LAO 2004 Budget Analysis: Capital Outlay Overview

Funding for capital outlay in the budget year totals almost $1.6 billion. This spending is funded almost exclusively (95 percent) from bond proceeds. Over 85 percent of the proposed spending is for higher education facilities.

The 2004-05 Governor's Budget proposes approximately $1.6 billion for capital outlay programs (excluding highway and rail programs, which are discussed in the "Transportation" chapter of this Analysis). This is spending on physical assets—such as college buildings, state parks, prisons, and office space. The Governor's plan would authorize General Fund expenditures of around $33 million and spending of nearly $1.5 billion from general obligation and lease-revenue bonds. Figure 1 summarizes the proposed 2004-05 capital outlay program. The proposed plan represents a decrease of over $600 million (29 percent) from current-year spending.

Figure 1 State Capital Outlay Program By Major Program Area
2003-04 and 2004-05 (In Millions)
	Estimated 2003-04	Proposed 2004-05	Difference
Legislative, Judicial, and Executive	$0.4	—	-$0.4
State and Consumer Services	219.3	$4.7	-214.6
Business, Transportation, and Housing	22.9	9.2	-13.6
Resources	433.7	65.5	-368.2
Health and Human Services	123.9	0.6	-123.3
Youth and Adult Corrections	288.6	21.6	-267.0
Education	5.6	69.9	64.3
Higher Education	1,055.4	1,375.8	320.4
General Government	45.2	32.9	-12.3
Totals	$2,194.9	$1,580.3	-$614.7

The Governor's budget indicates that the administration is currently evaluating various alternatives to reorganize and streamline existing conservation efforts in the natural resources area. Consequently, the Governor's budget has deferred the appropriation of some general obligation bond funds in the natural resources area until spring. (We discuss issues related to the resources bond in the "Crosscutting Issues" section of the "Resources" chapter of this Analysis.)

Funding Sources for Capital Spending

The Governor's budget proposes funding the capital outlay program primarily from general obligation and lease-revenue bonds. Other fund sources include the General Fund, special funds, and federal funds. Figure 2 compares the sources of funds for the 2003-04 capital outlay program to those proposed for 2004-05. The budget proposes increasing the amount for direct appropriations from the General Fund by nearly $9 million and decreasing the amount from special funds by around $59 million. With regard to bond appropriations, the budget includes $1.3 billion from general obligation bonds and $143 million from lease-revenue bonds.

Spending by Department

Figure 3 shows the amounts included in the Governor's budget for each department and the future cost for these projects. As shown in the figure, approximately $1.3 billion will need to be appropriated in the future to complete these proposed projects. Thus, the request before the Legislature represents a total cost of roughly $2.9 billion. Of that total, over three quarters is for higher education—with almost all from general obligation bonds.

Figure 3 2004-05 Capital Outlay Program Budget Year and Future Costs
All Funds (In Thousands)
Department	Proposed 2004-05	Future Cost	Total
State and Consumer Services
General Services (seismic)	$4,653	—	$4,653
Business, Transportation, and Housing
Transportation	$100	—	$100
Highway Patrol	250		250
Motor Vehicles	8,863	$30,800	39,663
Resources
Tahoe Conservancy	$1,192	—	$1,192
Conservation Corps	29	$583	612
Forestry and Fire Protection	9,256	—	9,256
Fish and Game	1,133	—	1133
Wildlife Conservation Board	21,500	—	21,500
Boating and Waterways	2,288	—	2,288
Coastal Conservancy	7,200	—	7,200
Parks and Recreation	22,676	1,599	24,275
Water Resources	270	—	270
Health and Human Services
Health Services	$200	—	$200
Mental Health	429	$4,832	5,261
Youth and Adult Corrections
Corrections	$18,840	$412,950	$431,790
Youth Authority	2,750	—	2,750
Education
Department of Education	$69,948	—	$69,948
Higher Education
University of California	$394,436	$409,027	$803,463
Hastings College	18,758	—	18,758
California State University	345,000	263,611	608,611
Community Colleges	617,592	202,289	819,881
General Government
Food and Agriculture	$19,653	—	$19,653
Military	12,251	—	12,251
Unallocated Capital Outlay	1,000	—	1,000
Totals	$1,580,267	$1,325,691	$2,905,958

Figure 4 2004-05 Capital Outlay Program Funding Sources by Department
(In Thousands)
Department	GO Bonds	LR Bonds	General	Special	Federal	Total
State and Consumer Services
General Services—seismic	$4,653	—	—	—	—	$4,653
Business, Transportation, and Housing
Transportation	—	—	—	$100	—	$100
Highway Patrol	—	—	—	250	—	250
Motor Vehicles	—	—	—	8,863	—	8,863
Resources
Tahoe Conservancy	—	—	—	$1,192	—	$1,192
Conservation Corps	—	—	$29	—	—	29
Forestry and Fire Protection	—	$5,150	4,106	—	—	9,256
Fish and Game	$203	—	—	930	—	1,133
Wildlife Conservation Board	21,000	—	—	500	—	21,500
Boating and Waterways	—	—	—	2,288	—	2,288
Coastal Conservancy	1,348	—	—	3,852	$2,000	7,200
Parks and Recreation	8,836	—	—	9,740	4,100	22,676
Water Resources	—	—	270		—	270
Health and Human Services
Health Services	—	—	$200	—	—	$200
Mental Health	—	—	429	—	—	429
Youth and Adult Corrections
Corrections	—	—	$18,840	—	—	$18,840
Youth Authority	—	—	2,750	—	—	2,750
Education
Department of Education	—	$69,948	—	—	—	$69,948
Higher Education
University of California	$339,436	$55,000	—	—	—	$394,436
Hastings College	18,758	—	—	—	—	18,758
California State University	345,000	—	—	—	—	345,000
Community Colleges	617,592	—	—	—	—	617,592
General Government
Food and Agriculture	—	$12,824	—	$6,829		$19,653
Military	—	—	$5,004	—	$7,247	12,251
Unallocated CO	—	—	1,000	—	—	1,000
Totals	$1,356,826	$142,922	$32,628	$34,544	$13,347	$1,580,267

Bond Funding and Debt-Service Payments

Debt Costs to Increase for Traditional Capital Outlays

As shown in Figure 5, the state's General Fund debt-service expenditures for bonds that support traditional capital outlay projects are projected to total $3.6 billion in 2004-05. This is up about $1.2 billion from the current-year level. Most of the increase is related not to more outstanding bonds, but to the deferral of roughly $900 million in annual debt-service principal payments in both 2002-03 and 2003-04 to help deal with the state's budget shortfall. The budget-year debt-service total consists of $3.1 billion related to general obligation bonds, and about $520 million related to lease-revenue bonds.

The Governor's 2004-05 spending plan contains an additional $1.25 billion in debt-service costs related to the $15 billion economic recovery bond authorized by Proposition 57, under the assumption that it will be approved by the voters in March 2004. This annual debt-service amount increases moderately in subsequent years. In 2005-06, the state would also incur $56 million in debt-service costs related to the budget's proposed pension obligation bond sale.

Debt-Service Ratio to Rise

In evaluating a state's capacity for bonded indebtedness and the impact of debt-service costs on its budget, one of the many factors that bond raters and potential investors look at is the state's debt-service ratio (DSR). This ratio is defined as the share of annual General Fund revenues that are devoted to principal and interest payments on General Fund-backed debt. There is no agreed-upon single ratio that fits all states, and the appropriate ratio for an individual state can vary depending on such factors as its need and preference for new infrastructure. As a general rule, however, a ratio in the general range of 6 percent or less has been recognized as a reasonable level for states.

As shown in Figure 6, California's DSR peaked in the mid-1990s at about 5.4 percent. It then declined through the second half of the decade. The ratio fell to about 3 percent in 2002-03 reflecting the deferral of debt payments discussed above.

Assuming approval of the education bonds on the March 2004 ballot, we estimate that the DSR would increase to about 5.3 percent in 2006-07 as authorized bonds are sold off, and then start to decline. If the annual General Fund costs associated with the economic recovery bond (Proposition 57, also on the March 2004 ballot) and the proposed pension obligation bond are included, the ratio would increase to about 7 percent in 2005-06 and remain at that level for the subsequent two years before starting to drift downward.

Bottom-Line Implications

If debt service related to budgetary borrowing is included, the state's DSR will rise significantly above its historical levels in the next year. The ratio will also be above the 6 percent general guideline noted above. Although we believe California would still have access to the credit markets, this could make it somewhat more costly for the state to undertake additional borrowing for traditional infrastructure needs in the near future. Regardless of the DSR's level, it is important to emphasize that the principal concern of the investment community and bond rating agencies at this time is not California's debt ratio per se. Rather, the state's continued budget difficulties are the primary factors cited in recent rating downgrades. Thus, the main concern amongst investors is the underlying need for California's budgetary borrowing in the first place—namely, its persistent budget deficit. California's progress toward eliminating its projected budget shortfall will be the main factor affecting the state's bond ratings and ability to market additional debt at reasonable costs in the future

Figure 2 Sources of Funds for Capital Outlay Program
(In Millions)
	Governor’s Budget
Funds	2003-04	2004-05
General Fund	$23.7	$32.6
General obligation bonds	1,340.2	1,356.8
Lease-revenue bonds	712.4	142.9
Special funds	93.6	34.5
Federal funds	25.1	13.3
Totals	$2,194.9	$1,580.3

Analysis of the 2004-05 Budget Bill

Legislative Analyst's Office
February 2004

Overview