Alternative Budget Overview

How Should the Legislature Approach Closing the 2008–09 Budget Shortfall?

Summary

In contrast to the administration’s across–the–board reduction budget–balancing approach that fails to prioritize state spending, we offer an alternative approach for the Legislature’s consideration. By making more targeted reductions; eliminating or modifying ineffectiveness or nonessential programs; and adding ongoing revenue solutions, we believe this approach offers the Legislature a better foundation to begin crafting a 2008–09 budget that focuses on essential services. This piece provides an overview of the key components of this alternative approach. Our alternative budget would end the 2008–09 fiscal year with a $1.3 billion reserve, and remain balanced through 2012–13.

Introduction

As we discuss in “Part I” of this publication, we recommend that the Legislature reject the Governor’s approach of across–the–board reductions. The administration’s approach to have virtually all programs share in the pain of balancing the budget has some surface appeal of “fairness.” Yet, it reflects little effort to prioritize and determine which state programs provide essential services or are most critical to California’s future.

In doing so, the administration has shifted much of the responsibility for crafting a workable budget to the Legislature. In the absence of a plan that prioritizes state spending, we offer an alternative approach for the Legislature’s consideration. By making more targeted reductions and adding ongoing revenue solutions, we believe our approach offers the Legislature a better foundation to begin crafting a 2008–09 budget.

We are sure that there are components of our alternative with which many Members of the Legislature will not agree. As such, we do not expect the Legislature to adopt the LAO alternative as an entire package. Rather, our hope is that the alternative approach helps demonstrate how the state can bring its revenues and expenditures into line without resorting to across–the–board reductions but rather using targeted expenditure reductions and revenue increases.

Organization of Alternative Budget. All of “Part V” of this publication relates to components of the LAO alternative budget.

• This piece provides an overview of the alternative, describes its key elements and programmatic features, and assesses what the state’s fiscal condition would look like under the alternative—both in the near– and longer–term.
• The second piece describes in detail the revenue increases upon which our alternative relies. It lays out our rationale for (1) reducing or eliminating certain tax credits and exemptions and (2) not adopting the administration’s proposal to add $2 billion in 2008–09 revenues by accruing dollars that are currently reflected as 2009–10 revenues.
• The third piece describes our recommendation to shift parole supervision of low–level criminal offenders from the state to counties, along with the funding to pay for it.
• The fourth piece assesses the Governor’s proposals for budgetary reform and offers an alternative approach.
• Finally, “Part V” concludes with a listing of all the expenditure–related savings proposals encompassed within the LAO alternative budget. Most of these proposals are discussed in more detail in our companion publication, Analysis of the 2008–09 Budget Bill.

Overview of LAO’s Alternative Budget Approach

In this section, we provide an overview of the LAO alternative budget approach. The key elements are summarized in Figure 1 and described throughout this piece. In building our alternative, we have begun with the Governor’s “workload” budget. We describe our method of scoring the savings included within our alternative in the box below.

General Fund Condition

Figure 2 shows the General Fund’s condition from 2006–07 through 2008–09 under the alternative budget’s assumptions and proposals. As shown, the alternative would end 2007–08 with a reserve of about $1.5 billion. For the budget year, the state would spend just over $200 million more than it received. Consequently, the state would close 2008–09 with a reserve of $1.3 billion.

Targeted Program Reductions and Additional Revenues

Our approach to balancing the 2008–09 budget contrasts sharply with that of the Governor’s budget.

• In contrast to across–the–board reductions, we make targeted reductions. This involves protecting funding for the state’s most important programs to the extent possible. Consequently, funding for ineffective, duplicative, and nonessential programs are reduced much more than under the Governor’s budget, or eliminated entirely. When we felt that the proposed reductions were reasonable, our alternative adopts the administration’s proposals.
• In contrast to the Governor maintaining virtually all existing state programs (at a reduced service level), we question whether the state should be operating or funding all existing programs. As a result, we target some programs for reform. In other cases, we recommend program responsibility be transferred to local government.
• In contrast to the Governor’s minimal inclusion of new ongoing revenues, we target those tax exemptions and credits for reduction or elimination that are not achieving their stated purposes.

Figure 3 captures where the major dollar savings are achieved under the LAO alternative approach.

A Balanced Budget Through 2012–13

As we did with the Governor’s budget, we forecasted state revenues and expenditures through 2012–13 under our alternative’s policies. For each year between 2009–10 and 2012–13, revenues and expenditures are relatively in balance under the LAO alternative. In some years, there is a small surplus (up to $800 million). In other years, there is a small shortfall (up to $1.3 billion). However, throughout the forecast period, the budget remains balanced—using available carry–in reserves from the prior year when necessary. At the same time, the budget is precariously balanced—meaning that slower revenue or faster spending growth than our current projections would push the plan somewhat out of balance.

Key Programmatic Features

In this section, we provide more detail on the LAO alternative budget within each program area. For each program area, we highlight the key features and provide a comparison to the Governor’s budget. Figure 4 summarizes the General Fund support that would be provided to major programs.

Deficit–Financing Bonds

Key Features of LAO Alternative. The administration recently sold an additional $3.3 billion in deficit–financing bonds. That action brings the total proceeds from these bonds to within about $400 million of the $15 billion maximum allowed under Proposition 57 (March 2004). Our alternative accounts for this sale. The basic mechanism for repayment of these bonds is the “triple flip,” which diverts one–quarter of a cent of sales tax revenues to debt payments. Supplementary payments on the deficit–financing bonds are made through the Budget Stabilization Account (BSA). The Governor may suspend this annual BSA transfer through an executive order. The Governor has indicated his intent to suspend this supplementary payment for 2008–09, reducing General Fund costs by more than $1.5 billion. In future years, we continue this policy of suspending the BSA supplementary payments in any year in which the state would otherwise face a year–end deficit. Even with additional suspensions, we estimate that the bonds would be paid off by the end of 2012–13.  

Comparison to Governor’s Budget. As noted above, we incorporate into our alternative the administration’s actions to issue the additional bonds and suspend the 2008–09 BSA transfer. In contrast to our approach, the administration has indicated its intent to reinstate the BSA transfer for 2009–10 and beyond. Under the administration’s plans, the deficit–financing bonds would also be paid off in 2012–13, though much earlier in that year.

Revenue Solutions

Key Features of the LAO Alternative. As we have done with respect to direct expenditure programs, we have reviewed the state’s tax–related programs—what are referred to as tax expenditure programs (TEPs)—and recommend changes to those that are not achieving their stated purposes or are of lower priority. These TEPs are special tax provisions in the law—such as exemptions, deductions, and credits—that attempt to encourage certain types of behavior or target relief to specific groups of people or businesses. Our proposals affect each of the state’s largest three taxes and are discussed in detail in the next piece of “Part V.” Although there are many other TEPs worthy of modification not on our current list, we have focused on changes that would not involve difficult federal conformity issues, implementation problems, or significant time lags before their fiscal benefits are realized. Figure 5 shows that our changes would generate revenues of $2.7 billion in 2008–09 and $2.5 billion in 2009–10. Our largest changes are to reduce the personal income tax dependent credit, limit the research and development credit for income taxes, and limit net operating loss deductions for corporations.

Comparison to Governor’s Budget. The Governor’s budget proposes to reinstate the one–year standard regarding use tax on out–of–state purchases ($21 million in added revenues). Our alternative includes this proposal. We, however, do not include the administration’s proposal to add $2 billion to 2008–09 revenues by accruing revenues that are currently reflected as 2009–10 revenues.

K–14 Education

Key Features of LAO Alternative. Our alternative would provide K–12 schools and community colleges with roughly the same amount of ongoing program support in 2008–09 as in the current year ($57.7 billion). Within that funding level, it would support growth in child care programs and enrollment growth at community colleges. It also would cover the ongoing costs of mandated education activities. It would not provide a cost–of–living adjustment (COLA), and it would make targeted reductions (totaling almost $180 million) to programs that are poorly structured, duplicative, or technically overbudgeted.

Our alternative also achieves substantial savings from elsewhere in the K–14 budget. Specifically, it achieves current–year savings of almost $1 billion by capturing funds that likely will not be spent by the end of the fiscal year and an additional $409 million by funding more of the Home–to–School transportation program from the Public Transportation Account. Our current–year alternative also results in the state prepaying a $150 million settle–up payment scheduled for 2008–09, thereby achieving a like amount of budget–year savings. Lastly, we recommend suspending the Quality Education Investment Act (QEIA) in 2008–09 for $450 million in savings. To ramp up QEIA at the same time as not providing a COLA to base programs supporting QEIA schools would be counterproductive.

Comparison to Governor’s Budget. Whereas the Governor’s budget proposes across–the–board cuts that reduce virtually all K–14 programs, our alternative takes a more strategic approach—weighing the merits of various programs and funding certain core costs while making selective reductions to other programs. The Governor’s plan also offers school districts little fiscal flexibility in responding to potentially tight budgets. On the other hand, our alternative includes a major categorical reform component that would greatly expand districts’ ability to use available funds to meet local needs. In addition, our alternative relies on adjusting current–year Proposition 98 spending down to the minimum guarantee to generate substantial budget–year benefits. Relative to the Governor’s plan, our alternative provides about $2 billion more for K–14 education in the budget year and results in a Proposition 98 suspension amount of about $800 million, rather than $4 billion.

Higher Education

Key Features of LAO Alternative. Our alternative for higher education seeks to fund costs consistent with the state’s Master Plan for Higher Education. It would fund anticipated enrollment growth of 1.8 percent at the University of California (UC) and 1.6 percent at the California State University (CSU). It would not fund COLAs, but would include augmentations equal to about 1.5 percent of the universities’ base General Fund budgets for nondiscretionary cost increases. Under our alternative, student fees at the universities would be increased by 10 percent, while funding for financial aid programs would be increased to cover the higher fee costs for financially needy students. As shown in Figure 6, our alternative would result in total General Fund savings of $553 million relative to the Governor’s workload budget.

Comparison to Governor’s Budget. The Governor’s workload budget for the public universities is based on his “compact” with UC and CSU, and includes substantial augmentations for enrollment growth and base increases. However, the budget also includes unallocated General Fund reductions that exceed the workload augmentations. Because allocating these reductions would be left to the segments, it is unclear what specific costs would be funded under the Governor’s proposal. In contrast, our alternative budget specifically funds enrollment growth and nondiscretionary cost increases. Our alternative also specifically links fee revenue to higher education funding needs. In contrast, the Governor’s proposal leaves student fee decisions to the universities, and ignores the contribution of fee revenue toward workload funding. Finally, while the Governor’s proposal would phase out a critical state financial aid program, our proposal maintains and funds all existing state financial aid programs.

Health

Key Features of LAO Alternative. Our overall approach in identifying health savings was to adopt cost–cutting measures that are least likely to result in either the elimination or severe reduction to programs that provide direct medical services. We also avoided making reductions when reduced program funding would result in increased costs in another program. Regarding rate reductions, we analyzed the rate histories of providers and generally only reduced the rates of those providers that had received rate increases in recent years. We also identified federal fund sources to backfill General Fund shortfalls when possible. In total, as shown in Figure 7, the LAO budget alternative would reduce costs in health services programs by more than $800 million below the Governor’s workload budget.

Comparison to Governor’s Budget. Our budget adopts many of the budget–balancing reductions proposed by the Governor. For example, our budget adopts cost containment measures intended to control regional center expenditures for a savings of $229 million. (We would continue these cost containment measures for the next few years but not implement them permanently as proposed by the administration.) Our budget also adopts the administration’s proposal to achieve savings of almost $42 million in the Healthy Families Program through a rate reduction for managed care plans, a cap on annual dental benefits, and increases in premiums and co–pays.

We however did not adopt other of the administration’s budget–balancing reduction proposals. For example, we did not include a 10 percent rate reduction to Medi–Cal providers because our analysis indicates that it could severely limit the access of Medi–Cal beneficiaries to providers. We did not adopt some of the administration’s proposals to reduce rates for some mental health programs for similar reasons. Overall, our approach requires fewer reductions likely to affect access to direct medical services that the administration’s budget plan.  

Social Services

Key Features of LAO Alternative. Most of the savings in the LAO alternative come from deleting the June 2008 and June 2009 state Supplemental Security Income/State Supplementary Program (SSI/SSP) COLAs, reducing the grants for SSI/SSP couples down to 125 percent of the federal poverty level, delaying CalWORKs performance incentives and the restoration of the Temporary Assistance for Needy Families reserve, and canceling the Integrated Statewide Automated Welfare System migration computer project. We also achieved savings by rejecting proposals for service level increases or start–up costs for recently created programs. In general, our proposed reductions do not reduce services, grants, or county administration for social services programs below the levels in place on July 1, 2007, unless there was a specific policy rationale for doing so. Figure 8 summarizes the major reductions.

Comparison to Governor’s Budget. Compared to the Governor’s budget, we have a greater reduction in SSI/SSP with substantially smaller reductions for California Work Opportunity and Responsibility to Kids (CalWORKs), In–Home Supportive Services, child welfare services, and foster care. With respect to income maintenance programs, we lowered grants for SSI/SSP couples because their grant is 131 percent of the federal poverty level (FPL) whereas SSI/SSP individuals and CalWORKs families are at 100 and 75 percent of FPL, respectively. In child welfare services, our reductions are limited to counties that have declining caseloads or more generous funding compared to the rest of the state. Finally, the LAO alternative provides current law workload funding for CalWORKs. While action will be required for the state to meet federal work participation requirements, it does not reflect either the Governor’s, or the LAO’s, CalWORKs policy proposals discussed in the 2008–09 Analysis.

Criminal Justice

Key Features of the LAO Alternative. There are a number of separate components to the LAO alternative in the criminal justice area. The major components are:

• Funding for various criminal justice local assistance programs would be reduced or eliminated because they do not have demonstrated results or serve a statewide purpose. Other programs are consolidated or funded from sources other than the General Fund.
• Certain crimes affecting lower–level drug and property offenders that sometimes result in state prison sentences—known as “wobblers”—would become misdemeanors punishable by county jail and probation.
• Our alternative budget reflects significant prison cost savings (not reflected in the Governor’s budget) that will result from recent juvenile and adult inmate and parole population trends and delays in implementing various new programs funded in the 2007–08 Budget Act.
• Funding for the judicial system would be reduced by suspending State Appropriations Limit adjustments on a one–time basis and using significant existing fund balances at the trial court level to buffer against the loss of state funding.

As shown in Figure 9, the combined fiscal effect of these proposals in 2008–09 would be almost $1 billion in savings.

Comparison to Governor’s Budget. The LAO alternative for reducing prison inmate and parole populations would achieve comparable savings to the Governor’s plans for early release and summary parole of offenders—at a reduced risk to public safety. Under our approach, the vast majority of offenders would face some criminal sanctions in the form of jail time or active probation supervision, rather than serving only minimal time in either prison or parole.

The administration proposes largely 10 percent across–the–board reductions in criminal justice local assistance programs. Our approach, which results in a greater level of General Fund savings overall, is based on a more comprehensive review of these programs that applies standard criteria for deciding which should be funded and at what level.  

Parole Realignment

Key Features of LAO Alternative. As we discuss in a later piece in “Part V,” our alternative budget includes a major realignment of responsibility for supervision of low–level criminal offenders released from state prison. Under our proposal, counties would receive slightly more resources than the state currently dedicates to this purpose ($495 million instead of $483 million). Counties would have broad authority to use these resources to reduce recidivism and improve public safety. Funding for parole realignment would come from a reallocation of: waste and water enterprise special district property taxes ($188 million), city Proposition 172 sales taxes ($178 million), and vehicle license fees retained by the DMV for administrative purposes ($130 million).

Comparison to Governor’s Budget. The administration does not propose any major program realignments.

Resources

Key Features of LAO Alternative. A common theme throughout the majority of the LAO resources–related proposals is taking advantage of opportunities to shift funding from the General Fund to fees (either by increasing existing fees or creating new ones)—by applying the “beneficiary pays” or “polluter pays” funding principles. Our major General Fund savings proposals related to fees are in the following program areas:

• Wildland firefighting ($239 million in savings).
• Flood management ($40 million in savings).
• Water quality management and water rights regulation ($30 million in savings).
• Timber harvest plan review and enforcement ($23 million in savings).
• State parks ($13 million in savings, the amount of the Governor’s reduction achieved largely by closing 48 state parks).

Our remaining savings proposals mainly involve shifting funding from the General Fund to bond funds (such as in the case of $21 million to support the Habitat Conservation Fund and $13 million for Colorado River management) or to available special fund balances.

Comparison to Governor’s Budget. With the exception of the Governor’s proposal to shift a portion of the state’s General Fund wildland firefighting costs to a new insurance policy surcharge, the Governor’s approach for budget–balancing actions in the resources area was generally to reduce General Fund program activities by 10 percent. Under the Governor’s approach, proposed reductions include activities that the Legislature has considered to be a priority and/or face substantial unmet funding requirements. These activities, often regulatory in nature, range from the development of public health goals for the state’s drinking water standards to the review of timber harvesting and coastal development proposals. In contrast to the Governor’s budget, our alternative budget takes advantage of alternative funding sources—including fees and bond funds—to create General Fund savings (frequently at a level much higher than proposed by the Governor’s budget) without reducing the level of program activity.

General Government and Transportation

Key Features of LAO Alternative. In the general government area, savings in the LAO alternative principally come from three areas:

• Employee Compensation and Retirement. The LAO alternative fully funds all existing financial obligations to state employees but provides no additional employee compensation funds for 2008–09. This includes rejecting the Governor’s proposal to provide a 5 percent pay raise to correctional officers retroactive to July 1, 2007 (reducing costs by about $500 million in 2007–08 and 2008–09 combined). Our forecast assumes that employees would begin to receive salary increases in 2009–10. Regarding the state’s retirement programs, making changes to achieve short–term budgetary savings almost always involves either legal risks or higher costs in the long term. Consequently, we propose no changes to retirement programs.
• Gambling Revenues. As we discuss in “Part III” of this publication, the Governor makes overly aggressive assumptions about the amount of General Fund tribal revenues that will be received. Our alternative adjusts those revenues to a more realistic level, but uses $141 million in tribal payments to benefit the General Fund. The Governor proposes these payments go to special funds (including a $101 million loan repayment to transportation).
• Tax Gap. Our alternative builds upon the Governor’s proposals to increase tax collection and enforcement. We redirect resources away from Board of Equalization activities which have low revenue benefits per dollar spent and towards the Franchise Tax Board.

Comparison to Governor’s Budget. Our proposed rejection of a pay raise for correctional officers is a large departure from the Governor’s spending plan. A recent LAO report found that current compensation levels for correctional officers are sufficient to meet personnel needs at the present time. In addition, our alternative rejects two administration proposals to reduce required funding to the California State Teachers’ Retirement System. Both proposals are legally risky and may not produce the intended savings. Our redirection of tribal payments reduces transportation funding on a one–time basis by $101 million. Like the Governor, however, we fully fund the $1.5 billion Proposition 42 transfer for transportation purposes. Regarding the tax gap activities, we spend slightly less than the administration—yet with the benefit of tens of millions of additional General Fund dollars.

Conclusion

The alternatives presented throughout this publication and the 2008–09 Analysis reflects, of necessity, judgments as to which programs are of higher priority, which are ineffective, and which are not essential for state government to administer. The Legislature’s assessment of its own priorities should form the framework of the adopted 2008–09 budget. As illustrated by our alternative, the Legislature will be forced to make many tough decisions as it crafts the 2008–09 budget. Making those tough decisions in a rational and thoughtful manner can bring the state’s revenues and spending into balance for the long term.