Proposition 2 Asks Voters to Revise the Rules for the State’s Current Rainy Day Fund

This is the first in a series of blog posts highlighting key components of the CBP’s analysis of Proposition 2, which will appear on the November 4, 2014 statewide ballot.

Setting aside funds in good economic times to help meet the challenges that arise during recessions is a sound budgeting practice. Budget reserves — also known as rainy day funds — are critical because they can help policymakers limit the need for deep cuts to vital public systems and services when tax revenues decline.

Californians have long recognized the importance of setting aside dollars for a rainy day. Ten years ago, voters created the state’s current rainy day fund by passing Proposition 58, a constitutional amendment placed on the ballot by the Legislature. Soon afterward, the state began depositing dollars into this reserve — called the Budget Stabilization Account (BSA) — and the balance reached $1.5 billion by 2007-08. During this same year, however, the Great Recession struck and began to take a toll on state revenues. In response, state policymakers withdrew every dollar from the BSA in order to help address the substantial budget shortfall that had emerged. Moreover, during the recession and its aftermath, Governors Schwarzenegger and Brown used the authority provided by Proposition 58 to suspend the annual BSA deposit for six consecutive years, through 2013-14. It was only with the current budget, for 2014-15, that Governor Brown felt confident enough about the state’s finances to let the BSA deposit go through unimpeded. As a result, the BSA balance now stands at $1.6 billion.

On November 4, California voters will have another opportunity to weigh in on the state’s budget reserve policies. Proposition 2, a constitutional amendment placed on the ballot by the Legislature, asks voters to rewrite the rules governing deposits into and withdrawals from the BSA. Our analysis of Proposition 2 shows that the measure’s reserve policies would set up a number of trade-offs, which in some cases involve limiting state policymakers’ discretion with regard to certain budget choices. For example:

  • Compared to current law, Proposition 2 would make it harder for state policymakers to suspend or reduce annual deposits into — and withdraw funds from — the BSA. Proposition 2 would require the Governor to declare a “budget emergency” in order to begin the process of suspending or reducing the BSA transfer and/or withdrawing dollars from the reserve. The measure narrowly defines a budget emergency as resulting from either (1) a disaster or extreme peril or (2) lack of sufficient resources to meet a specific General Fund spending threshold: the highest level of spending in the three most recent fiscal years, adjusted for state population growth and the change in the cost of living. Over time, this new policy could result in a larger reserve, which would help the state limit cuts to core public systems and services during an economic downturn. But this policy also could diminish state policymakers’ ability to effectively respond to some challenging budget situations, such as when revenues are rising more slowly than previously anticipated, causing a budget gap to emerge.
  • Unlike under current law, Proposition 2 would limit the amount of funds that could be taken out of the BSA in a single fiscal year. Proposition 2 would allow no more than half of the dollars in the BSA to be taken out unless funds had been withdrawn in the previous fiscal year. This restriction means that a smaller share of the reserve could be used to support public systems and services in the first year of a budget emergency. However, it also guarantees that reserve funds would be available to help offset budget cuts for at least two consecutive years.

In short, the question before voters in November is not whether California should have a rainy day fund. The state’s current budget reserve has been around for a decade, with rules that are locked into the state Constitution. Instead, the key question posed by Proposition 2 is whether the current rules for the BSA — which give policymakers wide discretion to decide how much to deposit and withdraw each year — are adequate to the task of helping the state save for a rainy day.

— Scott Graves