Friday, January 11, 2019

Newsom's Budget/Brown's Budget

Governor Gavin Newsom presented his (first) state budget yesterday for fiscal year 2019-20 (which starts on July 1, 2019). You will hear a great deal in the news media about "surpluses" and such. As usual in California budget-speak, what that term means is fuzzy.

The situation is complicated by the fact that we seem to be proliferating "reserves" in the General Fund, which is essentially the operating budget of the state and is what most people are talking about when they refer to the state budget. (There are in fact many funds outside the General Fund, the biggest of which deal with transportation such as roads and transit.)
You can think of the General Fund as the state's checking account for day-to-day operating expenses. At the start of the fiscal year, there is money in the fund, its "reserve." During the year, money flows in, primarily from taxes, and money flows out for spending on various purposes including debt service.

For decades, the state functioned with just the reserve in the General Fund. Under Gov. Schwarzenegger, voters approved an official Budget Stabilization Account which was supposed to function like a saving account. Money from the General Fund would be diverted into the BSA for a "rainy day." However, in practice the BSA never amounted to much under Schwarzenegger. When Brown came in, he got voters to approve a formula under which the BSA would automatically get some tax revenue diverted from the General Fund. Brown also got the legislature to put some money into the BSA above the formula requirement.

In Brown's final budget (for 2018-19, the budget we are under at present), a deal with the legislature created in addition another reserve: the Safety Net Reserve. So there are now three reserves related to the General Fund. Note that the proliferation of reserves makes understanding the budget more complicated. You can always raise one reserve by bleeding money out of the others and point to the one that increases with pride. But really, it is the sum of the reserves that matters. An increase in the total means that more money came in than went out in a fiscal year, a "surplus." A decrease in the total means more money went out than came in, a "deficit."

When Brown campaigned in 2010, the state was in a very difficult fiscal situation, thanks to the 2008 housing/flaky mortgage crisis and recession. In 2009,, the state at one point ran out of cash and handed out IOUs (called registered warrants) to some to whom money was owed. Part of Brown's campaign was a pledge of no new taxes without voter approval. He tried to get the legislature to approve a tax extension measure for the ballot during the first half year of his renewed governorship, but failed to get needed GOP support.  So the following year, he used the initiative process and got voters to approve Prop 30 which involved a higher income tax bracket at the top and a small sales tax increases.

Voters approved Prop 30 and subsequently approved an extension of its income tax component. The combination of the added tax revenue and the general recovery of the economy which began in mid-2009 brought in sufficient revenue to end the crisis. Brown repeatedly painted himself as the adult in the room who was restraining the legislature from over-spending. Of course, we can't rerun history and know what some other governor would have done. But we can look at Brown's final budget.

When Gov. Newsom presented his budget for 2019-20, he also included estimates for how we are doing now that we are midway through Brown's final budget for 2018-19. According to official figures, the regular reserve in the General Fund decreases by $7.137 billion (a deficit in that reserve). The Safety Net Reserve rises by $900 million ($0.9 billion). And the BSA (rainy day fund) rises by $4.125 billion). Sum these numbers together and you get an estimated net DEFICIT of $2.112 billion in Brown's final budget. (Of course, since we are only midway in that budget, the final figures once we complete the fiscal year will be different. But right now, these numbers are the official estimate/forecast.)

What about Newsom's proposed budget for 2019-20? Newsom keeps nominal General Fund spending at roughly the Brown level of $144 billion. In his budget, the regular reserve drops by $1.573 billion. The Safety net reserve is unchanged, e.g., we put a zero in for that one.** And the BSA/rainy day fund increases by $1.767 billion. The net is a surplus of $194 million (which is about 0.1% of General Fund spending).

In short, the proposed budget is precariously balanced next year after a deficit this year. At his budget presentation news conference, Newsom at one point complained about a headline or article which indicated that when you are at the top of the business cycle it's like being at the top of a mountain. The danger is that you can fall down. You can't fall up. And indeed, the danger is there.

Because there are reserves in the General Fund which Newsom forecasts will total $19.869 billion by the end of 2019-20, there is a cushion for a downturn. Moreover, because there are funds outside the General Fund, there is other cash available to the state (although if you keep taking cash from other funds, those funds will not be able to finance whatever function they are designated to support.)

As Newsom himself has pointed out, the state relies on a highly volatile tax base. About 7 out of 10 General Fund dollars comes from the progressive income tax. The tax is highly sensitive to financial markets (and how top earners react to that market). Downturns, however, have a severe effect, as former governors Davis and Schwarzenegger can attest.

As for UC, the new budget proposes no tuition increase and a 3% increase in total funding, ongoing (including tuition and miscellaneous UC sources) and so-called "one time." Note that "one time" suggests expenditures that occur only once. In fact, much of the funding is for deferred maintenance of physical capital. You can call that "one time" if you like, but the boundary between ongoing maintenance and deferred maintenance is fuzzy.

The university's official response is to praise the governor (who is an ex officio regent).*** One suspects that UC president Napolitano has calculated that there will be less tension between UC and Newsom than there was between UC and Brown (who was never particularly friendly to UC). Whether making nice now will buy anything in the future, as they say, remains to be seen. It might be noted that at one time there was a deal with Brown that would have allowed tuition increases in line with inflation. Not clear where that deal went. Old timers will remember the "compact" with Schwarzenegger (who seemed friendly to UC, at least compared with his successor). But the compact went out the window as soon as the state budget deteriorated.
* and
**There is a discrepancy with regard to the Safety Net Reserve. Brown's enacted budget indicates that $200 million was going into it. The Newsom version of Brown's budget now lists $900. That could be a typo in which case Newsom gets credit for another $700. Or more money could have gone into Brown's fund in which Brown gets the credit. We have gone with the Newsom data in the text.
UPDATE: A new LAO publication reviewing the governor's proposal indicates that there was indeed a typo in the governor's budget document. (See the footnote above marked **.) So Brown's deficit increases by $700 million and Newsom's surplus increases by that amount. The LAO document is at:

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