Kersten Communications

Increased state expenditures and weak economic growth among other things have opened up a $20.7 billion budget gap for the 2010-11 budget and caused the Legislative Analyst to project $20 billion annual budget deficits through the 2014-15 budget year unless corrective action is taken.

“It’s going to be another difficult year for the Legislature in order to close what is another very large budget problem,” said Legislative Analyst Mac Taylor in a webcast discussing the LAO’s new report titled “California’s Fiscal Outlook: The 2010-11 Budget.”  Taylor said the report normally “serves as a starting point for the Legislature’s budget deliberations” and indicated that the Legislature needs to find $21 billion in solutions to restore the budget to balance. 

Click the links to the following sections:  Executive Summary, Budget Outlook, Economy, Demographics, and Revenues, Expenditure Projections   

“Strings attached to the federal stimulus funding will result in much less spending flexibility than usual for the state in 2010-11,” states the report.  The report notes that there are limits on what the state Legislature can cut from K-12 education and other health programs as conditions of having received federal stimulus money.   

Taylor said there are several reasons for the reemergence of the large imbalance, including the use of a large number of solutions which were one-time in nature, the expiration of the temporary tax increases, increased state expenditures, disappearance of federal stimulus funding, and the softness in state revenues due to weak economic growth.   

 “The problem stays at about the $20 billion level for the next four years,” Taylor said.

Legislative Analyst Urges Legislature to Come Up With a Long Range Plan to Close Structural Budget Gap

“In 2008 and 2009, the state repeatedly approached insolvency—unable at times to meet some of its basic financial obligations in a timely way.  Unless the Legislature and the Governor take action over the next few years to address the deficit, there will be future periods when state finances teeter again near the brink,” states the report. 

The report urges the Legislature to “craft a sustainable framework for California’s public finances” but acknowledges that “it is unlikely that the Legislature can address all of the state’s massive, ongoing budget problems with permanent, ongoing solutions in the next year.”

At the time the July 2009 revisions to the 2009-10 Budget Act were signed into law, the administration estimated that the General Fund would have a $500 million reserve at the end of 2009-10.  The LAO’s updated projections estimate that the state faces a 2009-10 year-end deficit of $6.3 billion if no action is taken.

LAO Report Highlights Failed Budget Savings from 2009-10 Budget Agreement

“The vast majority of the new budget problem we have identified for 2009-10 can be attributed to the state’s inability to implement several major solutions in the July 2009 budget plan,” states the LAO in the report. 

The report highlights several failed budget solutions:

–An estimated $1.4 billion problem in the California Department of Corrections and Rehabilitation (CDCR) budget, which is largely the result of higher-than-budgeted spending by the prison medical care Receiver and policy adjustments to the prison and parole systems that were insufficient to meet budget reduction targets. 

–Nearly $900 million in higher-than-budgeted spending for the Medi-Cal Program due to the state’s inability to obtain additional federal funds or flexibility to reduce program costs. 

–The inability of the state to sell the State Compensation Insurance Fund (SCIF), a quasi-public workers’ compensation insurer, for the budgeted amount of $1 billion in 2009-10.  State Insurance Commissioner Steve Poizner (R) is opposed to the sale.

–More than $800 million of higher General Fund spending due to the state’s loss of a court decision that prevents the state from using “spillover” gasoline sales tax revenues and Public Transportation Account funds to reduce General Fund spending.   

–A nearly $1 billion increase in the Proposition 98 funding guarantee for K-14 education in 2009-10 due to the jump in state revenues caused by the enactment of temporary tax increases. 

“As a result of these updated projections, we estimate that the state faces a 2009-10 year-end deficit of $6.3 billion if no actions are taken,” states the LAO report. 

The state could lose additional court cases challenging several billions of dollars of spending reductions, including cases related to the shift of local redevelopment funds, state employee furloughs, and various health and social service reductions.  The state is also appealing a three-judge panel’s order to reduce the prison population to the U.S. Supreme Court.   

 New Budget Problem Looms in 2010-11 and Beyond

“Even at the time the 2009-10 budget was revised in July 2009, policymakers acknowledged a multi-billion-dollar shortfall for the upcoming 2010-11 budget,” states the report.

At the time, the Administration estimated the projected 2010-11 budget shortfall to be $7.4 billion.  The LAO said this estimate was based on a revenue estimate that was “too optimistic, to the tune of several billion dollars.”  The LAO also projects $3.5 billion in higher net spending than the administration forecast—principally the result of continuing trends in Medi-Cal, the transportation-related court case described above, and the CDCR. 

In total, the LAO projects an operating shortfall of $14.4 billion for 2010-11 for a total deficit of $20.7 billion for the 2010-11 budget, when the $6.3 billion year-end deficit for 2009-10 is included.

The projected budget shortfall is expected to rise to $21.3 billion in 2011-12, $23 billion in 2012-13, $20 billion in 2013-14, and $18.4 billion in 2014-15.        

The report also notes a number of additional spending risks that could drive the deficit even higher over the long term:

Poor Economic Growth:  Lower than expected tax revenues due to weaker than expected economic growth.

Ongoing Court Cases:  The state faces many ongoing lawsuits that could increase the budget shortfall by hundreds of millions of dollars, potentially billions of dollars.  The two most significant cases are the challenges to the requirement in the 2009-10 budget for redevelopment agencies to make payments totaling $1.7 billion in 2009-10 and $350 million in 2010-10 to benefit the General Fund.  There are also more than 20 lawsuits challenging the Governor’s state employee furlough policy, which was budgeted to provide more than $1 billion in savings in 2009-10. 

Potential Federal Health Policy Changes:  Congress is considering health care reform legislation that could expand the Medicaid program, change reimbursements to providers and affect state employee benefit costs.  The state’s current Medicaid hospital waiver expires in August 2010.  These potential impacts were excluded from the LAO estimates because their impact is uncertain at this time.    

Public Employee Retirement Liabilities:  Unfunded retirement liabilities of state entities are estimated to exceed $130 billion after significant declines in their investments in 2007-08 and 2008-09.  “Of perhaps even greater worry is that some categories of retirement costs—particularly retiree health costs and costs for the University of California’s pension plan—may rise significantly for decades, as the state has no plan to fully address those liabilities,” states the report. 

State Debt-Service Costs:  “The state’s debt-service ratio (the portion of General Fund revenues consumed by debt service) is rising rapidly due to implementation of the large voter-approved 2006 bond package, as well as the recent sharp drop in revenues.  It now appears very likely that debt services will comprise 9 percent of General Fund revenues—an unprecedented level—by the end of 2014-15,” states the report.

Borrowing Costs to Fund Insolvency in State Unemployment Insurance Fund:  The state’s unemployment insurance fund is currently insolvent.  In its most recent fund forecast, the Employment Development Department (EDD) projects that the fund will experience a year-end deficit of $7.4 billion in the 2009 calendar year, rising to $18.4 billion in 2010 and $27.2 billion in 2011.  EDD obtains federal loans on a quarterly basis to cover projected fund deficits.  To date, the state has borrowed about $4 billion, permitting California to make benefit payments to claimants without interruption.  Federal loans lasting more than one year will accumulate interest charges of about 5 percent per year.  The U.S. American Recovery and Reinvestment Act relieved the state from making interest payments for unemployment insurance loans through December 31, 2010, but after that date the state must resume making interest payments.  EDD estimates that the interest due in September 2011, for nine months of interest accruing from January 2011 through September 2011, is about $730 million.     

LAO’s Recommended Keys to Balancing the Budget

“Because the Legislature already has made so many difficult decisions, addressing the immediate $20.7 billion budget problem in the coming months may be even more difficult,” states the LAO report.

The LAO report recommends that the Legislature:

Take Early Action:  Every month of delayed action means a lost opportunity for savings.  Solutions often need early action in order to get a full year’s worth of savings in 2010-11.   

Focus on Long-Lasting Solutions:  The budget problems are long-term in nature which means that long-term solutions are needed.

Include Revenue Options:  “The state’s fiscal situation is so dire, however, that the Legislature may also have to revisit some of the temporary tax increases that are set to expire by the end of 2010-11,” states the LAO report.  The LAO believes the best candidate for extension is the vehicle license fee, because an increased fee is more consistent with what other states charge and the state’s tax on other property. 

Aggressively Seek New Federal Assistance:  “The 2009-10 budget was closed in large part due to the availability of billions of dollars in federal relief.”   The federal government is also under financial stress but the state can always lobby for more federal funds. 

Try the Ballot Again as an Option:  The Legislature’s attempts to use the May 2009 special election to help balance the budget were largely unsuccessful, in part due to the complexity of the package presented to the voters.  The Legislature has the option of using the statewide elections scheduled for June and November 2010 to present a more straightforward package of budget flexibility.  Options include redirecting revenues away from Proposition 10 (early childhood development), Proposition 49 (after-school programs) and Proposition 63 (mental health).       

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