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Proposed Budget Leaked Wednesday Night; Governor Calls for “Wisdom and Prudence” with Surplus Revenues

Proposes Authorizing Infrastructure Finance Districts with Reduced Voter Threshold

January 10, 2014
For the second time in his current term, a late afternoon leak of Gov. Jerry Brown’s proposed FY 2014–15 budget Wednesday shook things up this week in the Capitol. Originally scheduled for the constitutional release date of Jan. 10, the Governor moved his press conferences up to Thursday giving insiders advanced opportunity to analyze the numbers. For the first time in more than a decade, the news was good. The coming debate over allocating billions in surplus revenues stand in stark contrast to the $26 billion deficit the Governor faced in FY 2011–12.  
The Governor’s plan proposes an estimated $155 billion budget for the upcoming fiscal year starting July 1. The proposal outlines a $106.8 billion General Fund (GF) spending plan for FY 2014–15, an estimated $8 billion more than the current year’s budget. Education receives the largest funding allocations, with $45.2 billion directed to K-12 education and $12.4 billion to higher education. Together these funding allocations account for nearly 38 percent of the proposal’s spending provisions. Other significant allocations are $28.8 billion directed to health and human services, followed by corrections and rehabilitation at $9.5 billion. The proposed spending framework aligns with comments made by Gov. Brown that his budget proposal focuses on three main components: public safety, education and healthcare.  
As for revenues, a windfall from voter-approved Proposition 30 and high capital gain tax receipts from a rising stock market allows the state to project an increase of $5.7 billion in revenues compared to FY 2013–14. Yet the source of these revenues is volatile. An estimated $70 billion will come from personal income tax receipts followed sales and tax revenues at $24 billion. During the Sacramento press conference, the Governor pointed to charts demonstrating past volatility of the personal income tax revenues, warned against the dangers of overly committing to new programs, and maintained that the most prudent course is to repay debts and build a sizable reserve to prepare for a future downturn.
When asked about new taxes, such as a tax on oil extracted from California, the Governor stated he did not believe this is the year for new taxes. He praised the success of Proposition 30 and restated his 2010 gubernatorial campaign promise that he would not raise taxes without voter approval.      
The budget includes a proposal to place a rainy day fund constitutional amendment on the November statewide ballot. It projects a surplus of $6 billion in the remainder of FY 2013–14 and FY 2014–15.
Responses to the Governor’s proposal have been customarily mixed. State GOP officials are concerned that Democrats will jump at the chance to spend the modest budget surplus and ignore the need to save. Republicans are also concerned about the proposed spending increase and its effect on long-term budget stability. However, criticisms of Gov. Brown’s budget are not exclusively from Republicans as some Democrats have taken issue with his proposal as well. According to reports and social media posts, some Democrats are concerned that the proposal does not restore deep cuts made to public health services for the state’s more needy families. For the most part, Democratic leadership praised the Governor’s proposal as a prudent plan that correctly identifies and addresses the state’s most pressing needs while avoiding another budget deficit. The best use of surplus funds, however, promises to be the focus of much debate with some lawmakers including Senate President Pro Tem Darrell Steinberg (D-Sacramento) calling for funding of universal transitional kindergarten.
To tout his proposal, Gov. Brown held events in Sacramento, San Diego and Los Angeles. The presentations featured remarks by Governor Brown as well as Department of Finance Director Michael Cohen and Q and A with reporters. A video of the Governor’s Sacramento press conference is available online
Budget Reserve, Debt Repayment, and Elimination of the “Triple Flip”
The Governor advocated that “prudence” is crucial to budget stability. Characterizing the surplus as modest, he called for caution and warned that California suffers from budget instability because of reliance on capital gains, which historically zigzag. While FY 2014–15 is projected to begin with a surplus of $4.2 billion, the state will continue to face a wall of debt totaling $24.9 billion. The Governor’s proposal includes a plan to pay down that debt by the end of FY 2017–18. The budget also makes a 3 percent payment to the state’s Prop. 58 (2004) rainy day fund. Half of this payment will go to the rainy day fund, and half will go to pay back the previous-issued economic recovery bonds.
The proposed budget pays off more than $11 billion in state debt.  This includes eliminating deferred payments to schools ($6.1 billion), paying back some special fund loans, including transportation ($1 billion), and paying some other small deferred payments.
Welcome news, no doubt, to many local officials is the proposal to pay off remaining amounts owed on the state’s Economic Recovery Bonds ($3.9 billion). The repayment of these funds means the unwinding of the complex “triple-flip” funding formula. 
A Revised Rainy Day Fund
Over the last decade there have been several attempts to create a state reserve fund to better prepare the state for fiscal downturns. Voters approved Prop. 58 in 2004 to require the state to adopt a balanced budget and to direct 3 percent of annual revenues into a rainy day fund, but dire budget conditions and various loopholes revealed that Prop. 58 had little effect.
As part of a major budget agreement in 2009, a revision to Prop. 58 was included, which was passed as ACA 4 to be placed on the statewide ballot. That provision, however, to the consternation of legislative Republicans, has yet to be voted on after being shifted by Democrats through follow-up legislation to future ballots. The most recent proposal is to remove the previous ACA 4 from the ballot (requiring a two-thirds legislative vote) and replace it with a different proposal that:
  • Bases deposits on when capital gains revenues rise to more than 6.5 percent of G F tax revenues;
  • Creates a Prop. 98 reserve, where spikes in funding would be saved for future years, smoothing out school spending (without impacting the guaranteed level of funding under Prop 98;
  • Doubles the maximum size of the Rainy Day Fund from 5 percent to 10 percent of revenues;
  • Allows supplemental payments to the Wall of Debt or other long-term liabilities in lieu of a year’s deposit; and
  • Limits the maximum amount that can be withdrawn in the first year of a recession to half of the fund’s balance.
As with previous “rainy day” efforts, this latest one will need to be carefully evaluated as to its effectiveness in establishing a true and reliable state reserve fund that would help avoid some of the “boom and bust” turmoil experienced in the past.
Infrastructure Finance Districts (IFD)
To respond to the need for local economic development tools, the Governor put forward a proposal to revise existing Infrastructure Finance District Law (IFD) to make it more useable, including lowering the existing statutory two-thirds voter approval requirement to create a district to 55 percent.  While this proposal does not match provisions in League-supported IFD bill SB 33 by Sen. Lois Wolk’s (D-Davis), it is positive in the Governor has at least proposed something to revive local economic development tools since the elimination of redevelopment.
Missing from the discussion was any mention of a re-establishment of redevelopment powers to address community revitalization issues, such as advocated in League-supported AB 1080 (Alejo) focused on disadvantaged communities or SB 1 (Steinberg) focused on areas adjacent to transit. Perhaps this represents the beginning of a larger discussion.
IFD law has been on the books for nearly 30 years, but has been rarely used principally because it requires a two-thirds vote to establish a district and issue debt. Because the Governor’s IFD proposal lowers the voter threshold instead of eliminating it entirely, it is not clear whether this will be a sufficient help to local agencies to create much-needed infrastructure. IFD’s would use the tax increment mechanism previously used by redevelopment which had no such vote requirement.
In brief, the Governor’s proposal:
  • Expands the types of projects that IFDs can fund;
  • Allows cities and counties to create new IFDs and to issue related debt, subject to 55 percent voter approval;
  • Allows new IFD projects to overlap with former RDA project areas; and
  • Maintains current IFD prohibition on the diversion of property tax revenues from K-14 schools and requires entities seeking IFD creation to garner approval of the city that would be contributing revenue to the IFD.
However, in order to enjoy these enhanced IFD powers, the Governor’s proposal comes with several caveats relating to redevelopment dissolution. These requirements include:
  • Demonstrating that a city has remitted all of the unencumbered cash assets of its former RDA to the affected taxing entity — also known as a Receipt of a Finding of Completion from the Department of Finance;
  • Compliance with all State Controller’s Office RDA audit findings; and
  • Conclusion of any outstanding legal issues between the successor agency, the city that created the RDA and the state.
Enterprise Zones
In place of the former Enterprise Zone Program the state is offering a hiring tax credit, sales tax exemption for manufacturing or biotech research and development equipment purchases, and the California Competes tax credit that will be negotiated individually with businesses. The new program is revenue neutral over the next five years.
Environmental Quality
The budget proposal allocates nearly all $363 million of Proposition 39 revenue for energy efficiency projects to K-12 and community colleges.
The $363 million is broken down as follows:
  • $316 million and $39 million to K-12 and community college districts, respectfully, for energy efficiency project grants;
  • $5 million to the California Conservation Corps for continued technical assistance to K‑12 school districts; and
  • $3 million to the Workforce Investment Board for continued implementation of the job‑training program.
The budget proposal includes an appropriation of $850 million from Cap and Trade revenues, $250 million of which would go to energy efficiency and clean energy, natural resources, and waste diversion.
Allocations of particular note within the $250 million are as follows:
  • $80 million for energy efficiency upgrades/weatherization and renewable energy projects in low‑income dwellings within disadvantaged communities;
  • $20 million for the Department of Water Resources for water and infrastructure efficiency projects that also result in energy savings. This proposal will provide additional funding for grants that support water use efficiency projects, such as leak loss detection and repair projects that have a demonstrated ability to reduce GHG emissions. The proposal also supports efficiency upgrades at two State Water Project facilities, Thermalitio and Hyatt, which will result in more efficient generation of clean power and improved system reliability;
  • $30 million for the Department of Fish and Wildlife to implement projects that provide carbon sequestration benefits, including restoration of wetlands (including those in the Delta), coastal watersheds and mountain meadows;
  • $50 million for the Department of Forestry and Fire Protection to support urban forests in disadvantaged communities and forest health restoration and reforestation projects that reduce wildfire risk and increase carbon sequestration; and
  • $30 million for the Department of Resources, Recycling, and Recovery to provide financial incentives for capital investments that expand waste management infrastructure, with a priority in disadvantaged communities. Investment in new or expanded clean composting and anaerobic digestion facilities is necessary to divert more materials from landfills, a significant source of methane emissions.
For additional details on Cap and Trade funding, please see Transportation.
Reorganization of the Drinking Water Program
  • The budget proposal also seeks to transfer $200.3 million ($5 million GF) and 291.2 positions for the administration of the Drinking Water Program from the Department of Public Health to the Water Board.
The budget proposes to allocate $618.7 million for activities associated with the Water Action Plan. Expenditures of particular note are as follows:
  • $7.8 million to expand water storage capacity;
  • $11 million for safe drinking water in disadvantaged communities;
  • $20 million for water and energy efficiency;
  • $7.8 million for groundwater management activities;
  • $77 million for the Flood SAFE program; and
  • $472.5 million for Integrated Regional Water Management that includes local projects that increase regional self‑reliance and result in integrated, multi‑benefit solutions for supporting sustainable water resources. Program will provide incentives for both regional integration and to leverage local financial investment for water conservation efforts, habitat protection for local species, water recycling, stormwater capture, and desalination projects.
The budget proposal seeks to reform the Beverage Container Recycling Program as follows:
  • Three-year phase-out of processing fee subsidies. Offset payments that subsidize manufacturer costs will be reduced by $26.3 million in FY 2014–15, another $26.7 million in FY 2015–16, and by $14 million in 2016‑17 to reflect the full elimination;
  • Eliminate fee payments. Administrative fees paid to processors and recyclers will be eliminated, while also relieving their administrative burden by requiring and facilitating electronic filing. Projected savings are $13 million in FY 2014–15, with ongoing savings of $26 million beginning in FY 2015–16; and
  • Redirect existing funds to support local recycling and deter fraud. Eliminates existing city and county payments, and redirects funds to increase a competitive grant program by $3.5 million and establish a $7 million Recycling Enforcement competitive grant program.
  • Diversify funding for local conservation corps. The proposed budget replaces $15 million of existing Beverage Container Recycling Fund grants to local conservation corps by redirecting a like amount of other special funds to support local corps recycling programs. New funding for local corps programs will be provided by the Tire Recycling Management Fund ($5 million), the Electronic Waste Recovery and Recycling Account ($8 million), and the Used Oil Recycling Fund ($2 million).
The budget proposal makes several significant adjustments to the Department of Parks and Recreation. The proposed changes are as follows:
  • A one‑time increase of $14 million to the State Parks and Recreation Fund to continue existing service levels throughout the state park system to prevent park closures; and
  • $40 million to address critical infrastructure deferred maintenance needs.
Public Safety
For cities, the most significant piece is the continuation of the $27.5 million for front-line public safety funding. This goes exclusively to municipalities.
Other provisions that may have some impact on cities:
  • $500 million in lease revenue bonds for new jail construction (overwhelmingly directed at counties).
  • $128 million for county probation for SB 678 implementation, funding recidivism reduction strategies by county probation offices to prevent felony offenders from returning to prison (this should reduce re-offense rate, easing burden on local law enforcement).
  • Re-entry initiatives in local communities: $40 million for re-entry services.
    • Where county jail space is available, inmates due for release will be transferred from prison to receive re-entry services
    • Employment training
    • Substance abuse treatment
    • Additional services
  • $11.8 million for substance abuse treatment in state prisons.
  • $11.3 million for services for mentally ill parolees (represents an expansion of this program from 600 to 900 parolees).
As cities will remember, the Governor last January established a working group on transportation funding. The working group, dubbed the California Transportation Infrastructure Priorities (CTIP) working group, will continue meeting in 2014. While there is significant work ahead, the meetings have resulted in a new set of transportation priorities for the state which include preservation and maintenance, rail modernization, and SB 375 implementation. These priorities are evident in the budget proposal. 
The budget proposal includes an appropriation of $850 million from cap-and-trade revenues, $600 million of which would go to transportation. The $600 million is broken down as follows: 
  • $100 million to local governments to support implementation of sustainable communities strategies required by SB 375 (Chapter 728, Statutes of 2008). The grant program will coordinated by the Strategic Growth Council, and disadvantaged communities and projects that reduce GHG emissions will be prioritized;
  • $200 million for low carbon transportation programs to will support the Governor’s goal to deploy 1.5 million zero-emissions vehicles by 2025 (mainly through rebates) and for supporting research and development;
  • $250 million for the construction of the initial segment of High-Speed Rail (HSR) in the Central Valley; and
  • $50 million for a competitive grant program for existing rail operators for capital improvements to integrate rail systems and provide connectivity to the HSR system. 
For additional details on Cap and Trade funding, please see Environmental Quality.
In addition to the cap-and-trade revenues, the budget proposal includes $351 million in GF loan repayments. Funds from the repayment of the loans would be proposed as follows:
  • $100 million to cities and counties for preservation of local streets and roads that will be allocated using existing highway user tax formulas;
  • $110 million to fund pavement rehabilitation projects on state highways;
  • $100 million for traffic management mobility projects;
  • $27 million for highway pavement maintenance;
  • $9 million for active transportation projects; and
  • $5 million for environmental mitigation.
The proposal also includes Prop. 1B fund distribution to transit operators, intercity rail, and state highways and changes to the Capital Outlay Support Program and Aeronautics Program as a result of the Zero-Based Budget Review.
Employment Relations
The budget proposed to consolidate all public works and prevailing wage enforcement activities within a single unit within the Department of Industrial Relations. This would be funded by a new registration fee on contractors who choose to work on public works projects. The program would total $11.4 million with 83 positions, an increase of 20 positions over prior enforcement levels.
State Infrastructure Maintenance
The budget also includes $815 million for deferred maintenance in state parks, highways, local streets and roads, K-12 schools, community colleges, courts, prisons, state hospitals and other state facilities.
Legislature Has Ideas Too
Information on the priorities of legislators affecting the coming budget debates can be found in several recent documents.
In December, the Assembly Democratic Caucus released its “Blueprint for a Responsible Budget” that calls for the state to build a $8 billion reserve by FY 2016–17 and a constitutional amendment on to establish a Rainy Day Fund that helps the state achieve budget stability in the long-term. This proposal also calls for increased funding of early and higher education, child poverty programs, health access and job investments.
The Assembly Republican Caucus’ “California Budget Fact Check” is much less optimistic about a sizable state budget surplus. The report warns of unfunded liabilities totaling $354.4 billion between CalPERS, CalSTRS, UCRP and retiree healthcare. It also cautions that historically state lawmakers try to expand funding of programs in good times, which will decrease from a rainy-day fund. In addition, the Caucus is concerned that California remains too dependent on personal income taxes, which fluctuate widely.
Next Steps
The Governor’s State of the State Address is scheduled for Wednesday, Jan. 22 at 9:00 a.m. when a fuller explanation of his policy agenda can be expected. The Department of Finance is expected to release draft trailer bill language the first week in February that will include details of the proposal. In May the Governor will release his revised budget proposal for the coming fiscal year that must be passed by June 15 to take effect July 1.

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