California LAO advises lawmakers to sharpen red pencils

Bonds

The California Legislative Analyst’s Office take on the governor’s proposed budget found Gov. Gavin Newsom’s deficit estimates “optimistic,” though it lowered its own deficit estimates by $10 billion to $58 billion.

The main difference between Newsom’s budget for fiscal 2024-25 released last week, which projects a $38 billion deficit, and the LAO’s, is the governor expects the state will see an 8% increase in income tax collections in the current budget year, bringing in $15 billion more than the LAO estimate.

“The revenue estimate is optimistic, but plausible,” Legislative Analyst Ann Hollingshead wrote in the LAO report released Saturday. Midway through the current budget year, however, “we are yet to see clear signs of such a rebound.”

The LAO agrees the rebound in stock prices that occurred over the last year, especially in the spring of 2023, is one reason for optimism, but adds “stock market rallies can reverse as quickly as they start.”

California’s dependence on income taxes — and taxpayers who earn more than $1 million a year — creates volatility, because stock market gains, or losses, impact the income of the state’s wealthier taxpayers.

California Gov. Gavin Newsom said during his budget address his administration’s outlook is slightly less pessimistic than the LAO’s. Newsom is pictured touring a former Los Angeles shopping mall being converted to a medical and engineering research park by the University of California.

Bloomberg News

Newsom said during his budget address last week that his administration is a little less pessimistic than the LAO, and less concerned about talk of an impending recession.

The governor’s proposal also didn’t account for $15 billion in funding reductions to K-12 education and community colleges, and some other differences in spending that should be considered in calculating a deficit, the LAO said.

On the spending side, the LAO noted strengths and weaknesses. Plans to withdraw $13 billion from reserves is reasonable, as are the governor’s spending solutions, but the LAO said some spending-related solutions pose challenges, including Newsom’s proposal to pull $900 million from a reserve account meant to support health insurance and cash aid programs for low-income residents, and failing to outline how reducing some education-related spending could achieve $8 billion in savings.

The reserve withdraw would still leave $11 billion in California’s rainy-day fund, which the LAO report called “prudent” since the governor is projecting operating deficits ranging from $4 billion to $9 billion every year through 2026-27.

“Overall, the governor’s budget runs the risk of understating the degree of fiscal pressure facing the state in the future,” the LAO’s office wrote. “The Legislature will likely face more difficult choices next year.”

The LAO recommended lawmakers be mindful of out year deficits by developing a budget that plans for lower revenues over the next three years, maintains a similar reserve withdrawal, develops a plan for school and community college funding, maximizes reductions in one-time spending and applies a higher bar for any discretionary proposals and contains ongoing service levels.

“While the governor’s budget is balanced under the administration’s estimates for 2023-24, this is not the case for future years,” analysts said. “We recommend the Legislature avoid enacting a budget that plans for future deficits.”

The LAO says the state likely cannot afford the governor’s plans to push $8 billion in spending into future years. Though lawmakers could decide later not to fund the delayed expenditures, it would cause pressure on state and local transportation projects, for instance, according to the LAO, because the state departments and local agencies “will already be well underway in planning, financing and beginning to implement these projects, not providing this funding in future years would cause disruptions.”

Analysts also said lawmakers could develop their own plan for addressing school and community college funding. The LAO recommended using the existing balance in the Proposition 98 Reserve to help cover spending above the constitutional minimum in 2022-23. Such a solution would allow the state to reduce spending in 2022.

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