The Department of Veterans Affairs (DVA) provides services to California veterans and their dependents, and to eligible members of the California National Guard. The principal activities of the DVA include: (1) providing home and farm loans to qualifying veterans, using proceeds from the sale of general obligation and revenue bonds; (2) assisting eligible veterans and their dependents in obtaining federal and state benefits by providing claims representation, subventions to county veterans service offices, and direct educational assistance to qualifying dependents; and (3) operating veterans' homes in Yountville and Barstow, and next year also in Chula Vista, with several levels of medical care, rehabilitation services, and residential services.

The budget proposes total expenditures of $351 million for DVA in 1999-00. This is $9.4 million, or 2.8 percent, more than the estimated current-year expenditures. Total expenditures from the General Fund during the budget year would be $53 million, which is $8.4 million, or 19 percent, more than the estimated current-year level.

The increase in the budget reflects significant new staffing and funding for the activation of the new veterans' home in Chula Vista, with other DVA program spending remaining largely unchanged.

Size of Cal-Vet Portfolio Continues to Decline

The number of veterans holding Cal-Vet loans remains in steep decline despite efforts by administrators of the program to stabilize the size of the loan portfolio by cutting rates for borrowers and increasing its marketing efforts. As a result, program overhead costs are still growing. The Governor's budget calls for a review by the Secretary of Veterans Affairs regarding how the program can be restructured in order to allow surplus Cal-Vet funds to be used to meet other needs of veterans. We recommend enactment of legislation in 1999 to phase out new loan activity by the year 2007 and to seek voter approval in 2000 to redirect surplus Cal-Vet funds to other programs that jointly benefit veterans and state taxpayers.

LAO Report Called for Changes. In our January 1998 report, Rethinking the Cal-Vet Loan Program, we outlined our proposal to phase out additional Cal-Vet lending activity by 2007 and to direct surplus Cal-Vet funds to programs that will benefit both aging war veterans and state taxpayers. We noted that far fewer veterans than in the past need home loans, but that these veterans have a growing need for medical care, nursing home care, Alzheimer's treatment, and other types of state assistance. We concluded that it was time to rethink the state's approach to veterans' assistance given the changes which have occurred in recent times.

We based our recommendations on the decline in veteran participation in the program, as evidenced by the fact that the number of loans in the Cal-Vet portfolio as of June 30, 1997, was less than a third of the number at the start of the 1990s. We noted this was due to the aging of the veterans population and their exit from the single-family housing market, federal law restrictions which will by 2007 further shrink the pool of veterans eligible for Cal-Vet loans, and the availability of loans for veterans through the private sector and other governmental programs.

As a result of the decline in the size of the loan portfolio, the overhead cost of servicing each Cal-Vet loan had been growing. We also called attention to recurring financial losses stemming from past mismanagement of the program. The mismanagement had reduced the state's equity in the Cal-Vet operating fund (defined as the value of all program assets after all liabilities have been subtracted) by about $200 million or 44 percent of its value over 11 years.

In response to these and other concerns, we also noted in our report, DVA had undertaken significant reforms of the program. These changes included a reduction in Cal-Vet interest rates, refinancing of $1.6 billion in outstanding bonds to achieve lower borrowing rates, reconfiguration of staff operations, a tightening of management of Cal-Vet insurance programs, and a speed-up in efforts to intervene when loans became delinquent.

As both our office and DVA had recommended, the Legislature also enacted Chapter 362, Statutes of 1998 (AB 2097, Margett) to do away with historic requirements that virtually all Cal-Vet loans always bear the same interest rate, giving the program the same flexibility enjoyed by all of its loan market competitors. The Legislature also enacted Chapter 530, Statutes of 1998 (AB 2096, Margett) to permit Cal-Vet borrowers to make a lower down payment when obtaining loans. As we had recommended, the bill also established a statutory requirement that loans in excess of 80 percent of the value of a home be backed up by loan guarantees or insurance instruments to protect the state's financial interests.

How Is the Program Performing Now? The various changes implemented by the DVA over the past two years have strengthened both the management of the program and its financial condition. In 1997-98, the Cal-Vet operating fund showed a small net profit (about $4.3 million or an amount equal to 1.6 percent of the state's equity in the program) for the first time in six years. Although the Cal-Vet program continues to fail to meet its internally established loan issuance targets, the number of new loans issued monthly has increased both in number and in total dollars loaned above 1996-97 levels.

However, as we advised the Legislature last January would likely be the case, these program reforms have not stemmed the rapid decline in the number of veterans holding Cal-Vet loans. As can be seen in Figure 1, the number of new loans issued each month to purchase homes still is not keeping pace with the number of loans ended as loan-holders paid off or defaulted on their loans or died. About three or four loans typically are retired monthly for every one new home purchase loan issued.

Thus, the size of the home loan portfolio declined by about 3,200 loans and $90 million during 1998 to end the calendar year with a portfolio of 34,653 loans. That amounts to an 8.5 percent drop in the number of Cal-Vet loans, and a 4.1 percent drop in the dollar amount of its mortgage pool, in one year. (The dollar level decreased at a lower rate than the number of loans because the newly issued loans are for larger amounts than the old loans being retired.) About $300 million in borrowing authority from Proposition 206, a Cal-Vet general obligation bond act, remains untapped three years after it received voter approval because the Cal-Vet mortgage pool is shrinking.

This shrinkage occurred despite a drop in the Cal-Vet loan rate from 8 percent to 6.95 percent on April 1, 1998, the mounting of aggressive direct-mail and other marketing efforts to attract new borrowers and an all-time record year in California for home sales. The DVA data indicate that the volume of new loans issued by the Cal-Vet program did increase after the April 1 interest rate cut. However, the same strong housing economy and lower interest rates that increased the issuance of new loans also spurred many existing Cal-Vet borrowers to sell their homes and pay off their outstanding Cal-Vet loan, or to refinance their homes with funds borrowed from other sources.

Cal-Vet has again cut its loan rates for new borrowers as of January 1, 1999, with most new loans issued at a 6.65 percent rate and others at 5.95 percent. While this step and other new efforts to market the program, such as by paying commissions to participating mortgage brokers, may stimulate more loan activity in the short term, we believe the long-term decline in the portfolio as shown in Figure 2 (see next page) will continue.

Overhead Costs Continue to Grow. While the size of the loan portfolio has declined steadily, the state expenditures and staffing allocated by the DVA to administer the Cal-Vet program (which, under current law, are not subject to annual budget review by the Legislature) have stayed relatively stable over the last decade. For example, even though the size of the loan portfolio is dropping at an 8.5 percent annual rate, the 1998-99 workforce, as measured in full-time equivalent positions, is only 3.2 positions, or 1.3 percent, smaller than the workforce for the prior year.

As shown in Figure 3 (see next page), the contraction in the size of the loan portfolio while administrative expenditures remained relatively stable drove up the overhead cost per loan in 1997-98 to $712. That compares with an overhead rate of $241 per loan in 1989-90 and $519 per loan in 1996-97.

Financial Position of Program Improves. Several factors have recently improved the financial performance of the Cal-Vet program. The steady flow of cash back into the program operating fund from the pay-off of existing loans has left the Cal-Vet program with almost $1.5 billion in cash and investment assets as of June 30, 1998. The investment of these funds in U.S. Treasury notes, corporate bonds, private investment agreements, and other financial instruments earned almost a $79 million return for the program in 1997-98, allowing it to register a small profit for the year of $4.3 million even though the money earned from mortgage payments ($162 million) fell far short of what Cal-Vet paid to retire the bonds originally sold to fund the mortgages ($219 million).

The refinancing of Cal-Vet debt last year to take advantage of low market interest rates for new bonds also improved the program's bottom line. Debt repayment costs are projected to drop by $50 million annually by 2002-03. If Cal-Vet's financial projections prove accurate, the program will grow increasingly profitable over the next five years and will be earning a net income of $71 million annually by 2002-03. Cal-Vet administrators now project that the state's equity in the program will grow by $200 million by 2002-03, reaching $485 million.

While these Cal-Vet financial projections are already proving to be overly optimistic, we are convinced that prudent management would result in the future generation of surplus revenues in excess of the operational needs or contractual obligations of the program. We are advised that, unless the voters were to grant their permission, these surplus funds would accumulate in the Cal-Vet operating fund and could not be spent to benefit veterans in other ways.

The 1999-00 Governor's Budget Summary acknowledges these issues, and refers to a declining interest or need by veterans for home loans and an increasing need for other services for veterans. The budget plan indicates that the new Secretary of Veterans Affairs will report to the Governor by summer 1999 regarding the need for further restructuring of the Cal-Vet loan program and on ways that surplus funds in the Cal-Vet operating fund might be redirected to other pressing needs of veterans.

Analyst's Recommendation. Because the number of persons holding Cal-Vet loans has continued to decline while program overhead costs have continued to grow, we recommend that the Legislature take steps in 1999 to phase out new loan activity in the program by the year 2007 and seek voter approval to shift surplus Cal-Vet funds to other programs of greater benefit to veterans and state taxpayers.

The specific proposals are detailed in our January 1998 policy report on the Cal-Vet program and in the 1998-99 Analysis of the Budget Bill (page G-125). Key elements of our plan include (1) a technical review to determine the timing and estimated level of surplus funds in excess of the operational needs or contractual obligations of the program, (2) a public hearing process by the California Veterans Board to solicit the views of the veterans' community regarding the best use of surplus funds, and (3) legislative action this year to place a measure on the March 2000 ballot seeking voter approval to use surplus Cal-Vet funds for new purposes that jointly benefit veterans and state taxpayers.

Adjustments Should be Made to Veterans' Homes Budgets

The budget proposes $86 million, including $49 million from the General Fund, for the continued operation of veterans' homes in Yountville and Barstow, and to open a new home in Chula Vista. We recommend a series of modifications of the budget requests for the three homes to avoid overbudgeting of General Fund resources and to maximize the expenditure of federal funds and reimbursements for support of these facilities. In addition, we withhold recommendation on some other expenditure requests pending receipt of additional information.

Background. The Veterans' Home of California, which has been operating at Yountville in Napa County since 1884, provides five levels of medical and residential care for about 1,125 veterans. Specifically, it provides: (1) an acute care hospital for residents requiring significant medical services; (2) a skilled nursing facility (SNF) providing assistance in daily living, nursing, and therapy; (3) an intermediate care facility (ICF) providing both reduced living assistance and a minimal level of nursing care; (4) residential care in which minimal living assistance is provided; and (5) domiciliary care in which residents are fully self-sufficient.

The Veterans' Home of Southern California is planned to consist of four separate 400-bed facilities. The Barstow home in San Bernardino County was the first to open in February 1996 with a 120-bed SNF, a 60-bed ICF, and 220 domiciliary care beds. A third home in Chula Vista is now under construction and is scheduled to open by April 1, 2000, with a 120-bed SNF, a 60-bed ICF, 55 beds with residential care, and 165 beds with domiciliary care. Chapter 91, Statutes of 1997 (SB 584, O'Connell) provides that additional veterans' homes are to be established in the future in Lancaster in Los Angeles County and near the community of Saticoy in Ventura County.

The General Fund pays a significant share of the costs of operating the homes. The balance of support consists primarily of Medicare and Medi-Cal reimbursements for medical and nursing services, aid and attendance allowances from the U.S. Department of Veterans Affairs, and fees paid by home residents.

Costs for Homes Are High. The average cost per bed of operating the homes has long been high compared to public and private facilities providing similar services.

The average cost per day of operating a bed in Yountville's acute-care hospital in 1999-00 is estimated to be more than $1,800. That is more than double the average rate of $841 to be paid to California hospitals under the Medi-Cal program. Similarly, while the SNF unit at Yountville is projected to cost $295 per bed for each day of operation, other similar nursing facilities are paid $215 daily for the same services.

The cost increases have been especially significant at the Yountville home. If the 1999-00 budget for the home is approved as submitted, the average cost of an acute-care bed at Yountville would have increased by $170,000 each, or 35 percent, since 1997-98 due to declines in caseload and rising costs. (Yountville's 1998-99 costs were not compared because they include significant one-time costs for a new computer system.) Yountville SNF costs have also gone up, although much more modestly.

Barstow's nursing beds are proving to be less costly than Yountville's, but its domiciliary beds are almost twice as expensive on average to operate. Moreover, the share of domiciliary costs supported by the General Fund at the Barstow home in 1998-99 (almost $26,000 per bed) is eight times the cost at Yountville (about $3,700 per bed).

Overview of Analyst's Recommendations. Figure 4 (see next page) provides a summary of our recommendations regarding the veterans' homes in Yountville, Barstow, and Chula Vista. These recommendations are discussed in greater detail below.

Yountville Home Budget Issues. The proposed 1999-00 budget for operation of the Yountville home is $54 million, a decrease of $4.6 million, or 7.8 percent, below the current-year expenditure level. Of this sum, about $25 million, or 46 percent, of the support for the home would come from the General Fund. The decrease is because one-time funding of $4.9 million for a computer project at the home is not continued in 1999-00.

We recommend that the General Fund budget for Yountville be reduced by $514,000, with an offsetting and equal increase in reimbursements to take into account additional funding flowing to the home from 1998 cost-of-living increases in federal veterans' assistance programs.

We further recommend that the department report at May Revision budget hearings regarding the amount of further adjustments to the home's budget that are warranted to reflect: (1) increased revenues from 1999 cost-of-living adjustments in federal veterans' programs, (2) pending agreements with the U.S. Department of Veterans Affairs to increase reimbursements for pharmacy expenditures, (3) implementation of a Corrective Action Plan mandated by the Legislature last year to remedy problems in control of personnel and the home budget, and (4) implementation of a comprehensive management operation plan mandated by the Legislature last year that would analyze the staffing mix and mix of medical services provided at the home.

Figure 4
LAO Recommendations on Veterans' Home Budget Proposals
Yountville
	Reduce General Fund by $514,000 and increase federal funds and reimbursements by equal amount to reflect anticipated federal revenues.
	Report at May Revision regarding additional potential budget changes.
	Withhold recommendation on $385,000 requested for outside medical care for home residents because of pending study.
Barstow
	Reduce General Fund by $810,000 and increase federal funds and reimbursements by equal amount to reflect anticipated federal revenues.
	Report at May Revision regarding additional potential budget changes.
Chula Vista
	Approve $9.1 million in expenditures to activate the new home.
	Reduce General Fund by $513,000 for staffing and $920,000 for contract services because the proposed schedule for home occupation is unrealistic.
	Withhold recommendation on $1.8 million for Veterans Home Information System because a Feasibility Study Report for project awaits approval.
	Reduce General Fund by $108,000 for purchase of equipment the home has not identified.
	Withhold recommendation on $2.1 million for purchase of equipment for which cost documentation is lacking.
	Reduce General Fund by $81,000 for staffing to augment Sacramento budget office because proposed augmentation not justified.

We withhold recommendation on a proposed $385,000 General Fund augmentation to help pay the bills of home residents obtaining medical care outside of the home. We note that the home has previously been able to pay for these costs from within its existing budgeted funds. We believe this request is premature until the study that could lead to major changes in the home's medical care operations and staffing mix has been completed and submitted to the Legislature for review. This study could potentially identify efficiencies in the home's operations that could be used to offset the increased costs it is bearing for outside medical care for residents.

Barstow Home Budget Issues. The proposed 1999-00 budget for operation of the Barstow facility is about $17 million, an increase of about $200,000, or 1.2 percent, above the current-year expenditure level. About $10 million, or 61 percent, of the support for the home would come from the General Fund.

We recommend that the General Fund budget for Barstow be reduced by $810,000, with an offsetting and equal increase in reimbursements and federal funds expenditures. This recommendation takes into account additional funding flowing to the home from 1998 cost-of-living increases in federal veterans' assistance programs and other changes in home collections of federal funds and reimbursements.

We further recommend that the department report at May Revision budget hearings regarding the amount of further adjustments to the home's budget that are warranted to reflect: (1) increased revenues from 1999 cost-of-living adjustments in federal veterans' programs, (2) pending agreements with the U.S. Department of Veterans Affairs to increase reimbursements for pharmacy expenditures, (3) full implementation of the new Veterans Home Information System (VHIS), and (4) collection of reimbursements from third-party insurers of home members.

We would note that the Feasibility Study Report (FSR) justifying the $2.5 million VHIS computer project estimated that it would generate $1.5 million in increased home revenues from federal funds and reimbursements in the first year of implementation (originally to be 1995-96, but actually 1998-99 due to repeated delays in the project) and $6.9 million in the second year (now actually 1999-00). The increased revenues promised due to VHIS have not been included in the budget plan for the Barstow home. The 1999-00 budget also does not include any reimbursement revenues from third-party insurers, despite written assurances by the DVA to the Legislature that such a revenue collection effort would be undertaken after VHIS was implemented.

Chula Vista Home Budget Issues. The proposed 1999-00 budget for activation of the Chula Vista veterans' home is about $15 million. About 93 percent of the activation costs would come from the General Fund with the balance from federal funds and reimbursements.

As we discuss below, we recommend that the budget for the home be reduced by $1.6 million in General Fund expenditures and 18.3 personnel-years. We also withhold recommendation on another $3.9 million in proposed General Fund expenditures, to prevent overbudgeting of the home as it is phased into operation and to ensure that concerns over proposed equipment purchases and the cost-effectiveness of its computer system are resolved. We recommend approval of the remaining $9.1 million budgeted for the activation of the home in April 2000. Our specific recommendations are described below.

Our analysis indicates that the 1999-00 budget request is based upon unrealistic assumptions about how quickly the new home will be occupied by incoming residents. We would note that when funding was sought to activate the Barstow home, the DVA's overly optimistic assumptions in regard to the number of occupied beds resulted in the facility being over-budgeted by $5.4 million in 1995-96 and by $5.8 million in 1996-97. Notably, the initial budget request to activate Barstow assumed that the population of that home would phase in gradually, reaching 92 residents by the end of its third month of operation. In fact, the Barstow home population had only 32 residents by that time. Yet, the Chula Vista activation plan assumes that 313 residents will occupy beds in the new 400-bed facility within three months.

We believe that, because the Chula Vista home is in a location more likely to be preferred by veterans, the new facility will be occupied more quickly than Barstow (which as of November still had filled only 308 out of 400 beds). But we think it is unrealistic to believe, as the DVA assumes in its budget request, that all beds in the facility will be occupied by July 1, 2000. Accordingly, we recommend that the Chula Vista budget request be reduced by $513,000 and 16.8 personnel-years, to reflect a more reasonable pace for phasing in the beds. This reflects our assumption that one of two 60-bed SNF units and two of the four domiciliary buildings (about 80 beds) will not be needed during 1999-00.

Moreover, the amounts proposed in the budget for contracts for food service, laundry, housekeeping, and various specialized medical services cannot be justified even using the department's own assumptions about the occupation of the home. For example, the budget request includes $500,000 in 1999-00 for a contract for food preparation services at the home. Our analysis, based on a comparison of these costs with a similar contract at the Barstow home and a more realistic phase-in of the population at Chula Vista, indicates that this contract alone is overbudgeted by about $414,000. In summary, we recommend a total reduction for various contract services of $920,000.

We withhold recommendation on $1.8 million included in the budget request for development and installation of the VHIS at the Chula Vista facility. While such a computer project is needed to track and bill medical costs at the home and for many other important transactions, the DVA has yet to receive formal notification that its FSR on the project has been approved. (At the time this Analysis was prepared, we were advised that formal approval of the FSR was imminent.) Absent an approved FSR, the Legislature cannot determine the costs, benefits, and technological feasibility of the VHIS project.

Based upon our analysis of the Chula Vista activation proposal, we recommend a $108,000 reduction for equipment purchases because the budget request inappropriately includes a lump sum amount for unidentified portable equipment purchases. We withhold recommendation at this time regarding another $2.1 million requested for equipment because, at the time of our analysis, the DVA was unable to document the cost of each item it wishes to purchase. Without this information, the Legislature cannot determine whether the amount requested is justified.

A $81,000 request to add 1.5 personnel-years in budget staff for the DVA's Sacramento office to handle budgetary matters related to the Chula Vista home should be denied, in our view. The work could be handled by the existing DVA budget office personnel with assistance from the staff provided in the budget request for administrative and accounting functions.

Analyst's Recommendation. We recommend that the budget requests for the Yountville, Barstow, and Chula Vista veterans' homes be modified as shown in Figure 5 below to avoid overbudgeting of General Fund resources and to maximize the expenditure of federal funds and reimbursements at these facilities. We further recommend that DVA report at May Revision budget hearings regarding other issues discussed above that could lead to other fiscal adjustments to the budgets of the Yountville and Barstow homes.

Figure 5
Net Fiscal Effect of Recommendations On Veterans' Home Budget Proposals
(Dollars in Thousands)
	Yountvillea	Barstow	Chula Vistab
General Fund	-$514	-$810	-$1,622
Federal funds	--	+278	--
Reimbursements	+514	+532	--
Totals	--	--	-$1,622
Personnel-years	--	--	-18.3
a Also withhold recommendation on $385,000 in proposed General Fund expenditures.
b Also withhold recommendation on $3.9 million in proposed General Fund expenditures.

This appropriation provides for the state's contribution toward health and dental insurance premiums for annuitants of the Judges', Legislators', District Agricultural Employees', and Public Employees' Retirement Systems, as well as specified annuitants of the State Teachers' Retirement System. The program provides annuitants the option of selecting from 20 state-approved health plans (depending on where an annuitant lives).

Budget-Year Costs Are Uncertain

We withhold recommendation on the $347.3 million General Fund request for annuitant benefits pending final determination of premium rates for calendar year 2000.

The budget proposes total expenditures of $347.3 million from the General Fund for health and dental benefits for annuitants in 1999-00. This is $29.6 million, or 9.3 percent, more than estimated expenditures for this purpose in the current year. This increase reflects only expected growth in the number of annuitants. It does not include any changes in health premiums that would go into effect January 1, 2000. Figure 1 displays General Fund expenditures for annuitant health and dental benefits for the three fiscal years starting with 1997-98. Although these costs are initially paid from the General Fund, the state recovers a portion of these costs from special funds (about 33 percent) through pro rata charges.

The actual amounts needed in the budget year are dependent on negotiations over health premiums currently underway between the state and providers. These negotiated premium rates--which will cover the 2000 calendar year--should be available for review during legislative budget hearings. Pending receipt of the new rates, we withhold recommendation on the amount requested under this item.

Figure 1
Health and Dental Benefits For Annuitants
(In Millions)
Program	1997-98 Actual	1998-99 Estimated	1999-00 Budgeted
Health	$249.5	$285.1	$312.7
Dental	31.4	32.6	34.6
Totals	$280.9	$317.7	$347.3

A significant portion of state government expenditures is for compensation of state employees. The Governor's budget projects $13.4 billion in salary and wage expenditures for more than 282,000 authorized personnel-years in 1999-00 (including $4.6 billion and nearly 90,000 personnel-years in higher education). Including benefits (such as contributions to retirement and health insurance), estimated employee compensation expenditures are projected to exceed $17 billion for the budget year.

The following employee compensation issues are discussed below:

• The administration's proposals for employee compensation.
• Negotiations for new collective bargaining agreements.

Employee Pay/Benefit Increases

State Civil Service Employees. Most state employees (other than those in higher education) last received a general pay increase (3 percent) on January 1, 1995. Figure 1 shows a history of general salary increases for state civil service employees and the consumer price indices for the United States and California since 1981-82.

In the current year, employees in four of the 21 bargaining units received general salary increases ranging from 3 percent to 10 percent. In addition, employees not represented by a bargaining unit received a 3 percent salary increase.

The Governor's budget includes a total of $358 million ($164 million General Fund and $97 million each from special funds and nongovernmental cost funds) to provide increased compensation to state employees other than employees in higher education. The $358 million consists of (1) $168 million ($64 million General Fund) for the annual cost of any increases in employee compensation that are approved in the current year for employees currently in collective bargaining negotiations and (2) $190 million ($100 million General Fund) for employee compensation changes that may be agreed to through collective bargaining and become effective in the budget year. As discussed below, actual salary increases provided to employees by these funds are dependent on the terms of negotiated agreements. As an example, however, the $168 million amount could cover the annual cost of an average pay increase of 3 percent for those currently in collective bargaining. The $190 million that would be available for changes in the budget year could provide an additional salary increase of 2 percent for all employees.

Figure 1
State General Salary Increases
1981-82 Through 1999-00
Fiscal Year	State General Salary Increase	Consumer Price Index
		United States	California
1981-82	6.5%	8.8%	10.7%
1982-83	--	4.2	2.3
1983-84	6.0	3.7	3.6
1984-85	8.0	3.9	4.9
1985-86	6.0	2.9	4.0
1986-87	6.0	2.2	3.3
1987-88	3.8	4.1	4.2
1988-89	6.0	4.6	4.8
1989-90	4.0	4.8	5.0
1990-91	5.0	5.5	5.3
1991-92	--	3.2	3.6
1992-93	--	3.1	3.2
1993-94	5.0	2.6	1.8
1994-95	3.0	2.9	1.7
1995-96	--	2.7	1.4
1996-97	--	2.9	2.3
1997-98	--	1.8	2.0
1998-99 a	--b	2.0	2.1
1999-00 a	--c	2.6	2.8
a Department of Finance estimate of consumer price indices.
b Appropriated funds provided general salary increases of 3 percent to 10 percent for about 32,000 employees in 4 of the 21 bargaining units and a 3 percent salary increase for nonrepresented employees.
c Governor's budget proposal is equivalent to about a 2 percent general salary increase for all employees.

The Governor's budget indicates that the amount ultimately needed for employee compensation increases is dependent on reaching agreement with the 21 employee bargaining units through the collective bargaining process. In recognition of this, the budget bill includes provisional language stipulating that (1) the amount in the bill is not to be construed to control or influence the collective bargaining process and (2) the funds are to be distributed in accordance with approved memoranda of understanding (MOUs) for represented employees and based on salary and benefit schedules established by the Department of Personnel Administration (DPA) for nonrepresented employees. As discussed below, five of the 21 employee bargaining units have reached agreement on MOUs for the current year and the Legislature has approved four of them.

Employees in Higher Education. The University of California (UC) budget request sent to the Governor included a total of $97 million for employee compensation to provide salary and benefit increases to faculty and staff. Similarly, the California State University (CSU) requested $103 million for salary and benefit increases to faculty and staff. The Governor's budget, however, includes less total funding support for UC and CSU than requested and indicates that UC and CSU will develop specific budget plans in the spring to allocate the proposed funds (including monies for employee compensation). Consequently, the amount in the budget for employee compensation is unknown at this time.

New Collective Bargaining Agreements Still Under Negotiation

To strengthen the Legislature's oversight of collective bargaining, we recommend that the Legislature require a minimum 30-day review period for collective bargaining proposals and review proposals at budget hearings for adoption in the budget act. Further, the Department of Personnel Administration should report to the budget committees during budget hearings on the administration's collective bargaining proposals and the status of negotiations.

The DPA began negotiations in 1995 with the 21 bargaining units representing rank-and-file state employees (other than higher education) for new MOUs governing compensation and other terms and conditions of employment. These MOUs were to replace those that expired June 30, 1995. (Under current law, the provisions of expired MOUs generally remain in effect pending adoption of replacement MOUs.)

In 1998, DPA reached agreement with four of the 21 units and the Legislature approved these MOUs--California Correctional Peace Officers Association; California Department of Forestry Firefighters; Physicians, Dentists, and Podiatrists; and Health and Social Services/Professional. These MOUs are in effect until June 30, 1999. In addition, DPA has reached a tentative agreement with the California Highway Patrol, but at the time this Analysis was written the Legislature had not approved the MOU. This MOU, if approved, would also be in effect until June 30, 1999.

The Governor has indicated his desire to reach an early agreement with the remaining 16 bargaining units in the current year and also to reach agreement with all units for MOUs that would be effective after June 30, 1999. If this occurs, the Legislature will be presented with a large number of MOUs to consider over the next several months.

Strengthen Legislature's Collective Bargaining Oversight. In the past, the Legislature has received MOUs for approval late in the session. In addition, assessments of the total cost of the MOUs have not always been available or complete for consideration with the proposals. To ensure that the Legislature has the opportunity to appropriately review any proposed MOUs, we recommend that the Legislature (1) require a minimum 30-day review period between the submittal of proposed MOUs to the Legislature and hearings on the proposals to ensure that their fiscal and policy implications are fully understood and (2) review the administration's MOU proposals at budget hearings and adopt them in the annual budget act (or as amendments to the act if they are not available for review during budget hearings). This is consistent with our recommendation in past Analyses and with supplemental report language adopted by the Legislature with the 1996-97 Budget Act. Given this need to strengthen the Legislature's oversight of collective bargaining agreements, we further recommend that DPA report to the budget committees during budget hearings on the administration's collective bargaining proposals and the status of negotiations.

The state provides tax relief--both as subventions to local governments and as direct payments to eligible taxpayers--through a number of programs contained within this budget item. The budget proposes total relief of $1.6 billion, of which almost $539 million is appropriated through the budget bill.

Of the items appropriated in the budget bill, the homeowners' exemption is the largest. This provision, which is required by the State Constitution, grants a $7,000 property tax exemption on the assessed value of owner-occupied dwellings, and requires the state to reimburse local governments for the resulting reduction in property tax revenues. The exemption reduces the typical homeowner's taxes by about $75 annually. The Governor's budget proposes an expenditure of $401 million on this program in 1999-00. This is an increase of almost $6 million, or 1.5 percent, which reflects the expected growth in the number of homeowners claiming the exemption.

A number of the other tax relief programs were altered by the 1998 tax relief package implemented through Chapter 322, Statutes of 1998 (AB 2797, Cardoza), as discussed below.

1998 Tax Relief Package Increases Program Costs

Vehicle License Fee Relief. The 1998 tax relief package included a permanent reduction in the vehicle license fee (VLF) of 25 percent beginning January 1, 1999, with the potential of greater reductions beginning in 2000-01 if General Fund revenues grow faster than currently projected. Cities and counties receive most of the proceeds of the VLF, more than $3.6 billion in 1997-98. As part of the tax reduction agreement, cities and counties will continue to receive the same amount of revenues as under prior law, with the reduced VLF amounts replaced by General Fund spending. This General Fund spending is continuously appropriated and, therefore, does not appear as an item in the budget bill. The fiscal impact in 1998-99 is estimated at $557 million--with the first full fiscal year effect occurring in the budget year at about $1.08 billion.

Renters' Credit. The renters' credit program--which provides a personal income tax credit to Californians who rent their principal place of residence--was reinstated by Chapter 322, after having been suspended since 1993. In its reconstituted form, the renters' credit is nonrefundable and income-limited. The amount of the credit is $60 for single renters and $120 for married couples or heads of households, but not to exceed the filer's tax liability. Beginning with the 1998 tax year, the credit will be made available to single renters with incomes up to $25,000, and to married couples or heads of households with incomes up to $50,000. The estimated cost of the program in 1999-00 is $141 million. However, this cost is no longer shown as an expenditure in Item 9100; instead, it is shown as a revenue loss to the personal income tax.

Senior Citizens' Relief. Two programs provide property tax assistance to low-income homeowners and renters who are either senior citizens (age 62 or older), disabled, or blind. For homeowners, the tax assistance is provided in the form of a partial reimbursement of property taxes paid; for renters, the amount of assistance is based on an estimate of the property tax paid by the renter. For 1999-00, the income eligibility limits for these programs is increased to slightly more than $33,000, up from $13,200 in 1998-99. Consequently, many more Californians will be eligible for the programs, and expenditures for the two programs combined are expected to rise from $16.6 million in 1998-99 to $83.6 million in the budget year. Due to these changes, an estimated 17,000 new homeowners and 215,000 new renters will benefit from the programs.

This budget item contains appropriations to local governments for three purposes:

Citizen's Option for Public Safety (COPS). The COPS program was created in 1996 to provide local governments with funds for law enforcement. The budget proposes to again fund the program at $100 million in 1999-00, and we discuss the Governor's proposed changes to the program below.

Special Supplemental Subventions. Two programs provide specified local governments with special funding: (1) qualifying redevelopment agencies for revenues lost as a result of the repeal of the business inventory exemption subvention in 1984 ($5 million) and (2) counties with no incorporated cities on the basis that they are not eligible to receive the city portions of the gas tax and vehicle license fee distributions ($147,000).

State-Mandated Local Programs. This item includes funding to reimburse local governments for costs incurred in complying with certain state-mandated programs ($6 million).

This item also includes spending on the property tax administration loan program. This program was created by Chapter 914, Statutes of 1995 (AB 818, Vasconcellos) and extended through 2000-01 by Chapter 420, Statutes of 1997 (AB 719, Torlakson). This legislation appropriates $60 million each year for loans to counties for additional spending on property tax administration. These loans may be forgiven if counties can demonstrate that they have generated or preserved sufficient property tax revenues for schools to offset the costs of the loans. When the loans are forgiven, a cost is accrued in Item 9210. The budget recognizes a cost of $50 million for this purpose in both 1997-98 and 1998-99. The budget, however, shows no estimated costs for 1999-00, apparently on the basis that it is not known if any loans will be forgiven. It is most likely, though, that the state will incur costs of approximately $50 million in the budget year as loans are forgiven. Thus, we have assumed this spending amount in our assessment of the state's overall fiscal condition.

COPS Funding Should Be Considered In Larger Context of Local Fiscal Relief

We recommend the Legislature reject the Governor's proposal to modify and make permanent the Citizen's Option for Public Safety (COPS) program. Instead, we recommend that the Legislature consider the COPS monies in the larger context of state resources provided to restore the fiscal health of local governments. Specifically, we suggest that any local government relief funds that may be provided be used to transform California's system of local government finance into one that reflects modern needs and preferences of local communities.

Background. In 1996, the Legislature enacted Chapter 134, Statutes of 1996 (AB 3229, Brulte), which created the COPS program. Under this program, counties and cities receive state funds, on a population basis, to augment public safety expenditures. The Legislature has provided $100 million for the program each year since 1996-97.

Under the terms of Chapter 134, the $100 million of COPS funds is allocated as follows:

• $75 million to cities and counties for front line law enforcement.
• $12.5 million to district attorneys for criminal prosecution.
• $12.5 million to sheriffs for county jail construction and operations.

Chapter 289, Statutes of 1997 (AB 1584, Prenter) clarified the reporting requirements of the program and required the State Controller to compile a summary report on the allocation and expenditure of the COPS funds. At the time this Analysis was prepared, no such report has been submitted to the Legislature because, according to the Department of Finance, not all local governments have provided their information on the expenditure of the funds to the Controller. Chapter 289 also provides that the program sunsets at the end of 1999-00 absent new legislation.

The Governor's Proposal. The Governor's budget proposes to continue this program at the same $100 million funding level, but in the Governor's budget summary, the administration indicates that it will propose legislation that would change the program. First, the Governor indicates that he will propose that the program be made permanent, rather than expiring on June 30, 2000. Second, the Governor indicates that the legislation will require that all of the money be spent on front line law enforcement, and will provide an incentive for it to be used to hire new officers. Specifically, local governments that use the money to hire officers would receive the funds with no local match required, but governments that propose to use the money for other purposes, such as equipment purchases, would have to match the state funds on a dollar for dollar basis. According to the administration, these changes are in response to concerns expressed by law enforcement agencies that they were unable to use the funds to hire new officers because of the uncertainty of future appropriations.

At the time this Analysis was prepared, it was not clear whether the Governor's proposal would mean the elimination of the $25 million that previously went to district attorneys for prosecution and sheriffs for jail construction and operations, or whether the administration intends to apply the new conditions only to the $75 million portion.

Analyst's Concerns With the Existing COPS Program. In the 1997-98 Budget: Perspectives and Issues we detailed our concerns regarding the COPS program. Specifically, we evaluated how the program met four basic criteria for a state-funded local public safety program.

• Targeted to Specific Statewide Objectives. We believe that a prudent expenditure of state resources for local law enforcement should be targeted to the achievement of specific statewide objectives. As it presently stands, the COPS program simply seeks to increase the overall funds for public safety by $100 million with little focus on meeting specific objectives.
• Includes an Evaluation Requirement. In addition to establishing objectives that a state funded program should strive to achieve, recipients of state funds should be required to evaluate their efforts in order to measure their success. The COPS program requires no such evaluation, and the minimal reporting requirements that are in place do not appear to have been met, as no report on the program has been produced.
• Facilitates Information Sharing. While the state is not in a good position to direct or provide for local public safety, it can be an excellent source for information on what is working well in the many jurisdictions in the state. There is no requirement or mechanism for information sharing in the COPS program.
• Allocated Competitively. Competitive allocation of state funds for public safety allows the state to reward excellence in planning and program design. In addition, it allows smaller jurisdictions an opportunity to obtain more than just a token amount of funding, and provides an incentive for jurisdictions to band together to jointly obtain funds for regional projects. Although competitive allocation does add some administrative cost, the overall return on the investment of state money should also be much greater. The COPS program funds, however, are distributed on a population basis, not on a competitive basis.

The Governor's Proposal Does Not Remedy the Program's Deficiencies. In our view, the COPS program fails when measured against the criteria outlined above. The Governor's proposal to make it permanent will only exacerbate the problems by establishing an ongoing commitment for which there is little accountability. In addition, we have other concerns about the Governor's proposal that we outline below.

Allocations Will Be Too Small For Many Jurisdictions to Hire More Officers. Although the Governor's proposal to change the incentive structure does attempt to go further in identifying an objective for the program--hiring more front line law enforcement personnel--it is not workable in a majority of jurisdictions because their allocations would be so small. If $75 million of the funds were allocated among the approximately 530 local law enforcement agencies, about 296 agencies, or 56 percent, would receive such a small amount of money that they would be unable to hire even one full-time officer. If the program is changed so that all $100 million goes to front line law enforcement, we believe that 255 agencies would still be unable to support one officer. As a result, these smaller agencies will be forced to find local funds either to match the COPS money in order to use it to purchase equipment or to supplement the costs of hiring an officer.

Hiring of Additional Officers Not Always the Best Course of Action. Beyond the practical difficulties of achieving this objective in smaller jurisdictions, we believe that there is a policy question as to why the state should prefer that agencies hire new officers rather than purchase equipment. Some of the agencies that received COPS money used it to purchase new technology that allows them to be more efficient in their tracking, response, and investigation. We see no reason to prefer hiring new officers to these attempts to use existing personnel more efficiently.

Moreover, the Governor's proposal includes no specific objective that these new officers are intended to achieve. Research has demonstrated that different types of policing produce different results in terms of crime control, yet there is no direction in the COPS proposal as to what law enforcement objective is to be met. By way of contrast, the federal money that has been awarded to law enforcement agencies has been directed towards specific goals, primarily the implementation of community oriented policing services.

Redirection of Prosecution and Jail Money May Not Be in Best Interest of State and Local Government. Finally, if the administration is proposing to redirect the $25 million that previously went to counties for jails and district attorneys to front line law enforcement, we question whether the demands for more funding for front line services are any more pressing than for prosecution or local incarceration. Moreover, adding personnel in front line law enforcement tends to increase the workload for downstream criminal justice agencies by increasing the number of arrests and convictions. As a result, it is shortsighted to increase enforcement capacity without making some corresponding increase in resources for prosecution and punishment.

What Should the Legislature Do? We have outlined a number of concerns about the COPS program, both as it is currently structured and as it is proposed for modification. Based upon our review, we recommend that the Legislature reject the Governor's proposal. Should the Legislature choose to continue to appropriate funds for local public safety, we suggest that the criteria we outline be used to establish such a program.

Our analysis indicates that the use of the COPS monies should really be part of a broader discussion of local government finance. As we outline in our recent report, Shifting Gears: Rethinking Property Tax Shift Relief, we believe that the Legislature should consider the $100 million set aside for the COPS program in the larger context of state resources provided to restore the fiscal health of local governments. Specifically, we suggest that any local government relief funds that may be provided be used to transform California's system of local government finance into one that reflects modern needs and preferences of local communities

Public Employees' Retirement System Employer Contribution Rates

We withhold recommendation on employer contribution rates for retirement benefits pending (1) final determination of the actual rates to be applied in the budget year and (2) receipt and review of information regarding the actuarial assumptions underlying the rates.

This control section specifies the contribution rates for the various retirement classes of state employees in the Public Employees' Retirement System (PERS). The section also authorizes the Department of Finance to adjust any appropriation in the budget bill as required to conform with changes in these rates. In addition, the section requires the State Controller to offset these contributions with any surplus funds in the employer accounts of the retirement trust fund.

Under current law, PERS is responsible for developing employer contribution rates each year based on actuarial analyses. At the time this Analysis was prepared, a final determination of these rates had not been made.

The condition of the Public Employees' Retirement Fund, as of June 30, 1998, is one factor that will determine the 1990-00 state retirement contribution rates. Given the positive performance of the stock market through that date, we expect the downward trend in the state's contribution rates to continue, resulting in savings to the state. As an example, if the state's average contribution rate fell 1 percent, the General Fund savings would be about $50 million.

Consequently, we withhold recommendation pending final determination of 1999-00 rates and receipt and review of information from PERS regarding the actuarial assumptions underlying the determined rates. This information is typically available in March or April.

Stephen P. Teale Data Center Revolving Fund

Budget Proposes to Transfer Large Portion of Fund Balance

Control Section 15.00 would transfer from the Stephen P. Teale Data Center Revolving Fund to the General Fund and other funds an amount determined by the Department of Finance to be in excess of a sufficient balance in the fund. The Governor's Budget proposes to transfer $22.7 million from the balance in the budget year, which includes $11.3 million that would be returned to the General Fund and $11.4 million that would be returned to various special funds.

In our analysis of the Stephen P. Teale Data Center earlier in this chapter, we withhold recommendation on the proposed transfer of balances in the revolving fund pending receipt and review of additional information (please see our analysis of the Teale Data Center).

We withhold recommendation on proposed budget bill changes relating to expenditure authority delegated to the administration, pending further discussions with Legislative Counsel and the administration.

Through various budget bill provisions, the Legislature delegates to the administration the ability to spend money not specifically authorized in the annual budget act. Specifically:

• Section 26.00. This section allows the Department of Finance (DOF) to authorize the transfer of funds from one category of expenditure to augment a different category of expenditure within the same schedule.
• Section 27.00. This section authorizes a department to spend at a rate that will result in a deficiency by the end of the fiscal year.
• Sections 28.00 and 28.50. These sections allow the administration to spend unanticipated funds that come in after the start of the fiscal year (or reduce spending allocations). Typically, these are federal funds (Section 28.00) and reimbursements (Section 28.50)--not state revenue sources.

For all four sections, there is a 30-day notification period to the Legislature. This means that the administration may not approve additional spending authority before the Legislature--through the Joint Legislative Budget Committee--has had an opportunity to review the proposal. The basic reason for the Legislature to delegate this authority to the administration is to deal with certain unforeseen circumstances, especially when the Legislature is not in session (primarily during the fall).

Proposed DOF Changes. The changes proposed by the department generally fall into two categories--increased dollar thresholds before JLBC notification becomes necessary and opening up certain control sections to include local assistance and capital outlay. For instance, the department proposes raising the threshold for JLBC notification of intraschedule transfers (Section 26.00). Likewise, the department proposes to permit capital outlay projects to spend at rates that will incur deficiencies.

Given the importance of these budget provisions, it is crucial that the Legislature understand the reasons for the proposed changes. We will be discussing these issues further with DOF and Legislative Counsel and will report to the subcommittees at budget hearings on our recommendations. At this time, however, we withhold recommendation on the proposed changes.