LAO Analyzes Governor’s Special Session Proposals
The Magnitude of the Problem
Nonpartisan Legislative Analyst Mac Taylor (LAO) released an overview of the Governor’s special session Budget proposal on Tuesday, November 11, 2008, painting an even bleaker picture of the state’s finances than the Governor had only a week before when declaring the special session. When the revenue shortfall is combined with rising state expenses in the areas of caseloads, infrastructure debt service payments, and other expenditures, the LAO says the state will need $27.8 billion in solutions over the next 20 months.
The LAO attributes the biggest increase in state spending to the almost $1.5 billion less in expected property taxes to be received by school districts over three fiscal years. (The Administration had not updated its estimate of property taxes since the 2008-09 Budget was adopted.)
Absent corrective action, the LAO also projects shortfalls of $22 billion a year from 2010-11 through fiscal 2013-14. The LAO forecast does not include the potential effect of ballot initiatives that are expected to be put before voters in 2009, specifically, the Lottery securitization, which the LAO says could cost the state nearly $1 billion annually by 2013-14, or the Budget reform, which would redirect some General Fund revenues to a restricted account that would be difficult to access.
Following release of the report, Taylor did a Webcast. His main message to legislators was how staggering the problem is. Taylor said it may be as dire a situation as he’s seen while at the LAO. We turn to the LAO’s analysis of the proposal, and its suggested alternatives.
The Administration’s Proposal
The LAO briefly summarized the Governor’s special session tax increase proposals, including
1. 1.5% increase in sales and use tax rate (for three years).
2. Extension of sales and use taxes to some services.
3. Oil severance tax of 9.9%.
4. Five-cent per-drink increase in alcohol excise tax.
The LAO thinks that the revenue generated from these taxes could, in total, exceed what the Department of Finance estimated by about $1 billion over two years.
As regards Proposition 98 funding, the LAO notes that the Governor proposes a midyear reduction to K-12 funding of $2.2 billion, or a little more than 4%. Community colleges would see a reduction of $332 million, or a little over 5%. As the LAO says, most of the proposed reductions would come from base reductions to K-12 revenue limits and community college apportionments, though the 0.68% COLA would be rescinded, and $132 million would be captured from child care and other K-12 programs with lower-than-expected expenditures. The LAO does not mention the flexibility that would be provided CCC, but explains the administration’s K-12 flexibility proposal as follows:
[The] Governor would allow districts to transfer unlimited amounts and
completely drain prior–year ending balances from virtually any categorical
program. His flexibility proposals also include cutting reserves for economic
uncertainties in half, reducing routine maintenance reserves from 3 percent to
2 percent, and suspending local deferred maintenance matches.
Assuming the Legislature cut Proposition 98 by $2.5 billion in the current year, the Governor’s proposed reduction over the two years would total $3.2 billion from the funding levels assumed at the time the 2008-09 Budget Act was adopted only seven weeks ago.
As regards the state’s cash flow, the LAO noted the Administration’s issuance of
an initial
$5 billion in revenue anticipation notes (RANs), and concurred with “the
Administration’s estimate that, even if the state were able to obtain $2 billion
more in RAN proceeds from investors during 2008–09, the General Fund still would
be unable to meet all of its payment obligations on a timely basis without
additional remedial action by the Legislature.” The LAO says the Legislature may
need to enact additional cash management solutions either in the special session
or early in 2009. Reliance on additional borrowing through revenue anticipation
warrants (RAWs) was described as risky and expensive.
The Governor also proposes to tackle the unemployment insurance fund shortfall. The projected deficit in the fund will initially be covered by a federal loan on which interest will be payable. The LAO says the proposed unemployment insurance tax increase that would be effective in January 2010 could as much as double the tax paid per employee, depending on the stability of the employer’s workforce.
If the Legislature adopted all of the Governor’s proposals, and if voters approved the securitization of the Lottery to generate $5 billion in revenue, the Governor’s proposal would close the projected $28 billion gap, and leave the state with a $169 million reserve at the end of fiscal 2009-10. Because the sales tax rate increase would end after three years, as would the Lottery borrowing, the shortfall would again grow to between $9 billion and $11 billion annually in 2011-12 and beyond. As the LAO forecasts, the Governor’s proposal would address about one-half of the state’s long-term Budget problems. It is imperative, according to the LAO, that the Legislature take action immediately.
LAO Alternatives
1. Make midyear cuts of roughly $1 billion, as compared to the Governor’s $2.5 billion, by:
a. Eliminating the COLA provided in the 2008–09 Budget Act (the Governor also proposed this).
b. Finding one–time savings from lower–than–expected program expenditures.
c. For K–12 education:
i. Suspending some professional development activities, some maintenance, and some instructional material purchases.
d. For community colleges:
i. Increasing the credit fee from $20 per unit to $26 per unit, effective January 1, 2009.
ii. Reducing funding for certain credit-bearing physical education courses to the regular noncredit rate.
2. Score any current-year Proposition 98 spending that exceeds the minimum guarantee toward settle-up (prior-year Proposition 98 obligations). In other words, prepay the 2009-10 settle-up obligation by reclassifying some 2008-09 spending as settle-up.
3. Make some budget-year reductions now, in the special session:
a. $500 million in unspecified K-12 program eliminations.
b. Continue and further extend K-12 program suspensions.
c. Further increase the community college credit fee to $30 per unit, effective July 1, 2009.
d. Apply the regular noncredit funding rate to additional enrichment courses.
4. Identify low–priority categorical programs and cut them directly.
5. Educational Revenue Augmentation Funds (ERAF) Redevelopment Pass-Through Payments—Increase current-year amount by $50 million and make the pass-through requirement permanent. This would offset part of the annual revenue loss K-14 districts experience due to redevelopment.
The LAO proposes dozens of other options for closing the gap between revenues and expenses, including the following:
· Raise the vehicle license fee (VLF) from 0.65% to 1.00%, the same level as other property taxes; use the revenues to realign state programs
· Consider a smaller one-cent sales tax increase
· Impose a temporary 5% income tax surcharge on all personal income taxpayers
· Assume additional 5% fee increase for the University of California (UC) and the California State University (CSU)
· Phase out General Fund support for credits beyond 110% of those required to complete a degree at UC and 120% at CSU
· Raise Cal Grant B eligibility requirement from 2.0 to 2.5 grade point average
Next week, the LAO will release its regularly scheduled California’s Fiscal Outlook publication, which will have further detail regarding LAO projections. But it’s clear that the Budget problem is immense, that there are no easy solutions, and that action is needed now. We expect the Assembly to hold an initial hearing on the Governor’s proposal on Friday, November 14. Whether legislators are up to the task of quickly adopting the necessary long-term solutions to the mess is unclear. Stay tuned . . .
—Deborah Harmon