February 23, 2006

LAO 2006-2007 Budget Perspectives and Issues

The Legislative Analyst’s Office released its analysis of the Governor’s 2006-2007 Budget.  The Budget provides $2.9 billion for baseline cost increases, including $2.6 billion for cost-of-living adjustments (COLAs) for K-12 and community colleges. The budget proposes to spend an additional $1.4 billion to create new programs and expand existing ones.  

Major expansions include $426 million for after school programs, and $406 million in K-12 revenue limit increases for equalization ($200 million) and restoration of a prior-year COLA ($206 million).  For community colleges, the budget provides $130 million for equalization and $60 million for other increases.

LAO Proposition 98 Observations:

COLA:  The administration estimates a 5.2 percent COLA rate for K-14 programs, resulting in a cost of $2.6 billion in Proposition 98 funds in 2006-07.

The LAO estimates, using more recent data on actual inflation in the state and local government sector, a K-14 COLA of 5.8 percent.   Fully funding the higher estimate would cost just over $300 million more than the level currently funded in the Governor’s budget.   Final data needed to calculate the K-14 COLA factor will be available at the end of April.

LAO projects General Fund tax revenues will be $1.2 billion higher than the administration’s estimate in 2005-06 and $1 billion more in 2006-07.  They estimate that the additional revenues in 2005-06 will increase the minimum guarantee by $465 million.  

Prop 98: Since the Governor’s 2005-06 spending level is $265 million above the minimum guarantee, the extra revenues would only require an additional $200 million in Proposition 98 spending in 2005-06.  

Operating Shortfalls: The LAO estimates that if this budget were adopted, the state would face operating deficits of almost $4 billion in 2007-08 and $5 billion in 2008-09.  In addition, these are several factors that could add significantly to these shortfalls.  These include: (1) the loss of various court decisions, (2) unfunded costs related to retirement-related obligations, and (3) major reductions in revenue in the event of an economic slowdown.

The Governor’s budget proposes to spend $1.4 billion for new and expanded Proposition 98 programs in 2006-07.  Therefore, according to the LAO, the issue facing the Legislature is whether the state can afford this higher level of spending in 2007-08 and beyond.  

Issues for the Legislature relating to Proposition 98 that could affect the General Fund cost of meeting the minimum guarantee in future budgets:

Rebenching the Test 1 Factor: These transfers total $6.8 billion in 2006-07.   LAO states that to hold schools harmless from the shift of property taxes, the Test 1 percentage must be adjusted. This adjustment represents an important issue for the Legislature because LAO projects that Test 1 may become operative again as early as 2008-09.

  LAO recommends making this adjustment during the coming year so the Legislature has a clearer picture of the impact of its budget-year decisions on the state’s fiscal situation over the next few years.

Repeal of Proposition 49:  The budget provides $426 million in Proposition 98 spending above the minimum guarantee to expand the state’s after school program as required by Proposition 49.   May require voter approval.

LAO recommends the repeal of Proposition 49 for the following reasons: (1) it triggers an autopilot augmentation even though the state is facing a structural budget gap of billions of dollars, (2) the additional spending on after school programs is a lower budget priority than protecting districts’ base education program, and (3) existing state and federal after school funds are going unused.  If they choose to implement Proposition 49, the LAO states that the Legislature will need to clarify how Proposition 49 interacts with the Prop 98 guarantee.

Other K-12 Issues Identified by the LAO

In addition to its decision on the overall Proposition 98 level of spending the Legislature will face other key issues:

Mandate Finance in Need of Reform:  The budget includes $134 million to pay for the ongoing costs of state-mandated education programs in 2006-07  This is the first time in four years the Governor’s budget has included funding for these costs.  LAO believes that the process could be streamlined, reducing state and local administrative costs and making mandate funding more predictable for both districts and the state.

New Categorical Programs:  Given that both the state and school districts face difficult budget pressures, LAO believes it is unwise to direct funding to these lower priority issues because they: (1) do not address the major fiscal issues facing the state or school districts; (2) take a step backwards for categorical reform; (3) have basic policy flaws; and (4) contain virtually no planning, reporting, evaluation, or accountability components.

Williams Emergency Repair Program (ERP):  LAO recommends that the Legislature change the ERP to a grant program and enact legislation to eliminate the application and reimbursement process and instead send annual grants directly to districts based on average daily attendance at their deciles 1 through 3 schools. The LAO also recommends maintaining $50 million in the state ERP account to establish an emergency loan program that would continue even after the full $800 million for the ERP has been allocated.  

Other LAO Education Recommendations

Supplement Base With One-Time Funds:  If the Legislature desires to provide K-14 resources at levels similar to the Governor’s budget, LAO recommends the Legislature spend $1 billion on a one-time basis to reduce the state’s K-14 “credit card” debt.

School District Financial Condition:  Data on retiree health benefits suggest that a significant number of school districts and county offices have accumulated significant unfunded liabilities for future costs of retiree health benefits.

Require Districts to Address Liabilities:  LAO recommends enactment of legislation to require county offices of education and school districts to develop a plan for addressing long-term liabilities for retiree health benefits.

Negotiate a Plan to Use Federal Funds for Retiree Costs:  LAO recommends that the Legislature enact trailer bill language to allow districts to use state categorical program funds as part of a comprehensive plan for addressing retiree health liabilities and direct CDE to work with the federal government to develop a template that would guide district development of comprehensive plans for addressing unfunded retiree health benefits.

Create a Fiscal Solvency Block Grant:  LAO recommends that the Legislature redirect $393.5 million in Proposition 98 funds to a block grant that would provide districts and county offices with a source of funding to address the fiscal challenges they currently face.

Revenue Limits

Redirect Funding for Deficit Factor Reduction to COLA:  LAO recommends that the Legislature redirect the proposed $206 million for deficit factor reduction to pay for the increased costs of a higher COLA.

Increase Funding for Declining Enrollment Adjustment:   LAO recommends that the Legislature score an additional $75 million to recognize the cost of fully funding the declining enrollment adjustment.

Redirect Equalization Funding to Fiscal Solvency Block Grant:  LAO recommends the Legislature redirect the proposed $200 million for equalization to address the serious fiscal solvency issues faced by many districts in the state.  If the Legislature chooses to fund equalization, the LAO recommends allocating the funds based on a new formula that consolidates “add-on” programs into base revenue limits.

Mandates

Fully Fund Ongoing Mandate Costs:  LAO recommends augmenting the appropriation for mandates by $28.2 million in order to fully fund these costs in the budget year and amending the budget bill to list the specific mandates the appropriation is intended to cover.

Create New Mandate Block Grant:  LAO recommends appropriating K-12 mandate funds in a per-pupil block grant to districts in order to streamline and simplify the K-12 mandate process.

California Community Colleges (CCC):  LAO projects overall enrollment at CCC to increase by 1.75 percent in 2006-07.  Funding at this level would save $62 million relative to the Governor’s proposal.

Equalization: New Allocation Formula:  LAO recommends providing a final installment of funding towards its equalization goals.  The Governor proposes $130 million for this purpose.  However, because the existing formula for allocating funding to community colleges would erode the state’s equalization gains over time, LAO recommends that additional funding be provided for equalization contingent on enactment of legislation providing an allocation mechanism that preserves its equalization goals.

Reject $50 Million Expansion of Career Technical Education Initiative:  Because CCC will not distribute current-year money for this initiative until later this spring, LAO believes expanding the program at this time is premature. 

Direct Chancellor’s Office to Provide Update on Retiree Health Benefit Liabilities:  A new policy by the national Governmental Accounting Standards Board on retiree health benefits presents a major new fiscal challenge to community colleges.  LAO recommends that the Legislature direct the Chancellor’s Office to provide an update on the magnitude of these liabilities and current efforts to address them.