All Articles

In the coming few days, we will release comments on some of the Governor’s May Revision proposals. We also will provide our independent assessments of the administration’s current outlooks for the economy and state tax revenues.

Each state budget must make assumptions about the state’s economic condition over the next four or five years (the period sometimes called the “multiyear” period in California state budgeting). This post discusses the role of economic assumptions in multiyear state budget outlooks. (In a separate post later, we will discuss our assessment of the economic assumptions underpinning the administration’s May Revision.)

Background on Economic Assumptions. Multiyear assumptions about the path of the U.S. and California economies underpin every California state budget. The administration, for example, produces a multiyear estimate that shows one view of how its 2016-17 budget proposals would play out through 2019-20. Our office also will be producing a multiyear budget outlook, which we anticipate summarizing online within the next few days.

Our Multiyear Economic Assumptions Are Not “Predictions.” In the past, we have found that some misinterpret the economic assumptions underlying these multiyear budget estimates. Specifically, if one of our budget analyses assumes that the economy and stock market will grow over the next four or five years, some have said that our office “projects” or “predicts” or “forecasts” that such growth will continue over the entire multiyear period. This is not our intent, and in the future, we will be clearer about that.

Instead, we advise policy makers and others that no one can say with assurance that economic or stock price growth will continue for multiple years into the future or that growth will continue at a given pace each year. In fact, given the stage of the current economic expansion, some type of economic slowdown in the next four or five years is not only possible, but likely.

Economic Scenarios in Our Budget Analyses. Over the last few years, we have been changing the way we present and discuss our multiyear budget outlooks. Our main annual budget outlook, published each November, now presents a few different multiyear scenarios. These are just a few of the possible future scenarios for California’s economy, and they show a range of possible outcomes for the state budget if either continued growth or recession occurs. The range of outcomes in our November Fiscal Outlook is only illustrative. Actual performance over parts of the multiyear period could be stronger or weaker than any of the scenarios we present in our November report.

In our annual May Revision outlooks—finalized quickly after April’s tax receipts and in advance of the state’s June 15 budget deadline—there is little time for us to prepare multiple scenarios as we do in November. Instead, in May, we display one possible multiyear economic growth scenario. In our office’s case, this scenario is based on a national economic growth scenario developed by a leading national analytical firm, Moody’s Analytics. (The administration uses scenarios developed by a different leading national firm.) In our upcoming economic growth scenario, for example, we generally rely on Moody’s Analytics’ April 2016 “baseline scenario” for anticipated economic growth—the set of U.S. economic outcomes that firm believes is the “most likely” over the next few years. We then develop our own California economic estimates, assuming that the Moody’s Analytics’ multiyear economic scenario occurs at the national level.

While the baseline scenarios for the U.S. economy reflected in our analyses—and those of the administration—represent reasonable judgments of well-respected economists, we stress that our office’s use of these growth scenarios does not represent a prediction or a forecast that such growth will continue over the next four or five years. In fact, at the present time, we think there is a good chance that growth will be slower than our scenario assumes in one or more years between now and 2020. Yet, there is no precise way to predict when or if this will occur. For this reason, we advise the Legislature to be careful in making new budgetary commitments and consider the level of the state’s budget reserves as they craft the annual state budget.

Legislature Sets Annual State Revenue Projection. Each June, the Legislature essentially must adopt in the annual Budget Act a revenue projection for the upcoming fiscal year. Next month, for example, the budget that passes the Legislature must include an estimate of available state General Fund resources (based on a 2016-17 revenue projection), as well as implicit estimates of 2015-16 and prior years’ revenues. Each May, including this year, our analyses will contain our best advice to the Legislature on what Budget Act revenue estimates seem reasonable based on what we know about the economy at that time.

That being said, economic and revenue performance over the next year will differ from what we expect each May—either positively or negatively. By one year from now, for example, even small changes in the economy and stock market—compared to our current expectations—can cause state General Fund revenues to be several billion dollars higher or lower than we now estimate. Moreover, changes in prior years’ revenues resulting from new data or the state’s complex revenue accrual policies can cause budgetary changes of hundreds of millions of dollars or more. These uncertainties—inherent in California’s tax structure and budget processes—represent additional reasons for policy makers to consider carefully new budgetary commitments and reserve levels in each state budget package.

Follow @LAOEconTax on Twitter for regular California economy and tax updates.