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January 22, 2007

Implementing the 2006 Bond Package:
Increasing Effectiveness Through Legislative Oversight

(Note: This report was reprinted in our Analysis of the 2007-08 Budget Bill, published February 21st, 2007. In that publication we added a section related to the Governor's January 24, 2007 executive order intended to increase governmental accountability and public information about the use of the November 2006 bonds.)

Contents

Introduction

Section 1: Overview

Section 2: Transportation

Section 3: Resources

Section 4: Housing

Section 5: K-12 School Facilities

Section 6: Higher Education

In November 2006, California voters approved $42.7 billion in general obligation bonds to fund infrastructure projects in transportation, education, resources, and housing. The 2006 bond package represents a major opportunity for the Legislature to address many of the state’s most pressing infrastructure concerns. With more than $18 billion allocated to new programs, effective legislative oversight is critical to the success of the programs. In this report, we offer key considerations and recommendations to assist the Legislature in implementing the bonds.

 

 

Introduction

In November 2006, California voters approved five propositions which authorize $42.7 billion in general obligation (GO) bonds. The bonds cover a range of purposes, including transportation, education, resources, and housing. The bond package represents a major commitment by the Legislature, Governor, and the voters to improve the state’s infrastructure.

The large infusion of bond proceeds provides the state with a major opportunity to make infrastructure investments that will last for a generation or more. At the same time, in overseeing the implementation of the bonds, the Legislature faces several challenges. The bonds provide funding to many new programs for which goals and allocation criteria have yet to be established. The way in which these programs are crafted by the Legislature will help determine the level of the bonds’ success. In addition, ongoing legislative oversight of all of the funding would increase accountability and increase the likelihood of positive outcomes. This report aims to assist the Legislature in implementing the 2006 bond package. It offers key considerations and recommendations to the Legislature to help ensure the bond proceeds are used effectively and efficiently.

Organization of This Report. This report has six sections:

• “Section 1” provides an overview of the bonds, the programs funded, and their long-term financing costs. This section also broadly summarizes the Governor’s proposals for implementing the bonds. The section then discusses key implementation issues that cut across more than one of the bonds.

• “Sections 2 through 6” provide a program area by program area look at the bonds. In each section (transportation, resources, housing, K-12 education, and higher education), we provide a deeper look at the key issues facing the Legislature. We cover the Governor’s proposals in more detail, discuss specific programs which need attention by the Legislature, and make various recommendations regarding program implementation.

Section 1: Overview

The Bond Package

The 2006 bond package approved by the voters in November provides $42.7 billion for infrastructure spending. The package included five propositions spanning transportation (Proposition 1B), housing (Proposition 1C), education (Proposition 1D), and resources (Propositions 1E and 84).

Interest Costs. As GO bonds, the spending authorized will need to be paid back, with interest, from the state’s General Fund over time. In recent years, GO bonds have been paid off over a 30-year period. Since they are backed by the state’s general taxing power and generally exempt from taxation under federal law, the bonds tend to be sold with the lowest interest rate compared to other types of borrowing. In the voter information guide for the November 2006 election, we assumed most of the bonds would be sold at an average interest rate of 5 percent. (Proposition 1C, the housing bond, will have higher interest rates since a portion of the bonds are not eligible for the federal tax exemption.) Figure 1 summarizes the five bonds and the interest payments that we estimate will be made over the life of the bonds. The interest payments will almost double the costs of the bonds over their life-for a total cost of $84 billion.

 

 

Many Pots of Money. Within the five bond measures, there are many specified allocations of funds. In total, there are 67 pots of money included in the five bonds. The smallest such pot of money is in the housing bond and provides $10 million for self-help construction grants to organizations which assist households in building or renovating their own homes. In contrast, the largest pot of money is in the transportation bond and provides $4.5 billion for corridor mobility to reduce congestion on state highways and major access routes. Each pot of money has its own purpose, administering department, and restrictions (if any) on its use. Many different state departments will be involved in the implementation and allocation of the bonds. Figure 2 summarizes the broad categories of funding within each bond. In each of the individual program area writeups later in this report, there is a figure which provides a description of each of the 67 pots of funds.

 

 

Existing Versus New Programs. Some pots of funding provide state programs with additional resources. Many of these existing programs also have funds remaining from prior bond authorizations. In total, we estimate that almost $5 billion in prior bond funds have not yet been spent on these programs. (As noted in our K-12 discussion, there is an additional $4 billion available for an overcrowded schools program that was replaced with a new program in Proposition 1D.) In other cases, a pot provides dollars for a purpose never previously funded. In these cases, the program purpose at this point may be defined only by a few sentences. As shown in Figure 3, the bond package funds 21 new programs, representing more than 40 percent of total funding. Many of these new programs will need further implementing legislation in order to begin operating.

 

 

Appropriations. Most of the programs will need future legislative action to appropriate funding-either through the annual budget bill or separate legislation-before state departments can begin spending the funds. In some cases, the funds are continuously appropriated-meaning that funding obligations can be made by departments without additional legislative action. These continuous appropriations cover $9.4 billion of the bond funding. They apply to all K-12 education programs, a number of housing programs, and several pots within Proposition 84.

Governor’s Proposal

In this section, we provide an overview of the Governor’s approach to implementing the 2006 bond package, as outlined in the Governor’s proposed 2007-08 budget. In the specific policy area sections that appear later in this report, we provide a more detailed description of these proposals.

Proposed Expenditures for 2006-07 and 2007-08

As shown in Figure 4, the Governor is proposing to spend $11.5 billion of the bond funds by the end of 2007-08-or slightly more than one-quarter of the total available. Of this proposed spending, roughly $8.9 billion would be used for existing programs while $2.6 billion would be for new programs.

 

 

Current-Year Expenditures. Of the Governor’s proposed expenditures, $2.8 billion would be spent in the current year. In the case of the $1.1 billion for higher education, the Legislature appropriated these amounts in the 2006-07 Budget Act, with the assumption that Proposition 1D would be passed by the voters. In other cases, such as the $985 million for K-12 education facilities, $160 million for existing housing programs, and $60 million from Proposition 84, the funding is continuously appropriated and became available for spending upon the passage of the bonds. Regarding the $523 million in proposed transportation spending for the current year, however, the Legislature would need to enact urgency legislation to appropriate the funds if it wished to adopt the administration’s planned timing.

Budget-Year Expenditures. The Governor proposes spending $8.7 billion in 2007-08. In some cases, the administration proposes new staffing and statutory language to help implement the programs. In other cases, however, the Governor’s budget does not include any such requests despite a program being funded for the first time. While this proposed spending covers most of the programs authorized by the bond package, the Governor’s plan does not include spending for seven pots of funding, primarily for new programs.

Bond Package in the Context of the State Infrastructure Plan

Five-Year Plan Required. Chapter 606, Statutes of 1999 (AB 1473, Hertzberg), requires the Governor to annually submit to the Legislature a five-year infrastructure plan in January in conjunction with the submission of the Governor’s budget. The plan is required to identify new and renovated infrastructure requested by state agencies (including higher education), and aggregate funding for transportation and K-12 education. Additionally, the plan is required to provide a cost estimate and a specific funding source for the infrastructure projects identified. Thus, the plan represents the administration’s funding priorities for infrastructure improvements across all departments and programs.

Plan Not Submitted on Time. The administration did not submit a 2007 infrastructure plan this month. Instead, the administration reports that it plans to submit it on March 1, 2007. As such, it is difficult to assess precisely how the $43 billion bond package meets the state’s current overall infrastructure needs from the administration’s perspective. However, the administration’s 2006 plan identified total state infrastructure costs of $90 billion through 2010-11. Clearly, the 2006 bond package significantly increases the amount of funding available to address that $90 billion total. Yet, the two numbers are not directly comparable. The bond package funds a number of programs and purposes not envisioned within the administration’s five-year plan. For instance, the entire $2.9 billion in spending authorized by the housing bond was not identified as a state priority by the administration last year.

Governor Proposes Additional Borrowing. While the 2006 bond package made a sizable commitment to the state’s infrastructure, it did not address all aspects of the state’s infrastructure demands. For instance, the package contained no funding in the criminal justice area. In addition, areas that were funded by the bonds have identified additional demands. For example, Proposition 1D funds for education are expected to fund programs through only 2008-09. In recognition of these limitations, the Governor has proposed additional long-term borrowing as part of his 2007-08 budget package (presented as a second phase to his Strategic Growth Plan). The Governor proposes additional GO bonds totaling $29.4 billion to be put before the voters in 2008 and 2010 (see Figure 5). Of this amount, the vast majority-$23.1 billion-would be for education purposes. Education funding would be split about evenly between K-12 and higher education programs. Most of the remaining funds would be for water development projects ($4 billion) and court facilities ($2 billion). In addition, the Governor proposes the use of lease-revenue bonds totaling $11.9 billion-primarily for corrections and local jails. As with GO bonds, costs for lease-revenue bonds are paid off with General Fund revenues.

 

 

Our office’s review of the programmatic features of the new proposals is outside the scope of this report. Please see our forthcoming Analysis of the 2007-08 Budget Bill (to be released February 21) for a discussion of these new infrastructure proposals. In order to assist the Legislature, however, with questions concerning the affordability of additional bonds, we do discuss their fiscal implications in the section which follows.

Issues for Legislative Consideration

Below, we raise a number of issues that the Legislature will need to consider as it makes its decisions this year regarding implementing the bond package.

Costs and Affordability of the Bonds

Bond Costs and the Budget. Faced with ongoing budget shortfalls, as well as the administration’s proposals for additional borrowing, the Legislature will want to consider how infrastructure borrowing fits into the state’s budget plan. The cost of the 2006 bond package in the next few years-and its impact on the state’s budget-will depend primarily on the timing of bond sales, bond maturity structures, and the bonds’ interest rates. In turn, the overall affordability of the package will depend on how its costs affect the state’s future debt-service expenses-including costs for bonds that have already been sold, yet-to-be-sold bonds authorized prior to the November 2006 election, and any future bond authorizations. For example, in addition to the 2006 bond package, the state currently has about $37 billion of bonds outstanding on which it is making principal and interest payments, and another $25 billion in unsold bonds that voters have already approved for various purposes.

Key Assumptions. Our cost projections are generally based on the administration’s assumptions about the timing of bond sales. These assumptions suggest annual bond sales from all authorizations totaling over $10 billion in 2007-08, rising to a peak of nearly $16 billion in 2009-10. Our projections also assume:

• Maximum maturity lengths for GO bonds and lease-revenue bonds of 30 years and 25 years, respectively.
• GO bond interest rates of 4.5 percent currently, trending up over time to 5.7 percent, with lease-revenue bonds slightly higher.

Debt-Service Amounts. We currently estimate that the state’s annual debt-service costs for infrastructure-related debt outside of the November 2006 package amounted to $3.9 billion in 2005-06, and will be $4.1 billion in 2006-07 and $4.6 billion in 2007-08. These costs will peak at $5.4 billion in 2010-11 as additional already-authorized bonds are marketed, and then decline slowly thereafter as the bonds are paid off over their lifetime. When the bonds approved in November are included, total annual debt service is projected to rise from $4.7 billion in 2007-08 to a peak of $7.5 billion in 2014-15. Finally, when the additional GO and lease-revenue bonds proposed by the administration are included, debt service would peak at $10.4 billion in 2017-18.

Debt-Service Ratio. The ratio of annual debt-service costs to yearly revenues (DSR) is often used as a general indicator of a state’s debt burden. The DSR helps to look at debt from the perspective of affordability, as it takes into account the amount of revenues the state has available or is projected to have available to fund its programs (including debt payments).

Although concerns have sometimes been voiced in the past about DSRs in excess of 5 percent or 6 percent, there is no “right” level for the DSR. Rather, this depends on such things as a state’s preferences for infrastructure versus other priorities, and its overall budgetary condition. Some states, for example, have comparatively high DSRs but still experience favorable bond ratings. Examples include Maryland, New York, New Jersey, and Illinois.

From an affordability perspective, however, each additional dollar of debt service out of a given amount of revenues comes at the expense of a dollar that could be allocated to some other program area. Thus, the “affordability” of more bonds has to be considered not just in terms of their marketability and the DSR, but also whether their dollar amount of debt service can be accommodated on both a near- and long-term basis within the state budget. (As a rule of thumb, each $1 billion of new bonds sold at 5 percent interest adds close to $65 million annually to state debt-service costs for as long as 30 years.)

LAO Debt-Service Projections. Figure 6 shows California’s DSR in recent years and its projected outlook for the future. The DSR was well under 2 percent during most of the post- World War II period, increased in the early 1990s when it peaked at somewhat over 5 percent, and then fell below 3 percent in the early 2000s. It has since risen as new bond authorizations have been sold, and would peak at 4.6 percent in 2007-08 without the November 2006 bonds. Including the November bonds, the DSR is projected to peak at 5.6 percent in 2010-11. Finally, including the new GO and lease-revenue bonds proposed in the Governor’s budget, the DSR would peak at 6.1 percent in 2014-15. On top of these amounts are the payments the state is making on the deficit-financing bonds (Proposition 57) that were issued to help address the state’s ongoing budget problems, and which the administration is proposing to pay off during 2009-10.

Ensuring Adequate Legislative Oversight And Accountability

• The Legislature’s role in implementing the bond package is to provide:
• A statutory framework to effectively administer and distribute the funds.
• Appropriations of the funds.
• Oversight to ensure the programs are then administered in accordance with the Legislature’s and the voters’ intent.

This legislative role can help ensure that the $43 billion infusion of funding to the state is implemented with accountability and transparency.

Developing New Programs. Since the bonds commit $18.2 billion to new programs, one of the most important tasks for the Legislature will be to effectively design the frameworks for these new programs. Figure 7 lists each of the 21 new programs.

 

• Long-Term Benefit. Current law essentially requires that GO bonds be used only for capital purposes which have a long-term life. The principle behind this law is that the state should not conduct long-term borrowing for costs that only provide short-term benefits, such as day-to-day maintenance or operations costs. If, instead, bond proceeds were used for short-term benefits, it would mean that taxpayers three decades from now would be paying for the short-term benefits enjoyed by today’s California residents. In developing new programs, we recommend that the Legislature strongly enforce the principle that bond proceeds should only support projects that will provide a long-term benefit to the state.
• Criteria and Priorities. Another important consideration in establishing a new program is to ensure that the funding will reflect statewide priorities. The best way to accomplish this goal is to lay out in state law the program’s goals and the criteria for selecting projects which meet those goals. By defining who is eligible for the funds and what are the program’s priorities, grant recipients will have a fair opportunity to compete for funding. After allocations are made, the Legislature can use these statutory criteria to verify that the administering state department’s process met legislative priorities.

Appropriations. The “power of the purse”-appropriation authority-is one of the Legislature’s most powerful tools to ensure accountability. Without an appropriation, the administration cannot spend bond funds. Therefore, the Legislature should not appropriate funds until it is satisfied that the administration will spend them effectively. On the other hand, continuous appropriations provide minimal opportunities to ensure legislative oversight. Departments can spend continuously appropriated funds without any further action by the Legislature. While continuous appropriations may be appropriate in some circumstances, we recommend that the Legislature not add any new continuous appropriations to the bond programs. In addition, a continuous appropriation does not preclude the Legislature from instead including the appropriation in the budget bill “in lieu” of the continuous appropriation. As described in the resources section, we recommend that the Legislature take this approach for Proposition 84 programs with continuous appropriations.

Limiting Administrative Costs. Each dollar spent on administrative costs within a bond program is one less dollar that is available for infrastructure projects. The Legislature therefore should make every effort to ensure that administrative costs are contained to the greatest extent possible. By actively reviewing requests from the executive branch for staff and other administrative costs, the Legislature likely can increase the funds available for grants and projects. We have recommended in the past that no more than 5 percent of a program’s funding should go towards administrative costs in the resources and housing areas. That level of administrative funding for competitive grant programs is typically sufficient to provide enough state staff to effectively manage a program. (A strict cap on administrative costs may not make sense in every program area, particularly in those areas where the state is responsible for designing and constructing capital outlay projects such as the California Department of Transportation [Caltrans].)

Using Special Committees and Reporting. In the past, the Legislature has performed effective oversight of bond and other programs through the use of joint committee hearings and annual reporting requirements. For instance, by holding a hearing that merges both budget and policy committee members and staff (from one house or jointly between the Assembly and Senate), the Legislature may be better able to assess the full fiscal and policy implications of not only its decisions but also those of the administering entities. Similarly, annual reports from state departments can allow the Legislature to monitor the administration’s progress in achieving specific program objectives. Later in this report, we provide specific recommendations in areas where we think these techniques would be effective.

Infrastructure planning and financing is a complex issue because it is related to so many state functions and involves a long-term vision for the state. We have also recommended in the past that the Legislature establish special committees to deal with infrastructure and capital outlay issues. Looking beyond the 2006 bond package, a special policy or joint committee could assist the Legislature in focusing on the state’s long-term infrastructure planning. Such a committee could help the Legislature review the administration’s 2007 five-year plan and the Governor’s latest proposals for additional infrastructure borrowing.

Economic Impacts of the Bond Package

State expenditures on infrastructure can have important positive impacts on the economy in terms of employment, gross state product, and the various components of the tax base, such as personal income, corporate profits, and taxable sales. This is especially true to the extent that California is the origin of the various intermediate materials and supplies used in construction activities. In addition, infrastructure projects themselves can generate significant economic benefits, such as improved transportation networks that facilitate the movement of people and products, flood control projects which enhance property values and make new geographic areas available for business and residential uses, and school facilities that help produce a more educated labor force that in turn eventually enhances economic productivity.

Yet, while the magnitude of the 2006 bond package is substantial, it is only a fraction of the size of the overall economy and construction sector in California. For example, in the near term, the state’s gross domestic product is expected to be about $1.7 trillion and the combined statewide value of residential and nonresidential new building permits is roughly $70 billion (with probably two or three times that amount being the overall contribution of the building sector to the state’s economy once all of the indirect and induced economic activity associated with construction-related activity is considered). In addition, not all of the bond package represents a net increase in infrastructure funding compared to that which would have occurred without the package. Californians have typically passed individual new bond authorizations fairly regularly in past years. Thus, while the bond spending can be expected to have a substantial positive dollar economic impact, its magnitude will probably be modest in the context of the overall economy.

Timing Considerations

In evaluating the Governor’s proposals and developing its own funding schedule, the Legislature will need to balance several factors related to the timing of spending. Of course, there will be a desire to get the newly authorized funding appropriated and distributed quickly. This desire should be balanced with practical considerations that limit the state’s ability to effectively spend the funds in a short time period. In some cases, the Legislature may need to prioritize among the various infrastructure demands.

Personnel and Materials. As the Legislature considers the large level of new resources available from the bonds, it will need to determine the limits of capacity for state personnel to manage the expansion of programs. Particularly in the short term, the state may be unable to recruit, hire, and train a sufficient number of staff in some programs to accommodate a rapid rise in spending. If the work is for architectural or engineering services, the Legislature could make expanded use of contracted services, as permitted by Article XXII of the State Constitution. For instance in the case of Caltrans, without additional contracting out, the department may have to hire as many as 4800 new staff to deliver projects funded by Proposition 1B.

Another similar factor to consider is the effect of billions of dollars of public works projects on the costs of construction crews and materials. In recent years, the state (as well as other governments and private builders) have struggled with rapidly rising construction costs driven by limited supplies of trades workers and construction materials. For example, the cost of concrete has climbed sharply and has added significant costs to many projects. To the extent that the state funds projects more evenly over time, it may be able to partially mitigate this trend.

Quality of Projects. There is also tension between timing of projects and their quality. From past experience, spreading allocations over several funding cycles would likely improve the overall quality of the projects funded through competitive programs. To the extent that more funds are awarded in any given year for a competitive grant program, for instance, lower-score projects would tend to be funded. By spreading the dollars out, there is more time for higher-quality projects to be put together and submit applications. For example, this longer-term approach is proposed by the administration for the ongoing housing programs (as was the case with previous housing bonds).

Coordination Among State Entities Needed

As shown in Figure 8, at least two dozen state entities will be involved in implementing some component of the 2006 bond package. Throughout the package, there are program allocations for purposes that cut across traditional state departmental boundaries. One of the key roles for the Legislature will be ensuring that departments are communicating and coordinating with each other when appropriate. For instance, the new development programs within the housing bond aim to promote urban development, particularly near public transportation. At the same time, the transportation bond provides billions of dollars for transit improvements. As such, without close coordination among the departments administering these funds, the state may miss an opportunity to make both sets of money go further by linking projects and/or timelines. Likewise, both the housing and resources bonds contain funding for parks. While conceivably the state could operate distinct park grant programs in two departments, designating a single department (such as the Department of Parks and Recreation [DPR]) to act as the primary administrator of all park bond funds would likely result in lower administrative costs and more consistent project evaluation.