A Proposal to Reform the Budget Process and Improve California's Bond Rating

By Curt Pringle

"California must be more fiscally responsible. Just like families must save for the future and have a plan for unexpected expenses and emergencies, so must California. This proposal will greatly improve the budget process and the economic soundness of our state."

Pringle proposes two significant changes to the budget process to improve California's bond rating. These changes are:

• Setting up an automatic mechanism to assure the state has a reserve.

• Create a budget trigger that would address economic downturns mid-year.

Reserve Proposal:

Background:

California currently has a state budget which allocates $60 billion annually (3). Yet, during the 1990's the state has set very little aside in a reserve fund. In fact, since 1990, the state has had an average reserve of less than 0.4% a year(4). In the 1998-99 budget bill, in a year in which the state is facing an unexpected windfall of $4.4 billion, the budget bill passed off the Assembly floor with a reserve of only $130 million, or 2/10ths of 1 percent (5).

Year------------------Reserve------------Percentage

1990-91----------------$1,298 million----------3.1%

1991-92----------------$1,213 million----------2.8%

1992-93----------------$ 31 million----------0.1%

1993-94-------------(-)$ 540 million-------(-)1.4%

1994-95-------------(-)$1,019 million-------(-)2.5%

1995-96----------------$ 28 million----------0.6%

1996-97----------------$ 305 million----------0.2%

During the early 1990s the state experienced one of the deepest economic downturns in its history. Without a reserve, California was forced to make dramatic budget cuts and impose tax increases to balance its books.

Just like a family that must save to guard against unexpected emergencies, sound fiscal practices require the state to also plan for the unexpected.

The Proposal:

Pringle proposes that the state would set up an automatic trigger that would sweep excess revenues into a "Special Reserve Fund" at the end of the fiscal year. The "Special Reserve Fund" would be capped at 3% of General Fund Revenues (6). Any amount above the 3% would be returned to taxpayers pursuant to Proposition 4.

Funds in the Special Reserve Fund could not be appropriated in the regular budget process and the Budget Act could not project or assume the use of the "Special Reserve Fund" to balance the budget. The Governor and the Legislature could only appropriate these funds if:

• The appropriation is contained in a freestanding bill.

• The bill used to appropriate the money contained a finding that a fiscal emergency exists and that the state needs to withdraw money from the reserve fund to resolve that emergency.

• The bill was passed by a two-thirds vote of the Legislature and the Governor signed the bill.

Proposal compared to today's system:

Today, resources unexpended at the end of the fiscal year, including any unanticipated revenues, are swept into the Fund for "Economic Uncertainties." Unfortunately, instead of acting like a reserve fund, the Fund for Economic Uncertainties acts as an extension of the overall budget. In January, anticipating additional or unexpended revenues, both the Governor and the Legislature propose to spend this revenue as part of the budget for the next fiscal year. The appropriation for these funds is made in the overall budget bill and for all intensive purposes co-mingles the reserve with the general fund revenues. The effect is to treat the Fund for Economic Uncertainties as a checking account; Pringle's proposal would create a savings account to protect the state.

Implications if this mechanism were in effect today:

The May Revise anticipated that the 1997-98 fiscal year ended with $1.7 billion more revenues then originally projected. If the Pringle Reserve Proposal were in effect this year, this $1.7 billion would be automatically allocated as a reserve (7).

Budget Trigger Proposal

Background:

During the early 1990s, California experienced an unprecedented economic downturn. This recession resulted in budget deficits that reached a cumulative $8.8 billion over a six-year period.

Year------------Deficit/Surplus

1990-91---------(-)1,175 million

1991-92---------(-)2,962 million

1992-93---------(-)2,475 million

1993-94---------(-)1,481 million

1994-95-----------(-)712 million

1995-96--------------235 million

1996-97--------------461 million

Today's budget process begins in January when the Governor introduces his budget proposal. Through the spring and into early summer, the Legislature meets to consider the Governor's proposal and to craft their own budget response. The Constitution requires the budget be passed by June 15th of the year. Once the budget is passed, unexpected expenditures and economic downturns impact the state's budget plan with no correction mechanism. Unlike a family that reduces expenditures in light of a financial shortfall, the state does not adjust its spending plan to reflect unexpected expenditures or revenue shortfalls but merely accumulates a budget deficit.

The Proposal:

The state would set up a specific mechanism to facilitate the early resolution of budget shortfalls to prevent program disruption, provide fiscal stability and minimize or eliminate impacts on the state's credit rating. The mechanism would work as follows:

• If the general fund revenue receipts are less than the projected cumulative amount of General Fund receipts for the current fiscal year and this variance is greater than 2%, on January 10th, the Director of Finance shall send a report to the Governor, the Legislature, and the Chairs of the Senate and Assembly Budget Committees.

• If the Director of Finance finds that revenue and expenditure projections for the remainder of the fiscal year will not reduce the variance to less than 2%, then the Governor shall propose legislation within 30 days providing for sufficient General Fund expenditure reductions, revenue increases or both, to offset the amount of the shortfall.

• This legislation shall be considered by the Legislature on or before the end of the calendar month following the one in which the announcement of the fiscal variation was published.

The state budget is the engine that drives the state financial system. The current lack of fiscal accountability has resulted in reduced bond ratings, increasing the cost of borrowing. Creating and maintaining a prudent budget reserve and providing for budget corrections in an economic downturn, will save California millions in borrowing costs. Furthermore, a prudent reserve will ensure that in tough fiscal times, the state will not have to resort to tax increases or severe budget cuts.

1. California's ratings for General Obligation bonds by the major rating agencies are; Moody's A1, Standard & Poor's A+, Fitch AA-. California State Treasurer's web page, August 4, 1998.
2. California Debt Affordability Report 1997, State Treasurer's office.
3. Governor's May Revise.
4. Legislative Analyst Memo to Assemblyman Pringle June 1998.
5. AB 1656 contained a stated budget reserve of $170 million. Unfortunately, $40 million of that reserve was set aside to pay for developer fee relief related to the passage of a education bond package later in the session.
6. A 3% reserve in the 1998-99 budget represents $ 1.7 billion.
7. Governor Wilson proposed a $1.6 billion reserve in the May Revise.