State’s finances showing strength

From the Legislative Analyst’s Office: In November 2012, we projected that with continued growth in the economy and restraint in new program commitments, the state budget could see multibillion–dollar operating surpluses within a few years. In 2013, the Legislature and the Governor agreed to a restrained state budget for 2013–14, and our forecast of state tax revenue collections has increased since last year. Accordingly, we now find that California’s state budget situation is even more promising than we projected one year ago.

The Budget Outlook

Under Current Policies, $5.6 Billion Projected Reserve at End of 2014–15. The state’s 2013–14 budget plan assumed a year–end reserve of $1.1 billion. Our revenue forecast now anticipates $6.4 billion in higher revenues for 2012–13 and 2013–14 combined. These higher revenues are offset by $5 billion in increased expenditures, almost entirely due to greater required spending for schools and community colleges. Combined with a projected $3.2 billion operating surplus for the state in 2014–15, these factors lead us to project that, absent any changes to current laws and policies, the state would end 2014–15 with a $5.6 billion reserve.

Future Operating Surpluses Projected. We assume continued economic growth in future years. In such a scenario, we project that, under current laws and policies, state General Fund revenues will grow faster than expenditures through 2017–18, when the state’s projected operating surpluses reach $9.6 billion. The state’s temporary personal income tax rate increases under Proposition 30 (2012) expire at the end of 2018, resulting in a more gradual ramping down of these revenues over the last two fiscal years of our forecast. This helps prevent a “cliff effect” in our forecast, as our projected operating surpluses remain stable at just under $10 billion per year in 2018–19 and 2019–20.

Healthy Local Property Tax Growth Important for State Finances. Proposition 98 funding for schools and community colleges is provided by a combination of state General Fund spending and local property tax revenues. Throughout our forecast, healthy property tax growth—a byproduct of the recovering housing market—helps moderate the growth of required state General Fund spending on schools and community colleges. In addition to normal property tax growth, the state’s fiscal situation is helped by additional increases in school property taxes due to the dissolution of redevelopment agencies and the expiration of the “triple flip.” Both of these factors play a significant role in keeping annual state expenditure growth below revenue growth for much of our forecast period.

LAO Comments

Continued Caution Needed. Despite the large surplus that we project over the forecast period, the state’s continued fiscal recovery is dependent on a number of assumptions that may not come to pass. For example, our forecast assumes continuing economic growth and slow, but steady, growth in stock prices. As we discuss in this forecast, an economic downturn within the next few years could quickly result in a return to operating deficits. Further, the normal volatility of capital gains could depress (or boost) annual revenues by billions of dollars. In addition, our forecast assumes that the state repays liabilities with payment schedules set in current law. Other liabilities, including some items on the Governor’s wall of debt and the state’s huge retirement liabilities (particularly those related to the California State Teachers’ Retirement System), remain unpaid under our forecast. If additional payments are made in the future to repay these liabilities or to provide inflation adjustments to universities, the courts, state employees, and other programs, the operating surpluses in our forecast would fall significantly below our projections.

A Strategic Approach to Allocating Operating Surpluses. The state’s budgetary condition is stronger than at any point in the past decade. The state’s structural deficit—in which ongoing spending commitments were greater than projected revenues—is no more. We forecast that schools and community colleges will receive billions of dollars of new funding under Proposition 98. Across the rest of the budget, the Legislature and the Governor now face choices for how to allocate projected multibillion–dollar operating surpluses. We believe the Legislature should be strategic in how to make such allocations, taking into account the inherent volatility of the state’s revenue structure and uncertainty about the future course of the economy. We offer one possible approach. In it, we suggest giving high priority to building a strong reserve and paying off the budgetary liabilities accrued over recent years. We also believe the state should begin setting aside funds to address the growing unfunded retirement liabilities noted above. Finally, we also allocate amounts each year for the state to provide inflationary increases for existing programs and to create new commitments—whether they be for program restorations or expansions, tax reductions, or added infrastructure spending. Such an approach would well position the state for the next economic downturn, while at the same time allowing for incremental commitments to meet other priorities.

For the complete report from the LAO, click here.



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