Analysis of the 2006-07 Budget Bill Legislative Analyst's Office February 2006

Overview

The 2006-07 budget proposes total expenditures of about $2.9 billion for the state’s capital outlay program (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.

Figure 1 summarizes the proposed 2006-07 expenditures for the capital outlay program. The proposed expenditure level represents a decrease of about $ 2.1 billion (42 percent) from the current-year level. The decrease occurs primarily in the resources and higher education areas because most of the funding from general obligation (GO) bonds approved to date has been spent or committed. Of the $1.6 billion in proposed expenditures for higher education capital outlay projects, the budget proposes $1 billion to be funded from a 2006 bond measure. The measure has yet to be authorized by the Legislature and approved by voters. Without these bond-funded expenditures, total statewide capital outlay expenditures for 2006-07 would be lower than the current-year level by roughly $3 billion.

Funding Sources for Capital Spending

The Governor’s budget proposes funding the capital outlay program primarily from GO bonds and lease-revenue bonds. As shown in Figure 2, the budget requests $1.5 billion in funding from GO bonds and $855 million from lease-revenue bonds. In total, these bonds would make up about 79 percent of the program’s funding in 2006-07. About $192 million in capital outlay projects would be supported directly from the General Fund, while special and federal funds and other sources would provide $422 million in project funding.

The budget proposes increasing the amount from the General Fund by about $62 million, mainly for capital outlay at various correctional institutions. The budget also shows a decrease in expenditures of $341 million from various other funds. The decrease will mainly be in expenditures on state parks, various land conservancies, and veteran affairs.

Spending by Department

Figure 3 shows the amounts proposed in the Governor’s budget for each department’s capital outlay program. In total, the budget proposes $ 2.9 billion for capital outlay projects in 2006-07. Completing all the projects will require an additional $1.7 billion in future costs. Thus, the capital outlay program proposed in the budget represents total expenditures of roughly $4.6 billion.

As the figure shows, the bulk of the proposed expenditures will be for capital improvements in the three segments of higher education-totaling $1.6 billion (or 54 percent of total) in 2006-07, with anticipated future costs of $879 million. (We note that higher education is the only programmatic area to include bond fund expenditures in 2006-07 from the Governor’s Strategic Growth Plan. We discuss the plan in the “Crosscutting Issues” section of this chapter.) Other than higher education, the budget-year capital outlay program focuses on resources programs. The budget proposes $565 million in expenditures for these programs, including $208 million for the Department of Water Resources mainly for flood control, $207 million for the Department of Forestry and Fire Protection to replace and relocate various fire stations and facilities, and about $92 million for land acquisition by various conservancies. The resources projects will require a total of $391 million to complete in future years, mainly for flood control purposes.

For the Department of Corrections and Rehabilitation, the budget proposes capital outlay expenditures of $224 million in 2006-07. About 45 percent of the amount is for the construction of a condemned inmate unit at San Quentin. The remaining expenditures are primarily for projects to address deficiencies in water and wastewater treatment systems at various correctional institutions. The department’s projects will require an additional $106 million in future costs to complete.

Figure 4 displays the proposed expenditures for each department, by funding source. This shows that most expenditures for higher education and resources programs would be paid from GO bonds, while expenditures for transportation (buildings) would come from other sources including special and federal funds. The General Fund and lease-revenue bonds are the main sources of funding for correctional and fire protection projects.

Bond Funding and Debt-Service Payments

Figure 5 shows the state’s General Fund debt-service expenditures for bonds that support traditional capital outlay projects for the period 1997-98 through 2006-07. Debt-service expenses depend on several factors, including the volume of bonds sold and outstanding, their interest rates, and their maturity structures.

The figure shows that these expenditures have increased in recent years, and are projected to reach $4.2 billion in the budget year, up by about $380 million from the current-year level. This total consists of $3.6 billion related to GO bonds and nearly $620 million related to lease-revenue bonds. The especially large jump in debt-service expenses that occurred between 2003-04 and 2004-05 partly relates to the conclusion of a two-year debt-refinancing program undertaken by the Treasurer to help deal with the General Fund budget shortfall. This resulted in the deferral of about $900 million in annual debt payments in both 2002-03 and 2003-04, and thus also largely explains the debt-service fall off for those two years. Growth in debt-service costs in recent years also reflects previous voter approval and state issuance of a substantial amount of new debt for schools, resources, and other purposes.

Budget-Related Borrowing Also Imposing Costs

In addition to the costs associated with capital-outlay-related bonds, the state is also incurring annual costs for budget-related debt. This began with $1.1 billion in 2004-05 and will involve increasing amounts thereafter for the repayment of the deficit-financing bonds that were authorized by Proposition 57 (approved by the voters in March 2004). Although the repayment of these bonds comes directly from a one-quarter-cent share of the sales and use tax transferred from local agencies, the General Fund is required to make equivalent Proposition 98 payments to schools to compensate them for their transfer of property tax revenues under the state‘s so-called “triple flip” budgetary arrangement. The budget proposes to accelerate the repayment of these bonds by using the transfers from the Budget Stabilization Account specified in Proposition 58. The budget projects that, as a result, these bonds would be paid off by 2010.

Debt-Service Ratio Trending Upward

The level of General Fund debt-service payments stated as a percent of state revenues is commonly referred to as the state’s debt-service ratio (DSR). Although there is no correct answer about what a state’s DSR should be, many policymakers and members of the investment community look at the DSR as one helpful indicator of the state’s debt burden.

As shown in Figure 6, California’s DSR for traditional capital outlay purposes peaked in the middle of the 1990s at about 5.4 percent before falling to below 3 percent in 2002-03, in part reflecting the deferral of debt payments discussed above. The DSR then rebounded beginning in 2003-04, and the budget projects that it will reach 4.3 percent in 2005-06. Thereafter, the budget projects that it will reach 5.4 percent in 2009-10.