Read Our Blog Series on Proposition 2

October 27, 2014

A little over a month ago, the California Budget Project published our analysis of Proposition 2, a measure that will appear on the November 4, 2014 statewide ballot and would make changes to how California sets aside revenue both to build up reserves and pay down state liabilities.

In recent weeks, we’ve published a blog series aimed at highlighting some of the key components of Proposition 2 and our take on them. With Election Day just around the corner, we’re bringing links to this full series together into a single post, in an effort to help our readers understand what Proposition 2 would do and its potential impact in the coming years.

Topics covered by our blog series have included the following:

Proposition 2’s substantial revisions to the state’s current budget reserveCBP Director of Research Scott Graves looks at the changes that Proposition 2 would make to California’s existing reserve — the Budget Stabilization Account, or BSA — and some of the trade-offs that would likely result.

Proposition 2’s requirement that a portion of state revenues be set aside for paying down budgetary debt:  Executive Director Chris Hoene examines a critical — but often overlooked — provision of Proposition 2: that a share of state revenues would be set aside each year for the next 15 years to pay down budgetary debt. This post discusses why this requirement is important and what it could mean for state finances in the near and long terms.

The total amount of revenues expected to be set aside each year under Proposition 2: Scott Graves discusses how much the state would potentially set aside each year — both to pay down state liabilities and add to the budget reserve — and points out that the annual amount would not necessarily be higher under Proposition 2 than under current policy.

What Proposition 2 would likely mean for state funding for K-12 schools and community colleges: Senior Policy Analyst Jonathan Kaplan discusses the new state reserve that Proposition 2 proposes to create for K-14 education. This post explains that the impact of this new reserve on state education funding would be negligible, although local districts’ reserves could be affected.

For our full analysis of Proposition 2 — which touches on the above issues along with other facets of the ballot measure — read our recent brief. And be sure to check out our website and this blog for further commentary on Proposition 2 as well as Proposition 47, another key measure on the November ballot.

— Steven Bliss



Proposition 2 Asks Voters to Require the State to Pay Down Budgetary Debt for the Next 15 Years

October 14, 2014

This is the second in a series of blog posts highlighting the CBP’s analysis of Proposition 2, which will appear on the November 4, 2014 statewide ballot.

Proposition 2 is often casually referred to as a “rainy day fund” measure because it would significantly change the state’s budget reserve policies.

As we noted in our blog post last week, “setting aside funds in good economic times to help meet the challenges that arise during economic downturns is a sound budgeting practice. Budget reserves — also known as rainy day funds — are critical because they can help policymakers limit the need for deep cuts to vital public systems and services when tax revenues decline.”

In addition to changing the state’s rainy day fund policies, Proposition 2 would require the state to pay down “budgetary debt” over the next 15 years and, unlike with the deposits into the rainy day fund, would not permit policymakers to suspend these payments in times of fiscal emergency.

Our analysis of Proposition 2 raises concerns about not allowing for the temporary suspension of these debt payments. Policymakers often need flexibility in adapting to unexpected changes in economic and fiscal conditions, such as when state revenues are dramatically lower than had been anticipated.

Nevertheless, paying down budgetary debt that the state accumulated during and before the Great Recession — such as borrowing from special funds or underfunding pension liabilities — is necessary to ensure that the state has the capacity to fund vital programs and services in the future.

Budgetary debt is different than debt incurred to build capital projects. The usual way that state and local governments incur debt is to issue bonds to build capital projects, such as the Proposition 1 water bond that will also appear on the November ballot. These bonds finance capital assets, such as K-12 schools, colleges and universities, transportation facilities, prisons, and water projects. The bonds come in two forms: general obligation bonds that require voter approval and lease-revenue bonds that are approved by the Legislature. The bonds are sold to investors who are repaid, with interest, according to a fixed schedule over a term of 20 to 30 years.

The purpose of using capital debt is to spread the costs across the life of the assets. For example, if a school will be in service for 30 years it is not fair for taxpayers in the year it is built to bear the full cost of building the school. Spreading the costs to taxpayers over the 30-year life of the asset ensures that taxpayers today and in the future are paying proportionate shares.

As of June 30, 2014, the state had a responsibility to repay $87 billion of capital debt bonds from its General Fund, at a cost of $7.6 billion in 2014-15 in debt service payments. The state Constitution prioritizes repaying these bonds and provides little flexibility to alter the timing and amount of debt service payments.

Recognizing the distinction between capital debt and budgetary debt is important to understanding why paying down budgetary debt is required in Proposition 2. Proposition 2 would require paying down the following types of budgetary debt:

  • Making certain payments that were owed to K-12 schools and community colleges as of July 1, 2014;
  • Repaying dollars that were borrowed — prior to 2014 — from various state funds and used to pay for services typically supported with General Fund dollars;
  • Reimbursing local governments for state-mandated services that they provided prior to 2004-05, but for which the state has not yet provided payment;
  • Reducing unfunded liabilities associated with state-level pension plans; and
  • Prefunding other retirement benefits, such as retiree health care.

These liabilities are different from the capital debt described above. First, whereas the state repays capital debt to investors, budgetary debt is repaid to school districts, local governments, and branches of state government, or is the dollars set aside to pay for pension and health benefits for retired state workers and teachers.

Second, whereas capital debt buys long-living assets that provide benefits in future years, the budgetary debt targeted by Proposition 2 was incurred in prior years, for services already provided. In other words, this is debt that requires taxpayers in the future to pay for services delivered in the past.

Carrying large amounts of budgetary debt threatens the ability of the state to support vital public services and systems in future years. For example, the state provides many of its retirees with health benefits. Generally, the state does not set aside money for (or “pre-fund”) this cost as employees earn it. Each year, the state pays the medical bills of retirees out of current year General Fund revenues. In 2014-15, this is expected to exceed $1.8 billion. If the state had pre-funded these benefits, today’s state budget would have additional funds to spend on public services and systems such as schools, health care, human services, and higher education.

The Department of Finance reported earlier this year that the total unfunded retiree pension and health benefits owed by the state were $218 billion — much larger than the amount of General Fund-supported capital debt that the state must repay.

Proposition 2’s requirement that budgetary debt be paid down more quickly would mean that the state will free up significant funds in future years. But, getting there will cost more in the near term in order to avoid even larger payments and painful service cuts down the road.

— Chris Hoene


Proposition 2 Asks Voters to Revise the Rules for the State’s Current Rainy Day Fund

October 8, 2014

This is the first in a series of blog posts highlighting key components of the CBP’s analysis of Proposition 2, which will appear on the November 4, 2014 statewide ballot.

Setting aside funds in good economic times to help meet the challenges that arise during recessions is a sound budgeting practice. Budget reserves — also known as rainy day funds — are critical because they can help policymakers limit the need for deep cuts to vital public systems and services when tax revenues decline.

Californians have long recognized the importance of setting aside dollars for a rainy day. Ten years ago, voters created the state’s current rainy day fund by passing Proposition 58, a constitutional amendment placed on the ballot by the Legislature. Soon afterward, the state began depositing dollars into this reserve — called the Budget Stabilization Account (BSA) — and the balance reached $1.5 billion by 2007-08. During this same year, however, the Great Recession struck and began to take a toll on state revenues. In response, state policymakers withdrew every dollar from the BSA in order to help address the substantial budget shortfall that had emerged. Moreover, during the recession and its aftermath, Governors Schwarzenegger and Brown used the authority provided by Proposition 58 to suspend the annual BSA deposit for six consecutive years, through 2013-14. It was only with the current budget, for 2014-15, that Governor Brown felt confident enough about the state’s finances to let the BSA deposit go through unimpeded. As a result, the BSA balance now stands at $1.6 billion.

On November 4, California voters will have another opportunity to weigh in on the state’s budget reserve policies. Proposition 2, a constitutional amendment placed on the ballot by the Legislature, asks voters to rewrite the rules governing deposits into and withdrawals from the BSA. Our analysis of Proposition 2 shows that the measure’s reserve policies would set up a number of trade-offs, which in some cases involve limiting state policymakers’ discretion with regard to certain budget choices. For example:

  • Compared to current law, Proposition 2 would make it harder for state policymakers to suspend or reduce annual deposits into — and withdraw funds from — the BSA. Proposition 2 would require the Governor to declare a “budget emergency” in order to begin the process of suspending or reducing the BSA transfer and/or withdrawing dollars from the reserve. The measure narrowly defines a budget emergency as resulting from either (1) a disaster or extreme peril or (2) lack of sufficient resources to meet a specific General Fund spending threshold: the highest level of spending in the three most recent fiscal years, adjusted for state population growth and the change in the cost of living. Over time, this new policy could result in a larger reserve, which would help the state limit cuts to core public systems and services during an economic downturn. But this policy also could diminish state policymakers’ ability to effectively respond to some challenging budget situations, such as when revenues are rising more slowly than previously anticipated, causing a budget gap to emerge.
  • Unlike under current law, Proposition 2 would limit the amount of funds that could be taken out of the BSA in a single fiscal year. Proposition 2 would allow no more than half of the dollars in the BSA to be taken out unless funds had been withdrawn in the previous fiscal year. This restriction means that a smaller share of the reserve could be used to support public systems and services in the first year of a budget emergency. However, it also guarantees that reserve funds would be available to help offset budget cuts for at least two consecutive years.

In short, the question before voters in November is not whether California should have a rainy day fund. The state’s current budget reserve has been around for a decade, with rules that are locked into the state Constitution. Instead, the key question posed by Proposition 2 is whether the current rules for the BSA — which give policymakers wide discretion to decide how much to deposit and withdraw each year — are adequate to the task of helping the state save for a rainy day.

— Scott Graves


Proposition 2: Should California Prioritize Paying Down Debt and Significantly Change State Budget Reserve Policies?

September 25, 2014

Yesterday the California Budget Project (CBP) released its analysis of Proposition 2, the rainy day fund measure that will appear on the November 4, 2014 statewide ballot.

Proposition 2 would amend the California Constitution to make key changes to state budgeting practices. These include rewriting the rules for the state’s current budget reserve; requiring that certain state liabilities be paid down each year for 15 years; and creating a new state budget reserve for K-14 education, though with significant constraints both on when dollars would be placed in this new account and on the amount of these deposits.

The CBP’s analysis examines the provisions of Proposition 2, including those that would govern deposits into and withdrawals from the reserves. This analysis also discusses what the new debt payment and reserve policies would mean for the overall state budget and for K-14 education funding, along with other policy issues raised by the measure.

The CBP neither supports nor opposes Proposition 2. This analysis aims to help voters make an informed decision based on the merits of the proposal.

— Steven Bliss