Editor’s note: Here is an edited version of the Legislative Analyst’s Office May 17 analysis. Read these articles for local analysis of the state budget surplus:
- Zach Friend, Supervisor, Second District: tpgonlinedaily.com/county-perspective-on-state-budget-proposals-for-fairgrounds-homeless-broadband/
- John Laird, State Senator, District 17: tpgonlinedaily.com/california-comeback-budget-priorities/
Key Takeaways
We Estimate the State Has a $38 Billion Surplus to Allocate. We estimate the state has $38 billion in discretionary state funds to allocate in the 2021‑22 budget process, an estimate that is different than the Governor’s figure—$76 billion.
The differences in our estimates stem from our differing definitions. The Governor’s estimate includes constitutionally required spending on schools and community colleges, reserves, and debt payments. We do not consider these spending amounts part of the surplus because they must be allocated to specified purposes.
In Contrast to the Governor, We Recommend Legislature Restore Budget Resilience. Despite a historic surge in revenues, the Governor uses $12 billion in reserve withdrawals and borrowing to increase spending. The state will need these tools to respond to future challenges when federal assistance might not be as significant. We urge the Legislature not to step back from its track record of prudent budget management.
State Appropriations Limit (SAL) Is Important. The Governor’s May Revision estimates the state will collect $16 billion in revenues in excess of the limit this year. However, the ultimate amount of a potential excess will depend on decisions by the Legislature, which has substantial discretion in how to meet the constitutional requirements.
Addressing Many Issues or Making Significant Inroads on Fewer Issues. The May Revision includes roughly 400 new proposals. While the surplus is large enough to make significant inroads in addressing a few key policy priorities, it is unlikely sufficient to do so across the number of issues contemplated in the May Revision. If the Legislature preferred to make substantial progress in a few key areas, it could allocate the surplus in a targeted manner.
Consider Postponing Some Decisions. The surplus, in combination with the federal fiscal recovery funds, represents resources equal to about half of pre-pandemic General Fund budgets. Departments’ capacity to allocate this funding in a timely and effective manner likely will be constrained. More importantly, the Legislature’s time to deliberate over choices is extremely limited. We recommend the Legislature delay some decisions.
Introduction
On May 14, 2021, Gov. Newsom presented a revised state budget proposal to the Legislature, the “May Revision.” In coming days, we will analyze the plan in more detail and provide comments in hearing testimony and online.
This information is based on our best understanding of administration proposals as of Saturday, May 15, 2021. In many areas, our understanding of the administration’s proposals will continue to evolve as we receive more information. We only plan updates for changes greater than $500 million.
General Fund Condition
Revenues Higher by $51 Billion Compared to Governor’s Budget. Reflecting very strong cash collections in recent months, the May Revision adjusts 2020‑21 revenues (and transfers) up by $26.8 billion to $182 billion. This represents a 27 percent increase over 2019‑20, the largest single-year increase in over four decades. Much of these revenue gains carry over into the budget year, with 2021‑21 revenues being adjusted up $24.4 billion to $179 billion.
Constitutionally Required Spending Higher by $16 Billion. The constitution requires the state to spend minimum annual amounts on schools and community colleges (under Proposition 98) and budget reserves and debt payments (under Proposition 2). Mainly due to higher revenues, relative to January, constitutionally required spending is higher by nearly $16 billion.
Costs Reduced by $3 Billion. Other budgetary costs are, on net, lower by $3 billion compared to January. This number obscures billions of dollars in budgetary changes. For example, relative to the Governor’s budget, the Legislature enacted $6.4 billion in spending increases and revenue reductions through early action. Baseline costs associated with the state’s major safety net programs are lower by $3.7 billion.
Total Reserves Would Reach Nearly $20 Billion Under Governor’s May Revision. Under the administration’s proposals, total reserves would reach $19.8 billion in 2021‑22. This total differs from the administration’s estimate of total reserves because we exclude the dedicated reserve for schools and community colleges, which we do not consider part of General Fund reserves.
Spending Choices
The Governor made choice n allocating state and federal money, totaling $85 billion: the General Fund surplus, school and community college spending, American Rescue Plan funds for relief and capital projects. Schools and community colleges would receive the largest allocations. In the other category, the second largest, are $5.5 billion for broadband, $1.1 billion to replenish the state Unemployment Insurance Trust Fund, and $305 million for the Employment Development Department to address workload.
General Fund Surplus
We estimate the Governor had a $38 billion General Fund surplus to allocate in the 2021 May Revision. This surplus reflects higher revenues, higher constitutional spending, and net lower other spending.
What Is the General Fund Surplus? The Governor’s May Revision is the starting point for legislative deliberation. Ultimately, the Legislature will make its own determination about how to allocate available funds. Here we estimate how much capacity the budget has to make those allocations under the Governor’s revenue estimates. We answer this question by assessing which of the Governor’s proposals are “discretionary.” We define discretionary spending to mean spending, reserve deposits, debt payments, and tax reductions not already authorized or required under current law. (Our definition of discretionary excludes the cost to maintain current state services, such as base increases for the universities and employee compensation.)
Why Does This Figure Differ From the Governor’s Estimate? The Governor and administration have cited a surplus estimate of about $76 billion, which is different than our estimate. The primary reason is the Governor’s estimate of the surplus includes constitutionally required spending, whereas our estimate excludes it. For example, the Governor counts $27 billion in constitutionally required spending on schools and community colleges, nearly $8 billion in required reserve deposits, and $3 billion in required debt payments. After excluding these amounts, our surplus estimates are nearly the same.
How Can These Monies Be Used? In a normal budget year, General Fund surplus monies are available to use for any public purposes. This is not necessarily the case in this May Revision. That is because the State Appropriations Limit, which limits how the state can use revenues that exceed a specified threshold, applies to the budget process this year. The administration allocates $23 billion towards purposes that meet SAL requirements. The remaining surplus is used more flexibly.
The Governor Proposes Allocating $26 Billion in Surplus Funds to Spending. Using the $38 billion surplus, the Governor proposes roughly 400 spending proposals, which would cost $26 billion. Less than one-quarter of these proposals are unchanged from the Governor’s budget. The remaining three-quarters are either modified proposals or entirely new proposals.
State Appropriations Limit
SAL Limits Use of Surplus. Each year, the state compares the appropriations limit to appropriations subject to the limit. If appropriations subject to the limit exceed the limit (on net) over any two-year period, there are excess revenues.
The Legislature can use excess revenues in three ways: (1) appropriate more money for purposes excluded from the SAL (under the Governor’s proposal, the common new spending is capital outlay), (2) split the excess between additional school and community college district spending and taxpayer rebates, or (3) lower tax revenues.
How Does the Governor Use the Surplus for SAL-Related Purposes? Under the administration’s proposals, $23 billion of the surplus is split between two SAL-related purposes:
$15 Billion in Discretionary Spending on Excluded Purposes. The Governor’s General Fund discretionary proposals include $15 billion in discretionary SAL exclusions. These exclusions are proposals for capital outlay projects.
$8 Billion for Tax Rebates. The administrations estimates indicate the state would have excess revenues of $16.2 billion across 2020‑21 and 2021‑22. The Governor allocates half of these excess revenues—$8.1 billion—to taxpayer rebates for taxpayers with incomes less than $75,000. The administration does not allocate the remaining half to schools and community colleges. (The State Constitution allows the state two years to make the payments.) The estimate of the amount owed to K-14 education could change substantially in coming years due to changes in revenue estimates and legislative decisions.
Noteworthy Administrative and Proposed Statutory Changes. These three changes increase room under the SAL. First, the administration will stop counting vehicle registration fees as proceeds of taxes. Second, the administration is making an correction of its treatment of school-related deferrals. Third, the administration is proposing trailer bill language to absorb school districts’ room. We think all these changes are reasonable.
American Rescue Plan
What Are ARP Flexible Funds? The Rescue Plan included $350 billion in funding to state and local governments for fiscal recovery. California’s state government will receive $27 billion. In addition, California will receive $550 million in Coronavirus Capital Projects Fund, which also are available to the state on a more flexible basis.
How Can These Monies Be Used? The state can use the fiscal relief funds: (1) to respond to the public health emergency or negative economic impacts associated with the emergency; (2) to support essential work; (3) to backfill a reduction in revenue that has occurred since 2018‑19; or (4) for water, sewer, or broadband infrastructure. The state has until Dec. 31, 2024 to use the funds. The U.S. Department of the Treasury recently released detailed guidance.
The Governor’s Proposal. The single largest proposal using these monies is $5.5 billion for broadband access, affordability, and infrastructure; next, nearly $5 billion to housing and homelessness and $3.6 billion to higher education, nearly $3 billion for health and nearly $3 billion for resources and environment. The administration also proposes language to provide flexibility to reallocate these funds. We are still receiving information from the administration on the uses of these funds.
School and Community Colleges
Governor’s Spending Choices. The State Constitution sets a minimum annual funding requirement for schools and community colleges. The May Revision includes nearly $23 billion in spending proposals to provide the constitutionally required funding increases. The Governor proposes allocating nearly $10 billion to pay down deferred payments from previous years, $5 billion (including $2.1 billion ongoing) for high-poverty schools and districts, nearly $1.4 billion for community colleges, and the remaining $6 billion) for other K-12 spending.
Budget Structure
For the $38 billion General Fund surplus, which excludes spending on schools and community colleges, the Governor allocates: $25 billion to one-time or temporary spending, including nearly $15 billion for capital outlay; $7 billion to revenue-related reductions; $3.4 billion to the Special Fund for Economic Uncertainties; and nearly $2 billion to ongoing spending increases, although these costs would grow substantially over time. The Constitution requires the state to set aside $11 billion for reserves and debt payments.
One-Time Spending
The Governor proposes spending $25 billion of General Fund surplus monies on a one-time or temporary basis. The majority of these one-time proposals ($15 billion) meet the definition of capital outlay under the SAL and are excludable.
Governor Proposes $15 Billion in Spending on Capital Outlay. The Governor proposes allocating $15 billion of General Fund to capital outlay. For example, the Governor’s General Fund proposals include $2.6 billion for transit and rail projects, $2 billion for affordable college student housing, $550 million for Homekey (to house the unhoused), and $500 million for zero-emission vehicle fueling infrastructure. If the Legislature wants to make different decisions (without statutory changes or fund shifts), it can either: (1) use the funds to make tax rebates and additional payments to schools, (2) spend on other SAL-excluded purposes, or (3) use the funds to reduce taxes.
Governor Proposes $10 Billion in Spending on One-Time or Temporary Programs. The Governor proposes spending $9.8 billion on a one-time or temporary basis for a various program expansions that are not capital outlay. The largest proposals include $500 million for Golden State teacher grants and a $500 million endowment for learning-aligned employment.
Reserves and Debt
$11 Billion in Constitutional Reserve and Debt Requirements. With the administration’s revenue estimates, the Constitution would require the state to deposit $7.6 billion into the Budget Stabilization Account and spend another $3.4 billion to pay down debts. These deposits would be required regardless of whether the state made withdrawals from the account in 2020 to address the anticipated budget problem. They are large because of revenue revisions.
Using Surplus, Governor Repays $700 Million in Loans and Proposes Special Fund for Economic Uncertainties Balance of $3.4 Billion. The Governor also dedicates $700 million in discretionary resources to repay special fund loans and sets the balance of the fund at $3.4 billion for the end of 2021‑22, somewhat higher than balance at the end of June 2020. Notably, the administration’s multiyear estimates include a negative balance of $6 billion in the Special Fund for Economic Uncertainties in 2022‑23.
Governor Maintains Borrowing and Reserve Withdrawals. The Legislature passed the 2020‑21 budget in the face of major uncertainty. Revenues were expected to fall sharply. The Legislature took $54 billion in actions to address that problem ━ it withdrew funds from reserves, shifted costs, reduced spending, and increased revenues. However, under the administration’s estimates, General Fund tax revenues actually grew between 2019‑20 and 2020‑21 by 27 percent, the largest increase in four decades.
While the Governor’s proposals this year eliminate most of the spending-related budget solutions, they do use reserve withdrawals and borrowing from 2020 for $12 billion in spending.
Tax Reductions
Governor Proposes $7.1 Billion to Tax- and Revenue-Related Reductions. The most significant of these proposals is $8.1 billion in tax rebates to households with incomes of $75,000 or less.
These payments would satisfy half of the constitutional requirement under the SAL.) Partially offsetting the cost of the rebates is revenue from a proposal for a new tax on certain businesses.
Ongoing Spending
Governor Proposes $1.8 Billion in Spending on Ongoing Programs, With Significant Outyear Cost Increases. The Governor’s spending proposals also include $1.8 billion in ongoing discretionary spending. (We exclude funding provided to maintain the cost of current state services, such as base increases for the universities and employee compensation, from discretionary spending. These baseline cost increases increase ongoing spending by roughly $2.3 billion.)
Some of the largest include the Governor’s proposals to increase child care slots, expand full-scope Medi-Cal coverage to all adults 60 and older and to implement reforms to Medi-Cal called California Advancing and Innovating Medi-Cal (CalAIM). Some of these proposals are phased in over a multiyear period, so we estimate the cost at full implementation of all of these proposals at $3.7 billion in 2024‑25. By 2024‑25, the state would spend $2.7 billion ongoing for Transitional Kindergarten. (Under the Governor’s proposal, spending on schools and community colleges under Proposition 98 would increase to accommodate this expansion.)
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LAO Comments Budget Structure
In Contrast to the Governor, Recommend Budget Resilience. Despite a historic surge in revenues, the Governor proposes to use nearly $12 billion in reserve withdrawals and borrowing to increase spending. Using strategies designed for a budget crisis to support state spending at this time is shortsighted and inadvisable.
The state will need these tools to respond to future challenges when federal assistance may not be as significant. In the next recession, the state is likely to have sizeable declines in revenues. To avoid reductions to safety net programs that support Californians when economic hardship is most acute, budget reserves are critical. For instance, in last year’s budget process, when the state anticipated a historic budget problem, cuts to safety net programs were largely avoided because of the state’s significant reserves. We urge the Legislature not to take a step back from its track record of prudent budget management.
Budget Decisions Are More Complex Due to State Appropriations Limit. The SAL places significant restrictions on how the Legislature can use the surplus. The Legislature, however, can make different decisions, which will affect whether tax rebates or future tax cuts are necessary. Moreover, the Legislature could change calculation of the SAL. Ultimately, the Legislature has substantial discretion.
Spending Choices
Proposals to Address Problems Exacerbated by Crisis. Appropriately given the dramatic and widespread impacts of the pandemic, many of the Governor’s larger proposals seek to mitigate either the pandemic’s direct impacts or problems exposed by the health and economic crisis.
The Governor’s homelessness proposal would allocate significant resources to a long-standing problem that has been heightened by the pandemic. The state also plays a foundational role in enabling economic growth by maintaining well-functioning infrastructure, transit, and higher education.
The May Revision includes many proposals in these areas. A notable number of proposals augment new programs, rather than making significant increases to existing safety net programs—like California Work Opportunity and Responsibility to Kids (CalWORKs) and Supplemental Security Income/State Supplementary Payment (SSI/SSP)—or rate increases in programs like the Department of Developmental Services.
Trade-Off: Address Many Issues or Inroads on a Few. The May Revision aims to address many well-known problems, for which solutions—particularly coming out of a pandemic—are less understood. For example, whether the administration’s workforce proposals will attract workers to retrain remains to be seen. Many of the Governor’s proposals touch on similar issues, but ways in which they would interact remain unclear. We recommend considering whether to spread funding across many dissues or to dedicate more substantial resources to a smaller set of problems for which the Legislature has greater assurance of success.
Limited Capacity for Oversight. The surplus, in combination with the federal fiscal recovery funds, represents resources equal to about half of pre-pandemic General Fund budgets. This is an extraordinary amount of funding. Departments’ capacity to allocate this funding and oversee new spending will be limited. While the administration proposes a relatively small new unit in the Department of Finance to oversee new federal spending, more robust mechanisms for both state and federal funding—administratively and legislatively—are warranted.
Consider Withholding Some Decisions. The administration proposes allocating almost all of the surplus and fiscal relief funds now. Given the constrained time line of the budget process, limited administrative capacity, and potential for future action at the federal level, we recommend the Legislature withhold decisions on some components of the May Revision. Delay would give the Legislature more time to determine which solutions would be most effective and develop a detailed plan. For example, the Legislature could wait to allocate the federal fiscal relief funds until more is known about what supports and services are needed as more Californians return to work, federal relief winds down, and the pandemic ebbs.
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To view charts and updates, see lao.ca.gov/Publications/Report/4432