LAO 2004-05 Budget Analysis: Perspectives and Issues

Analysis of the 2004-05 Budget Bill

Legislative Analyst's Office
February 2004

Major Expenditure Proposals in the 2004-05 Budget

In this section, we discuss several of the most significant spending proposals in the budget. For more information on these spending proposals and our findings and recommendations concerning them, please see our analysis of the appropriate department or program in the Analysis of the 2004-05 Budget Bill.

Proposition 98


The Governor's budget proposal suspends the Proposition 98 minimum guarantee by $2 billion in 2004-05. Thus, the overriding issue for the Legislature in crafting the 2004-05 budget for K-12 education and the community colleges (both funded primarily through Proposition 98 funds) is whether to approve the proposed suspension. If suspended, the Legislature then could set the funding level for K-12 education and the community colleges at whatever level it felt appropriate. How the Legislature addresses the issue of suspension will shape K-14 budgets for the next several years.

The Governor's budget proposes $46.7 billion in Proposition 98 funding for 2004-05. This is $751 million, or 1.6 percent, higher than the revised current-year amount. This provides sufficient resources to fully fund enrollment growth, statutory cost-of-living adjustments (COLAs), and some program expansions and restorations. The Governor's budget, however, does not provide a COLA for the community colleges and some K-12 categorical programs.

Governor's Suspension Proposal Reasonable. Given the size of the structural deficit and Proposition 98's share of General Fund expenditures (roughly 40 percent), it would be very difficult to close the budget gap without suspending Proposition 98. Absent a suspension, the Legislature would either have to :

As noted above, even with suspension, the Governor's proposed Proposition 98 funding level provides sufficient resources to fully fund growth, COLAs, and some additional expansions and program restorations. Accordingly, we recommend the Legislature suspend the minimum guarantee for 2004-05. If the Legislature chooses to suspend, we recommend the Legislature determine the appropriate level of K-14 funding by balancing K-14 priorities with its other General Fund priorities—without regard to the dollar amount of the suspension.

Suspension Would Result in Multiyear Savings. Figure 9 shows our estimate of the annual savings to the state from the Governor's proposed suspension. The figure shows that the $2 billion of General Fund savings in 2004-05 grows by about $100 million each year, reaching $2.4 billion by 2008-09. In other words, the savings grow with the annual growth in K-12 attendance and personal income. We explain below why the savings from the Governor's proposed suspension increase over the forecast period.

Current Maintenance Factor Paid Off First. Figure 10 shows the impact a $2 billion suspension would have on widening the gap between the required minimum guarantee and the long-term Test 2 level (this gap is known as the "maintenance factor"). Absent suspension, the state would slowly close the gap between the Proposition 98 funding level and the long-term Test 2 level over the forecast period. (We estimate this maintenance factor payoff at over $200 million annually on average.) Lowering the 2004-05 spending level by $2 billion through suspension, however, widens the gap from the long-term Test 2 level.

The shaded area shown in Figure 10 represents the savings to the state from the Governor's proposal. Since the state does not pay off its preexisting maintenance factor over the period shown, the maintenance factor created by suspension ($2 billion) generates savings of that magnitude each year. (As noted above, it actually grows slightly because of growth in K-12 attendance and per capita income.) When the state fully restores all maintenance factor and returns to the long-term Test 2 level (which based on our forecast would be after the period shown in Figure 10), the savings to the state from the $2 billion suspension would end. However, in the interim, the state would generate annual savings from the Governor's proposed suspension.

Issues for Legislative Consideration

Legislature Can Eliminate Prior- and Current-Year Proposition 98 Obligations Through Suspension. For 2002-03 and 2003-04, the Governor proposes to fund Proposition 98 a total of $966 million below the existing minimum guarantee levels. The budget, however, does not propose suspension in these years. Thus, for these years the state would need at some future time to appropriate additional resources to "settle up" to the minimum guarantee. Under the Governor's proposal, the state would not begin paying the settle-up obligation of $966 million until 2006-07. This effectively creates a $966 million loan from Proposition 98 to the General Fund until that time. While this would help the state's balance sheet in the short run, the "tab" would have to be paid in 2006-07. Given that the budget does not fully address the state's structural problem (see "Part I" of the 2004-05 Budget: Perspectives and Issues), the loan would add to the state's problem when the settle-up payments were made in 2006-07.

Due to the severity of the state's fiscal situation, we recommend the Legislature suspend the minimum guarantee for 2002-03 and 2003-04, thereby eliminating the $966 million future obligation. If the state does not suspend the minimum guarantee for 2002-03 and 2003-04, the state will be obligated to pay off the $966 million in the near term regardless of the state's fiscal situation at the time.

"Credit Card" Balance High and Growing. The Governor's proposal continues the recent trend of increasing future state obligations to fund current expenses. The result has been a steadily growing balance on the state's education credit card. Combined, the credit card balance would grow from $3.5 billion in 2003-04 to $3.8 billion in 2004-05 under the Governor's budget, an increase of $321 million. Most of this increase results from a lack of funding for state mandates, which we estimate will exceed $300 million in 2004-05. Given the large and growing backlog of mandate claims, the mandate deferral presents special problems for the state. By the end of 2004-05, the state is likely to have a total of almost $1.6 billion in outstanding Proposition 98 mandate liabilities. We provide several recommendations to reduce the costs of K-12 mandates in the "Education" chapter of the Analysis of the 2004-05 Budget Bill.

To address the overall balance, we recommend the Legislature begin gradually paying off deferrals and develop a repayment plan to eventually restore all deferred funds. We note that since school districts and community colleges have already spent the funding to meet the program obligations of the deferred programs, any funding provided to reduce deferrals is effectively general purpose in nature at the local level. In the budget and future years, we recommend the Legislature make it a priority to repay deferrals before making expenditure increases or funding new programs.

K-12 Proposition 98


The Proposition 98 allocation to K-12 schools (which includes local property tax revenues) is proposed at $41.9 billion or $6,941 per pupil for 2004-05 (adjusted for funding deferrals). This represents an increase of $175 per pupil, or 2.6 percent, from the revised current-year estimate.

The major 2004-05 budget proposals include:

Issues for Legislative Consideration

Proposed Categorical Program Consolidation. The Governor proposes to consolidate $2 billion in funding for 22 existing categorical programs into revenue limits. With this change, districts would have complete discretion over the use of these funds. The proposal would balance this new flexibility by requiring a district plan that is intended to increase local accountability for district spending decisions. In addition, the budget proposes to provide additional flexibility for five small school safety competitive grant programs.

We believe these proposals take a significant step toward the goal of establishing a streamlined system of categorical programs by increasing fiscal and program flexibility and reducing state and local administrative costs. We recommend several modifications to the list of programs included in the revenue limit. Most significantly, we recommend the Legislature exclude from the consolidation staff development programs and programs that support services for special needs students because we are concerned that local incentives are likely to lead districts to underinvest in these two areas. Instead, we recommend (1) creating a teacher quality block grant from ten existing categorical programs and (2) restructuring Economic Impact Aid by adding other programs serving special needs students.

Of the 17 programs we recommend shifting into revenue limits, three are not ones the administration proposes shifting. Specifically, we recommend shifting K-3 and high school class size reduction, as well as deferred maintenance. We also suggest modifying the budget's school safety program proposal. Specifically, we recommend creating a block grant that would contain funding from all existing categorical and state-mandated local programs in this area. This would give districts greater flexibility over the use of funds and reduce the state and local administrative burden of existing categorical programs and mandates.

Higher Education

The state's higher education agencies include the University of California (UC), the California State University (CSU), the California Community Colleges (CCC), Hastings College of the Law, the California Student Aid Commission, and the California Postsecondary Education Commission. Of these agencies, only funding for CCC is part of Proposition 98. The 2004-05 budget proposal would reduce total General Fund support for higher education by $197 million, or 2.3 percent, from the revised 2003-04 level. When all fund sources are included (such as student fees, which the Governor proposes to increase at all three segments, and federal funds), total support for higher education increases by $803 million, or 2.6 percent.

We are concerned that a number of the Governor's proposals would unreasonably impede student access to higher education. In the Analysis, we offer recommendations to better promote access while still achieving the level of General Fund savings envisioned by the Governor.

California Community Colleges


The Governor proposes Proposition 98 funding (General Fund and local property taxes) of $4.7 billion for CCC in 2004-05. This represents an increase of $320 million, or 7.3 percent, from the Governor's current-year estimate. Adjusting for deferrals, the CCC's increase in Proposition 98 funding would be $120 million, or 2.6 percent.

The Governor's proposal would provide $121 million to fund enrollment growth of 3 percent, or about 32,000 additional full-time equivalent (FTE) students. This is higher than the statutory rate of 1.8 percent, in part to accommodate the Governor's proposal to redirect 10 percent of new freshman enrollment from UC and CSU to CCC. The budget proposal also includes $80 million to raise per-student funding in low-revenue districts, thus promoting the "equalization" of per-student funding among districts.

The Governor's CCC budget includes two new fee proposals. First, regular student fees would increase from $18 per unit to $26 per unit. The average full-time student taking 24 units per academic year would pay an additional $192. The new fee amount would permit needy students (who do not pay fees at community colleges) to collect up to $112 in additional federal Pell Grant aid. The Governor's second fee proposal applies to students who already hold a baccalaureate degree. Instead of paying the $26 per unit fee, these students would pay $50 per unit. The combined effect of the two fee proposals would increase student fee revenue by $91 million, thus permitting General Fund savings of the same amount.

Finally, the Governor's proposal would consolidate funding from some categorical programs into general apportionments, thus providing districts with greater flexibility in using these funds. It would also rearrange several other categorical programs into larger groups.

Issues for Legislative Consideration

In the Analysis, we assess the major features of the Governor's CCC proposal. While we generally support the proposed fee increases and the enrollment growth augmentation, we raise the following concerns:

Categorical Reform Proposal Needs Work. We support the objective of categorical reform. However, we believe that the Governor's proposal to move some categorical funding into base apportionments lacks adequate accountability measures. In addition, we believe that the regrouping of several other categorical programs is largely symbolic because proposed restrictive language would prevent any new flexibility for local districts. We recommend ways to address these concerns.

State Should Address Existing Obligations Before Expanding Programs. While we support the goal of equalization, we believe that the $80 million proposed for this purpose would be better spent addressing existing obligations. For example, the Governor's budget would defer $200 million in 2004-05 apportionment costs to 2005-06, and would defer tens of millions of dollars in state reimbursements to districts for mandated programs. We recommend that the $80 million for equalization instead be applied to these or other existing obligations.

Other Higher Education Programs


The Governor's budget proposes a variety of student fee increases at UC and CSU. These include a 10 percent increase in undergraduate fees, a 40 percent increase in graduate fees, and a 20 percent increase in nonresident tuition. The budget also reduces General Fund support for professional schools, assuming UC will backfill these reductions with fee increases. These fee increases would generate about $300 million in new fee revenue, which in turn would backfill unallocated General Fund reductions of the same amount. The Governor's budget also proposes a new student fee policy for UC and CSU. (The policy would not apply to CCC.) In general, the policy limits future fee increases to 10 percent per year.

While increasing student fees, the budget cuts back on eligibility for Cal Grant financial aid programs and reduces the value of some Cal Grant awards. At the same time, the budget increases funding for campus-based financial aid programs run by UC and CSU.

The budget reduces funding for various UC and CSU programs, including all General Fund support for outreach programs at the two segments. Consistent with legislative intent expressed in the 2003-04 budget package, the Governor's 2004-05 proposal does not include new funding for enrollment growth at UC and CSU. In fact, it reduces enrollment funding by about 7,000 FTE students and redirects these students to CCC.

Issues for Legislative Consideration

The combination of fee increases of up to 40 percent, restricted and reduced financial aid, and defunding of K-12 outreach programs could seriously hinder student access to higher education. While we understand that the state's fiscal situation justifies some reductions in General Fund support for higher education, we believe that a similar level of savings can be achieved in a way that would better preserve student access. In the Analysis we make a number of recommendations to accomplish these ends.

Preserve Selected Outreach Programs. We recommend establishing a College Preparation Block Grant to allow targeted K-12 schools to contract for outreach services. We also recommend that state funding for a small number of existing outreach programs at UC and CSU be preserved.

Align Student Fee Increases to Student Costs. We recommend adoption of a fee policy that bases student fees at all segments on a fixed percentage of educational costs. While we support the Governor's proposed budget-year increases in undergraduate fees, we recommend adoption of smaller fee increases for resident graduate students and nonresident undergraduate students.

Maintain Integrity of Cal Grant Program. We make a number of recommendations that would ensure state Cal Grant aid is sufficient to address the identified costs, including planned fee increases, experienced by needy students.

Segments Still Have Unused Enrollment Funding. Although the Governor's budget includes no new funding for enrollment growth at UC and CSU, we find that both segments have unused enrollment funding in their base budgets that would permit them to enroll more students in 2004-05 than are enrolled in the current year. 

Health and Social Services

Under the Governor's budget proposal, state General Fund expenditures for health and social services programs would total $24.6 billion in 2004-05, about 31 percent of proposed General Fund spending for all purposes.


The Governor's budget plan includes a number of specific proposals intended to reduce 2004-05 expenditures for health and social services programs to help address the state's fiscal problems. The types of proposals presented to the Legislature include: (1) caps on the enrollment of certain programs, or certain populations in those programs; (2) the imposition of other restrictions on program eligibility; (3) the restructuring of some state programs into a county block grant; (4) reductions or freezes in rates and wages paid to various health care providers; (5) suspension of cost-of-living adjustments; (6) reductions to specified cash assistance grants; and (7) increases in the fees paid by program beneficiaries.

In addition to these specific types of budgetary changes, the administration has also outlined in concept several broader proposals to reform health and social services programs for the stated purpose of reducing their cost and improving program results in the long term. Among these proposals are the following:

Issues for Legislative Consideration

We discuss and comment upon many of the Governor's specific budget reduction proposals, as well as the longer-term reforms that he has outlined in concept, in the "Health and Social Services" chapter of the Analysis. There are several key factors that the Legislature may wish to consider as it evaluates the merit of his broader reform proposals. We discuss these in more detail below.

Right Programs Focus of Reform. In general, the administration has chosen to focus on containing the costs of the state's fastest-growing health and social services programs. Our initial review indicates that the Governor's budget plan has chosen good candidates for these broader reform efforts. With the exception of Foster Care and CalWORKs, the programs outlined above involve significant General Fund costs and are projected to experience average expenditure growth of about 7 percent over the next five years. If major cost-reduction efforts were successful in these programs, the state would have taken some significant steps toward addressing the ongoing gap between current-law state revenues and spending that we have forecast through 2008-09.

Reforming CalWORKs makes sense for two reasons. First, the program is experiencing cost pressures because the state has virtually exhausted all of its available federal TANF carryover funds. Second, program participation is below the levels envisioned in the CalWORKs statute and is also below the standards contemplated under the pending congressional versions of federal welfare reform reauthorization.

More Specifics Needed. In some cases, the administration has identified an aggregate amount of future state savings from the proposed changes, but has not indicated the specific amount of savings identified with each separate component of the reform package. In other cases, the estimated overall fiscal impact of the proposed changes has not been identified. Also, some proposals are so general in their nature that it is not clear exactly how program benefits or services would change if they were adopted

Thus, in many cases the Legislature does not have sufficient information at this time to fully assess the impact of the Governor's reform proposals. The administration has indicated its intention to work with "stakeholders"—the various parties affected by the programs—to further develop the broad reform concepts into more specific proposals. The work product from these activities is proposed to be submitted to the Legislature at a later date—in some cases, at the time of the May Revision.

In general, we recommend that the Legislature request that the administration present more detailed information about its proposals during budget hearings, prior to the May Revision. We are concerned that a mid-May submittal will not provide the Legislature with sufficient time to assess the merits of the Governor's proposals or to consider appropriate modifications, where necessary, to improve them. 

Be Open to Additional Reforms and Alternatives. Based upon our knowledge of the affected programs, a number of the Governor's proposals appear to represent a good starting point for discussions of program reform. However, we recommend that the Legislature broaden the discussion in some cases to consider complementary reforms that go beyond those the Governor has offered, and in other cases, to consider alternatives to the administration approach.

For example, while the administration has put forward a potentially worthwhile proposal to expand Medi-Cal managed care to additional counties within California, we would urge the Legislature to also examine the idea of shifting an additional 330,000 aged or disabled beneficiaries from fee-for-service medicine to managed care to both improve the quality of their health care and to reduce state costs. In this case, our approach would complement, and not conflict, with the administration proposal. (We discuss this proposal in more detail in "Part V" of this volume.)

Given the current low rate of engagement with program activities, we concur that the CalWORKs program is in need of reforms which will increase work participation so that recipients can move toward self-sufficiency. We are concerned, however, as discussed in the Analysis, that the Governor's proposals to restrict eligible work activities may unnecessarily limit county flexibility to find the optimal mix of work, training, and employment activities so as to help recipients leave cash assistance. Further, the administration's assumptions concerning the effectiveness of its proposed reforms may be overly optimistic. Given that counties have a fiscal incentive to help recipients become self-sufficient, the Legislature should consider retaining as much county flexibility over program control as is possible. Finally, in evaluating the Governor's welfare reform proposal, the Legislature should weigh the benefits of increased program participation against the potential adverse impact on children in families who are unable or unwilling to comply with stricter work requirements

The Governor has suggested a good starting point for discussion of foster care reforms. To improve the foster care system, we suggest that the Legislature examine three additional potential areas of reform beyond those proposed by the Governor. First, in previous analyses, we have presented Foster Family Agency (FFA) reform proposals that would reduce the length of time a child stays in FFA homes by increasing the incentive to move toward permanency placement. This could substantially reduce state costs. Second, under current law, specialized care increments paid to Foster Care providers vary by county and have little rational connection to the actual needs of the child. We suggest reforming these increments so as to reflect state policy concerning the special needs of foster youth rather than historical rate structures which vary by county. Finally, we would suggest developing and implementing a detailed plan to increase the supply of foster family homes, which are the lowest cost type of placement.

Another program that could benefit from reform is the fast-growing Adoptions Assistance Program (AAP). Currently, AAP provides the maximum foster care grant to virtually every child who is adopted from the foster care program regardless of whether that child would be "hard to place" with an adoptive family. We recommend that the Legislature consider (1) setting AAP grants at levels that recognize the adoptive parents' financial responsibility for their adoptive children and (2) tying benefit levels more closely to the needs of the adoptive children. (We discuss our proposal in more detail in the Analysis.)

Timing an Important but Secondary Concern. As the Legislature considers the Governor's proposals, it should carefully assess whether the savings that are proposed can be achieved in the time frame identified in the budget plan. This is a particularly important issue for the Legislature to consider in cases in which the budget plan assumes the achievement of savings in the budget year. For example, our analysis indicates that it may be difficult to obtain the savings projected for 2004-05 from reform of the foster care system. To the extent that the budget plan overestimates the fiscal benefit of such reform proposals, it could prolong the state's fiscal difficulties by contributing to future budgetary shortfalls.

However, we also recommend that the Legislature consider the timing of the "payoff" from program reform as a secondary matter, and to first judge reform proposals primarily on their overall policy merit and potential long-term fiscal benefit to the state. In other words, we urge the Legislature not to disregard reform proposals simply because their savings will be minimal or nonexistent in the budget year, or perhaps even require an "up-front" investment of state resources in the short term to accomplish. This is because, while a particular reform proposal may not "ramp up" to provide substantial state savings in some instances for another year or more, the state's structural budget gap means that those savings may nonetheless be needed to help prevent future budget shortfalls.

Juvenile Justice System Reform


The Governor's budget proposes a number of reforms for the California Department of Corrections (CDC) and the Youth Authority. (For our comments on the administration's proposals in CDC please see page D-68 of the Analysis.) In this piece, we discuss the Governor's proposals regarding the Youth Authority. 

The Governor's Budget Summary indicates that the administration seeks to preserve the mission of the Youth Authority by focusing its efforts on treatment and training, and the provision of services for specialized populations. The budget proposes to accomplish this by moving certain wards out of the Youth Authority and into CDC. Specifically, it proposes to lower the age jurisdiction of the Youth Authority from wards who are 25 years of age to those 22 years of age. It also proposes sentencing reform, referred to as "blended sentence," in which the juvenile is given a dual sentence to both the juvenile and adult system, so that he or she can be transferred to prison under certain circumstances.

Details Lacking on Fiscal and Programmatic Impact. At the time this analysis was prepared, the details of the Youth Authority proposals had not been provided to the Legislature. Based upon the description in the budget summary document, and discussions with Youth Authority staff, it seems likely that the proposals will shift some costs from the Youth Authority to CDC. In addition, to the extent that the proposed sentencing changes affect juvenile and/or criminal trial procedures, there potentially could be unknown budgetary impacts on state trial court funding and local law enforcement.

The Problem

The Governor's budget suggests that the problem facing the Youth Authority is that it has had to shift its focus away from its rehabilitation mission in order to control the behavior of wards that have limited interest in rehabilitation. We believe the Legislature should take a broader view of juvenile justice reform.

From our perspective, the juvenile justice system in California is bifurcated with the state and local systems providing many of the same services. Because both the state and local governments provide services, there is a reduced level of accountability for program outcomes, and reduced local incentives to develop programs targeted to all juvenile offenders. The state has a unique opportunity because of the declining population of wards at both the state and local levels, as well as the trend of below average growth in the juvenile population, to reform this system.

Issues for Legislative Consideration

We agree with the Governor's policy goal of improving treatment and training opportunities for juvenile offenders because this is consistent with the statutory mission of the Youth Authority. We also agree that there may be opportunities to target resources to the provision of specialized services, and that this would be an improvement over providing across-the-board treatment services which are duplicative of services provided at the local level. 

As an alternative to the Governor's proposal, the Legislature may wish to consider a reform proposal that we have recommended in the past (Making Government Make Sense: Applying the Concept in 1993-94, May 1993). It would (1) shift responsibility for the relatively small population of youthful offenders in the Youth Authority back to the counties and (2) change the role of the state to that of a "service provider" from whom the counties would buy services.

Local Control and Delivery. Under the current system, the state assumes full responsibility for the treatment and incarceration of certain wards. From the time the wards are committed to the Youth Authority to the time they complete parole, the programming and much of its attendant costs fall squarely on the state. As we discuss below, counties pay a share of incarceration costs. Even when these juveniles—or young adults as the case may be—return to their communities on parole supervision, the state remains responsible for funding their services.

As an alternative, our proposal would shift responsibility for these youth offenders—including both incarceration and community supervision—to the local governments. Under this model, the state would be a service provider to the counties. Counties would make the programmatic and fiscal decision to serve juvenile offenders locally or send them to state institutions.

Funding Mechanism. Although our proposal envisions shifting responsibility for both incarceration and community supervision to the local level as part of the local juvenile justice system, from a funding perspective it may be desirable to handle them separately.

State and Local Benefits of Reform. We believe this reform proposal will likely result in a number of benefits. First, it would reduce the level of duplication within the state and local system. Second, it would place both programmatic and fiscal control of juvenile justice services at the local level, which would make one entity accountable for program outcomes, and at the same time provide greater discretion to communities. Third, we believe it would provide counties a stronger incentive to intervene early with criminal offenders and develop alternative methods of incarceration and services to minimize the risk of reoffending. Fourth, it would provide counties an incentive to build upon the services that are already provided at the local level.

Consider a More Specialized Role for Youth Authority. The downsizing of the Youth Authority that would likely occur under this proposal would also present an opportunity for the development of more specialized programs. Rather than offering across-the-board services to juvenile offenders, the state may offer specialized services to a targeted group of juvenile offenders. For example, the Youth Authority has experienced an increase in the number of wards with mental health needs. Our discussions with state officials indicate that local juvenile justice systems in many counties are not equipped to serve juvenile offenders with a combination of violent offenses, and mental illness. One option for legislative consideration is targeting the Youth Authority mission to serving this population, and perhaps other special populations of youthful offenders. The objective would be to focus the state's resources on providing services that are lacking at the local level, and that would be costly to develop in individual counties.


California's state transportation programs are funded by a variety of sources including special funds, federal funds, and general obligation bonds. The State Highway Account (SHA) has traditionally provided the primary source of state funds for transportation, with revenues generated mainly from an 18-cent per gallon tax on gasoline and diesel fuel (referred to as the gas tax) and truck weight fees.

In 2000, the Legislature enacted the Traffic Congestion Relief Program (TCRP) to supplement state transportation funding from 2000-01 through 2005-06, primarily by redirecting the sales tax on gasoline to transportation purposes. (Otherwise, these funds would have gone to other state General Fund purposes.) The original TCRP was to provide funding for several transportation programs, including $4.9 billion for 141 specified projects and about $2.7 billion for other capital outlay projects, local street and road improvements, and mass transportation programs.

The TCRP was later extended by statute through 2007-08. In addition, in March 2002, the voters passed Proposition 42, which committed the sales tax on gasoline to transportation in perpetuity. However, Proposition 42 also contained a provision that allows this funding to remain in the General Fund under specified circumstances.

Substantial Transportation Funds Used to Help the General Fund. Since the enactment of TCRP, most of the additional money that was supposed to be used for transportation purposes has instead remained in the General Fund. Transfers to transportation funds have been delayed or suspended, and much of the General Fund money that was transferred has been loaned back. Specifically, since 2001-02, about $2.2 billion in TCRP and Proposition 42 funds have been loaned to the General Fund. This amount includes a total of about $1.4 billion prior to the enactment of Proposition 42, and $856 million in 2003-04 as a result of the partial suspension of Proposition 42. Under current law, these loans are to be repaid by 2005-06 and 2008-09, respectively.


The Governor proposes a number of actions in transportation in order to provide an additional $2 billion in help to the General Fund for 2003-04 and 2004-05 combined.

2003-04 Mid-Year Changes. In November 2003, the administration proposed the following actions to provide $920 million in help for the General Fund:

Budget-Year Adjustments. For 2004-05, the Governor proposes to:

Proposed Transportation Aid to General Fund Is Substantial. The Governor's mid-year proposals together with the Proposition 42 suspension in 2004-05 would provide about $2 billion in transportation funds to the General Fund in the current and budget years. Combined with previous loans of $2.2 billion, the Governor's proposals would bring the total aid to the General Fund from various transportation funds to about $4.3 billion since 2001-02.

Proposals Would Reduce Already Limited Transportation Funding in the Near Term, Causing Project Delays That Harm the Economy. The state had expected a large influx of funding in transportation for the past few years, but this influx has not materialized. Specifically, state funding promised in the TCRP has been delayed and loaned back to the General Fund, and truck weight fee revenues have been lower than anticipated. In addition, a delay in the reauthorization of the federal transportation act has resulted in less federal money available for transportation in 2003-04 than originally anticipated. This decline in expected funding has severely restricted the state's capacity to fund new transportation projects, causing project delays.

Delays in transportation projects harm the state's economy. When the transportation system fails to keep pace with the state's population and travel demand, traffic congestion worsens. Congestion now costs California drivers more than $4.7 billion in wasted time and fuel—thereby diverting these resources from more productive uses, causing higher costs and reduced profits for businesses, and potentially reducing economic output and jobs.

By reducing near-term transportation funding in the current and budget years, the administration's proposals would further slow transportation projects. Eliminating funding for TCRP projects would result in complete stoppage of work on many of these projects, resulting in unknown closeout costs.

Proposals Would Increase Instability for Transportation Funding in the Long Term. While vehicle travel and transportation funding requirements continue to increase, inflation-adjusted state transportation revenues have declined, primarily revenues from the state gas tax. In addition, the level of future transportation revenues is highly uncertain. The primary source of uncertainty is the possibility that Proposition 42 will be suspended in the future, particularly in light of projected ongoing General Fund problems. These problems also make it highly unlikely that the General Fund will repay on schedule the substantial loans it has received from transportation. Uncertainties in funding, particularly for large projects with multiple funding sources, could result in projects being cancelled or delayed, incurring potentially large costs in the process.

Issues for Legislative Consideration

In considering the Governor's proposals related to Proposition 42, the Legislature should address (1) how much funding to provide to TCRP projects in the near term, if any, and (2) how to provide long-term funding stability for the state's transportation program.

Should TCRP Projects Be Continued in the Near Term? A significant near-term transportation funding decision facing the Legislature is whether to suspend all TCRP funding and repeal the program, as proposed by the administration, or to continue funding the program at some level. Repealing the program would eliminate all project expenditures in the budget year, but would also result in unknown project closeout costs. Additionally, eliminating dedicated funding for TCRP projects means that some of the projects would compete with other non-TCRP projects for funding in the State Transportation Improvement Program (STIP). This could cause a reprioritization of projects in many regions of the state, with some existing STIP projects being pushed back. As a result, both TCRP and STIP projects would be delayed.

To decide on whether to repeal the program, the Legislature first needs to know what is the expected cost to close out TCRP projects. Absent this information, the Legislature cannot compare the potential fiscal impact of all the options before it.

If the Legislature decides not to terminate the program, it has various options to allow the program to proceed. These range from funding only projects with existing allocations, to providing enough funding to allow allocations for new projects in the budget year. Clearly, the more projects the Legislature decides to fund, the more money will have to be provided. Increasing funding for TCRP projects would compete with other legislative priorities.

How Can Long-Term Funding Stability Be Provided? Funding stability is of paramount importance for transportation projects. Uncertainty in funding makes long-term planning difficult. Large fluctuations in funding, like those experienced in recent years due to TCRP and Proposition 42, result in money being wasted due to stopping and restarting work on projects. Thus, stabilizing transportation funding would increase the efficiency of transportation expenditures. The Legislature has primarily two options to reduce funding uncertainty, both requiring a change in the Constitution.

While both options would increase long-term transportation funding predictability, they differ in terms of the amount of transportation funding they provide. Since identified transportation funding requirements far outweigh available funding, if the Legislature chooses to repeal Proposition 42, we believe the lost transportation funding should be replaced from a different source.

Gas Tax Is a Logical Transportation Funding Source. Transportation spending has traditionally been funded by an excise tax on gasoline and diesel fuel. This tax has several qualities that make it a logical source for transportation funding:

Because of the qualities noted above, we believe that the state should rely on the excise tax on gasoline and diesel fuel as the main source of transportation funding. We estimate that an increase of 6-cents per gallon in this tax would generate about the same amount of revenue that otherwise would be provided by Proposition 42. In addition, since Proposition 42 revenue increases with inflation over time, a per-gallon excise tax meant to replace this revenue would also need to grow over time to remain at that value level.

Recommend That Legislature Raise and Index Gas Tax to Provide Stable Transportation Funding. To provide ongoing predictability for transportation funding at a level equivalent to that envisioned under current law, we recommend that the Legislature take actions to (1) ask the voters to repeal Proposition 42 and (2) increase the state gas tax to provide an equivalent amount of revenue as would be generated under Proposition 42. Furthermore, to prevent the future erosion of transportation funding relative to road use, we recommend that the gas tax be indexed to the California consumer price index.



Funding for Resources and Environmental Protection Programs. The Governor's budget proposes a few fee increases in order to reduce General Fund expenditures in the resources area, the largest being an increase of $15 million in state park fees. General Fund support remains substantial for 2004-05 in the following areas.

Bond Expenditure Proposals. The budget proposes $136 million of bond funds for various resources and environmental protection programs—a reduction of about 97 percent from estimated bond expenditures in the current year. This substantial reduction largely reflects the administration's decision to defer the submittal of most of the Governor's resources bond proposals to later in the spring. The significant bond expenditure proposals in the January budget include: 

CALFED Bay-Delta Program. The budget proposes $68.6 million of state funds—spread throughout six state departments—for CALFED-related programs in 2004-05. Of this amount, $12 million is proposed from the General Fund, with the balance mainly from State Water project funds ($33.4 million) and various bond funds ($20.3 million). This level of expenditure is an 87 percent reduction from the current year. This substantial expenditure reduction largely reflects the administration's decision to defer to later in the spring the submittal of most of the Governor's resources bond proposals.

The largest state expenditures for CALFED are proposed for water conveyance ($21.5 million) and ecosystem restoration ($11.9 million).

Issues for Legislative Consideration

Funding for Resources and Environmental Protection Programs. We identify a number of opportunities to shift General Fund costs to fees, beyond those proposed in the Governor's budget. Adopting our recommendations would result in General Fund savings totaling $170 million. Fees are an appropriate funding source in these cases, either because the state is (1) providing a service that directly benefits an identifiable person or business (such as fire protection services) or (2) administering an environmental regulatory program (such as coastal development permitting or timber harvest plan review) that could reasonably be funded from entities seeking regulatory approval to conduct a business activity.

The specific opportunities for General Fund savings are:

Bond Expenditure Proposals. We offer a framework to assist the Legislature in evaluating the Governor's forthcoming bond proposals:

CALFED Bay-Delta Program. The CALFED program is estimated to cost about $9.2 billion over the program's first seven years from 2000-01 through 2006-07. However, a funding gap of roughly $6 billion exists, based on actual funding to date and projections of expected funding. Our review finds that, to date, there has been little direct application of the "beneficiary pays" principle in allocating the costs of this program. We recommend applying this principle in funding CALFED, both as a means to address the funding gap and provide a more appropriate allocation of the program's costs to the program's beneficiaries.

We recommend a funding framework for CALFED, consisting of the following four steps to be taken by the Legislature:

Employee Compensation

Pay for State Employees. State employees were scheduled for a salary increase on July 1, 2003 (5 percent for most employees). In order to generate 2003-04 savings, the prior administration entered into negotiations with employee unions. Bargaining units that agreed to defer these salary increases received additional benefits. In particular, in exchange for delaying pay increases for one year, the administration agreed to (1) pay 80 percent of health insurance costs effective January 1, 2004; (2) allow employees to accrue one additional vacation day per month (approximately equivalent to the deferred 5 percent salary increase for most employees); and (3) in some cases, continue the suspension of employees' retirement contributions to maintain take-home pay at June 2003 levels.

Retirement Costs. The state makes annual contributions to the PERS and the State Teachers' Retirement System (STRS) to fund retirement benefits for state employees and teachers that will be paid out in the future. In 2004-05, the estimated state contribution to PERS is $2.6 billion. Of that amount, the General Fund would contribute $1.4 billion. The General Fund provides the entire state contribution to STRS, which is estimated at $1.1 billion in the budget year.


Increased Pay for Employees. The Governor's budget includes $875 million ($464 million General Fund) for increased expenses in employee salaries and benefits. Specifically, the increased funds would primarily pay for:

Retirement Changes. The Governor's budget has three retirement-related proposals:

Issues for Legislative Consideration

Incurring Debt for Operating Costs Is Ill Advised. Courts have thus far prevented the state from issuing pension obligation bonds. Regardless of its legality, incurring decades worth of debt to avoid an annual operating expense as a budget-balancing tool is poor fiscal policy. Consequently, we recommend that the Legislature reject the administration's pension bond proposal.

Additional Contributions From Current Employees Would Require Agreement of Unions. Increasing current employee retirement contributions would require the agreement of state employee unions. It is unclear at this time what concessions the administration would have to make in order for unions to agree to such a change. Thus, when reviewing negotiated contracts for approval, the Legislature will have to consider the merits and costs of the total package.

State Could Adopt Proposal for New Employees on Its Own. The administration has assumed that rolling back retirement benefits for new employees would be negotiated as current collective bargaining agreements expire. This would delay full implementation for several years. This delay, however, is not necessary. The state previously has changed retirement benefits for new employees through legislation outside of the collective bargaining process. Adopting this proposal immediately would increase state savings in the short term.

Other Options Worth Considering. In addition to considering the administration's proposal for new employees, the Legislature should also consider alternatives such as Tier 2 and defined contribution plans for all new employees. These alternatives would result in more state savings and provide other state benefits. For instance, defined contribution plans would give the state predictable retirement expenses each year.

Mid-Year Spending Reductions

In order to achieve budget savings in the current year, Control Section 4.10 of the 2003-04 Budget Bill authorizes the administration to reduce state operations appropriations, abolish positions, and reallocate funds among items of appropriation. Specifically, Control Section 4.10 instructs the administration to abolish as many as 16,000 positions throughout state government and reduce individual state operations appropriations by up to 15 percent. The reductions to appropriations must total at least $307 million, including at least $181 million in General Fund reductions. The administration is required to notify the Legislature 30 days prior to adjusting an appropriation pursuant to Control Section 4.10.

Appropriations Reduced by $425 Million. Thus far, the administration has notified the Legislature of Control Section 4.10 actions reducing appropriations by $425 million ($181 million General Fund). The administration has also eliminated 9,313 positions. Figure 11 summarizes the reductions by program area.

Figure 11

Control Section 4.10 Reductions, by Program Area

(Dollars in Millions)




Reduction to Appropriations








Criminal Justice








General Government
















Higher Education








K-12 Education
















Social Services
























   Totals may not add due to rounding.


As part of the Governor's budget, all of the Control Section 4.10 reductions already implemented have been built into departments' baselines for 2004-05. In addition, as part of its mid-year reductions proposed in November 2003, the administration stated its intention to use Control Section 4.10 to make further reductions this year in General Fund appropriations totaling $150 million (beyond those already shown in departmental budgets). As with the reductions already implemented, the administration expects to build these additional reductions into departments' 2004-05 budgets to provide ongoing savings. The administration, however, does not propose to include any language similar to Control Section 4.10 in the 2004-05 Budget Bill

Issues for Legislative Consideration

Program Impact Unknown. The Control Section 4.10 reductions were implemented with almost no detail provided to the Legislature regarding their programmatic impact. For example, in fall 2003, we sought to determine how the reductions would affect the delivery of services and the collection of revenues. The administration, however, has not shared the departmental reduction plans (which would allow this type of detailed analysis) with the Legislature. On December 22, 2003, after the 30-day legislative review period elapsed, the administration did provide details on the positions eliminated. Yet, this information still does not provide sufficient detail to determine programmatic impacts. For instance, the information lists which positions were eliminated but not the specific work that the positions were performing. The information also does not tell the Legislature if the eliminated positions' workload will be absorbed by other positions or no longer completed.

Reductions Reflect Administration's—Not Legislature's—Priorities. Any unallocated reduction authority given to the administration will expose legislative priorities to reductions. On the natural, an administration will protect its own priorities and sacrifice programs that it deems less important. In order to protect its own priorities, the Legislature would need to identify specific lower priority reductions during the budget process—rather than relying on unallocated reductions. While the full programmatic impact of the Control Section 4.10 reductions may not be known for some time, it is likely that many of the reductions will have been made to programs of particular interest to the Legislature. For example:

Will the Reductions Affect Revenues? In the absence of programmatic impact information, it is impossible to assess how the reductions will affect the collection of revenues for some departments. For example, the Board of Equalization's (BOE) appropriations were reduced by $16.5 million and the Franchise Tax Board's (FTB) appropriations were reduced by $21.9 million. The administration has reported that BOE's reductions will reduce General Fund revenues by $27 million in 2004-05, but has not indicated a revenue loss associated with FTB's reductions.

Are the Reductions Achievable? In addition, it is not known if the reductions are actually achievable. For instance, the CDC General Fund appropriation was reduced by $23 million through Control Section 4.10. The administration, however, then requested a General Fund increase in the hundreds of millions of dollars through the deficiency process. In essence, rather than reducing costs for CDC, the administration simply shifted $23 million of costs to the deficiency process. 

Questionable Benefit of Including Special Funds. While the state's financial problems are largely limited to the General Fund, Control Section 4.10 authorizes position reductions and savings in all funds. As noted in Figure 12, non-General Fund appropriations have been reduced by $243 million. In some cases, the special fund position and appropriation reductions may have streamlined operations, eliminated unnecessary positions, or created efficiencies. Through the course of our analysis of the Governor's budget proposals for 2004-05, however, we have found that the implementation of some of these special funds reductions has been detrimental to the state's efforts to serve the public—while providing no benefit to the General Fund. Moreover, as a result of reductions to staff and appropriations, fees or other revenues paid into special funds may now sit unused because there is no staff to implement the scheduled programs. For instance:

Conclusion. While Control Section 4.10 has generated significant savings, it has resulted in a number of unintended consequences. We concur that this administrative authority should be discontinued.

Maximizing Federal Funds

Under the Governor's budget proposal, federal funds for the support of state operations and local assistance programs would total $55 billion in 2004-05, a decrease of about $3 billion, or 5.2 percent, below the revised current-year level of spending. 


Efforts to Secure Additional Federal Funds. The administration proposes various actions to increase the state's share of federal funding or to reduce the impact on the state of various federal sanctions and mandates in order to help hold down the growth in state costs. The administration indicates it is pursuing issues related to health and social services programs, transportation, homeland security, criminal justice, and education funding, and assumes that these efforts to secure federal assistance will collectively result in $350 million in offsets to state costs.

The administration has specifically indicated that it will seek action by Congress to ensure that the state receives its "fair share" of federal funds by (1) extending a temporary increase allowed last year in the federal share of costs for the Medicaid Program (known as Medi-Cal in California), thereby reducing the state share of support for Medi-Cal; (2) making available to the state federal matching funds to offset its estimated $182 million annual cost for providing nonemergency services, such as family planning and long-term care, for undocumented immigrants; (3) updating state allocations for federal Child Care and Development Fund grants that disadvantage California; (4) changing federal allocation formulas for homeland security funds to base them on a state's threat and vulnerability to terrorism; (5) seeking congressional help to increase the state's share of federal transportation funding; and (6) increasing community college fees to the point where California students would become eligible to access the full grant levels allowed for federal Pell Grants, and making students aware of their eligibility for federal education tax credits.

Relief Sought From Federal Mandates and Sanctions. The administration has also indicated that it will seek relief from various federal requirements that could have a fiscal impact on the state. Among the requirements cited are (1) mandates that information materials be sent to all mental health managed care clients, (2) financial penalties assessed against the state for delays in establishing a statewide child support system, (3) sanctions for error rates in the Food Stamps Program, (4) disallowance of federal funding for the Child Welfare Services/Case Management System, and (5) potential financial sanctions against the state for noncompliance with Child Welfare Program standards. The state is already subject to penalties for the child support system delays (estimated at $220 million for 2004-05). The state budget plan at this point generally does not account for costs relating to the other potential sanctions identified by the administration.

Issues for Legislative Consideration  

Federal Funding a Longstanding Concern. Federal funds are a critical source of support for a wide range of state programs. Seemingly minor changes in governmental programs can put the state at a major financial disadvantage in its receipt of federal funds. For example, in our discussion of the transportation budget in the Analysis (please see page A-32), we note that the state's conversion from fuel blended with MTBE to an ethanol blend could reduce federal revenues to California by as much as $563 million in 2005-06 and by more than $700 million annually thereafter. Because the federal tax on ethanol-blended fuel is about 29 percent less than on fuel with no ethanol content and a portion of the revenue is directed to the federal General Fund, federal funding for California's projects would be less than before the conversion.

Some Actions Within State Control. Our analysis indicates that there are some steps the state can take largely on its own to take greater advantage of available federal funding. For example, in the Analysis, we propose that some participants in the largely state-funded Access for Infants and Mothers program be shifted to the Healthy Families Program, in which two dollars in federal support can be drawn down for each one dollar of state funding. Similarly, in the "Crosscutting Issues" section of the "Health and Social Services" chapter of the Analysis, we highlight a strategy by which "quality improvement fees" could be assessed on certain groups of medical providers to draw down additional federal funding and reduce state program costs.

Likewise, in our analysis of the Food Stamps Program, we raise concerns about a proposal in the Governor's budget plan to repeal a recently enacted state law to expand eligibility for food stamps by 81,000 individuals. While the proposed repeal would achieve General Fund savings of about $3.5 million in the budget year, and somewhat lesser savings thereafter, it would also result in foregoing federal food coupons in the amount of about $203 million annually. In addition, forgoing that amount of food coupons would have the effect of reducing overall consumer spending by families. (Since they would have to pay more for food, they would have less to spend on other taxable items.) We estimate that this would cause an offsetting revenue loss of $4.5 million annually to the General Fund—more than the estimated administration savings of $3.5 million associated with the proposed repeal.

Similarly, we note in the "Department of Fish and Game" write-up in the "Resources" chapter of the Analysis, that the state could maximize federal funds for the Fisheries Restoration Grant Program by augmenting Proposition 40 bond funds to fully meet the federal requirement for state matching funds. Finally, we recommend approval of the Governor's proposal to increase fees at the Community Colleges. This fee level would enable federal Pell grant recipients (roughly 10 percent of all Community College students) to receive a $112 increase in their awards.

Some Actions Would Require Federal Help. While there are steps the state could take on its own to maximize the availability of federal funds, other changes would require federal congressional or regulatory action to accomplish. For example, changes are possible in the federal Medicaid Program that could save the state as much as hundreds of millions of dollars annually on the cost of operating Medi-Cal. We cite some examples below:

The Legislature may wish to consider which if any such changes are in keeping with its own policies, and how the state could be most effective in advocating those changes it believes are warranted in Medicaid and other state programs to increase federal funding and reduce state program costs.

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