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Last Updated: 5/21/2014
Budget Issue: Multiyear forecast of state finances under Governor's May Revision proposals
Program: Budget Forecast
Finding or Recommendation: This note provides a brief description of our multiyear forecast of state finances if the Legislature were to adopt the Governor's May Revision proposals.
Further Detail

This note describes the results of our initial forecast of what the state's future fiscal condition would be if the Legislature adopted the Governor's proposed budget package (including his May Revision proposals). This is intended to help the Legislature understand the longer-term implications if it were to adopt his budget package. While our projections assume implementation of the Governor's proposals, we use our own independent revenue and economic forecasts—as described in our recent Overview of the May Revision publication—and our own projections of spending for state programs.

Differences Between November Fiscal Outlook and This Forecast. The projections in this forecast are in contrast to those in our November Fiscal Outlook. In November, our projections generally assume that current law and policies remain in effect throughout the next several years. In some cases, this means that our November and May forecasts make very different assumptions about future state fiscal policies. This May forecast, for example, assumes approval of both the Governor's CalSTRS payment plan and ACAX2 1 (J. Pérez), the rainy-day fund measure that will be on the November 2014 ballot.

2014-15: $850 Million Higher Reserve Than Administration Forecasts. With regard to the 2014-15 budget, we project that if the Legislature adopts the Governor's May Revision, the state would end 2014-15 with $3 billion in the state's two budget reserves: the Budget Stabilization Account (BSA) established by Proposition 58 (2004) and the state's traditional reserve, the Special Fund for Economic Uncertainties (SFEU). This total is roughly $850 million higher than the administration's estimate for these reserves ($2.1 billion). Of the difference, $500 million is explained by our higher revenue and property tax estimates ($3.2 million), offset by higher estimates of the Proposition 98 guarantee through 2014-15 ($2.7 billion). The remainder (about $350 million) is due to our lower net estimates of spending across the rest of the budget. Most of the difference in our spending estimates relates to the Medi-Cal Program. In a recent analysis, we found that the administration's estimates of per-enrollee costs for mandatory Medi-Cal expansion enrollees were too high and recommended that the Legislature adopt lower estimates that decrease General Fund spending on Medi-Cal by about $300 million in 2013-14 and 2014-15 combined.

Growing Reserves Under LAO Forecast Assumptions. As we discussed in our November 2013 Fiscal Outlook, we—like the administration and many other economic forecasters—assume a moderately growing economy throughout our budget forecast period. (We summarized our current economic assumptions in the appendix of our recent Overview of the May Revision.) Under our current forecast assumptions, including an assumption of modest increases in stock prices after 2014, we forecast that the state's combined budget reserves in the BSA and SFEU would grow gradually over our forecast period under the Governor's policies. Specifically, we forecast that the combined reserve balances would grow from $3 billion at the end of 2014-15 to $4.5 billion in 2015-16, $6.8 billion in 2016-17, and $10 billion in 2017-18, assuming no additional future spending commitments above those proposed in the May Revision. The bulk of this growth results from deposits to the BSA—both those resulting from the existing requirements of Proposition 58 in 2014-15 and those assumed to be required beginning in 2015-16 if voters approve ACAX2 1 on the November 2014 ballot. Under ACAX2 1, the BSA balance would only be able to be accessed for spending on state programs under specified conditions of a budget emergency, as declared by the Governor. As our forecast assumes no such budget emergencies are declared over the next several years, the BSA's balance is projected to grow to total $7.2 billion in 2017-18, while the SFEU then would have a balance of $2.8 billion, resulting in a total reserve of $10 billion.

Compared with the administration, our office assumes higher amounts of capital gains taxes flow to the General Fund during the forecast period, particularly in the near term. Under ACAX2 1, through 2029-30, annual deposits to the BSA are required (except when suspended or reduced in a declared budget emergency) to equal 0.75 percent of estimated General Fund revenues plus half of the taxes on capital gains above 8 percent of General Fund tax revenues not needed to fund Proposition 98 requirements. (Through 2029-30, annual payments equal to this BSA deposit would be required for supplemental payments on specified debt obligations, including wall of debt or unfunded pension liabilities.) Our higher forecast of capital gains results in much higher BSA deposits and supplemental debt payments than under the administration's multiyear budget projections. Specifically, the required BSA deposits under our forecast total $2.4 billion in 2015-16, $1.7 billion in 2016-17, and $1.5 billion in 2017-18, compared to around $1 billion per year in the administration's forecast. Because all future capital gains estimates are subject to great uncertainty, so are any of these types of projections.

Large Volume of Debt Payments Reflected in Forecast. Compared to our November 2013 forecast, our office's new May forecast includes substantial additional payments to reflect the Governor's proposals to retire debt through (1) the supplemental debt payment requirements of ACAX2 1 beginning in 2015-16, (2) his proposals to retire additional obligations and pay off the state's "wall of debt" obligations by the end of 2017-18, and (3) hundreds of millions of additional state General Fund payments each year for state pension systems (including the Governor's CalSTRS payment plan and the recent decision of the CalPERS board to adopt new actuarial assumptions related to retiree mortality).

Under ACAX2 1, hundreds of millions of dollars or more of supplemental debt payments would generally be required annually through 2030. This would add a significant new consideration to the annual budget process. If ACAX2 1 passes and General Fund revenues materialize as we forecast over the next few years, key decisions for the state will include which debts to pay off with the required supplemental payments and whether to make additional one-time debt payments above those required by ACAX2 1 to pay off the wall of debt on the Governor's proposed timetable.

Operating Surpluses Now Can Be Characterized As Much Smaller Than Before. After 2014-15, the administration's multiyear estimates now forecast small operating surpluses of no more than $600 million per year through 2017-18.

Our newly updated forecast of the Governor's budget policies shows a $1.7 billion operating surplus in 2017-18. This operating surplus calculation, however, is not easily comparable to the ones listed in our prior Fiscal Outlook and other forecasting publications. That is mainly because now, under the Governor's May Revision policies, we are lowering what the operating surplus otherwise would be to reflect the requirements of ACAX2 1 to make deposits to the BSA and supplemental debt payments beginning in 2015-16. In addition, operating surpluses are now lower than they were in our November 2013 Fiscal Outlook in order to reflect other changes, including (1) higher estimates of spending in the Medi-Cal Program and some other programs, (2) small net changes due to our increased revenue and resulting Proposition 98 forecasts (for more information on our Proposition 98 forecast, see these links), (3) the Governor's 2014 proposals to spend more on universities, the courts, and some other programs, (4) the Governor's CalSTRS funding proposal, and (5) the Governor's proposals to make additional wall of debt payments above those required by ACAX2 1 in order to retire all of those state obligations by the end of 2017-18.

LAO Contacts: Ryan Miller and Jason Sisney.