Part I: State Fiscal Picture

LAO Bottom Line

The Budget Proposal

The Budget's Economic and Revenue Projections

Total State Spending

General Fund Condition

How the Plan Addresses the Budget Shortfall

Ongoing Savings in Budget Plan

Budget's Reform Proposals

LAO Outlook

2005-06 Budget Would Have $2.9 Billion Reserve

Reserve Estimate Provides Overly Optimistic Picture Of State's Fiscal Condition

Budget Reduces, But Does Not Eliminate, State's Structural Shortfall

Considerations for the Legislature

Part II: Perspectives on the Economy and Demographics

Summary

Recent U.S. Developments

Personal Income and Jobs Finally Improved

Oil Prices Soared, But Did Not Fuel Inflation

Recent Monthly Reports Suggest Continued Growth

California Trends

How Strong Is Job Growth?

Regional Picture—Bay Area Finally Stabilizing

The Budget's Economic Outlook

National Outlook

California Outlook

LAO's Economic Outlook

National Outlook

Other Elements of the U.S. Outlook

California Outlook

Comparison to Other Forecasts

Risks to the Outlook

The Demographic Outlook

State Population to Approach 38 Million in 2006

Population Growth Components

Growth to Vary by Age Group

Overall Budgetary Implications

Part III: Perspectives on State Revenues

The Budget's Forecast for Total State Revenues

Recent and Proposed Revenue-Related Changes

Tax Agency Enforcement and Compliance Measures

Abusive Tax Shelters

Tax Gap

The Budget's General Fund Revenue Outlook

The LAO's General Fund Revenue Outlook

Year-End Cash Trends Positive

LAO Forecast

The LAO's Forecast for Major Revenue Sources

Personal Income Tax

Background

California PIT Liabilities Concentrated at High End of Income Spectrum

PIT Liabilities—History and Forecast

PIT Revenue Forecast

Sales and Use Tax

Background

SUT Rates

Taxable Sales Growth Accelerated in 2004

SUT Revenue Forecast

Corporation Tax

Background

Profits Soared in 2004

CT Revenue Forecast

Other Revenues and Transfers

The Budget's Forecast for Special Funds Revenues

Part IV: Perspectives on State Expenditures

A. An Overview of State Expenditures

Proposed Total Spending in 2004-05 and 2005-06

Allocation of Total State Spending

General Fund Spending

Special Funds Spending

Spending From Federal Funds and Bond Proceeds

Federal Funds

Bond Proceeds

Budgetary Borrowing

State Appropriations Limit

An Historical Perspective

B. Major Expenditure Proposals In the 2005-06 Budget

Proposition 98

Background

Governor's Proposal

Issues for Legislative Consideration

Current-Year Guarantee Level Is Pivotal

Building a Base Budget for 2005-06

STRS Proposal Lacks Benefits

K-14 Priorities Under a Higher Guarantee

K-12 Proposition 98

Background

Governor's Proposal

Issues for Legislative Consideration

Higher Education

Background

Governor's Proposal

Issues for Legislative Consideration

Health Services

Background

Governor's Proposal

Issues for Legislative Consideration

Social Services

Background

Governor's Proposal

Issues for Legislative Consideration

Judiciary and Criminal Justice

Background

Governor's Proposal

Issues for Legislative Consideration

Transportation

Background

Governor's Proposal

Issues for Legislative Consideration

Resources

Background

Governor's Proposal

Issues for Legislative Consideration

Employee Compensation

Background

Governor's Proposal

Issues for Legislative Consideration

Local Agency and Education Mandates

Background

Governor's Proposal

Issues for Legislative Consideration

Significant Attempt to Reduce 2005-06 Mandate Costs

Additional Mandate Costs Pushed Into the Future

Changing a Commitment to Local Agencies

Major Proposals Lack Explanation

Apparent Inconsistency With Proposition 1A

Part V: Major Issues Facing the Legislature

Governor's Budget-Related Reforms

Summary

Description of Provisions

Proposition 98

Suspension, Test 3, and Maintenance Factor

Treatment of Overappropriations

Late Budgets and Midyear Adjustments

Current Law

Proposal

Proposition 42 Transfers

Loans From Special Funds

Payment of Obligations Within 15 Years

Key Issues Relating to Governor's Proposals

What Problems Do the Proposals Address?

Administration's Main Concern—Autopilot Spending

How Do the Governor's Proposals Stack Up?

Proposition 98 Proposal Seriously Constrains Legislative Flexibility

Across-the-Board Reductions—A Blunt Tool

Issues Raised by Other Provisions

What Alternatives Could the Legislature Consider?

Addressing Public Pension Benefits and Cost Concerns

Summary

Introduction

Background

Defined Benefit Plans Are Core of Public Retirement

How Are Defined Benefit Plans Funded?

Four Sets of Laws Govern State and Local Government Retirement Plans

Key Issues With Current Defined Benefit Plans

Concerns Regarding Benefits

Benefits Are "Locked In"

Some Benefit Formulas Are Overly Generous For Maintaining Living Standard

Final Salary Used to Calculate Retirement Benefit

Retroactive Benefit Enhancements

Concerns Regarding Funding

Volatile and Uncertain Contribution Rates

Employees Shielded From Costs of Retirement Decisions

How Can the Legislature Address These Issues?

Governor's Defined Contribution Plan

Proposal Would Resolve Identified Issues With Current System

Other Advantages

But Also New Concerns

What Have Other Entities Done?

Identified Issues Can Also Be Addressed Within Defined Benefit Structure

Possible Benefit Changes

Possible Funding Changes

Other Pension Possibilities

Blended, or Hybrid, Plans

Cash Balance Plans

Conclusion

Assessing the Governor's Reorganization Proposals

Summary

Introduction

Reorganization Process

How Should the Legislature Approach the Reorganization Plans?

Boards and Commissions

Governor's Proposal

Fiscal Effect

Key Legislative Considerations

Youth and Adult Corrections Reorganization

Background

Governor's Proposal—Major Changes

Fiscal Effect

Would the Reorganization Improve Efficiency And Result in Savings?

Key Legislative Considerations

Would the Reorganization Plan Improve Accountability?

Effectiveness: Not Enough Information to Evaluate

Strategic Plan Has Very Optimistic Timeline for Implementation

Focus on Rehabilitation Will Require a Major Shift

Risk of Combining Youth Programs and Adult Programs Can Be Mitigated

Intergovernmental and Interagency Partnerships Matter

Reorganization Alone Will Not Address Chronic Problems

Conclusion

Transportation Funding Instability Continues

Summary

Introduction

Budget Proposes Continued Transportation Aid to General Fund

Budget Proposes $1.5 Billion to Aid General Fund

Tribal Gaming Bonds Deferred to Budget Year

Proposition 42 Protected in Future, But Repayments Delayed

State Transportation Funding Is Already Limited and Uncertain

Several Factors Have Limited Transportation Funding

Unresolved Current-Year Issues Create Additional Uncertainty

Governor's Proposals Raise Further Transportation Issues

Proposals Further Constrain Near-Term Transportation Funding

Budget-Year Funding for TCRP Is Uncertain

Long-Term Funding Stability Is Still Paramount

Conclusion

Hard Decisions Before the Legislature: Toll Bridge Seismic Retrofit

A History of Delays and Cost Increases

Current Status

Major Decisions Before the Legislature

Should the Bay Bridge East Span Be Redesigned?

How Shall the Program Be Funded?

Future Oversight Should Be Improved

Conclusion

Water Policy Issues Facing the State

Summary

Introduction

Addressing the Flood Management Crisis

The Problem

Background: Responsibilities for Flood Management

Aging Infrastructure and Deferred Maintenance

Escalating Development in Floodplains

Declining Fiscal Resources

State's Potential Liability Exposure

White Paper's Solution Strategies to Address Crisis

Governor's Budget: First Steps in Addressing Crisis

Recommended Next Steps

Financing the Calfed Bay-Delta Program

Background

Governor's Budget Proposal

The Ten-Year Finance Plan: A Summary

Uncertainty Underlying Finance Plan

How Should the Legislature Respond to Finance Plan?

Conclusion

Evaluating the Administration's California Rx Proposal

Introduction—Discounts for Drugs

The Governor's Proposal for Pharmacy Assistance

Weighing the Pros and Cons and the Alternatives

Summary

Lowering the State's Costs For Prescription Drugs

Introduction

Background

Basics of the Prescription Drug Market

Federal Laws and Programs Regulate Drug Prices

State Agencies Use Different Methods To Purchase Drugs

State Agencies Purchase Many Different Kinds of Drugs

Recent Actions by Legislature and Administration May Lower Future Drug Costs

Deficiencies Found in State's Procurement and Administrative Operations

State Is Paying Non-Medi-Cal Drug Prices for Medi-Cal Patients

State Does Not Leverage Medi-Cal's Purchasing Power For All State Programs

DGS Not Providing Sufficient Leadership

Insufficient Collaboration Among State Agencies

Multiple Formularies Redundant

CDC Pharmacy Operations Need Improvement

Potential Approaches to Lowering State's Drug Costs

CPR's Approach to Lowering Drug Costs

LAO Recommended Actions to Lower State's Drug Costs

Changes to Federal and Statewide Statutes

Changes to Federal and Statewide Statutes

Changes in Departmental Practices

Conclusion