In spite of a budget in excess of $100 billion, Governor Gray Davis' recently proposed State Budget focuses heavily on one-time appropriations and offers only $250 million to aid fiscally strapped local governments. MIR is pleased to present the following report issued by the Legislative Analyst's Office, which summarizes the proposed allocations and places them within the context of our current economy. The LAO concludes by warning the Legislature to balance one-time expenditures with ongoing program funding.
Introduction
On January 10, 2001, the Governor released his proposed $100 billion plus State budget. This analysis briefly reviews the Governor's budget plan and provides our preliminary reactions to it.
LAO Findings
• The budget fully funds most existing State programs, covering costs for caseloads and inflation. It also provides for major new initiatives in the areas of education and energy. However, many initiatives will require further development, and additional spending beyond that proposed will be needed in some areas .
• The budget assumes $2.3 billion less in resources than the $10.3 billion in uncommitted funds we reported in November, primarily reflecting the recent slowing in the national economy. The budget proposal allocates the remaining $8 billion in uncommitted resources to finance increased spending ($5.5 billion), cut taxes ($0.1 billion), and provide for a budgetary reserve ($2.4 billion).
• Of the total $8 billion the Governor allocates, about 70% is for one-time purposes and the remainder is ongoing.
Overview Of The Governor's Budget
The Budget Totals. California's strong economic and revenue performance have once again provided sufficient resources to both fund existing priorities and finance new ones. The Governor's 2001-02 budget proposes total State spending of $102 billion (excluding expenditures of federal funds and selected bond funds). This represents an increase of $7.5 billion, or 7.9%, over the current year. Slightly over 80% of this total spending is from the General Fund, while the remainder is from special funds. As discussed below, the main focus of the Governor's budgetary initiatives involves education and energy.
[T]he budget projects that General Fund revenues will total $79.4 billion in 2001-02, an increase over the current year of $2.5 billion (3.3%). By comparison, budget-year General Fund expenditures are estimated at $82.9 billion, an increase of $3.1 billion (3.9%) over 2000-01. After accounting for various set-asides, the Governor's estimated 2001-02 year-end General Fund budgetary reserve is $1.9 billion, or about 2.4% of expenditures.
How the Budget Allocates Resources
The budget allocates approximately $8 billion in resources not committed for current-law requirements in 2001-02. This is about $2.3 billion less than the $10.3 billion in funds we had estimated would be available in our November report. The difference is primarily related to the effects of the recent national economic slowdown, partly offset by higher carry-in balances from 1999-00.
Figure 2 shows how the budget proposes to allocate the $8 billion. About $5.5 billion is for new spending initiatives, $0.1 billion is for tax reduction, $1.9 billion is allocated for the reserve, and $0.5 billion is set aside for litigation.
Of these uncommitted resources, about 70% ($5.7 billion) is for one-time uses (including funding reserves and supporting State programs), and the remainder ($2.3 billion) is for ongoing uses. The key issue that the Legislature faces in the coming months is identifying its own priorities for committing these funds, and determining how they compare to the Governor's priorities and proposals.
Main Features Of The Governor's Proposal
Focus Remains On Education. For the third year in a row, the Governor's proposal contains significant new ongoing funds for education. It proposes significant increases to support various K-12 initiatives directed at teacher and principal training, student achievement at middle schools, and settlement of a mandated cost claim for special education. In higher education, the budget includes significant ongoing increases for each of the three segments, as well as funds for increased financial aid, student outreach, and part-time instructor salary increases.
Energy Also A Priority. The budget also includes a $1 billion set-aside for energy-related initiatives, relating to the current electricity crisis facing the State. The funds would be available for programs directed at energy conservation and to increase supply. The administration indicates that specific proposals will be developed in consultation with the Legislature.
Mostly One-Time Spending In Non-education Areas. With the exception of the expansion of the Healthy Families program, most of the policy-related increases in the noneducation portion of the budget are for one-time purposes. [T]he budget is proposing about $3.3 billion in new one-time programmatic spending in 2001-02 (this one-time amount excludes the $2.4 billion noted earlier that is allocated to reserves). This includes the $1 billion set-aside for various energy initiatives and $772 million in direct appropriations for capital outlay. The budget also includes significant one-time funds for local fiscal relief, new housing initiatives, and various environmental and resources-related purposes.
The Budget's Economic & Revenue Outlook -Underlying Economic Assumptions
Background. The economic picture has been evolving rapidly during the past couple of months. Beginning in late November, there has been an almost uninterrupted string of reports indicating that the U.S. economy's expansion is slowing. This is evidenced by reports of falling consumer confidence levels, weak Christmas retail sales, disappointing company profits, and scaled-back investment plans for 2001. The stock market also suffered significant losses late in the year, with the NASDAQ index falling by over 25% between the start of November and the end of December. At year's end, it was clear that the U.S. economy was slowing sharply, although the effects of this slowdown in California remain to be seen.
Slower Growth Expected. The admin-istration's outlook calls for further slowing in the U.S. economy, which is expected to persist through most of 2001. A recession, however, is not anticipated. As indicated in Figure 4, U.S. real gross domestic product is projected to expand at an annual rate of about 2.5% in the first three quarters of 2001, reflecting sluggish growth in consumer spending and a marked slowdown in business investment, before rebounding late in the year. California's economy is expected to follow the same pattern as the nation, slowing in the first half of 2001 before rebounding late in the year. For example, the State's personal income growth is projected to slow from 11.7% in 2000 to about 5.7% in 2001, before rebounding to 6.9% in 2002. The slowdown in 2001 relative to 2000 reflects reduced stock-option income as well as more moderate employment gains.
Revenues
Modest Increases Anticipated. Revenues during the first six months of 2000-01 were quite strong, with receipts from each of the major taxes exceeding by significant margins the 2000-01 budget forecast made last spring. In contrast, the administration currently forecasts that revenue growth will slow during the next 18 months, in line with the more subdued gains projected for the economy. Specifically, the forecast calls for General Fund revenues of $76.9 billion in 2000-01 (a 6.9% increase from 1999-00) and $79.4 billion in 2001-02 (a 3.3% increase from the current year).
The Governor's budget forecast assumes that the quarter-cent sales tax reduction, certified by the Director of the Department of Finance (DOF) this past October, will be in effect for calendar year 2001, but not 2002. The forecast also includes proposed tax reductions totaling $109 million in the budget year. These include increases in the manufacturers' investment credit, a three-day "sales tax holiday," and various other targeted provisions. The revenue forecast also assumes various accounting changes affecting the tobacco settlement revenues and sales taxes allocated for transportation purposes.
Initial LAO Assessment. After adjusting for accounting changes and tax proposals, the budget forecast is down from our November projection by $3.1 billion in the current year and budget year combined. In light of the recent negative economic and stock market developments that have taken place, a downward revision of this general magnitude is reasonable. The most recent revenue-related information available in early January has been mixed. On the positive side, personal income tax collections during the important year-end period (when taxpayers remit their final quarterly prepayments) modestly exceeded the new budget forecast (although by less than in past years). On the other hand, however, most U.S. economic news continues to be negative, suggesting that the U.S. slowdown could be significantly sharper than anticipated by the administration. We will continue to assess economic and revenue developments as they occur, and incorporate them into our own updated revenue projections which will be released with our publication entitled The 2001-02 Budget: Perspectives and Issues next month.
Budget Proposals By Program Area
Local Government. The budget includes $250 million in one-time general fiscal relief, to be distributed according to a similar formula used in the past two budgets (50% based on an Educational Revenue Augmentation Fund contribution and 50% per capita).
Housing. The budget proposes $200 million in 2001-02 for incentive payments to local governments to encourage the production of housing units. These funds, combined with $100 million appropriated in the current year, can be spent for any purpose by local governments.
Capital Outlay. The budget includes a total of $2 billion for capital outlay projects, of which $1 billion is financed from bonds, $780 million from direct General Fund appropriations, and $207 million from special funds and federal funds. Of the direct General Fund appropriations, about $308 million is for UC, including $150 million for the Merced campus and $108 million for four science and innovation centers. The remainder is for forestry and fire protection, corrections, and general State facilities.
Electricity & Energy. The budget includes a $1 billion set-aside for various electricity-related programs, most of which remains to be detailed. In addition, it provides $50 million to the DOF to allocate to State agencies for their higher energy bills. It also provides $16.1 million to various State agencies for such purposes as expediting the power plant siting processes, electricity-related forecasting and market monitoring, development of building efficiency standards to address peak electricity demand and transmission system reliability, electrical energy rate stability and conservation, and utility audits.
Considerations For The Legislature
The Governor's proposed budget fully funds most existing programs, covering caseloads and inflation. It also contains significant new funding for the Governor's priorities in education and energy, as well as substantial amounts of largely one-time expenditures in a variety of other program areas.
Our initial review also indicates, however, that a number of the Governor's proposals lack adequate detail and will require further development. For example, the administration has provided limited detail with its proposals relating to diesel emissions reductions, river parkways, clean beaches, and capital outlay for UC.
In reviewing the Governor's budgetary proposals in the coming months, the key challenge for the Legislature will be to identify its own spending and tax priorities for utilizing the available $8 billion in resources that the Governor has allocated, and determine how they compare to the Governor's priorities and proposals. Another important challenge facing the Legislature will involve developing the proper balance between one-time and ongoing uses of funds to ensure that in meeting its priorities, the State's fiscal resources will not become overcommitted in future years especially given the uncertainties about the economy.
This report was prepared by Brad Williams, David Vasché, and Keely Martin Bosler with the assistance of many others throughout the office. The Legislative Analyst's Office (LAO) is a nonpartisan office which provides fiscal and policy information and advice to the Legislature. www.lao.ca.gov.
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