Crafting the 2015-16 State Budget: Constraints and Opportunities

The state budget, as we often say, expresses our values and priorities as Californians. These values and priorities are debated each year by the Legislature and the Governor, with input from members of the public at key stages of the budget process. Yet, while state policymakers have choices about the overall size of the budget as well as how to prioritize different areas of spending, the range of available choices is constrained by a number of factors, particularly the complicated rules that voters have added to the California Constitution in recent decades.

In other words, lawmakers and the Governor make revenue and spending decisions within a complex framework of voter-approved constraints and priorities. While these constitutional limits are always a factor in the state budget process, this year they’re especially conspicuous as policymakers prepare to craft — in the coming weeks — a budget for California’s 2015-16 fiscal year, which begins this coming July 1.

Key Constraints on 2015-16 Budget Choices: Proposition 98, Proposition 111, and Proposition 2

A key issue that state policymakers now face is whether they’ll have sufficient discretion in allocating state revenues to ensure that the new state budget addresses California’s diverse needs and appropriately balances critical state priorities.

This issue stems from two sets of budget-related formulas that voters added to the state Constitution beginning in 1988. One set of formulas originated with Proposition 98 of 1988, as modified by Proposition 111 of 1990. Among other things, these measures provide a minimum funding guarantee for K-12 schools and community colleges. The second set of formulas was added to the Constitution this past November by Proposition 2. This measure requires the state to set aside some revenues each year in order to build up a rainy day fund and pay down certain state budgetary debt, such as unfunded pension liabilities and loans from special funds to the state’s General Fund.

Here are the details:

As of this past March, state revenues for the fiscal year that we’re currently in (2014-15) were $1.3 billion higher than the amount that Governor Brown assumed in his January 2015 revenue forecast. Then, in April, revenue collections from the state’s personal income tax alone exceeded the Governor’s estimate for the month by $1.8 billion. These trends suggest that total revenue collections for 2014-15 — which ends this coming June 30 — will likely be “billions above” what the Governor had projected in January, according to the Legislative Analyst’s Office (LAO).

However, even if this positive revenue trend continues into 2015-16, it’s possible that all — or nearly all — of these higher-than-projected revenues would be required to go to K-12 schools and community colleges as a result of Propositions 98 and 111, according to various scenarios outlined in an April 7 LAO report. What’s more, with higher revenues in 2015-16, state policymakers would have to boost Proposition 2 debt payments and rainy day fund deposits beyond the levels that Governor Brown assumed this past January.

More recently, the LAO has noted that if 2014-15 revenues alone exceed the Governor’s forecast by “well over $4 billion,” some of the revenues above this threshold might produce a “bottom line” benefit for the state’s General Fund because of how the state’s K-14 education funding formulas work. In other words, a portion of any revenues above this roughly $4 billion threshold could be available to support other key state priorities outside of Proposition 98 and Proposition 2. However, the LAO suggests that any such gains “likely would be small.”

In short, state policymakers could face an unusual situation this coming June: billions of additional tax dollars surging into state coffers, with little or no ability to direct those funds to state priorities other than K-14 education (Proposition 98) and reserves/debt payments (Proposition 2). Under this scenario, none — or perhaps a relatively small amount — of the additional revenues would be available for other critical priorities that lawmakers are currently debating. These include:

Without a doubt, K-14 education, reserves, and debt payments are important state priorities. However, there is a clear need for leaders to be able to balance priorities across a mix of vital services, many of which are still operating at recession-era lows. The LAO’s recent analyses suggest that such flexibility could be in short supply during the current state budget cycle.

Is this outcome written in stone? No. In their April 7 report, the LAO acknowledges that, “Given the number of variables involved, many other outcomes are possible.” These variables won’t start coming into focus until after Governor Brown releases his revised 2015-16 budget — the “May Revision” — next week. Still, the fact that the budget scenarios outlined in the LAO’s April 7 report are within the realm of possibility raises concerns about the structure — if not the application — of Proposition 98’s complex formulas as well as the interaction between Proposition 98 and Proposition 2.

Opportunities Within Constraints: Finding the Revenues to Fund Priorities Outside of Proposition 98 and Proposition 2

Even if virtually all state revenues that exceed the Governor’s January forecast do end up going to Proposition 98 and Proposition 2 — which, again, is not a foregone conclusion — policymakers would still have options for supporting additional state priorities in the 2015-16 budget. Some of these options fall into the “to be determined” category: Given the complexity of the state’s constitutional budget formulas as well as other factors, these funding opportunities won’t become clear until after the Governor releases the May Revision next week.

But some options are clear right now. State General Fund dollars could be “freed up” for other important priorities by adjusting various policies and assumptions included in Governor Brown’s proposed 2015-16 budget, which he released this past January. These freed-up state dollars — which exceed $1 billion, according to LAO estimates — fall into two groups: those that are already “in the bank” and those that could be freed up through additional state actions.

California has already “banked”:

  • $450 million in state savings in 2015-16 due a change in how the federal government funds the Children’s Health Insurance Program (CHIP). As we’ve explained, President Obama recently signed a bill that significantly increases the share of CHIP costs paid by the federal government. As a result, California will spend an estimated $450 million less on CHIP costs than the Governor assumed in his proposed budget, dollars that can be redirected to other state priorities in 2015-16.

In addition, state policymakers could free up:

  • $400 million by counting additional local property tax revenues toward the Proposition 98 minimum funding guarantee, which the LAO notes would “effectively reduc[e] the state General Fund obligation for Proposition 98.” (Proposition 98 expenditures are funded with both state General Fund dollars and local property tax dollars.)
  • $186 million by repaying loans from certain state transportation funds using dollars required under Proposition 2 to go toward debt payments, rather than paying back these loans with General Fund dollars outside of Proposition 2, as the Governor proposes. (State policymakers borrowed from these transportation funds in prior years to help close General Fund shortfalls.)
  • $125 million by adjusting the Proposition 98 minimum funding guarantee to reflect — as the LAO puts it — “the additional ongoing local revenue schools have received from the dissolution of redevelopment agencies since 2012-13.”
  • $20 million or more by reducing the number of incarcerated individuals who are housed in relatively expensive “contracted facilities,” such as private prisons located outside of California. Housing these individuals in state prisons is generally less costly, as the LAO notes.

The LAO identifies two additional opportunities to free up state dollars in 2015-16, each of which involves paying down a larger amount of state debt with Proposition 2 revenues, rather than with state General Fund dollars outside of Proposition 2. These options focus on (1) “settle-up” payments owed to K-12 schools and community colleges under Proposition 98 and (2) debts to local governments for state-mandated services for which the state has not yet provided payment. It appears that these options could free up at least several hundred million additional General Fund dollars in 2015-16.

Looking Toward the Governor’s May Revision

Many of the uncertainties now surrounding the 2015-16 state budget — as well as opportunities for boosting state support for a broad range of public services and systems — will be clarified once the Governor releases his revised budget next week. For now, the possible scenarios outlined by the LAO remind us of how constitutional rules can complicate state policymakers’ efforts to craft an annual spending plan that addresses California’s diverse needs and appropriately balances key priorities.

— Scott Graves