Highlights and Analysis of the 2016-17 State Budget - Updated

Wednesday, September 28, 2016

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Executive Summary

Budget Overview.  The 2016 Budget Act includes record-high General Fund revenues and spending.  The budget shows strong education spending, prudently includes an extra $2 billion deposit to the state Rainy Day Fund, and provides much needed funds for the strained system of community services for the developmentally disabled.  Apart from General Fund spending, the budget also adopts a creative $2 billion homelessness program for the mentally ill to be funded using existing mental health funds.   Unfortunately, this budget misses opportunities to fix core programs and implement reforms.  Instead, the Governor and legislative Democrats have used the state’s short-term revenue surge to make massive spending commitments, such as the new minimum wage mandate enacted in March.  These spending choices are likely to lead California back to deficits within a few years.

Revenues Hit Record Highs.  The budget includes General Fund revenue of $123.6 billion in 2016-17, a record high that exceeds the 2015 Budget Act by $6.7 billion and 5.7 percent.  While revenues are still increasing from year to year, the most recent financial data suggest the economic tide may be shifting. Even so, General Fund revenue are projected to grow each year through 2019-20, despite the expiration of the temporary Proposition 30 taxes.

Record Spending and Looming Deficits.  Overall General Fund spending reaches a record $122.5 billion in 2016-17, an increase of $7.1 billion and 6.2 percent over the 2015 Budget Act.  California has experienced a surge of tax revenues in recent years both because of economic growth in Silicon Valley and because of Proposition 30. However, although spending on core programs like education has increased significantly, Democrats have also used these short-term revenues to launch billions of dollars in new long-term spending commitments such as optional Medi-Cal and human services expansions and the new minimum wage mandate.

Because of the Democrats’ spending choices, expenditures will grow faster than revenues through 2019‑20 (the last forecasted year), setting the stage for deficits once again.  The Administration now projects General Fund operating deficits of $2.1 billion in 2018-19 and $4.3 billion in 2019‑20.  These looming deficits show that Democrats did not learn the lessons of the past, and underscore the need for more prudent budget choices.

Now, many Democrats are supporting a ballot initiative that would extend the Proposition 30 income tax increases for 12 years.  It is a highly cynical strategy for the majority party to ramp up spending today, then turn around and claim the only solution to California’s deficits is to raise taxes. We already live in one of the most expensive states with one of the worst business climates.

Transportation and Infrastructure: Sacramento Offices Instead of Roads for Everyone.  While California’s infrastructure needs are vast, the budget unfortunately chooses to fund Sacramento offices over starting to fix roads for everyone.  The budget authorizes $1.3 billion for construction and renovations to office buildings in Sacramento.  Senate Republicans believe that roads around the state should be a higher priority and called for a portion of these funds to be redirected to complete $754 million in local transportation projects that were just cancelled. Instead, Democrats rejected this opportunity to benefit the entire state, and the budget takes no significant actions on transportation.

Homelessness Bond Redirects Existing Funds.  The budget includes funding for a plan to use about 7 percent of existing Proposition 63 mental health funds for a $2 billion revenue bond to help address the problem of the homeless mentally ill. This new program would spend up to $140 million in bond proceeds annually.  Senate Republicans support efforts to address homelessness and believe that the $2 billion homelessness bond is a prudent redirection of existing funds.

Broader Housing Reforms Left Unaddressed.  The budget also included the potential for $400 million to expand affordable housing programs more broadly, but these funds were contingent on the Legislature eventually adopting the Governor’s proposed “By Right” land use reforms.  Under the By Right proposal, developments that meet certain criteria would not be subject to local discretionary review.  However, the Legislature did not take any action on the By Right proposal or other significant housing reforms prior to the end of the 2016 legislative session. 

Cap and Trade Spending Added at 11th Hour.   The budget enacted in June removed most Cap and Trade funding due to major legal questions and doubts about how much revenue upcoming auctions would generate.  The recent auctions in May and August 2016 raised only a fraction of the expected funds.  However, on August 31, the final day of the legislative session, the majority party added $900 million in Cap and Trade spending to the budget by passing two Cap and Trade bills without a single committee hearing. These funds will be spent on a variety of programs, many of which are of questionable value, though $50 million targeted at dairies and livestock operations and $25 million for healthy forests are commendable.

Rainy Day Reserve Fund.  The state’s Rainy Day Fund (Proposition 2 of 2014) would grow to reach $6.7 billion by the end of 2016-17, or 5.4 percent of General Fund revenue.  Commendably, this balance includes the extra $2 billion deposit into the Rainy Day Fund that the Governor proposed.  This additional deposit is an essential component in preparing for anticipated economic downturns given the low level of the reserve as a percent of revenue.

Minimum Wage Will Cost State Billions. The budget reflects the state’s minimum wage ramp-up, which adds a 50 cent increase on January 1, 2017, with $39 million in General Fund costs for the 2016‑17 fiscal year. These costs will increase rapidly, however.  The Administration projects annual General Fund costs will be $1.1 billion by 2019-20, when the minimum wage reaches $13 per hour, and $3.4 billion when the $15 wage is fully implemented. These costs would contribute substantially to the projected state deficits in future years.

New Human Services Spending Commitments.  The budget authorizes the repeal of the CalWORKs “Maximum Family Grant” policy, which previously prohibited increasing cash grants for parents who had additional children while enrolled in the program.  This action, which launches program costs that will reach $250 million upon full implementation, unfortunately chooses feel-good spending increases over reforms that would address the program’s dismal lack of success in encouraging welfare recipients to obtain high school diplomas and take steps toward independence.  The budget also increases child care rates by $94 million General Fund without adopting any reforms to make the program function more efficiently.

K-12 Education.  The Proposition 98 minimum funding guarantee would rise to $71.9 billion, an increase of $3.5 billion over the prior budget. Senate Republicans applaud this new high that is almost $25 billion or 52 percent more than the post-recession low in 2011-12. The budget also adds a one‑time $200 million College Readiness block grant and several other increases to encourage teacher preparation and credentialing.  Unfortunately, it reflects legislative Democrats’ rejection of the Governor’s proposal to reform existing preschool and early education funding.

Higher Education. The Budget Act continues the modest increases to the University of California (UC) and California State University (CSU) budgets of recent years.  Student tuition for both systems would remain unchanged.  Also included for both UC and CSU are some funds that are contingent on adding students. The CSU also will receive $35 million targeted at improving graduation rates.  

Public Safety. The budget modifies the Governor’s proposal to spend $250 million up-front for local jail construction and instead authorizes the use of lease-revenue bonds in the amount of $270 million for that construction in future years.  Unfortunately, the budget misses an opportunity to fix core problems in the judicial system such as a lack of judges in rural areas and a lack of sufficient legal assistance for foster kids in dependency courts.

Managed Care Organization (MCO) Revenue.  The budget reflects net revenue increases of $1.1 billion resulting from the MCO package enacted in February.  These revenues free up General Fund from Medi-Cal to be used elsewhere in the budget. In addition to direct MCO spending, the budget also includes $266 million General Fund to continue funding the restoration of a previous 7 percent reduction to the In-Home Supportive Services program and limits this restoration to the three‑year duration of the MCO tax. 

Services for the Developmentally Disabled.  The budget reflects additional General Fund spending of $343 million ($559 million total funds) to improve community-based care for the developmentally disabled.  Most of these funds were authorized as part of legislation enacted during the recent special session.  Senate Republicans applaud this major step toward stabilizing community care for disabled Californians.  However, the budget still does not address unfunded mandates such as costs for exempt employees whose pay must be adjusted under minimum wage mandates. 

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