November 30, 2011

Response to LAO's Economic Forecast 

On November 16, 2011, the Legislative Analyst’s Office (LAO) released its five-year economic projections.  They were consistent with the LAO’s May 2011 report regarding state General Fund revenues.  The LAO, however, has indicated that they expect slower growth and recovery than in their previous May report.  Based on their economic outlook they project that most of the mid-year K-14 budget cuts will be triggered. The following is our economic forecast for 2011 through 2014, which contrasts our forecast and the LAO’s forecast.

More Optimistic

Our projection is more optimistic than the LAO’s because the most recent economic data has trended toward lower unemployment and higher employment, which should result in more personal income tax and sales tax revenues.  Corporate tax revenues are not expected to recover as quickly as personal income and sales taxes, because corporate tax changes made in 2009 allowed corporations to pay the lower of two tax formulas.

The LAO’s economic forecast assumed that during the 2012 year unemployment will average 11.8 percent, 11.2 percent in 2013 and 10.3 percent for the 2014 calendar year. 

The current trends indicate that it is more likely that the unemployment rate will drop below 10% by the end of 2013.  Already in November 2011 the state unemployment rate has declined to 11.7 percent.  Our economic projection for the 2012 year is an unemployment rate averaging between 11.3 and 11.5 percent for the full year, with a 2013 average of 10.5 percent unemployment that will decline to 9% in 2014. 

While still high, our projection is more consistent with the LAO’s 2010 projections for the 2012, 2013 and 2014 years, although it does reflect a slightly less robust growth and recovery than had been projected by the LAO in 2010.

As more people are employed, we believe there will be an accelerating cycle of wages and income tax revenue increases along with the greater discretionary income for spending leading to sales tax revenues increasing. The LAO is projecting that the big three state tax revenue producers (personal income tax, sales and use tax and corporation tax) will decrease by 9% in 2011-12 and then increase at approximately 5% per year for 2012-13 through 2013-14. Conversely, in November 2010 the LAO expected a 9.4% drop and then about 6% annual growth in 2012-13 and 2013-14.

Once again, because our projection is a more optimistic employment forecast, we forecast that state revenues will be closer to a 6% annual General Fund revenue growth rate in 2012-13 and 2013-14 with less than a 9% drop in 2011-12.  Our projection uses as its base the 2011-12 General Fund big three revenues of approximately $80.5 billion which, when combined with insurance and other General Fund revenues, will reach $86.7 billion which means no significant 2011-12 mid-year trigger budget cuts will occur for K-14.

Guarantee Increasing Faster Than State Revenue

In the LAO projection, they state their expectation that the Proposition 98 minimum guarantee will increase by approximately $4 billion in 2012-13 and then another $2.5 billion each subsequent year.  Because our projection assumes a moderate recovery, rather than the weak recovery projected by the LAO, our projection is that the minimum guarantee will be slightly higher by approximately $400 million in 2012-13 and an additional $1 billion in 2013-14.  

Upside Opportunities – Downside Risk

Most of the economic projections have been weighting the downside risk from Europe, federal dysfunction and a slowing United States economy. Consequently, other than for litigation losses by the state, there is not a significant amount of downside risk for the Proposition 98 and state General Fund revenue projections. 

The upside opportunity of an even better improving economy is not probable because our projections for moderate growth is at the top of growth projections.

Good News – Bad News

The good news is that the economic indices continue to move toward a better economy and the probability that any significant K-14 second level mid-year cuts will not occur.  Additional good news is that recovery, while moderate, will generate significantly greater funding obligations for the Proposition 98 minimum guarantee and provide the opportunity to start repaying inter-year deferrals and restoring revenue limit deficits.

The bad news is that the United States and California have fragile economies and an unexpected jolt could cause the moderate recovery to reverse leading to the mid-year cut. Additional bad news is that the LAO was very clear in outlining to the Legislature reasons why Proposition 98 should be suspended again and public education full funding should not be provided. Because in the past the Legislature has tried to protect non-education funding at the expense of education, the LAO proposal could find traction in a majority vote budget. 

Click here to view demographic information.

~Dave Walrath