Highlights and Analysis of the Governor's Budget

Thursday, January 26, 2017

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Executive Summary

Overview: Budget Deficits Return Despite Record Revenues.   California continues to set new records for revenue each year, but with Democrats solely in control of the state budget, deficits are now set to return.  The Governor’s January budget projects a deficit of $1.6 billion General Fund in both 2016‑17 and 2017-18.  To address this gap, the Governor proposes $3.2 billion in spending adjustments over a two-year period.  This is generally the appropriate overall approach to address this deficit, but some reductions should be targeted better to avoid harming the middle class.  Under the Governor’s proposal, California’s budget would be only precariously balanced in future years, as shown in the chart, despite the proposed spending changes and the enactment of higher taxes in 2019 through Proposition 55.  Additional steps to restrain spending and shore up the reserve would be prudent to guard against a slowing economy or possible federal policy changes.

Revenues Hit Record Highs.  The budget adjusts the growth of revenues downward in the current year by $1.7 billion General Fund compared to the enacted budget.  Despite this revision, General Fund revenue would still grow each year and reach $125.2 billion in 2017-18, a record high that exceeds the 2016 Budget Act by $3.2 billion and 2.7 percent.  General Fund revenue is projected to grow 3.9 percent annually through 2020-21.

Spending Growth Creates Deficit.  Overall General Fund spending would still reach a record $122.8 billion in the current year, even after the Governor’s proposed adjustments, and would remain virtually constant at $122.5 billion in 2017-18.  Although Senate Republicans cautioned against spending beyond our means, billions of dollars in recent long-term spending commitments made by Sacramento Democrats have returned California to a deficit situation.

Proposed Solutions Revise Spending.  The Governor proposes $3.2 billion in spending revisions to address the deficit, including:   

  • $1.7 billion to adjust Proposition 98 education spending down to the constitutionally guaranteed level. Education spending would still grow year-over-year. 
  • $907 million to reduce or forego one-time spending included in the 2016 Budget Act, including $400 million for affordable housing and $300 million for Sacramento office buildings.
  • $553 million in other spending reductions, including pausing rate increases for child care and phasing out certain scholarships for the middle class.

Although reining in spending is the appropriate overall approach to closing the gap, Senate Republicans believe that priorities like child care and middle class scholarships could be maintained if spending adjustments are targeted at other, faster growing areas of state spending.

Rainy Day Reserve Fund Grows.  The state’s Rainy Day Fund (Proposition 2 of 2014) would grow to $7.9 billion by the end of 2017-18, or 6.3 percent of General Fund revenue. The budget largely maintains the extra deposit of $2 billion authorized in the enacted budget (adjusted slightly down to $1.8 billion) and would deposit $1.15 billion into the Rainy Day Fund in 2017-18 based on the constitutional formula.  This progress is commendable, though the reserve is likely inadequate given the magnitude of California’s potential revenue swings.

Federal Funds Assumed to Continue.  The Governor’s budget for 2017-18 does not include any adjustments to plan for possible reductions in federal funding to California in future years. While the federal government has yet to enact any changes, the $19 billion received for the optional expansion of Medi-Cal to adults is likely to be most at risk.  Senate Republicans believe that California should engage constructively with its federal partners to ensure our residents’ needs are met.

Current Year Deficit in Medi-Cal.   General Fund expenditures in the Medi-Cal program are $1.9 billion higher than the 2016 Budget Act. The Administration attributes this deficit largely to a one‑time payment of drug rebates to the federal government and a miscalculation of costs related to the Coordinated Care Initiative (CCI), a pilot in seven counties for low-income elderly adults and people with disabilities (dually eligible in Medi-Cal and Medicare).  The Administration also finds that previously assumed savings have not appeared for the CCI, and is proposing to end the program (though the related Cal-MediConnect program would continue).

Transportation Tax Plan.  The budget includes $4.3 billion for transportation infrastructure, funded by increased taxes and fees on motorists and largely similar to the Governor’s 2015 proposal.  Senate Republicans agree that California’s transportation infrastructure needs to be repaired, but with California motorists already paying the highest gas prices in the continental United States, raising gas taxes would add to an already-high burden.

Cap and Trade Approval Proposed.  The Governor’s budget proposes to spend $2.2 billion from Cap and Trade revenues on various programs such as high-speed rail, housing, and transit as well as other new and continuing programs.  This funding will be allocated only upon legislative approval of the Governor’s 2/3 vote tax proposal to extend the Cap and Trade program beyond 2020.  This would allow the Cap and Trade revenues to be spent on any state program regardless of whether those programs reduced greenhouse gas emissions.

Proposition 98 Education Funding Grows.  Proposition 98 funding for K-14 education would grow by $4.8 billion over three years, slowing by $1.7 billion from the 2016 Budget Act level due to lower-than-expected revenue growth.  Revised total Proposition 98 expenditures (including local funds) are $68.7 billion in 2015-16, $71.4 billion in 2016-17, and $73.5 billion in 2017-18.  K-12 per-pupil spending would approach $11,000.

Higher Education.  The budget increases base funding for the University of California by about $131 million (including $50 million in tobacco tax funding earmarked for graduate medical students), to over $3.5 billion, and for California State University by about $157 million, to almost $3.7 billion.  Both UC and CSU have expressed interest in increasing tuition, but the Governor’s proposal assumes flat tuition for both systems. 

Affordable Housing.  In order to close the deficit, the budget eliminates the $400 million set-aside for affordable housing that was included in the 2016 Budget Act. Although the Governor does not include a plan for increasing the housing supply in California, the budget outlines guiding principles that include avoiding use of General Fund for any possible subsidies, reducing the per-unit price, streamlining housing construction, and incentivizing local jurisdictions to meet housing goals with funding and other regulatory benefits.

Significant Raises for State Employees.  The Governor has recently negotiated generous contracts for state employees that provide pay raises between 8 percent and 27 percent over the contract period.  These raises come as many working families struggle to find good-paying jobs.  These new contracts, along with existing agreements, will increase state spending on employee compensation by $1.1 billion ($602 million General Fund) in the 2017-18 budget.

Pension and Retiree Health Costs Continue to Climb.  State spending on retiree health and pension obligations continues to outpace almost any other area of the budget.  The Governor’s budget provides $10.8 billion in spending for pension and retiree health in the 2017-18 budget, an increase of 11 percent over spending in last year’s budget.  By the 2020-21 budget, costs for pension and retiree health are on pace to exceed $12.5 billion, partly due to CalPERS’ recent decision to adjust its earnings forecast.

Early Prison Releases Loom as Proposition 57 Implementation Begins.  The budget reflects a plan to implement Proposition 57 (2016), which expanded parole eligibility and sentence credit earning opportunities for state prison inmates.  The Administration projects a decrease in the number of inmates, largely from an expansion of sentence credits being developed under the ballot initiative.  To the extent expanded credits are truly earned, this proposal could have merit, but some parts of the Governor’s plan are questionable.

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