12-1-06 Legislative Analyst Forecasts Continuing Budget Deficits

Volume 19 For Publication Date: December 1, 2006 No. 25

Legislative Analyst Forecasts Continuing Budget Deficits

In a press conference on November 15, 2006, on her office’s budget forecast, Legislative Analyst Elizabeth Hill indicated that, while the State Budget will end in the black this year, the gap between ongoing revenues and ongoing expenditures will continue through 2011-12. Ms. Hill noted that the Legislature and Governor have yet to address this imbalance and that, at this stage of the economic cycle, the state should be building a reserve rather than deficit spending. She pointed out that several western states were building reserves reaching 10% while California’s current-year reserve will be exhausted by the end of 2007-08, unless corrective action is taken.

State Budget Outlook

For the current year, the Legislative Analyst’s Office’s (LAO’s) forecast anticipates an increase in the year-end reserve of $1 billion to $3.1 billion as a result of stronger revenues in both 2005-06 and the current year, plus a minor net reduction in expenditures. This $3.1 billion reserve will be available to partially fund what the LAO anticipates as a $5.5 billion budget gap in 2007-08. The Legislature and the Governor will have to agree upon an addition $2.4 billion in budget solutions in order to end 2007-08 with a positive fund balance. Ms. Hill pointed out, however, that the $3.1 billion would be one-time funds and that an ongoing imbalance of $5 billion would emerge in 2008-09.

The LAO has incorporated the decline in energy prices into its forecast and has noted that this decline has “breathed new life” into the economic expansions for both the state and the nation. Despite this favorable development, the LAO concludes that economic growth will remain subdued through 2007, in large part because of declines in the real estate sector. The LAO forecasts a decline in state personal income from 6.5% in 2006 to 5.4% in 2007, with a slight upturn to 5.9% in 2008. The LAO’s corresponding outlook for General Fund revenue growth is 5.6% for the 2007-08 fiscal year, followed by a 7% increase in 2008-09.

The LAO notes that the state’s economy, like the nation’s, remains vulnerable to energy supply disruptions, which can lead to rapid price increases similar to what was experienced in the summer of 2006. Unlike the nation, however, California is in “uncharted territory” with respect to home price appreciation. The LAO forecast assumes that price and construction declines remain modest by historical standards. If, however, steeper reductions occur, economic growth could be depressed for several years.

Proposition 98 Funding for 2007-08

Several months ago, there was a concern that the increase in Proposition 98 funding for 2007-08 might not be sufficient to fully fund the statutory cost-of-living adjustment (COLA). The LAO forecast indicates that there will be enough—but that is primarily because the statutory COLA is lower than previously projected.

The LAO projects that the 2007-08 statutory COLA will be 3.8%, down from the 5.92% COLA in 2006-07, due to the decline in energy prices and also construction costs. With this level of COLA, along with the anticipation that statewide ADA will decline by 0.5%, the LAO projects that the increase in Proposition 98 funding—estimated to be $2.4 billion or 4.3% in total—will be sufficient to fund the 3.8% COLA plus provide about $350 million for program improvements for K-12 education and community colleges.

Proposition 98 Funding for 2008-09 and Beyond

For the period 2008-09 through the end of its forecast in 2011-12, the LAO projects that the statutory COLA will decline further—to 3.0% for 2008-09 and then to be in the range of 2.7% to 3.0% for each of the following three years. But at the same time, the LAO is projecting sizable increases in Proposition 98 funding—increases that are sufficient to fund the statutory COLA plus provide augmentations for K-14 education of $1.1 billion in 2008-09, $1.0 billion in
2009-09, and more than $2 billion per year in both 2010-11 and 2011-12.

The LAO states that, given this forecast, “the Legislature could use 2007-08 to develop a coherent, overarching reform plan.” The LAO adds that the plan for K-12 education “should include clear student achievement goals and flexibility in how to meet them as well as fiscal reforms that would allow monies to be pooled and administration to be streamlined.”

Of course, funding for K-14 education doesn’t exist in a vacuum and whether the projected growth in Proposition 98 funding will materialize depends in part on how the state solves its structural budget problem.

—Paul Goldfinger and Robert Miyashiro