growth in the number of filled positions (FTEs), administrative functions, such as those carried while the other half reflects higher per-employee out by the Controller and Treasurer. Within these costs due to increases in salaries and benefits for departments, state operations costs primarily existing positions. consist of employee compensation and operating Increase in FTEs Mainly Concentrated in expenses and equipment (OE&E), such as leases Five Departments. While we do not have any and consulting services. The state’s information comprehensive or reliable data on actual General technology (IT) costs cut across these categories, Fund supported FTEs by department, DOF as they can be associated with both personnel provided us with data on authorized positions and OE&E. (The box on the next page provides by departments. Importantly, due to technical additional detail on recent growth in IT costs.) adjustments in position authority, these data The costs of debt service and repayments are also do not give a reliable picture of growth in the included in state operations. Overall, from 2019-20 number of employees receiving paychecks from to 2026-27, General Fund state operations costs the state. Nonetheless, the data suggest that grew by $9 billion. authorized General Fund FTEs increased by about Employee Compensation Accounted for 18,000 between 2019-20 and 2026-27 (a 17 percent $6 Billion of the Growth. As described in the box increase) and five departments are responsible on page 17, we have extremely limited data on for 10,000 of these positions—more than half the General Fund spending on employee compensation increase. After setting aside technical adjustments, (there is reliable data, however, on total employee the major reasons for the increases are: compensation across all funds). In fact, we cannot • California Department of Forestry and say with certainty how much General Fund the Fire Protection (CalFire). New positions state spends on salaries or benefits, or how many expanded CalFire’s capacity to fight fires, full-time equivalents (FTEs) are filled using General including additional fire crews, firefighter Fund resources. Further, our different imperfect hand crews, and relief and support staff. data sources tell different stories. That said, The composition of positions also shifted using data from the Department of Finance over this period, moving from temporary (DOF) that is the basis for budget estimates, our (seasonal) roles to more permanent, analysis would indicate that growth in employee higher-cost positions. compensation costs were split roughly evenly • Department of State Hospitals (DSH). between increases in salary costs and increases About three-fourths of DSH’s new positions in benefits costs (like health care and pension were added to support existing workload, contributions) for state employees. These increases following the department’s Mission-Based reflect both the increases in compensation Review to align staffing and resources and to provided to existing employees, as well as the increase capacity at the Metropolitan hospital. cost of adding additional positions (or workers). The remaining one-fourth support new (Importantly, there is a distinction between the services, primarily staff for the Incompetent to number of positions a department has authorized Stand Trial Solutions program. by the Legislature, and the number of positions actually filled. The difference between the two www.lao.ca.gov 15 analysis full AN LAO REPORT Information Technology (IT) Costs Cut Across State Operations State spending on IT (which includes spending on both operating IT systems as well as IT projects under development) does not fit neatly into a single cost category. IT expenditures span both employee compensation—including salaries and benefits of state IT workers—and operating expenses and equipment, which include, for example, software licenses, hardware, and cloud services. As a result, IT costs are embedded throughout the state operations figures discussed in this section. This box examines IT as a crosscutting lens on state operations cost growth. Growth in State IT Expenditures Spending on Overall IT by Category. All Funds (In Billions) As shown in the figure below, overall state IT expenditures have grown substantially $7 Mobile Phones since 2019-20, driven primarily by increases Network 6 Telecommunications in personnel and services and consulting Hardware Cloud Services costs. (We do not have this data for 5 Software Services/Consulting General Fund spending only, so the figure Personnel 4 shows all funds.) Personnel costs grew steadily, reflecting both workforce expansion 3 and rising compensation. Services and 2 consulting costs grew sharply through the 1 early part of the period before moderating, driven largely by a wave of major 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25a 2025-26a modernization projects. Software and cloud a 2024-25 and 2025-26 expenditures are estimated, not actual expenditures. services—while smaller in absolute terms— IT = information technology. grew faster than most other categories, consistent with a broader shift away from traditional on-premises IT infrastructure. General Fund Spending on IT Projects. State IT Project Funding Has The figure below shows General Fund spending Grown Substantially Since 2019-20 on new IT projects. These are discrete, often General Fund (In Millions) multiyear initiatives to replace legacy systems or build new service delivery platforms—and spending $1,000 Prior-Year Obligations 900 on them grew dramatically between 2019-20 New Approvals 800 and 2022-23. This growth likely reflects several 700 concurrent factors: the availability of enhanced 600 500 federal pandemic-era funding, longstanding costs 400 to address aging state systems, and increased 300 demand for digital service delivery. While new 200 100 project approvals have since moderated, prior-year obligations from previously approved projects 2020-21 2022-23 2024-25 2026-27ª Note: Prior-year obligations reflect the ongoing costs of IT projects approved in now account for a substantial share of annual IT previous fiscal years that continue to require funding in the current year. project spending, reflecting the multiyear nature of a 2026-27 reflects proposed funding from the Governor's budget. large-scale IT investments. IT = information technology. 16 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT Serious Data Limitation on General Fund Employee Compensation In conducting this analysis, we discovered that there is no reliable source of data on General Fund employee compensation spending, including reliable data on the General Fund cost of salaries, benefits, and—most acutely—the number of filled, General Fund-supported positions. Nearly all workforce data reported by the California Department of Human Resources and the State Controller’s Office is on an “all funds” basis, rather than by fund source. Although the Department of Finance provided department-level data on authorized General Fund full-time equivalent employees, these data are not centrally audited or quality controlled, and we identified inconsistencies. As a result, the estimates presented in this section should be interpreted with caution. • Department of Justice (DOJ). Over half across three departments—California Department of the new positions at DOJ support new of Resources Recycling and Recovery, Office of services, primarily resulting from new Emergency Services, and DGS—and an increase of legislation, including increased oversight of $1 billion across all other departments.) peace officers and firearm regulations. • Department of Social Services (DSS). HOW MUCH OF STATE One-third of the new positions at DSS are OPERATIONS GROWTH WAS THE related to sustaining existing services, and RESULT OF NEW SERVICES? two-thirds to providing new services. The majority of the $9 billion growth in state • Franchise Tax Board (FTB). The majority operations—perhaps around $6.5 billion—reflects of new positions at FTB are related to costs to sustain existing services rather than to maintaining existing services, including expand or create new services. In particular: to staff the Enterprise Data to Revenue project, a major IT modernization effort at • Employee Compensation. Changes in the department. per-person salaries and benefit costs represent a mix of automatic and discretionary Overall, these findings suggest that the recent increases to sustain service levels. Salary FTE growth has been driven more by expanding growth is primarily driven by General Salary and creating new services than by sustaining Increases and other salary adjustments, existing services. which are discretionary decisions made by Other Costs Net to a $3 Billion Increase. the Legislature and administration through Debt payments drove the remaining increase the collective bargaining process. However, in state operations costs. Specifically, debt these are generally set in line with inflation to payments increased $5 billion during this maintain purchasing power. Cost increases period, with retirement-related debt payments associated with employee benefits—such as increasing $3 billion (driven by the requirements retirement contributions or health premiums— of Proposition 2 [2014]) and other debt payments occur automatically under existing law and increasing by $2 billion. These other debt payments labor agreements. By contrast, increases include debt service on general obligation bonds in FTEs, as described above, reflect a (largely issued before 2019-20) and interest on the combination of sustaining existing services state’s Unemployment Insurance (UI) loan from the and creating new service levels, with most federal government. This $5 billion increase in debt of the growth likely attributable to new payments was offset by a net reduction of $2 billion service levels. across all other areas of state operations. (This reduction reflects the net of a $3 billion reduction www.lao.ca.gov 17 analysis full AN LAO REPORT • Debt. Nearly all debt repayments are related the $5 billion increase can be attributed to to sustaining existing services. While UI debt expanded services. represents new debt incurred since 2019-20, • Other. Nearly all growth in this category it does not expand services relative to the is associated with sustaining existing level that existed prior to this period. Only the service levels. increases in GO bond debt service for newly authorized bonds—about $400 million—of WHY HAS SPENDING GROWN $100 BILLION SINCE 2019-20? Overall, Majority of Growth Attributed to Expansions and New Services Are a Sustaining Services. Since 2019-20, total General Meaningful Share of Spending Growth. Within Fund spending has grown by $102 billion. Across local assistance, discretionary choices to expand the three categories of spending—local assistance, services—such as Medi-Cal coverage for certain state operations, and K-14 education—about immigrants, child care slot expansions, or MCS 70 percent of cost increases went to sustaining eligibility—account for roughly 20 percent of overall services and 30 percent went to expanding them. growth. Although relatively small proportionally, in Nearly All Growth Attributable to a Handful dollar terms—about $12 billion—these expansions of Areas. Programmatically, a substantial are not insubstantial. In addition, expansions majority of this total growth—across sustaining of services within K-14 education total about and expanding services—is attributable to higher $14 billion General Fund. spending on K-14 education ($37 billion), Medi-Cal ($25 billion), DDS ($8 billion), IHSS ($8 billion), Figure 6 child care ($4 billion), and To What Extent Did Cost Increases universities ($3 billion). Sustain or Expand Services Across the Budget? K-14 Education Spending Saw (In Billions) More Service Expansions Than the Rest of the Budget. Outside of spending on K-14 education, a $50 substantial majority of cost growth 45 Sustain Existing Services has supported sustaining existing 40 Expand or Create New Services programs rather than expanding or 35 creating new services. In contrast, 30 K-14 funding growth has been 25 20 more evenly split. Specifically, 15 we estimate that about half of 10 Proposition 98 growth sustained 5 existing services, while the other half funded expansions and new Local Assistance K-14 Education State Operations programs. Figure 6 summarizes these differences. 18 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT WHAT ARE WAYS TO MEASURE SPENDING GROWTH? Each year, the Legislature and the Governor by the voters, govern the use of about half of must develop and adopt a balanced budget. state General Fund revenue. As such, to the As such, the state’s spending capacity is almost extent revenues grow faster than inflation and entirely driven by the revenues its tax structure population, so too will these requirements. generates. In recent years, that revenue growth has • Differences in the State’s Programmatic been significant, growing 60 percent cumulatively Cost Structure. The consumer price index since 2019-20. This is less than the overall growth (CPI) measures price changes for a standard in General Fund spending, however, which is basket of consumer goods and services. 70 percent over this period. (The difference The state’s expenditures, however, are is essentially the reason the state has an concentrated in certain areas—such as health operating deficit.) care, education, and human services—where In addition, significant parts of the state’s cost growth can differ from CPI. For example, spending are driven by constitutional formulas although medical cost inflation during this largely outside of the state’s direct control. Most period was below CPI, prior to the pandemic, notably, Proposition 98 requires the state use a set it typically was higher. of formulas to determine how much state General • Changes in the Composition of the Fund should be spent on schools and community Population. While the state’s overall colleges. Typically, these formulas require the state population has remained relatively flat since to set aside 40 cents of every additional dollar in 2019-20, certain populations have grown more revenue collected. Although a smaller contributor, rapidly. For example, the share of Californians Proposition 2 also uses formulas to determine how over 65 years old has grown over 20 percent much must be set aside for reserves and debt during this time. When populations served by payments. Together, these requirements effectively the state’s programs grow—even when total predetermine the use of about half of new revenues. Figure 7 State Spending Growth Exceeded Growth in General Fund Spending Grew Faster Than Inflation and Inflation and Population. Population, but Less Quickly Than the Incomes of Millionaires Total General Fund Cumulative Growth spending since 2019-20 grew significantly more than 80% inflation and population, as 70 seen in Figure 7. Growth Incomes of Millionaires General Fund in inflation and population, 60 Spending however, do not necessarily 50 capture the cost to maintain Income of All Californians the state’s current suite of 40 state service commitments 30 for a few reasons: 20 • Constitutional Inflation and Population Spending 10 Requirements. Propositions 98 and 2, 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 2025-26 2026-27 both constitutional amendments adopted www.lao.ca.gov 19 analysis full AN LAO REPORT population may be flat—the state’s costs for …But Not the Growth in Incomes of the providing its suite of services changes. State’s Highest Earners. As noted earlier, in large • Changes in Utilization. Program spending part, the state’s spending capacity is driven by also is driven by the intensity of the services its revenue structure. The state’s General Fund provided per recipient. In programs such as revenue structure relies on personal income taxes, developmental services and Medi-Cal, costs the rates for which are progressive, increasing depend on treatments and services rather as individuals’ incomes increase. In fact, over than broad demographic categories. 40 percent of personal income taxes are paid by those earning $1 million or more. This progressive State Spending Growth Also Exceeded design was intentional and reinforced by the Growth in the Economy… Another way to measure voters through the passage of Propositions 30 the growth in spending is to compare it to the state (2012) and 55 (2016). As such, as the incomes of economy. One measure of the state economy, the highest earners in the state increase, so too personal income growth (of all Californians), also does the state’s budget capacity. Currently, the did not grow as fast as state spending as seen in state’s programmatic commitments also reflect this Figure 7. Again, however, growth in the economy is redistributive characteristic, with over 60 percent not a perfect corollary for state cost pressures for of spending (outside of K-14 education) committed several reasons. For example, eligibility for public to programs that serve lower-income Californians. services typically is greater when the economy is Overall, compared to the growth of incomes of the not growing quickly. highest-income Californians, however, the budget generally has not grown quite as quickly, as seen in Figure 7. WHAT DO THESE FINDINGS MEAN FOR ADDRESSING THE DEFICIT? In conducting this analysis, we aim to give the Eliminating Deficits Could Require $30 Billion Legislature context on its spending commitments to $60 Billion in Additional Revenues. The as it embarks on the difficult work of addressing the state’s ongoing deficits are projected to be in the structural deficit. In this section, we provide some range of $20 billion to $30 billion annually. Due context for the decisions that could lie ahead based to the effects of Proposition 98 (and, to a lesser in part on this analysis. extent, Proposition 2), eliminating deficits through tax increases alone would require substantially Can the Legislature Raise Revenues to more in new revenues than the deficit itself— Eliminate Deficits? potentially $30 billion to $60 billion per year. This Ultimately, the decision over whether to address is because each additional dollar of General Fund the state’s budget deficits through revenue revenue triggers roughly $0.40 to $0.50 in required increases or spending reductions is a decision spending, primarily for K-14 education. about how big state government should be. This is State’s Capacity Under SAL Will Decline. a question for elected policymakers, not our office. The SAL limits the state’s ability to spend tax As a practical matter, however, the Legislature’s revenues on general purposes. Currently, the state ability to raise revenue to eliminate the deficit is has $34 billion in available room under the limit. (For constrained by constitutional provisions adopted by a full explanation of the SAL, see our report, The voters—most notably Proposition 4 (1979), which State Appropriations Limit [2021]). This capacity created the state appropriations limit, or SAL. is temporarily elevated due to a voter-approved temporary adjustment to the limit under 20 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT Proposition 35 (2024), which increased the limit by 2019-20 outside of K-14 education—including about $9 billion for a period of four years. Once this full-scope Medi-Cal coverage for undocumented temporary increase expires, available room under individuals, child care slot expansions, university the SAL will decline. funding increases provided above inflation, Constitutional Constraints Likely Preclude a enhanced fire-fighting services, and increased Revenue-Only Solution. Looking ahead, several oversight of peace officers—the resulting savings factors—like growth in the economy and revenues— would total about $15 billion, roughly half of the will affect the state’s capacity under the SAL. Even projected structural deficit. after accounting for these uncertainties, however, Closing Remaining Gap With Tax Increases the magnitude of revenue increases required Would Require Significant Action. Closing the to eliminate the projected deficits very likely remaining gap through revenue increases would exceeds the state’s available room under the SAL. require major tax actions. Our office recently Accordingly, unless the Legislature asks voters published a report outlining various options the to amend the State Constitution, addressing the state has to raise or lower taxes (see Comparing state’s projected deficits likely will require at least Options to Raise and Lower Taxes). To start, voters some—if not significant—spending reductions. would need to extend the higher personal income tax rates put in place by Propositions 30 (2012) and What Is the Scope of What Is Required 55 (2016), which were enacted to address lingering to Eliminate Forecasted Deficits? structural deficits following the Great Recession. In this section we provide some illustrative Because these tax increases are scheduled to examples of what would be required to eliminate expire under current law, extending them does not the structural deficits. These examples are address any of the deficit (it only prevents the deficit not recommendations; they are intended to from becoming even larger). As such, on top of that, illustrate the magnitude and severity of the state’s the state would need to enact more tax increases. fiscal challenge. For example, this could include doing all of the following: (1) raising personal income tax rates by For Example, Eliminating Every Service 6 percent (not percentage points) across the board, Expansion Adopted Since 2019-20 Only Closes (2) increasing the corporate tax by 6 percentage Half the Gap. Even if the state eliminated every points, and (3) raising the sales tax by one cent. discretionary service expansion enacted since CONCLUSION In Hindsight, Underlying Costs and sustaining services (largely automatic or legally Discretionary Choices Were Not Affordable. required) and discretionary expansion provides The persistence of the state’s deficits strongly an initial framework for evaluating trade-offs in the suggests the balance of the state’s spending budget. Ideally, policymakers would be provided commitments and revenues is not sustainable. In clear, systematic information on whether higher retrospect, the state could not afford to sustain its spending has translated into improved outcomes existing services while funding the chosen suite of or other measurable public benefits. For some expansions and new programs under the same tax programs, the state does have rich data on revenue structure. performance metrics, but for other programs data Evaluating Trade-Offs Will Be Challenging. is much more limited. Even when good data are In the midst of budget challenges, deciding available, however, addressing this question is which programs to reduce or sustain requires extremely difficult because it is difficult to draw understanding the relative benefits of each causal conclusions about how much outcomes of those programs. The distinction between are changed by state spending. That challenge grows when looking across the state’s full range of www.lao.ca.gov 21 analysis full AN LAO REPORT programs and services. That said, this report offers revenue gains may temporarily mask structural a first step in making fiscally sound evidence-based imbalances, but in the coming years, the fiscal policy decisions. realities are likely to be undeniable. Addressing Difficult Decisions Ahead. Despite imperfect the budget gaps will require sustained and information, policymakers will need to make difficult consequential action—through revenue increases, budgetary decisions in the years ahead. Near-term spending reductions, or likely both. 22 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT www.lao.ca.gov 23 analysis full AN LAO REPORT LAO PUBLICATIONS This report was prepared by Ann Hollingshead with contributions from 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. 24 LEGISLATIVE ANALYST’S OFFICE