Budget outlook better than expected, LAO says, but energy spikes and infrastructure bonds pose potential threats

California’s financial picture has brightened significantly, with revenues
up nearly $4 billion over earlier estimates. But there could be clouds on
the horizon in the form of long-term debt, says the Legislature’s
nonpartisan fiscal adviser.

“We’re not out of the woods,” said Legislative Analyst Elizabeth Hill in her
annual Fiscal Outlook report. “But the prior actions we’ve taken are really
starting to mitigate the problems we’ve had.”

She added that the decision to suspend Proposition 98 in 2004-05, and
reductions in health and welfare spending have helped close the state’s
deficit hole.

Hill said revenues were up a combined $3.9 billion over earlier estimates
for the 2004-05 and 2005-06 fiscal years, driven largely by taxes derived
from higher corporate profits. Combined with $2.5 billion in savings
lawmakers found over the same period, the LAO estimates the state will end
the year with $5.2 billion in reserves, up $4 billion from earlier
estimates.

Good economic news has driven down estimates for the state’s intractable
structural deficit, which the LAO estimated at just under $3 billion for the
2005-06 fiscal year. The LAO report predicts this will peak in 2007-08 at
$4.3 billion and decline to well under $1 billion three years later. Early
estimates from various sources had the deficit peaking at anywhere between
$7 billion and $9 billion, according to Jean Ross, executive director of the
California Budget Project.

Amid the good news, some political problems await for this year’s budget
fight. It has been widely speculated that Democrats would seek a return of
some or all of the $3 billion in funds education groups say there are owed.

State Superintendent of Public Instruction Jack O’Connell quickly issued a
press release after the LAO report came out, citing the $3 billion and
stating “the fact that our budget was balanced on the backs of students
should not be celebrated.”

However, at a press conference last week, Schwarzenegger remained
defiant on this subject. “It’s not like I took money from education or
couldn’t find the money for education,” Schwarzenegger said. “It just wasn’t
there.”

Then there is a $50 billion gorilla looming on the horizon: The governor’s
proposed 10-year infrastructure bond. There is widespread consensus that
California needs a large infrastructure bond in order to fix levees and the
state’s dysfunctional transportation system. Senate president pro tempore
Don Perata, D-Oakland, has been championing a $10.3 infrastructure bond;
Assembly speaker Fabian Nunez, D-Los Angeles, has been preparing his own
bond, largely dealing with education. If it were to go through, the
Schwarzenegger bond could subsume both proposals.

The report does not take the potential $50 billion bond into account, Hill
said. The current budget projects the state will pay $3.9 billion in
principal and interest on debt service in the current year, rising to $6.1
billion in 2010-11. While the state’s bond rating and long-term debt
situation have improved, Hill added, any decision to take on large amounts
of new debt could be worrisome.

“We’re now spending more on debt service