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Home My WebLink About19 GOVERNOR'S PROPOSED BUDGET INCLUDING RDA ELIMINATIONAGENDA REPORT MEETING DATE: FEBRUARY 15, 2011 Agenda Item 19 Reviewed: Finance Director N/A TO: HONORABLE MAYOR AND COUNCIL MEMBERS AND TUSTIN REDEVELOPMENT AGENCY BOARD MEMBERS VIA: DAVID C. BIGGS, CITY MANAGER & RDA EXECUTIVE DIRECTOR FROM: CHRISTINE SHINGLETON, ASSISTANT CITY MANAGER SUBJECT: GOVERNOR'S PROPOSED BUDGET INCLUDING REDEVELOPMENT AGENCY ELIMINATION SUMMARY Governor Brown has released a 2010-11 Budget proposal, which includes the proposed elimination of redevelopment agencies. The City Council at its meeting of February 1, 2011 continued discussion on this item. RECOMMENDATION It is recommended that the City Council and Redevelopment Agency oppose on record the Governor's proposal to eliminate redevelopment agencies, and authorize the transmittal of correspondence opposing the proposal and participate, as needed, at the state level in opposition activities. Additional impacts of the budget proposal as it would financially impact the City should continue to be monitored, and the Mayor and City staff shall be authorized to take any advocacy positions to minimize impacts on the City. FISCAL IMPACT The proposal would affect all Tax Increment and Low and Moderate Income Housing Funds and the Redevelopment Agency's ability to finance all future capital and public improvements, affordable housing, and other redevelopment projects within the City. BACKGROUND/DISCUSSION On January 10, 2011, Governor Brown released his 2010-11 Budget proposal. An overview by the Legislative Analyst's Office (LAO) is attached. The proposal offers $26.4 billion in "solutions" and allows fora $1 billion reserve. The proposal is expected to go to the State Legislature in March, however, the Assembly Budget Committee has City Council /Agency Report February 15, 2011 Redevelopment Elimination Page 2 already begun meeting and there is discussion and a recommendation from the LAO advocating adoption of urgency legislation. Since the budget proposal also includes new taxes, or at least an extension of taxes due to expire, adoption of the budget would require a 2/3rds majority vote in both the Assembly and Senate to pass. If the necessary approvals cannot be obtained, strategy discussions have already begun to determine how the budget could be adopted with a simple majority under the provisions of the recently approved Proposition 25, with the tax increase component perhaps put on the ballot by the legislature through a budget trailer bill process that many are arguing would only require a majority vote. Perhaps the most significant impact of the Budget proposal is the Governor's intention to do away with local redevelopment agencies by July 1, 2011. However, an additional component of the budget proposal impacts state services such as fire, community- based corrections, management of low level offenders, mental health services, foster care and adult protective services to local government. Although the budget does not include much detail, the county is the likely entity to be given responsibility for these additional services. A shift of program responsibilities from the state to the county could have financial implications for the City or have other community impacts, particularly if offenders have to serve their terms in county facilities and/or on probation rather than in a state facility. Attached for Council consideration is a draft letter opposing the elimination of redevelopment, especially as it affects former military bases, such as the former MCAS- Tustin. It is important that Tustin make its case and that the state recognize, in particular, the unique characteristics associated with former military bases and those communities that have acquired these blighted and antiquated former military facilities. A critical assumption in the City's original acquisition of the former MCAS Tustin site from the Department of the Navy, and our continuing refinement of the business plan for the Tustin Legacy project, was that redevelopment revenues would be available for implementation activities. All former closed military bases that have been included within a Redevelopment Project Area should be exempted from any proposal to eliminate redevelopment. Approved for Forwarding By: ~~~ / Christine A. Shinglet Assistant City Mana r David C. Biggs City Manager Office of the City Council DAFT February 15, 2011 Honorable Jerry Brown Governor, State of California California State Senators California State Assembly Members State Capitol Sacramento, CA 95814 RE: Military Base Closure Communities' Reuse and Redevelopment Programs Are Key to California's Long-Term Budget Deficit Solution Dear Governor Brown and California State Legislators: The City of Tustin stands united with all jurisdictions of closed military bases and with all redevelopment agencies throughout California in support of the continuation of redevelopment. The City of Tustin fully understands the serious financial realities and tough decisions faced by the State's massive budget deficit. We support State efforts to find appropriate long-term solutions to the structural problems with the State's budget, and understand that hard choices will need to be made during these difficult economic times. However, as part of the State's long-term solution to its budget deficit, we urge you to reconsider your proposal to eliminate redevelopment in California and would request that you consider at least exempting former military bases from any such proposal. By so doing, you will support the ability of former military bases to have continued access to redevelopment financing and other appropriate mechanisms to generate significant new jobs, tax revenues and private sector investment. As one of the jurisdictions in California with a closed military base (the former MCAS- Tustin), the City of Tustin itself suffered the loss of approximately 2,000 civilian personnel, 4,105 active duty military personnel, and 3,150 dependents of active duty military personnel, contributing to the local economy. The closure of the former MCAS- Tustin also resulted in the loss of between $121-173 million of capital into the local economy. The City of Tustin strongly believes, and studies have shown, that redevelopment of former military bases presents one of the greatest opportunities for a faster and more sustainable economic recovery for the State. Closed military bases are strategically located throughout the State in highly urbanized, land-constrained regions, and along key transportation routes. The properties offer extraordinary potential for new large-scale mixed-use communities, as well as dynamic logistic and employment centers. Mayor Jerry Amante • Mayor Pro Tem John Nielsen Deborah Gavello • Rebecca "Beckie" Gomez • AI 1~1un-ay The Honorable Jerry Brown February 15, 2011 Page 2 Moreover, since former military bases previously were under federal government ownership, and therefore did not pay State or local taxes, neither the State nor local governments currently receive the fiscal benefits that would accrue from the privatization and reuse of these lands. This has resulted in a dual economic impact to our communities and the State of both loss of jobs and productivity due to base closure and the economic recession. It should be an imperative of the State to move these base closure properties onto the tax rolls and create the thousands of jobs that accompany reuse. A 2007 study indicated that reuse of the unconveyed portions of the 25 closed military bases in California:~l~ • Will support 117,000 permanent jobs and an annual average of 10,000 temporary construction jobs; • Will generate $21 billion in real estate value, the majority of which comes from private investment; • Will result in $276 million in tax revenue annually to the State, which represents the average salary for over 4,900 new teachers; • Will create $152 million in annual tax revenue to local governments, which represents the average salary of 2,000 new police officers; • Will produce 23,000 housing units within predominantly urban infill locations, including more than 6,600 below market rate units; In Tustin's case, development of the former MCAS-Tustin represents one of the largest development projects in Southern California. Upon completion, the master planned community will create over 4,210 dwelling units, of which 1,131 units will be for affordable and homeless households, over 200 acres of open space and parkland, and up to 6.7 million square feet of private commercial development, all of which will generate approximately 24,000 permanent new jobs and up to 32,700 temporary construction jobs. At build-out, the total assessed valuation of the project is estimated at over $4.46 billion which will result in creation of approximately $8.8 million in tax revenue annually to local governments, school districts, and other local taxing agencies who, prior to the base's closure, did not see one dime of revenue from the site. The State and affected local governments will not realize any of these benefits unless Tustin and other closed military bases retain their redevelopment authorities under State Law, including access to tax increment financing. The City of Tustin, in development of the former MCAS-Tustin, and ~1~ Economic Impact Analysis of Delayed Military Base Reuse in California, Economic & Planning Systems, January 2007 The Honorable Jerry Brown February 15, 2011 Page 3 unparalleled by most other development sites. Without continued access to redevelopment tools, including redevelopment financing, these properties may never be able to leverage private investment and become productive parts of our communities. Tustin and its private partners have poured millions of dollars of investment into the community-based planning processes for the former MCAS-Tustin since 1991. The City of Tustin and its Redevelopment Agency have a realistic expectation that the investment that has been made in redevelopment of the facility to date will be recovered locally and also used to generate additional redevelopment activities and job creation. Elimination of redevelopment would deliver a devastating blow and delay further redevelopment activities at former military bases. Further, the extensive public/private planning and development negotiations for the Marine Corps Air Station in Tustin has shown that tax increment financing is critical to the feasibility of recovery programs that support major job growth, sustainable communities, and important affordable housing. We are confident that with your leadership California will solve its budget problems and that investment in closed military bases will help accelerate our economic recovery, produce new jobs and address important environmental and community issues. Thank you for your serious consideration of our request to exempt former military bases from any proposal to eliminate redevelopment in California. The promise of reusing closed military bases throughout all regions of California should be protected and allowed to become a reality through retaining redevelopment tools and key redevelopment financing as authorized in the California Health and Safety Code. Any State budgetary solutions need to recognize the negative economic impacts already experienced by local communities as a result of base closures and realignments and the unique challenges associated with redeveloping former military bases. I would be more than happy to meet with you and your staff members individually or as a group to further articulate the importance of continuing to provide legislative support and relief for former military bases in California. I can be reached at (714) 573-3012. Sincerely, Jerry Amante Mayor cc: California Association of Cities California Redevelopment Association Association of Defense Communities David C. Biggs, City Manager Christine Shingleton, Assistant City Manager 1_.~C) lvlac Taylor. Legislative Analyst .7anuary 12, 201.1 L 'l, - L _ ~ ~ - - ~O~I~~TE~?T~ Executive Summary ..................................................................................................3 Overview ...................................................................................................................5 Economics, Revenue Projections, and Tax Proposals ..........................................10 State-Local Realignment ........................................................................................16 Redevelopment ......................................................................................................20 Expenditure Proposals ...........................................................................................22 2 Legislative Analyst's Office www.lao.ca.gov ~`hq,y ~xr+' X25.4 Billion budget Frobiem €dentifieci by Aclministratior~ fidministration's Estimaie Seems Reasonable. lne administration's ,udget proposa identifies a $25.4 billion budget problem that the Legislature and the Governor must address between nova and the time they agree on a 2011-12 budget package. Our initial assessment is that this estimate is reasonable. The $25.4 billion problem consists of an $8.2 billion deficit that would remain at the end of 2010-11 absent additional budgetary action, as well as an estimated $17.2 billion gap between current-law revenues and expenditures in 2011-12. Reasons for the Budget Shortfall. As we discussed in our November 2010 report, California's Fiscal Outlook, the major reasons for this budget problem are the inability of the state to achieve previous budget solutions in several program areas, the expiration of various one-time and tempo- rary budget solutions approved in recent years, and the failure of California to obtain significant additional federal funding for key programs. A weak economic recovery continues, meaning that elected leaders cannot rely on the economy to solve this huge budget problem. Governor's Plan: Realignment, June Election, and Expenditure Cuts Realignment and Voter-Approved Tax Increases Are Key Elements. Two significant and inter- related themes run through the Governor's budget proposal: (1) his plan to submit a proposed exten- sion of the four temporary tax increases adopted in February 2009 to voters in a June 2011 special election and (2) his plan to restructure the state-local relationship in the delivery of services (by shifting funding and responsibility to local governments for those services). Expenditure Reductions Touch Nearly Every Area of State Funding. The Governor's budget includes many significant ongoing program reductions, posing very difficult decisions for the Legislature. His proposals touch nearly every area of the state budget=often (as in Medi-Cal) with proposed reductions similar to ones suggested by the.prior Governor and rejected by the Legislature. While the Governor's revenue proposals result in a $2 billion increase in the Proposition 9$ minimum funding guarantee for schools above its current-law level, his budget would result in a small programmatic funding decline for K-12 and more significant reductions for community colleges and child care programs. Plan Would Improve Budget Situation Considerably Administration Estimates $1 Billion Reserve at End of 2011-12. The administration estimates that the Governor's plan would cut the 2010-11 deficit in half and leave the state with a $1 billion reserve at the end of 2011-12. The plan relies on legislative approval of statutor~7 changes necessary to achieve budget solutions by March 1. Administration Says Plan Would Eliminate Deficit for at Least a Few Years. The administra- tion projects that the Governor's proposed budget package would eliminate California's budget deficit for at (east the next three years and leave the state with a surplus during that period, albeit a very small one in some years. The Governor proposes that voters approve only five-year extensions of temporary taxes, some of which would be used to fund realigned local services. At this time, it is unclear how the Governor plans to replace the proposed temporary taxes when they expire at the end of this five-year period. www.lao.ca.gov Legislative Analyst's Office 3 LC'"':-`L BINGE LAG Commenfis GOVeYYtOY~F 1`'1'6~OSCt~ 15 Gt ~dd(.i StaYtInLQ F`OIYIi. nE SIeteaCes anotl-ier huge budget aeficit. r: ;fight of this dire circumstance; tl'ie Governor's proposal includes reductions in nearly every area of c tt'ie stale budget arc a package o, revenue proposals treat merit serous 1eg15lat1Ve COZ]SlCleratlor,. ~~\~f think the Governor's package is a good starting point for Iegislative deliberations. Focuses on Multiyear and Ongoing Solutions. We credit the Governor's efforts to craft a budget plan that is heavily focused on multiyear and ongoing solutions. As such, his proposal shows great promise to make substantial improvements in the state's budgetary health-both in the short run and over the long term. The administration, in fact, estimates that its plan would eliminate the state's deficit-at least for the next three fiscal years. Our early assessment of the outyear effects of the Governor's budget is somewhat less favorable than the administration's. Nevertheless, its adop- tion would go a long way toward eliminating the state's persistent budget gap. Governor Puts Some Bold Ideas on the Tabte. The Governor's proposals to "realign" state and local program responsibilities and change local economic development efforts have much merit. His realignment proposal would shift $5.9 billion in state program costs to counties and provide a comparable amount of funds to support these new county commitments. We believe that this type of decentralization of program delivery and authority could promote innovation, efficiency, and responsiveness to local conditions. The Governor also puts forward dramatic changes in the area of local economic development by proposing the elimination of redevelopment agencies. We think this makes sense, as the state's costs associated with redevelopment have grown markedly over the years even though there is no reliable evidence that the program improves overall economic performance in the state. Still...Some Significant Risks in the Governor's Plan. 'The Legislature should favor budget .~,,~ solutions that have a strong likelihood of actually achieving budgeted savings or revenue increases. As such, there is significant work ahead to fill in the details of some of the Governor's ambitious, complex budget proposals-especially the realignment and redevelopment proposals, which involve many legal, financial, and policy issues. Acting to pass key budget legislation by March 1, as the Governor proposes, would be helpful even if a special election were not called. Early budget actions give departments more time to implement spending reductions. If it adopts the Governor's timeline and special election approach, the Legislature would have the opportunity in the months after March 1 to review routine budget proposals for departments, adopt clean-up legislation to clarify elements of this complex budget package, and consider alternative budget-balancing solutions in case voters reject the June ballot measures. In total, around $12 billion of the Governor's proposed budget solutions (tax extensions and changes to Proposition 10) are dependent upon voter approval in June. Conclusion California's elected leaders need to take big steps toward restoring the state government to fiscal solvency and rebuilding the trust of California's residents in state government. The Legislature's most important function is its control of the state budget. In drafting a 2011-12 budget plan, the Legislature will have to make difficult decisions on both its spending and tax commitments, but it also has the opportunity to reorder state and local government functions to improve the delivery of public services. In the coming weeks, we will work to provide additional guidance on the Governor's proposals and, where appropriate, offer alternatives to them. 4 Legislative Analyst's Office www.lao.ca.gov ~~~ ~~ ~u~e_- K~~~ The Governor releasee riffs proposes ~C1~-~ budget package on januar; iC; 2Cii; One 4Neek aiier his inauguration. 'his report is our ollice's initial reaction to this package. ]n the coming weeks; as more information becomes available from the Governor Proposes $26.4 Billion of Genera( Fund Solutions. In tota; t;ie Governor proposes Total Cf ~LE.~ billion iri blldget sollltion~. if aQOpteG and achieved in full, the Governor's budget plar_~ would leave the state with a reserve of around administration, we will provide further analysis to $1 billion at the end of 2011-12. assist the Legislature in its budget deliberations. Administration Estimates a $25.4 Billion Shortfall Failed Budget Solutions and Expiring Measures Contribute to the Shortfall. Based on a review of current-law General Fund revenues and program spending, the 2011-12 Governor's Budget estimates that, without corrective action by the Legislature and the Governor, the state would end 2011-12 with a $25.4 billion deficit. Under the administration's estimates, the Legislature and the Governor would need to identify at least $25.4 billion of General Fund budget solutions between now and the time that they adopt the 2011-12 Budget Act. Specificall}; the administra- tion estimates that the General Fund will end 2010-11 with a deficit of $8.2 billion (as opposed to the $1.5 billion reserve balance assumed when the October 2010 budget package was adopted). For 2011-12, the Governor estimates that the gap between expenditures and revenues will be $17.2 billion. Our office also pegged the size of the 2011-12 budget problem at $25.4 billion in our I`TOVember 2010 report, California's Fiscal Outlook. As we discussed in that report, the reasons for this year's state budget shortfall include the inability of the state to achieve previous budget solutions in several program areas, the expiration of various one-time and temporary budget solutions approved in recent years, and the inability of the state to obtain signifi- cant additional federal funding for key programs. How the Budget Addresses the Shortfall A Mix of Expenditure Reduc#ions and Tax Increases. Figure 1 (see next page) shows our office's categorization of the $26.4 billion in pro- posed budget solutions. The Governor proposes to reduce current-law General Fund state expendi- tures by $12.5 billion, as summarized in Figure 1. (These expenditure-related solutions include both reductions in services and benefits and use of other funding sources in lieu of the Genera] Fund.) The Governor proposes a total of $14 billion in new rev- enues, of which $3 billion is attributed to 2010-11. The additional revenues to be deposited in the General Fund would result in a $2 billion increase in the Proposition 98 minimum funding guarantee for schools and community colleges. (The adminis- tration scores its revenue package at $12 billion over two years: the $14 billion described above, less the $2 billion increase in the Proposition 98 guarantee. Figure 1 categorizes the Proposition 98 change separately from the revenue package.) The remain- ing $1.9 billion in solutions comes from borrowing from special funds and other sources. We discuss the significant proposals in the Governor's budget in more detail later in this report. Realignment and Voter-Approved Revenues Are Key Elements. Two significant and inter- related themes run through the Governor's budget package: (1) his plan to submit a proposed exten- sion of the four temporary tax increases adopted in February 2009 to voters in a June 2011 special elec- tion and (2) his plan to restructure the state-local www.lao.ca.gov Legislative Analyst's Office 5 ~G`..-;~ BuDG~- -- rE~atlOnstiIp Iri irE ~Ei1VEr~%Ci Sc="'~ICE~ i u'v Sriifilr.~ funding ar_~d ?"esponsibiit?- tc 1cca~ ~overnrnents for those services;. Tu-c cf the temporary tax incr eaSES prOpOSed fOr the une SpECla etECtlOn ballot (the percentagE point sales tax increasE and the 0.~ percentage point inaease in tt]e vehicle Figure 1 Shift redevelopment funds to Medi-Cal and trial courts - $1.7 $1.7 Reduce benefits and provider payments and charge copayments in Medi-Cal - 1.7 1.7 Impose time limits, grant reductions, and service cuts for CaIWORiCs - 1.5 1.5 Reduce UC and CSU budgets - 1.0 1.0 Use Proposition 10 reserves and some ongoing revenues for children's programs - 1.0 1.0 Fund transportation debt costs primarily using weight fees $0.3 0.8 1.0 Use Proposition 63 funds to support community mental health services - 0.9 0.9 Reduce developmental center and regional center spending - 0.8 0.8 Shift some adult and all juvenile offenders to local jurisdictions - 0.6 0.6 Reduce IHSS hours of service, limit domestic services, and tighten eligibility - 0.5 0.5 Reduce state employee salary and medical costs - 0.4 0.4 Suspend, defer, or repeal state mandates - 0.3 0.3 Reduce SSI/SSP grants for individuals to the federal minimum - 0.2 0.2 Adopt unallocated funding reduction for the courts - 0.2 0.2 Reduce Receiver's inmate medical care budget 0.1 0.2 0.2 Achieve efficiencies in state operations - 0.2 0.2 Reduce other spending - 0.3 0.3 Subtotalsa ($0.4) ($12.1) ($12.5) xE ReL~l~i~i~s~ - _ ~- General Fund Revenue Solutions Extend the 0.25 percentage point personal income tax surcharge for five years $1.2 $2.1 $3.3 Extend reduction in dependent exemption credit for five years 0.7 1.2 2.0 Make single sales factor mandatory for multistate firms 0.5 0.9 1.4 Repeal enterprise zone tax credits 0.3 0.6 0.9 Adopt other revenue measures 0.4 0.1 0.5 Subtotals ($3.2) ($4.9) ($8.1) Local Realignment Revenue Solutions Extend 0.5 percentage point vehicle license fee increase for five years $1.4 $1.4 Extend 1 percentage point state sales tax increase for five years - 4.5 4.5 Subtotals (-) ($5.9) ($5.9) Total Revenue Solutions ($3.2) ($10.9) ($'14.0) ~- ens _. n - " 8orroHr ~~~-~ ~ _ -" _ r. ~~ . ~, Loans, transfers, and loan extensions from special funds $0.5 $0.9 $1.4 Borrow from Disability Insurance Fund for UI interest payments - 0.4 0.4 Other loans and transfers - 0.1 0.1 Subtotals ($0.5) ($1.4) ($1.9) ''~, 6 Legislative Analyst's Office www.loo.ca.gov Budget Solutions Proposed by the Governor (Genera/ Fund Beneflf, in Billions) Subtotal may not add due to rounding. IHSS = In-Home Supportive Services; UI =Unemployment Insurance. license fee [~TLFj would be dedicatee tG rending the realignment of programs from the state tc local entities. 'The Governor also proposes a signi leant change tc the way that local redevelopment acti ~~ i- ties are `ended. Most Solutions Extend Beyond the Budgei Year. Apart from the temporary borrowing of $1.9 billion, the vast majority of the proposed budget solutions are intended to last beyond the budget year. In the case of the temporary tax increases, they would be in effect for five years. General Fund Condition Solutions Estimated to Leave State With $1 Billion Reserve at End of 2011-12. Figure 2 shows the administration's estimates of the General Fund condition under the Governor's proposals. The esti- mated deficit at the end of 2010-1 l would be cut in half to about $4.1 billion. In 2011-12, revenues would decline 4.8 percent to $89.7 billion, while expendi- tures would decline 8.2 percent to $84.6 billion. The state would have an operating surplus of $5.1 billion, offsetting the carry-in deficit and leaving a $1 billion reserve at the end of 2011-12. Administration Says Its Solutions Would Figure 2 Governor's Budget Genera! Fund Condition (Dollars in Mi/lions) Eliminate the deficit for at least a Few fears. lY'ie administration projects that the proposed budge: solutions would eliminate the states budget deficits ror the next three years and leave the state with a surplus; albeit ~ very small one in some years; through this period. (Specifically, the administra- tion estimates that the General Fund would have an operating surplus of $15 million in 2012-13, $2.4 billion in 2013-14, and $7 million for 2014-15.) At this time, it is unclear how the Governor plans to replace the proposed temporary taxes-which are to be used to fund ongoing realigned local services-when they expire at the end of five years. Absent a plan to replace these taxes, there could be a substantial fiscal "cliff 'for the General Fund after the five-year period. Proposed Accelerated Budget Timeline Administration Proposes Trailer Bills-Not Budget Act-by March I. The administration has proposed an accelerated budget process with a target date of March 1 to have all of the enabling legislation necessary to implement the budget solutions in place. It is our understanding that the administration does not propose to have a budget act passed by March 1, but rather only "trailer bills" (the legislation that makes the statutory changes required to implement budgetary solutions or to place items on the special election ballot). This approach would allow the Legislature and the administration to Expenditures $87,237 $92,208 $84,614 -8.2% put in place the budget Ending fund balance -$5,343 -$3,357 $1,725 solutions required to Encumbrances $770 $770 $770 address the budget deficit ' ~ in March and then final- ` Special fund for economic uncertainties. ]Ze aCtlOn On the budget www.lao.ca.gov Legislative Analyst's Office 7 Prior-year fund balance -$5,147 -$5,343 -$3,357 Revenues and transfers 87,041 94,194 89,696 -4.8% Total resources available $81,894 $88,851 $86,339 zo -~ ~i.,~ac=- bi ~-pi"eSiil2"iablti i r: J uP.c-~riCi" t0 tree ~,egiSlatiire £ u ne i~ corstitutienal deadline I^or adopting balanced budget. In the Vie?~~~ O t!"ie administra- tion; ti~?is would alo?~~ per the incorporation o anV upGateG ~a1% 1-CeViSGis IOi'eCaStS; aS Wel! aS t}'ie results of the special election. Most or all of the trailer bills passed by March under the administration's approach seemingly would require atwo-thirds vote of each house of the Legislature. This is because Proposition 25 (approved by voters in November 2010) appears to require passage of a budget act to designate trailer bills needing only a majority vote. June Special Election. 1t is our understanding that the Governor proposes to put two ballot measures before the voters in a June special election: (1) a constitutional measure to extend the temporary tax increases by another five years and to dedicate two of these revenues to realignment and (2) a measure to change Proposition ]0 to allow the funds to be used in the Medi-Cal Program. (In addition, two measures have already qualified for the next statewide ballot through the initia- tive process: a measure to change the term limits currently in place for legislators and a measure to increase cigarette taxes to fund additional cancer research.) We understand the Governor ~~ill ask that a separate measure be placed on a future election ballot to allow new mechanisms for funding redevelopment at the local level. LAO COMMENTS The Governor's Package Is a Good Starting Point Reasonable Estimate of the Size of the Budget Problem. Our initial assessment is that the Governor's budget provides a reasonable estimate of the size of the budget problem the Legislature and the Governor must address between now and the time they agree to a 2011-12 budget package. ?4~iost; but rot ai; budget solutions also appear to be scored reasonably, assuming that theti are enactec on the Governor's accelerated budget legislation deadline.'We discuss our reactions to sped c budget proposals throughout this report.; Expenditure Reductions Touch Nearly Every Area of State Funding. The Governor's budget includes many significant ongoing program reductions, posing very difficult decisions for the Legislature. His proposals touch nearly every area of the state budget-often (as in Medi-Cal) with proposed reductions similar to ones suggested by the prior Governor and rejected by the Legislature. While the Governor's revenue proposals result in a $2 billion increase in the Proposition 98 minimum funding guarantee for schools above its current-law level, his budget would result in a small program- matic funding decline for K-12 and more significant reductions for community colleges and child care programs. Tax Package Includes Some Sound, Policy- Based Proposals. The Governor's plan includes several tax proposals that we have previously recommended, including adoption of mandatory single sales factor apportionment for multistate and multinational firms and elimination of enterprise zone tax credits. As we describe later in this report, the proposed extension of the temporary increases in income and sales tax rates poses more difficult issues, but we think the Governor's proposed tax extensions merit serious consideration. Focuses on Multiyear and Ongoing Solutions. We credit the Governor's efforts to craft a budget plan that is heavily focused on multiyear and ongoing solutions. As such; his proposal shows great promise to make substantial improvements in the state's budgetary health-both in the short run and over the long term. The administration, in fact, estimates that its plan would eliminate the state's deficit-at least for the next three fiscal years. ~'""~' 8 Legislative Analyst's Office www.lao.ca.gov t.. Gur early assessr?:ent oi^ the out-year effects o; trE Governor's budget is somewhat less iaverable tl-iar the administration s. l~'evertheiess; its adoptio `~ioti!Ci go a iOrig Vt'aV toward eliminating ire Staten persistent budget gap. Governor Puts Some Bold Ideas on the Table Restructuring the State-Local Relationship. The Governor's budget includes a major "realign- ment" of state and local program responsibilities. It would shift $5.9 billion in state program costs to counties and provide a comparable amount of funds to support these new county commitments. We believe there is much merit in the proposal as decentralizing program delivery and authority could promote program innovation, efficiency, and responsiveness to local conditions. Overhauling Redevelopment. The budget also puts forward dramatic changes in the area of local economic development, by proposing the elimination of redevelopment agencies. We•think this makes sense, as the state's costs associated with redevelopment have grown markedly over the years even though there is no reliable evidence that this program improves overall economic performance in the state. Stifl...Some Significant Risks in the Governor's Plan Realignment and Redevelopment Proposals Pose Challenges. While the proposals on realign-. ment and redevelopment have great promise, both will require considerable work by the Legislature to sort through many legal, financial, and policy issues. Implementing these complex proposals in away that ensures the programmatic benefits and budgetary solutions will be challenging-especially given the short time frame laid out in the budget plan. Many Details Still Need to Be Worked Out. As some of the solutions proposed by the Governor are compiex and cut across many aspects of goverr_- ment; it is unsurprising that just one 1~~eek into the ne`a- administration's tern-i; there are areas where SpECiI1C implEmeritation and practical details are miSSirig. 1-or example, the budget does riot inGicatE specifically how much of the proposed savings in the Department of Developmental Services (DDS) would be achieved. This lack of detail should not preclude a prompt beginning to legislative consid- eration of any proposal. Nevertheless, the imple- mentation details-the administration's approach to navigating the legal and practical complexities of many proposals-will determine the level of risk and the corresponding likelihood of successful implementation. As we have stated previously, we suggest that the Legislature favor budget solutions that have a strong likelihood of actually achieving budgeted savings or revenue increases. Some Savings Estimates Are Optimistic. As we discuss in detail later in this report, our initial review of the Governor's budget. suggests that in some key program areas, the administration's esti- mated savings are optimistic. These areas include some proposals in corrections, state employee health plans, and In-Home Supportive Services (IHSS). In addition, the budget plan includes $200 million of unallocated reductions to state operations for efficiency purposes. In some cases, the administration has not provided significant detail yet on how the savings from these proposals would be achieved. Historically, such lack of detail often has been associated with budget actions that fail to produce the desired level of savings. Proposed budget solutions of over $1 billion could be affected, based on our very early review. Much Would Depend on the Outcome of the June Special Election. Under the Governor's proposals, around $12 billion of the proposed budget solutions (tax extensions and changes to Proposition 10) will depend on-voter approval in the June special election.lf the voters reject some www.lao.ca.gov Legislative Analyst's Office 9 r., .' t~ .-?~ ,:CGS: Gr ail of these SG1utiOr+S; the Legislature would neec tG promptl~% enact aGC'lltlOnal C'~itS Gr alternati~,~e revenue solutions prior tG the start Gfthe neu> risca' veal" Ir !t!~'• Legislature Needs to Act Quickly Accelerated Timeline. If the Legislature accepts the administration's proposed approach for a June special election, the proposed timeline-to adopt key budget-balancing statutory measures by March 1-has significant advantages. Aside from the timing requirements for the special election and the desire to provide voters a clear idea of the Legislature's path to balancing the budget, many of the Governor's proposals will require lead time to plan and implement. Given the proposed acceler- ated budget process, the Legislature will need to work quickly with the administration to develop details on each of the proposals and to develop well-crafted legislation on how the solutions are to be implemented. If the Legislature chooses different solutions than those presented by the Governor, a similarly accelerated timeline may still be needed to maximize the opportunity to realize the full amount of budgeted solutions. In the months following March 1, the Legislature would have the opportunity to review routine budget change proposals for departments; adopt clean-up egisla- tion needed iG clarify elements of this complex budget package; and consider alternative budget- balancing solutions in case voters reject t17e ~urie ballot measures. The Legislature Faces Many Critical Decisions in the Coming Weeks. If the Legislature chooses the Governor's proposal as a starting point, there are still a number of critical questions to be addressed, such as the Legislature's preferred mix of spending cuts and revenue increases, the amount of authority to be devolved to the administration in the form of unallocated or unspecified reductions in some departmental budgets, and what actions (if any) to put before the voters in a June special election. Also, although the Governor's proposal contains many new ideas, there are a signifitant number (such as those proposed in Medi-Cal) that the Legislature has previously considered and rejected. The Legislature will need to consider if a change of approach to these proposals is appropri- ate at this time or whether there are alternative actions that it prefers. In the. coming weeks, we will work to provide additional guidance on the Governor's proposals and, where appropriate, offer alternatives to them. E~p~~~CS, RE~/ENU~ PF~C.~~CT~~[~~~ AN[~ TAX PRC~PQSAL~ The Governor's budget package includes the administration's forecast of national and state economic activity and state revenues-including its tax increase and other revenue proposals. (We refer to the forecast of state revenues without the Governor's revenue proposals as the "current-law" revenue forecast.) This section first discusses the economic and current-law revenue forecast of the administration. Next, it describes the Governor's major revenue proposals. ECONOMIC AND REVENUE FORECAST Economic Forecast Current Modest Recovery Forecasted to Continue. The administration's new economic fore- cast assumes continuation of the currently modest economic recovery, including ongoing actions of the Federal Reserve-through its support of low '",~""~: interest rates and a policy known as "quantitative easing"-to support the recovery. As shown in 10 Legislative Analyst's Office www.lao.ca.gov 201 ~-f2 BUDGE Figure 3, the administration's January 2011 eco- nomic forecast is more pessimistic than our office's May 2010 forecast, upon which the revenue esti- mates in the October 2010 state budget were based. The budget's 2011 forecast reflects the economy's generally disappointing performance in 2010 and is quite consistent with the economic forecast our office released in our November 2010 publication, California's Fiscal Outlook. Economic Forecast for 2011 May Be Too Pessimistic. In December 2010, Congress enacted a major tax and unemployment benefits measure. Among other actions, this federal measure extended federal income tax cuts adopted during the prior presidential administration, as well as long-term unemployment insurance benefits. These actions appear to be reflected in the administration's new economic forecast. The administration notes, however, that, its forecast does not consider the new payroll tax relief, one component of the recent federal legislation. This omission occurred because much of the administration's work on the forecast had to be completed prior to passage of the federal legislation. As shown in Figure 3, the most recent li.S. economic forecast of IHS Global Insight, a national forecasting firm, projects significantly more robust growth in 2011 due in part to the federal tax measure. Currently, our office's national economic outlook aligns more with that of IHS Global Insight. Accordingly, there appears to be some upside for the national economy in 2011. Since California's economy generally rises or fall with the U.S. economy, this upside has the potential to affect state revenues positively in 2010-11 and 2011-12. 2012: Modest Recovery and Continued High Unemployment. For 2012, as Figure 3 shows, the administration's new national economic forecast tracks closely with that of IHS Global Insight. The feared "double-dip".recession now seems quite unlikely. Like our office's recent outyear forecasts, however, the administration's forecast assumes that the economic recovery will continue to be modest and the state unemployment rate will remain above 10 percent for a prolonged period. Weak housing markets and the depressed level of home building also should remain major drags on the California :~~.-. figure 3 United States Percent change in: Real Gross Domestic Product 3.0% 2.2% 3.2% 3.1% 2.9% 2.9% Employment 2.0 1.0 1.4 2.7 1.8 2.0 California Percent change in: Personal income 4.4 3.8 NA 4.4 4:0 NA Employment. 0.9 1.5 NA 1.5 2.5 NA Housing permits (thousands) 70 74 NA 93 122 NA Unemployment rate (percent) 11.9 12.1 NA 10.9 11.3 NA a The assumptions for state revenue a dopted in October 2010 in the 2010-77 Budget Act wer e derived from our office's May 2010 economic and revenue forecast. NA =. Not applicable. IHS Global Insight does not produce state-level forecast information of this type. www.lao.ca.gov Legislative Analyst's Office 11 201 i-i2 BUDGE- economy. All of these factors are likely to depress ~ Various technical adjustments, including consumer confidence and, therefore, the willing- updated assumptions concerning accruals ness and ability of individuals and firms to spend of revenues to particular fiscal years. and invest for some time. California's elected The bulk of the remainder of the decrease in leaders cannot count on the near-term budgetary problems of state and local governments to be solved by a rebounding economy. Current-Law Revenue Forecast Current-law revenue forecasts project receipts of taxes and other revenues, without incorporating proposed tax changes. The administration develops a current-law revenue forecast as part of its budget development process. 2010-11. The administration now forecasts current-law General Fund revenues and transfers of $90.7 billion in 2010-I1. This is up by $3.7 billion (4.2 percent) from 2009-10 revenues, but down by $3.5 billion (3.7 percent) from the revenue forecast adopted with passage of the state budget in October 2010. This $3.5 billion decrease from the 2010-11 budget act assumptions-including a $1.7 billion decreased assumption for personal income tax (PIT) revenues-includes: 2010-1 I current-law revenues probably results largely from the new economic forecast. It appears that these forecast-related differences represent a relatively small portion of the $3.5 billion decrease. 2011-12. In the current-law revenue forecast for 2011-12, General Fund revenues and transfers drop from forecasted 2010-11 levels by $7.2 billion (7.9 percent) to a total of $83.5 billion. This decline reflects the scheduled expiration in current law of temporary increases in sales and use taxes (SUT), PIT, and VLF that were adopted by the Legislature in February 2009. The administration's SUT estimate for 2011-12 is $1.3 billion lower than our November 2010 state budget forecast, but $1.1 billion of this difference results from the administration's treatment of the 2010 "fuel tax swap" in its forecast. The swap eliminated General Fund sales taxes on gasoline, but our November forecast assumed the swap would end in November 2011 due to the passage • A $782 million decrease due to recent federal of Proposition 26. By contrast, the administration tax changes resulting in the loss of all planned makes no such assumption in its current-law fore- estate tax revenues in 2011 and 2012 • About $400 million of decreased state revenue in 2010-11 due to expected changes in taxpayer behavior as a result of the recent federal tax legislation. The Governor's budget proposal assumes that taxpayers delayed realizing some capital gains, dividend, and other income from 2010 to later due to the extension of lower tax rates for these items. • Around a $400 million decrease resulting from Proposition 22's prohibition of the state borrowing of funds from certain transportation accounts. cast. Furthermore, the Governor's budget package proposes that the Legislature "re-enact" the swap with atwo-thirds vote. Accordingly, if one excludes the fuel tax swap, the administration's current-law forecast is very similar to our November forecast for SUT. LAO Comments Administration's Economic Forecast May Be Too Pessimistic for 2011. As described above, the effects of the recent federal tax legislation, among other factors, cause us to be somewhat more opti- misticthan the administration about the course of the national economy in 2011. The various ,,"""M~, 12 Legislative Analyst's Office www.lao.ca.gov 2Q1l-12 BUDGE• federal tax cuts, including the payroll tax, and tl'ie extended unemployment benefits seem likely tc have a stronger near-term stimulative effect on economic activity than reflected in the Governor's budget forecast. This, in turn, should promote stronger economic activity in California in 2011. As shown in Figure 3, the administration's forecast for U.S. gross domestic product growth in 2011 is about 1 percentage point below that of some other forecasters. As a rule of thumb, a 1 percentage point increase in national economic growth translates roughly to similar growth in the state economy and revenues. Initial Impression: Revenue Forecast Is Reasonable. For 2009-10, 2010-11, and 2011-12 combined, our initial assessment is that the admin- istration's revenue forecast is reasonable. Our early impression is that there is somewhat more potential for an "up side" to the revenue forecast than a "down side." In 2010-11, monthly "agency cash" revenues from the General Fund's "Big Three" taxes (PIT, SUT, and corporation tax [CT)) are about $1 billion above the administration's monthly forecast through December 2010. Recently, PIT withhold- ing-largely derived from wages and salaries-has been running more than 10 percent above the same months from 2009. Sales taxes also have been performing reasonably well. We are optimistic that these trends will continue for the rest of the fiscal year. Balancing this optimism, however, is the weak performance to date of CT revenues-$355 million (8.9 percent) below the 2010-11 forecast through December-and our uncertainty that estimated PIT payments will meet monthly targets over the next six months. For 2011-12, our initial impression is that the current-law revenue forecast appears reasonable. While the administration's overall economic fore- cast is cautious, the budget package also assumes the resumption of significant growth in net capital gains by taxpayers-an increase of 29 percent in 2011 and 24 percent in 2012. The huge amount of accumulated capital losses by investors resulting from the implosion of financial, housing, and othe?~ asset markets in recent years makes it particularly difficult to rely on such positive capital gains assumptions for purposes of budgetary planning. Moreover, an enormous stock of corporate net operating losses-carried forward from prior years, but unable to be used by firms through tax year 2011 due to provisions included in recent budgets- makes us somewhat cautious about the 2011-12 baseline CT forecast as well. GOVERNORS RfVENUE PROPOSALS The key fea#ure of the Governor's revenue proposals is his request that the Legislature place before voters in June 2011 measures that would extend for five years the four temporary tax increases approved in February 2009: • A 0.25 percentage point increase in each of the state's basic marginal rates for the PIT, which would be extended to apply to tax years 2011, 2012, 2013, 2014, and 2015. • An extension (as above, for tax years 2011 through 2015) of the temporary reduction of the PIT dependent exemption credit to the same level as the personal exemption credit. (For the 2010 tax year, the personal exemption credit was $99. Prior to the temporary tax increases, the dependent exemption credit was $309.) • An extension of the 1 percent SUT rate increase for fiscal years 2011-12 through 2015-16. This would maintain the state General Fund's share of the total tax rate at 6 percent. • An extension of the 0.5 percent. VLF increase for fiscal years 2011-12 through www.fao.ca.gov Legislative Analyst's Office 13 1G1 i-12 BUDGET 2015-16, maintaining the rate at 1.15 percent. increased Revenues for General Fund and Proposed Local Realignment Funds $9.6 Billion More Revenues and Transfers for General Fund Over Two Years. As shown in Figure 4, the Governor's budget package would increase General Fund revenues and transfers by $9.6 billion over 2010-11 and 2011-12 combined. Of this $9.6 billion, about $5.2 billion ($1.9 billion in 2010-11 and $3.3 billion in 2011-12) consists of revenue from the proposed extension of the two temporary PIT increases described above. The Governor also proposes that the Legislature enact two measures that would primarily increase CT rev- enues, but also would increase payments by certain PIT filers. These two measures would: (1) replace the optional single sales factor method for apportioning a multistate or multinational firm's taxable income to California with an apportionment method that would require companies to use the single sales factor method and (2) eliminate tax credits for certain investments made in enterprise zones. Combined;-these two proposals would increase General Fund revenues by $811 million in 2010-11 and $1.5 billion in 2011-12. The administration's General Fund estimates also assume $1.4 billion of new loans, transfers, or loan extensions from state special funds over the two fiscal years, a $362 million loan to the General Fund from the Unemployment Compensation Disability Fund to pay the state's unemployment insurance loan interest obligations to the federal government, and several other smaller revenue measures. $5.9 Billion for Proposed Local Realignment Funds in 2011-12. Under the Governor's pro- posal, voter approval to extend the temporary tax increases also would provide $5.9 billion of SUT and VLF funds for the proposed local govern- ment realignment funds-outside of the General Fund-in 2011-12. Over the five-year extension, Personal Income Tax $45.5 $2.3 $47.8 $46:2 $3.6 $49.7 Sales and Use Tax. 26.7 - 26.7 24.1 - 24.1 Corporation Tax 10.8 0.7 11.5 9.7 1.2 11.0 Subtotals, "Big Three" ($83.0) ($3.0) ($86.0) ($79.5) ($4.8) ($84.8) Insurance Tax $1.8 - $1.8 $2.0 - $2.0 Vehicle license feeb 1.5 - 1.5 0.2 - 0.2 Sales of fixed assets _ 1.2 - 1.2 - - - Otherrevenues 2.3 - 2.3 2.2 $0.1 2.3 Net transfers and loans 1.0 $0.5 1.4 -0.8 1.2 0.5 Total Revenues and $90.7 $3.5 $94.2 $83.5 $6.1 $89.7 Transfers a Does not indude proposed 54.5 billion of increased sales and use tax and 51.4 billion of vehide license fee revenue, which would be deposited to local realignment funds- not the General Fund b Revenues for 2011-12 consist of late receipts of prior years' fees payable to the General Fund. °'""`,,~ 14 Legislative Analyst's Office www.lao.ca.gov Figure 4 Gouernor's Proposals Increase General Fund Revenues and Transfers by $9.6 Billion Over Two Years (In Billions) 201 i-i2 BUDGET ~... these amounts would be expected to grow. The administration's forecast assumes that the SUT and VLF amounts grow to $7.3 billion in 2014-15. Estimates on Budget Proposals Incorporate IVewAccrual Method. Generally, the state oper- ates under an "accrual" accounting system that requires recognition of revenues and expenditures to the fiscal year in which they are realized. The administration's budget package estimates 2010-11 and 2011-12 revenues from its PIT and CT proposals with a new budgetary accrual technique that accrues a portion of final payments to the prior fiscal year. Such final payments previously have been accrued to the same fiscal year in which they are received. The new accrual method increases estimated General Fund revenues in 2010-11 and 2011-12 (combined) by $860 million. By changing year-over-year revenue growth, this method may affect calculation of the Proposition 98 minimum funding guarantee. There may be legitimate accounting reasons to adopt the new approach, but additional justification from the administration is needed. Large Elements of Governor's Tax Proposals Are Sound, Policy-Based Proposals. In prior pub- lications and legislative testimony, we have voiced support for enactment of several of the Governor's key revenue proposals: LAO Comments Basing Budget Plan on June 2010 Election Obviously Carries Some Risk. With atwo-thirds vote of each house, the Legislature would have the option of approving extensions of the tem- porarytax increases without resorting to a vote . of the people. The Governor, however, proposes submitting the temporary tax increase measures to voters. These proposed temporary tax increases provide over $11 billion of the Governor's proposed $26 billion in budget solutions. The proximity of the proposed early June 2010 special election date with the Legislature's June 15 deadline for enacting a balanced budget highlights the risks inherent in this approach. Should voters reject the measure, the Legislature would have to ensure that alternate budget-balancing measures were promptly put into place. • Adoption of a mandatory single sales factor apportionment method for the income of multistate and multinational firms. • Elimination of enterprise zone tax credits. • Reduction of the PIT dependent exemption credit to the same level as the personal exemption credit. • Adoption of a VLF rate of around 1 percent-similar to the base tax rate for other property. We recommend that the Legislature either approve these proposals and enact them into law or, as the Governor suggests for. the temporary tax measures, submit a request to voters to approve the increases. Temporary PIT and SUT Rate Increases Merit Consideration. The proposed extension of the temporary increases in the PIT and SUT rates poses more difficult issues. The current rates are some of the highest in the nation, and the continuation of the rates would affect the work and investment decisions of many individuals and firms. On the other hand, as temporary increases, they would have less negative impacts on economic planning and decision making than permanent ones. More importantly, adoption of the proposed temporary tax extensions would "buy time" for the Legislature to develop additional ongoing solutions in future years while delaying additional cuts on top of the billions of dollars in permanent spend- ing reductions already proposed by the Governor. Accordingly, we think that the Governor's proposed tax extensions (or something. similar) merit serious consideration. www.lao.ca.gov Legislative Analyst's Office 15 ~Oli-1~ BUDGE i ~~ Major Proposals Major Realignment of State-Local Programs. A centerpiece of the Governor's budget proposal is a major realignment of program duties, similar to the plan enacted by the state in 1991. In short, the Governor's plan raises $5.9 billion in taxes, and shifts $5.9 billion to counties to implement increased program obligations. To enable counties to manage their increased fiscal responsibilities, the administration proposes giving them increased authority over the realigned programs. Although much of the Governor's proposal makes sense, certain key elements-including the extent of county program authority and the meth- odology for allocating funds-still are under devel- opment. As such, the Legislature will have much work to do in reviewing the proposal, shaping it to meet its policy objectives, and potentially placing a funding measure before the state's voters in June. Proposed Revenues. Under the plan, the state's voters would decide whether to extend by five years two tax increases due to expire on June 30, 2011: a one cent sales tax and the 0.5 percent VLF General Fund rate. If the voters approve these tax extensions, the revenues would be dedicated to implementing the realignment plan. After the taxes expire in 2016, the state would be responsible for providing local governments with replacement revenues, but these revenues are not specified in the plan. If voters do not approve the proposed tax extensions, the realignment plan would not be implemented. The administration indicates, however, that it would continue with its plans to shift to counties the responsibility for certain lower-level adult and juvenile offenders. The administration indicates that it did not include the $5.9 billion realignment revenues in its calculation of Proposition 98's minimum funding guarantee because the new realignment revenues would be allocated to counties, not the state. Multiyear Approach. Farts of the administra- tion's proposed realignment are phased in over time. For example, the community supervision responsibilities sent to counties would expand over time as more state inmates were released from prison. The administration estimates that counties would be responsible for about 18,500 parolees in the budget year, growing to 66,900 upon full imple- mentation in 2014-15. In addition, the Department of Forestry and Fire Protection (CalFire) would continue to provide fire protection and medical emergency response until local governments assumed these responsibilities. During the first years of this realignment plan, therefore, some of the realignment revenues would be allocated to the state to pay for its costs to continue operating the realigned programs. , The administration also indicates that it plans ~. to propose in the future a second realignment ("Phase 2") mainly involving health care and social services. Key Issues Concept of Re-Sorting Program Responsibilities Makes Sense. Several times over the last 20 years, the Legislature has achieved notable policy improvements by reviewing state- local program responsibilities and taking action to realign program and funding responsibility to the level of government likely to achieve the best out- comes. In 1991, for example, the Legislature shifted state mental health responsibilities to counties, giving counties a more reliable funding stream and the authority to develop innovative and less costly approaches to providing services. While implemen- tation of realignment proposals has been complex, the net result of these changes is that California ,,. ,.,.. 16 Legislative Analyst's Office www.~ao.ca.gov 20i i-.2 BUDGE state and local governments have better ability tc implement their programs successfully. Could the state improve other program out- comes by further realigning state-local responsibili- ties? If so, which programs should the state control and which should local government control? While there is no single "right" answer to these questions, we find that programs tend to be more effectively controlled by local government if (1) the program is closely related to other local government programs, (2) program innovation and experimentation are desired, and (3) responsiveness to local needs and priorities is important. In addition, assigning full control over program governance and financing to a single level of government has the benefit of reducing fragmentation of government programs and focusing accountability for program outcomes. The Legislature will need to carefully assess, these issues in crafting realignment proposals, as once implemented, they can be very difficult to modify. (The nearby box lists LAO reports that provide a more extensive discussion of program realignment.) Most of the Programs in the Administration s Plan Make Sense. Figure 5 (see next page) summa- rizes our initial review of the programs proposed for inclusion in the administration's realignment plan. Most of the programs we list in the first group ("Programs Suited for Realignment") are ones that this office previously has .proposed for realignment to local government. In our view, decentralized . program delivery and authority could promote program innovation, efficiency, and responsiveness to local conditions, and these potential program benefits outweigh whatever benefits are realized from the programs being uniformly administered at the, state level. Very few programs in this first group, however, could be realigned without addressing some sig- nificant legal or policy issues. Most notably, in the case of the administration's plan to realign Child Welfare Services, the Legislature would need to address how a decentralized system could work with a federal government that sets regulations, oversees program performance, and assesses state penalties when performance is inadequate. LAO REACIiGNMENT REPORTS Over the years,.. our office haspub- : , _ e fished numerous ..- Parole Realignment and the 2008-09 Budget • 2008 reports (see list) on the subject of state Realignment and the 2003-04 Budget 2003 and local program Realignment Revisited: An Evaluation of the 1991 Experiment 2001 MState-County Relations realignments. With The Governor's 1995-96 State-County Realignment Proposal 1995 one exception„all of Making Government Make Sense: Applying the Concept 1993 the rep©rts were pub- In 1993-94 dished in "Part V" of Making Government Make Sense: A More Rational Structure 1993 the Perspectives and For State and Local Government Issues in February of the year shown. Making Government Make Sense: Applying the Concept in 1993-94 was published separately in May 1993. These reports are available on our webste: www.iao.ca.gov. www.lao.ca.gov Legislative Analyst's Office 17 201 i-i2 BUDGET In addition, one program in this first group- A$ 3632 Services-merits realignment, but not in the manner proposed by the administration. Instead; schools should have programmatic and financial responsibility for this program providing mental health services to special education pupils. While schools may wish to contract with county mental health departments to provide these pro- grams, the primary fiscal and program responsibil- ity should reside with schools. Realigning Some Programs Merits Careful Review. The second group of programs in Figure 5-the Early and Periodic Screening, Diagnosis and Treatment Program (EPSDT), Mental Health Managed appropriate because it would consolidate related pots of money for behavioral (substance abuse and mental health) services. These changes could allow counties to spend these funds more flexibly and better coordinate mental health services with other county-run programs, such as a realigned drug and alcohol treatment system and rehabilitation programs for criminal offenders. At the same time, however, we note that federal health care reform expands the number of persons eligible to receive Medi-Cal mental health services beginning in 2014. Consolidating behavioral health programs with counties could limit the state's options for better coordinating mental health services with other ~.a•>~.F Care, Substance Abuse Figure 5 Treatment, and Existing Which Programs Are Suited for Realignment? Community Mental LAO Initial Review of Governor's 2011-12 Realignment Plan Health Services-merit (In Millions) careful legislative con- sideration for several Programs Suited for Realignment reasons.. First, the admin- Fire and Emergency Response Activities $250 $250 Local Public Safety Programs 506 506 istration proposes to use Local Jurisdiction for Lower-Level Offenders and Parole 1,802 908 Proposition 63 funds to Violatorsa pay the first year costs of Adult Parole to the Counties' 741 410 Juvenile Justice Programs 258 242 the three of these pro- Adult Protective Services 55 55 grams (EPSDT, Mental AB 3632 Servicesb - 104 Health Managed Care, Foster Care and Child Welfare Services 1,605 1,605 and AB 3632), a use of this Program Meriting Consideration Substance Abuse Treatment 184 184 measure's funds that may Early and Periodic Screening, Diagnosis and Treatment - 579 not be permissible. Programb Second, realigning Mental Health Managed Careb - 184 Existing Community Mental Health Services - 1,077 EPSDT, Mental Health Program Not Suited for Realignment Managed Care, and Court Security 530 530 Substance Abuse Unallocated Revenue Growth - 621 Treatment raises questions Totals (Administration Estimates) $5,931 $7,255 regarding program flex- 1% Sale's Tax $4,549 $5,567 ibility and the implemen- 0.5% Vehicle License Fee 1,382 1,688 tation of federal health Total Revenues (Administration Estimates) $5,931 $7,255 Realigning care reform a Costs decline by 2014-15 as state reimbursements end. Funding in 2014-15 count erated and at lower costs full o assumes this program is . . y y p b First-year costs for this program are paid from Proposition 63 resources. these programs appears 18 Legislative Analyst's Office www.lao.ca.gov ~Ol i-iL BUDGE [ Ivledi-Cal services across the state. Thus, although this office previously has recommended realigning most behavioral health programs to counties, we recommend the Legislature consider these factors before including these programs in the realignment plan. Finally, the last program in this category includes all mental health services funded under the 1991 realignment plan. The administration proposes to include these programs within its 2011 realignment plan-and allow use of the mental health funds from the 1991 realignment plan for other purposes. Because very few details regard- ing this change are available, we cannot assess the merits of this component of the plan. Court Security Shift Is Problematic. While the state is now responsible for the operations of the trial courts, current law requires that security for the trial courts generally be provided by county sheriffs at a cost to the state. Under the administra= tion's realignment plan, state funding to pay for security for trial courts would be shifted to counties and state General Fund support in the judicial budget far court security-would be reduced by a commensurate amount. In our view, this approach does not make sense. While control of funding for court security would be shifted to counties, the state judicial system .would continue to be responsible for the overall operation of the courts. Absent financial control, the courts would have dif- ficulty ensuring that the sheriffs provided sufficient security measures. We believe a better and more cost-effective approach would be to (1) clarify that the state is responsible for trial court security and (2) adopt a separate state law change authorizing the state to use competitive bidding by various private or public entities, including sheriffs, for the would require achieving a broad consensus among many parties. Achieving this broad consensus within the timeframe to prepare a measure for the Tune ballot will be difficult. Counties are likely to have many questions about the source of revenues to replace the sales tax and VLF in five years, the extent of program authority that will be transferred to counties, the initial program funding levels, the potential for future state increases in county program requirements, and whether the rate of realignment revenue growth will match the rate of program growth. Fiscal Estimates Require Further Review. Although most of the administration's estimates regarding the fiscal impact of the proposed realignment programs appear reasonable, some of the estimates require further examination. For example, our preliminary review indicates that the administration maybe double counting certain savings associated with shifting adult and juvenile offenders to counties. That is, the administration scores the same savings twice-in the realignment plan and as part of the department's budget. Our preliminary review also indicates that the realign- ment plan understates the cost of the AB 3632 program by up to about $200 million. provision of these security services. Need to Address Local Concerns. Given the requirements of the California Constitution and . voter-approved measures, enacting realignment Alternatives Could the Legislature Change the Mix of Programs? There is no perfect list of programs to realign. The Legislature could modify. the Governor's proposed list of programs to meet its policy objectives. In considering alternative pro- grams for inclusion in realignment, we recommend the Legislature: • Focus on programs where innovation, responsiveness to community interests, and efficiency are paramount. • Avoid programs where statewide unifor- mity is important, where statewide benefits www.lao.ca.gov Legislative Analyst's Office 19 2011-i2 BUDGET are the overriding concern, or where the primary purpose of the program is income redistribution. Our initial review suggests that there are other programs to consider for realignment. For example, the Legislature could consider realign- ing pharmaceutical costs for Medi-Cal patients receiving specialty mental health services to the counties, thereby ensuring that all costs for provid- ing services to patients are consolidated. It could also consider going back to the voters to allow the permanent realignment of all Proposition 63 funding to counties, along with increased flexibility in the use of these funds. Finally, the Legislature could consider realigning funding and responsibil- ity to the counties to provide treatment to persons determined by the courts to be incompetent to stand trial for criminal offenses. We will continue to explore these and other options. Could the Legislature Change the Scale of Realignment? Realignment, implemented cor- rectly, can improve the management and delivery of programs. For this reason, we believe the Legislature's decision to realign a program should focus on program policy objectives-not simply on raising a specific amount of revenues. To that end, we recommend that the Legislature begin its work by identifying programs that would benefit from realignment. Should the Legislature determine that it wishes to raise more revenues than it wishes to realign programs, we recommend the Legislature avoid adding programs to the realignment package that are inconsistent with the concept of realign- ment-orprograms over which the Legislature is unwilling to grant counties greater control. Conversely, should the Legislature determine that it wishes to raise fewer revenues than it wishes to realign programs, we recommend the Legislature avoid deleting programs from the realignment package. Instead the Legislature could finance the realignment plan, in part, by redirecting existing state or local revenues. Is it Possible to Implement Realignment Without Raising Taxes? While realignment often is associated with tax increases, it need not be imple- mented that way. Although it would be difficult in light of the state's fiscal difficulties, the Legislature could enact realignment by earmarking a portion of existing state revenues as the dedicated revenues for realignment. Addressing Legal Complexities in State Ballot Measure. The administration's plan will ,, require considerable work by the Legislature to sort through many legal, financial, and policy issues. Certain voter-approved measures also will constrain the Legislature's authority to shift program responsibilities to counties and redirect the use of mental health funds. For example, Proposition 63 may not permit the proposed shifts in mental health funds. In addition to requesting voter approval for any proposed tax increase, the Legislature also may wish to request voter approval of these elements of the realignment plan. REDEVEL~~'NiEI~~' Major Proposals Shift Responsibility for Local Economic Development. The administration proposes a sub- stantive shift in responsibility for local economic development programs. The budget phases out state authorization for two economic development programs: redevelopment (discussed below) and enterprise zones (discussed previously). To give communities greater capacity to promote economic development, the administration indicates that it will support a constitutional amendment to allow local voters to approve tax increases and general obligation bonds for these purposes by a 55 percent majority. 20 Legislative Analyst's Office www.lao.ca.gov 26ii-i~ BUDGE; <.-. ..~ Phase Out Redevelopment. For more than 50 years, state law has authorized cities and counties to create redevelopment agencies. The administra- tion proposes to revise these laws to (1) dissolve the state's 425 redevelopment agencies and (2) transfer their revenues (primarily, over $5 billion of annual property tax revenues) to local successor agencies. The successor agencies would use these funds to retire redevelopment debts and contractual obliga- tions and make other payments described below. The successor agencies also would shift any unspent redevelopment housing funds to local housing authorities to use for low- and moderate-income housing. Use of Funds in First Year. In 2011-12, the successor agencies would use the redevelopment revenues to: • Pay redevelopment debts and obliga- tions, estimated by the administration to cost $2.2 billion. • Offset $1.7 billion of state Medi- cal ($840 million) and trial court ($860 million) costs. • Allocate $1.1 billion to schools and other local agencies pursuant to current laws that require redevelop- ment agencies to "pass through" some of their funds to affected local agencies. • Distribute $210 million to cities, coun- ties, and special districts in proportion to these agencies' current shares of the property tax. Use of Funds in Future Years. Beginning in 2012-13, any property tax revenues remaining after the successor agencies pay redevelopment debt would be distributed to other local governments in the county. Distributions of these revenues generally would follow provisions in existing law, except that: The additional K-14 district property taxes would augment their existing state funding (not offset state education spending) and would be distributed tc districts throughout the county based on enrollment. • The property taxes that otherwise would be distributed to enterprise special districts.would be allocated instead to counties. (These districts primarily are fee-financed water and waste disposal districts.) Key Issues Proposal Has Merit ... Shifting rESponsibility for local economic development to local ~govern- mentsmakes sense. Local communities are in the best position to determine the types of programs and assistance needed to promote development in their communities. Ending state-assisted local economic development programs like redevelop- ment also makes sense. Redevelopment projects divert property taxes from K-14 districts, increasing state education costs by billions of dollars annually. The state's costs associated with redevelopment has -grown markedly over the last couple decades, yet we find no reliable evidence that this program improves overall economic development in California. Finally, recent passage of Proposition 22 limits the Legislature's authority to modify the scope of redevelopment to reduce its costs on. the state or local agencies. ..:But Faces Considerable Implementation Issues. The administration's plan will require considerable work by the Legislature to sort through many legal, financial, and policy issues. Several voter-approved constitutional measures, for example, constrain the state's authority fo redirect redevelopment funds, use property tax revenues to pay for state programs, or impose increased costs www.lao.ca.gov Legislative Analyst's Office 21 2~i I-~L gU~J~CT on local agencies. In addition, the administration's plan does not address many related issues, such as clarifying the future financial responsibility for low- and moderate-income housing (currently; a redevelopment program). Redevelopment Debt Costs May Be Understated. Although the administration's approach to estimating the annual cost of redevelop- ment debt is reasonable, their assumptions regarding debt terms, interest rates, and other factors err on the side of understating debt costs. Our initial review indicates that the annual cost to pay these debts could be $1 billion or more higher than the admin- istration assumes. If our initial review is correct, this would reduce the funds available for other purposes. For example, the Legislature may not be able to use $1.7 billion of these revenues for state programs and make $1.1 billion in -pass-through payments to local governments. Rationale for Increased School Funding Not Clear. The rationale for providing school districts with property tax revenues in addition to their existing property taxes is not clear. The administra- tion's proposal does not devolve more responsibili= ties to school districts. The distribution of these additional school property tax revenues would be uneven throughout the state, with schools in 15 counties (where there is little or no redevelopment) not getting additional property taxes and schools in counties (where there is extensive redevelop- ment activity) receiving significant sums. The distribution of these new property tax revenues further complicates an already complicated school finance system. Need to Pause New Redevelopment Activities. Developing the statutory measures to implement this important, but complex, proposal will take considerable work by the Legislature. During this time-potentially several weeks or months-it is possible that redevelopment agencies could take actions that increase their bonded indebtedness and contractual obligations. If so, these new finan- cial obligations could constrain the state's ability to redirect redevelopment revenues and to realize the state savings and local benefits anticipated in the administration's proposal. Accordingly, we recom- mendthat the Legislature pass urgency legislation as soon as possible prohibiting redevelopment agencies-during this period of legislative review- from taking actions that increase their debt. Specifically, the urgency legislation would prohibit redevelopment agencies from (1) taking on any new debt that would be included on their Statement of Indebtedness-the statement that identifies redevel- opment agency debt and makes the agency eligible for property tax revenues, or (2) creating, amending, or extending any redevelopment project areas. This approach would preserve the Legislature's options as it reviews the administration's proposal, but would not have a lasting effect on redevelopment agencies if the Legislature elects not to adopt it. EXPENDITURE PR.C)P~SALS~ PROPOSITION 98 Major Proposals, Proposition 98 funds K-12 education, child care, the California Community Colleges (CCC), and various other state agencies (including the state special schools and juvenile justice). The Governor's budget "~"~ ,:; reduces total Proposition 98 spending by less than 1 percent from the current year to the budget year. As shown in Figure 6, K-12 funding would change neg- ligibly from 2010-11 to 2011-12. By comparison, CCC funding would be reduced $361 million or 6.3 percent. The Governor's Proposition 98 plan includes no cost- of-living-adjustments but funds enrollment growth for 22 Legislative Analyst's Office www.lao.ca.gov [l)i I-![ BUDGET K-12 education (0.22 percent) and CCC (L9 percent). Below, we discuss Proposition 98 K-14 and child care issues in more detail. In the higher education section, we discuss various other community college issues (such as student fees) in more detail. Assumes Tax Package Adopted, Funds Minimum Guarantee. The Governor's proposal funds Proposition 98 at the minimum guarantee in 2011-12. The proposed spending level assumes adoption of the Governor's tax plan to raise $4.8 billion in additional state General Fund rev- enues, primarily from the extension of higher per- sona] income tax rates. These additional revenues increase the Proposition 98 minimum guarantee by $2 billion in 2011-12. Absent these additional revenues, the minimum guarantee would have fallen year over year whereas, with the additional revenues, the guarantee stays virtually flat. (The Governor's proposals to maintain higher rates for the sales tax and the vehicle license fee would not increase the Proposition 98 minimum guarantee since those revenues would flow directly to local governments for realignment.) K-l2 Programmatic Funding Declines Slightly Year Over Year. Under the Governor's plan, K-12 Figure 6 K-12 Education General Fund Local property tax revenue Subtotals California Community Colleges General Fund Local property tax revenue Subtotals Other Agencies Totals, Proposition 98 General Fund Local property tax revenue programmatic funding per student decreases by about $100 or i.4 percent from 2010-11 to 2011-12. Most of the decline in K-i2 per student funding is attributable to the Ioss of federal stimulus funding (though many districts reserved a significant portion of their federal education jobs funding for 2011-12, thereby mitigating the cliff effect). As shown in Figure 7 (see next page), K-12 per student programmatic funding in 2011-12 would be 6.4 percent lower than the 2007-08 level. Figure 8 (see page 25) lists the budget's major Proposition 98 spending proposals for 2011-12, the most significant of which are discussed in more detail below. Proposes Large New Deferrals. The most substantial component of the Governor's Proposition 98 plan consists of $2.2 billion in new inter-year deferrals from 2011-12 to 2012-13- $2.1 billion from K-12 revenue limit payments and $129 million from CCC apportionment pay- ments. Although the administration has not yet determined from which months K-12 revenue limit payments would be deferred, it has indicated that deferrals likely would not be repaid until September or October of 2012. For community colleges, the $31,732 $32,239 $32,401 $162 0.5% 12,328 11,557 11,406 -152 -1.3 ($44,060) ($43,796) ($43,807) ($11) (-) $3,721 $3,885 $3,542 -$343 -8.8% 2,000 1,892 1,873 -19 -1.0 ($5,721) ($5,777) ($5,415) (-$361) (-$6.3%) $93 $85 $78 -$7 -8.7% $49,874 $49,658 $49,300 -$358 -0.7% $35,546 $36,209 $36,021 -$188 -0.5% 14,327 13,449 13,279 -170 -1.3 www.lao.ca.gov Legislative Analyst's Office 23 Proposition 98 Funding 20 i i-11 BUDGET deferral would be made from apportionment pay- ments otherwise made in January through May of 2012 and also would likely not be repaid until September or October of 2012. (In addition to the inter-year deferrals, the Governor proposes to continue intea-year deferrals to help with the state's cash flow problems. The Governor's intra-year deferral plan would delay $2.5 billion in K-12 pay- ments and $200 million in CCC apportionments beginning in July 2011, reflecting the same magni- tude as the 2010-11 intra-year deferrals.) Significantly Reduces Child Care Funding. The Governor proposes to achieve $750 million in Proposition 98 child care savings by making four major policy changes: (1) reducing child care subsidies by about 35 percent; (2) reducing income eligibility for subsidized child care from 75 percent to 60 percent of state median income (SMI), (3) eliminating subsidized child care for 11- and 12-year olds, and (4) reducing California Work Opportunity and Responsibility to Kids (Ca1WORKs) Stage 2 caseload based on CaIWORKs reform proposals (discussed later in the report). With regard to the 35 percent rate reduction, the administration proposes providing local agencies discretion over how to translate lower subsidies into reduced payments to child care providers; with the expectation that child care slots and days of service remain the same. The savings resulting from these proposals would be offset by a $256 million increase to the Ca1WORKs Stage 3 program-reflecting a proposed restoration of an earlier budget act veto. After accounting for various other federal and state adjustments, the Governor's 2011-12 proposal would reduce total funding for Proposition 98-supported child care programs by about $652 million (29 percent) and child care slots by about 9,900 (3 percent) compared to 2010-11. Proposes Various Other Changes. The Governor proposes a $400 million reduction to community college apportionments. In addition, the Governor reduces Proposition 98 funding for the Division of Juvenile Facilities by $8.7 million to reflect athree-year phase-out linked with his Figure 7 K-12 Programmatic Fundinga (Dollars in Millions Unless Otherwise Specified) Programmatic Funding K-12 ongoing fundingb $48,883 $43,215 $40,717 $42,945 $43,131 New payment deferrals - 2,904 1,679 1,719 2,063 Settle-up payments - 1,101 - 267 - Public Transportation Account 99 619 - - - Freed-up restricted reserves° - 1,100 1,100 - - ARRA funding - 1,192 3,575 1,192 - Federal education jobs funding - - - 421 781 Totals $48,982 $50,130 $47,070 $46,544 $45,975 Per-Pupil Programmatic Funding K-12 attendance 5,947,758 5,957,111 5,933,761 5,951,826 5,964,800 K-12 per-pupil funding (in dollars) 58,235 $8,415 $7,933 $7,820 $7,708 Percent'Change''Fro'm` 2007-OS° ~' - 2.2% ` -3.7°k` -5.0°r6 -6.4°k a Excludes federal funds not associated wfth stimulus package, lottery, and various other local funding sources. b Includes ongoing Proposition 98 funding, Proposition 98 accounting adjustments, and funding for the Quality Education Investment Act. ~ Reflects LAO estimates of funds spent in each year. 24 Legislative Analyst's Office www.lao.ca.gov 20i?-i2 BUDGE. realignment proposal and provides no funding authority for the state's student and teacher data systems pending a comprehensive review of the twa projects. In contrast to the proposed reductions, the Governor proposes two notable K-12 augmentations. First, the Governor provides $90 million to cover the ongoing cost of about 35 K-14 mandates. Though this is the same level of support as provided in the current year, the state used one-time funds in 2010-11. Second, the. Governor provides $43 million in ongoing funding (and $11 million in one-time funding) for the Emergency Repair Program. This program provides grants to low-performing schools to pay for school facility repairs that are needed for public health or safety reasons. (In response to a lawsuit, the state adopted statute specifying that it would provide a total of $800 million for the program. To date, the state has provided $338 million.) of existing K-14 fiscal relief options. For both school districts and community colleges, the Governor proposes to extend "categorical flexibility" from 2012-I3 througl-i 2014-15. (With this flexibility; school districts can use the funding associated with about 40 categorical programs for any educational purpose and community colleges can use the funding associated with about a dozen programs for any categorical-program purpose.) For school districts, the plan also would extend the existing K-3 Class Size Reduction (CSR) rules from 2011-12 through 2013-14. (These rules apply more modest funding reductions to K-3 classes that exceed 20 students.) Additionally, for school districts, the Governor proposes extending for two years ±he existing statutory provisions that reduce routine maintenance requirements, suspend deferred maintenance requirements, postpone instructional materials purchases, and lower unrestricted budget Extends Flexibility Provisions Two Years. The reserve requirements. Governor's plan also includes atwo-year extension Eliminates the O,~ice of the Secretary of Education (OSE). To help streamline the state's K-12 Figure 8 governance structure, the MajOf PYOpOSitIOI1 98 SpeCld1i19 ChallgeS Governor's budget elimi- 2011-12 (IrrMillions) nates OSE. Eliminating _ P,„r, OSE would result in Backfill prior-year one-time K-14 actions $2,167 non-Proposition 98 Fund K-12 revenue limit cost increases 470 General Fund net savings Make various other K-14 adjustments 96 0 of roughly $400 000 in Fund ongoing K-14 mandates 9 , Fund Emergency Repair Program 43 the current year and Defer K-12 revenue limit payments -2,064 $1.6 million in the budget Eliminate Special Disabilities Adjustment -74 Make technical reduction to Economic Impact Aid -54 year. Phase out Department of Juvenile Facilities funding -9 Restore CaIWORKs Stage 3 child care veto 256 Key Issues Reduce child care subsidies by 35 percent -577 Magnitude of Cuts Reduce child care income eligibility ceiling to 60 percent of SM I -79 Eliminate child care eligibility for 11-and 12-year olds -59 in Each Area Could Be Reflect Stage 2 child care savings from CaIWORKs reforms -34 Reexamined. In building Reduce CCC apportionments -400 the Governor his plan Defer CCC apportionment payments -129 , Total Changes -$358 reflected his priori- SMI =state median income. ties-largely to insulate www.lao.ca.gov Legislative Analyst's Office 25 X011-i~ BUDGE- school districts from further cuts while notably reducing the state's child care programs and requir- ing asignificant cut to the community colleges. In building its Proposition 98 package, the Legislature has many factors tc consider, such as the different populations, needs, programmatic quality, and public benefits of K-12 education, community colleges, and child care. After weighing the asso- ciated trade-offs, the Legislature may want to consider distributing Proposition 98 reductions differently among the three areas. Further Reliance on Deferral Raises Important Questions. The state's reliance on deferrals over the past several years has placed a large cash flow burden on school districts and community colleges. At existing levels, 16 percent of 2010-11 Proposition 98 program will be paid in 2011-12. Under the Governor's proposal, 20 percent of 2011-12 Proposition 98 program would be paid in 2012-13. Nonetheless, adopting deferrals would help mitigate the reductions that districts and community colleges otherwise would need to make in 2011-12. We are concerned, however, that addi- tional deferrals would continue the deterioration of school district and community college fiscal health and could result in the need for state emergency loans to avoid insolvency. These deferrals would be especially problematic if, as indicated by the administration, they are not paid until the fall of 2012 (all existing deferrals are paid by August). The intea-year deferrals further exacerbate the situation-in essence deferring already-deferred payments until even later in the next fiscal year. Combined, the inter-year and intra-year deferrals could result in school districts and community col- leges facing significant cash flow difficulties in the summer and fall of 2012. Approach to Child Care Reductions Has Some Merit, Some Serious Flaws. We believe two of the Governor's child care proposals merit consideration whereas we have serious concerns with one of the proposals. Specifically, vve think the Governor's proposal to lower the income eligibility ceiling to 60 percent of SMI is reasonable in that it targets services for the neediest families. Similarly, the pro- posal to lower the age limit merits consideration. While we know of no other state that limits sub- sidized child care to children 10 or younger (most states set maximum age at 12 or 13), California funds an extensive before and after school program in which slots could be prioritized for displaced 11- and 12-year olds. We have serious implementation concerns, however, with the proposed 35 percent across-the-board rate reduction. This proposal would result in a substantial reduction to provider rates that are already below federal guidelines, and it raises questions as to what quality of care such low payments would be able to purchase. Furthermore, ceding authority to local organiza- tions (which are in most cases not public agencies) to implement the reduction by adjusting provider rates and family copayments in different ways likely would lead to further inconsistencies in the avail- ability and quality of care. Some Savings Potentially Unachievable. We believe that up to $128 million of the Governor's anticipated Proposition 98 savings cannot be realized. Specifically, the Governor assumes a $54 million technical reduction to the Economic Impact Aid (EIA) program given the program has not spent all budgeted funds in recent years. However, the state already has made substantial downward adjustments to EIA base funding amounts in recent years, and newly released data indicate very little of the 2010-11 appropriation will go unused. Combined with the projected growth in K-12 enrollment, this information suggests the Governor's estimates are overly optimistic. Additionally, the Governor assumes $74 million in savings due to the- sunset of one component of the state's special education program known as the Special Disabilities Adjustment. We believe making „~.~"'~. ~~x 26 Legislative Analyst's Office www.lao.ca.gov 20ii-1~ BUDGET this reduction could violate federal maintenance- of--effort (MOE) requirements, in which case the state would need to continue providing the same amount of funding for some other special educa- tion purpose. Alternatives for Legislative Consideration Other Child Care Options Could Be Better Than Across-the-Board Reduction. After contem- platingthe desired mix of Proposition 98 reduc- tions, the Legislature could consider a different combination of policy changes to realize child care savings. In making these changes, we recommend using the guiding principle of prioritizing services for the most needy families and children. The Governor's proposals to reduce income and age eligibility ceilings meet this criterion. To generate additional savings, the Legislature could further reduce eligibility below the proposed 60 percent of SMI and age ten. Other options the Legislature could consider in lieu of reducing subsidies by 35 percent include: more moderate, statewide reductions to provider rate ceilings for licensed and/or license exempt providers; increasing paren- tal fees; and reducing the amount agencies receive for program administration and parental support. Could Go Further in Providing More Flexibility, Improving School Finance System. While extending the flexibility provisions by two years provides additional fiscal relief to districts, the Governor's plan misses some opportunities to further expand flexibility. For example, as recom-. mended last year, we continue to recommend the state extend flexibility to three of the state's largest stand-alone K-12 categorical programs-K-3 CSR, Home-to-School Transportation, and After School Safety and Education. We also continue to recom- mend consolidating career technical education programs and removing certain restrictions related to contracting out for noninstructional services as well as priority and pay for substitute teaching positions. Additionally, we continue to recommend Iinking categorical "flex" funding to average daily attendance, thereby assuring that the associated funding remains connected to students. We also think the Governor and Legislature could make more significant strides toward improving the K-12 school finance system by not merely extending the sunset for the existing flexibility provisions but by thinking about how to strategically redesign the state's K-12 school finance system such that it better serves districts and the public in both the short and long term. HIGHER EDUCATION Major Proposals Sizable General Fund Reductions for All Segments. The Governor's budget includes unallo- cated $500 million General Fund reductions for the University of California (UC) and the California State University (CSU). The Governor intends that these reductions be achieved primarily by reduc- inginstructional cost. The budget also includes a $400 million reduction in general purpose "appor- tionment" funding for the community colleges, and proposes unspecified changes in funding formulas. Tuition Increases for All Segments. The UC and CSU have already approved tuition increases of 8 percent and 10 percent, respectively, for the 2011-12 academic year. Total tuition revenue for the universities is estimated to increase by about $400 million, supporting core programs and campus-based financial aid. The Governor proposes to increase community college fees from $26 per unit to $36 per unit, generating about $110 million in additional revenue that would in effect fund enrollment growth of almost 23,000 full-time equivalent (FTE) students. Full Funding for Financial Aid Programs. Unlike his predecessor, the Governor proposes no reductions in existing financial aid programs. The budget proposal includes augmentations to fully cover www.lao.ca.gov Legislative Analyst's Office 27 20ii-t2 BUDGES fee increases in the CaI Grant programs, and assumes full fee waivers at the community colleges covering more than one-half of all- credit FTE students. Majo~• Financial Aid Fund Shift. The Governor's proposal would shift $947 million in Cal Grant costs from the General Fund to federal Temporary Assistance for Needy Families (TANF) funds. This fund swap would have no net effect on total funding for Cal Grants. As discussed later in the report, the TANF funds would be provided through an interagency agreement with the Department of Social Services, whose TANF funding would be freed up by the Governor's pro- posed cuts in Ca1WORKs. Key Issues University Cuts Needed, but Volatility an Issue. Volatility in public funding is one of the persistent challenges universities confront.in man- aging their operations. The universities received a double-digit General Fund augmentation in the current year, followed by the Governor's even larger proposed reduction for 2011-12. Efforts should be made to smooth out these peaks and valleys, while still achieving needed General Fund savings. Unclear How Segments Would Accommodate General Fund Cuts. Although the administration intends that the segments' General Fund reductions be achieved primarily through cost reductions and increased efficiency, the proposed budget package includes no language that would ensure such an outcome. In the past, the segments have responded to unallocated cuts in a variety of ways, including . midyear tuition increases, enrollment reductions, and furloughs, as well as some efforts at increased efficiency. Alternatives for Legislative Consideration Shift Part of Universities' Cuts to Current Year. Rather than impose a $500 million cut for each university in the budget year, the Legislature may wish to achieve part of that savings by reducing the universities' current-year augmentations. Such an approach would smooth out the volatility of augmentations and cuts that would otherwise result. Evidence suggests that the universities were already preparing for smaller current-year augmentations prior to enactment of the budget in October. This alternative would bring the universities' current-year funding more into line with those contingency plans, and would preserve more funding for the segments to provide education services in the budget year. This would allow additional time for the state to seek alternative savings for the future, or for the segments~to align their out-year costs with projected funding levels. Ensure Reductions Meet Legislature's Expectations. The Legislature could amend the budget package to specifyhow the segments accommodate General Fund reductions. For example, it could specify the number of FTE students it expects the universities to enroll and the maximum tuition levels the universities should charge. To ensure compliance, General Fund appropriations could be tied to the meeting of these expectations. Similarly, the Legislature could specify whether it will permit CCC to reduce overall funded enrollment, and how it expects cam- puses to prioritize course enrollment. For example, the Legislature could limit the total number of taxpayer-subsidized credit units that students may earn at a community college. Develop Longer-Term Fee Strategy for .Community Colleges. The Governor's proposal to increase community college fees makes sense, because California's fees are by far the lowest in the country, and existing financial aid programs shield low- and moderate-income students from paying fees. Moreover, federal tax credit programs ensure that most fee-paying students will be reimbursed for the fees they pay, up to about $60 per unit. For this reason, the Legislature could increase fees ~v=F 28 Legislative Analyst's Office www.lao.ca.gov 2G11-IL BUDGE beyond the $36 per unit proposed by the Governor as a way of leveraging more federal funds to support CCC programs. CASH ASSISTANCE Major Proposals SSI/SSP Grant Reduction. Effective June 1, 2010, the budget for the Supplemental Security Income/State Supplementary Program (SSI/SSP) proposes to reduce the maximum grant for indi- viduals to the minimum required by federal law (from $845 per month to $830 per month). The revised grant would be approximately 92 percent of the 2010 federal poverty guideline. This proposal would result in General Fund savings of $15 million in 2010-11 and $177 million in 2011-12. CaIWORKs Grant Reduction. The Governor proposes to reduce CaIWORKs grants by 13 percent effective June 1, 2011, resulting in General Fund savings of $14 million in 2010-11 and $405 million in 2011-12. For a family of three, this proposal would reduce maximum monthly grants from $694 to $604 in high-cost counties and from $661 to $575 in low-cost counties. Repeal of July 2011 Changes. In 2009 the Legislature enacted a series of changes to Banc- tion policies, time limits, and eligibility rules for CaIWORKs. The Governor's budget proposes to delete these changes, resulting in a cost of about $135 million. Establishment of a 48-Month Time Limit. In lieu of the 2009 CaIWORKs changes, the budget proposes, effective July 1, 2011, to establish a 48-month time limit, applied retroactively, on the receipt of Ca1WORKs cash assistance for all recipients. This would apply to both adults and children, with narrow exceptions. Previous months of cash aid would count toward the 48-month limit, including months in which a recipient had been exempted from participation requirements or was temporarily disabled. However, children in families in which the adult was meeting federal participa- tion requirements would be allowed to receive aid beyond 48 months. This proposal would result in savings of 5833 million. Continuation of Block Grant Reductions While Repealing Participation Exemptions. For 2009-10 and 2010-11, the Legislature reduced the county block grants for welfare-to-work services and child care by approximately $375 million each year. To help counties prioritize resources given this reduction in funding for Ca1WORKs services, budget legislation exempted families with a child under age two, or with two or more children under the age of six, from work participation require- ments. Prior budget legislation also provided that, for anymonth for which a recipient has been excused from work participation requirements due to lack of support services, the case does not count toward the state's time limit for their receipt of cash aid. The Governor's budget proposes to continue a reduction of $377 million in county block grants while repealing the exemptions. Figure 9 lists the proposed solutions for SSI/SSP and Ca1WORKs, totaling $1.7 billion. Figure 9 Cash Assistance Programs Major Solutions {General. Fund Benefit, in Millions) SSI/SSP Reduce grants to the federal $15 $177 minimum Ca1WORKs Establish 48 month-time limit - 833 Reduce grants by 13 percent 14 405 Reduce county block grants - 377 Repeal July 2011 sanctions - -135 and time limits Reduce age eligibility for - 34 child care Subtotals (CaIWORKs) ($141 ($1.5141 Totals $29 $1,691 www.lao.ca.gov Legislative Analyst's Office 29 2011-1t BUDGET Key issues Minimal Budget Risk and No Loss of Federal Funds. The Governor's proposals warrant serious consideration by the Legislature, given that they provide $1.7 billion in budgetary savings that the state is likely to achieve with no loss of federal funds. This is because the CaIWORKs federal block grant is fixed at $3.7 billion, and the federal portion of the SSI/SSP grant is not affected by the level of state supplementation. Due to the Ca1WORKs MOE requirement, about $530 million of the General Fund savings is achieved within the CaIWORKs budget and about $950 million is achieved by trans- ferringfreed-up TANF funds (from the proposed programmatic reductions) to the Student Aid Commission to offset Genera] Fund costs there. Balancing the Need for Cal WORKS Savings With Program Goals. The Legislature can control costs in Ca1WORKs through changes in eligibility rules, grant levels, and the availability of welfare- to-work services to assist recipients in becoming self-sufficient. The Governor's proposals impact all three areas. In considering these proposals, the Legislature faces a difficult balancing act. On the one hand, the Legislature must achieve savings because of the state's budget deficit. On the other hand, the policy goal of the Legislature in creating the Ca1WORKs program has been to (1) maintain a safety net for low-income families with chil- dren who cannot support themselves financially (especially during a deep recession); (2) encourage Ca1WORKs recipients to transition to self-suffi- ciency through work, education, and training; and (3) preserve a county delivery system committed to these goals. As it evaluates the Governor's budget reduction proposals, the Legislature should con- sider the trade-offs involved among these factors. Grant Reduction: Pros and Cons. The grant reduction proposal has some merit in that it achieves significant budgetary savings while retaining some level of income maintenance.for iow-income families. Moreover, an increase in CalFresh benefits (formerly known as Food Stamps) w~ partially offsets (about 22 percent) the grant reduc- tion. For a family of three in a high-cost county, the combined grant and CalFresh benefits would drop from $1,155 to about $1,090 per month, or about 71 percent of the federal poverty level (FPL). However, we also note that the state has never reduced grants by more than 6 percent before. The proposed grant package would be the lowest level in decades relative to the FPL: Block Grant Reduction Problematic Without County Flexibility. As noted earlier, the previously enacted two-year reduction in county welfare- to-work block grant funds was accompanied by additional exemptions from work participation requirements, which allowed counties to manage the reduction in funding. The Legislature should consider adopting similar work participation exemptions, or some other mechanism to allow counties more flexibility, if it adopts the proposed reduction in funding for these Ca1WORKs services. The Impacts of the Proposed 48-Month Time Limit. The proposed 48-month time limit presents very difficult issues for the Legislature. Historically, the CaIWORKs program has provided a safety net for children even when the parents have exhausted their allowable five years of assistance. Moreover, in the past, the Legislature explicitly provided that months when a family did not receive welfare-to- work services would not count toward their time limit. Under this proposal, about 115,000 families and 234,000 children would lose all benefits. They would be eligible for General Assistance, potentially resulting in a cost shift to counties in the hundreds of millions annually. Research by the Public Policy Institute of California (PPIC) (focusing on a period when the economy was healthier) suggests that time limits with complete family benefit terminations do not significantly increase overall poverty rates among ,'"'""+ 30 Legislative Analyst's Office www.lao.ca.gov 201 i-i~ BUDGET children of single mothers. The PPIC study also sug- gested,however, that while enforcement of tighter time limits for aid would motivate some families to obtain work and move out of poverty, some families would likely end up poorer due to such a change. This study did not address retroactive application of time limits as the Governor proposes. Alternatives for Legislative Consideration Modifying the Earned Income Disregard. Under current law, California "disregards" (does not count) the first $225 of income and 50 percent of each dollar earned beyond $225 when calculating a family's monthly grant. This policy provides a work incentive for families. Savings in the range of $200 million annually could be achieved by simplifying the disregard to a flat 50 percent of all income earned. Prospective and or Phased Implementation. If the Legislature wants to pursue a family benefit ter- mination time limit, it could elect to adopt it pro- spectively, allowing current recipients some time to work their way off cash aid before hitting the time limit. Similarly, because the state has never reduced grants by more than 6 percent, the Legislature could phase in the 13 percent over two years. While these approaches would reduce the benefit to the General Fund from the Governor's proposal, they would still achieve a measure of savings that would grow over time. Further Reductions to Welfare-to-Work Services. Another potential budget solution would be to increase the Governor's proposed reduction to county block grants in accordance with increased county flexibility or exemptions. IN-HOME SUPPORTIVE SERVICES Major Proposals Additional Reduction in Hours for Services. The Governor's budget proposes to reduce autho- rized hours for all IHSS recipients by 8.4 percent to achieve state savings of $128 million in 201 i-12. This across-the-board reduction would be in addi- tion to a 3.6 percent reduction enacted as part of the 2010-11 budget. The budget assumes that an appeals process would allow 21,000 recipients to receive a full restoration of hours and 62,000 recipi- ents to receive a partial restoration of hours. Elimination of Domestic Services for Recipients in Shared Living Environments. Under current law, domestic services are reduced some- what based on the number of persons in the house- hold. The Governor's budget proposes to eliminate, with certain exceptions, domestic and related care services for recipients who live with others to save $237 million in 2011-12. Domestic and related care services include housework, meal preparation, meal clean-up, laundry, shopping, and errands. Eliminate All Services for Recipients Without a Physician's Certificate. Lastly, the Governor proposes to eliminate from IHSS recipients who do not have certification by a physician that they need these services to prevent their placement in an institution, such as a nursing home. The budget assumes that 43,000 recipients (10 percent) will lose IHSS eligibility and that the state would save $121 million in the budget year. Figure 10 (see next page) lists the proposed solutions for IHSS totaling almost $0.5 billion. Key Issues Legal Risks Exist. Any time services are reduced or eliminated, there is some risk of litiga- tion asserting that the change puts recipients at risk of institutional placement, which could violate the U.S. Americans with Disabilities Act. The Governor has proposed several measures, such as the appeals process to restore. domestic hours, to limit }egal risks associated with these proposals. On the other hand, recent litigation in Washington State sug- gests that there is some legal risk for the proposals to eliminate domestic and related care services for www.lao.ca.gov Legislative Analyst's Office 31 201i-?~ BUDGES wish to reconsider reduc- Figure 10 fn-Home Supportive Services ing state participation Major Solutions for 2Q1 ~ -12 in IHSS provider wages (General Fund Benefit, in Millions) as part of the 2011-12 -- - -- -- , . -~ ~ _-~- _ ~, - -.--.y ~ budget plan. A reduction '~ ~° from $12.10 to $10.10, for Additional reduction in hours for services $128 example, could save about Eliminate domestic services in shared living environments 237 Eliminate all services for recipients without a physician's certificate 121 $100 million annually. To Total $486 address some of the con- cerns of the federal court, recipients who live with other persons. the wage reduction could Savings Estimates May Be Overstated. Some savings estimates, such as the one related to the adoption of physician certification requirements, appear to be overstated. . High-Hour Recipients Lose Most. When making reductions to the IHSS program, we have generally recommended an approach in the past of targeting reduction to those least likely to enter a skilled nursing facility. However, the proposed across-the-board reduction in service hours results in the greatest loss of hours for recipients who are assessed to need the most hours. We have proposed that the Legislature begin to move toward a system that would better target services to those most at risk of institutionalization. Alternatives for Legislative Consideration Reduce State Participation in Provider Wages Pursuant to a Study. The state, together with counties, provides funding to support the wages paid to IHSS workers. The federal courts enjoined California from implementing a 2009-10 reduc- tion in state participation in wages from $12.10 to $10.10. The court ruled that the state should have conducted a study of the impacts of a wage reduction on the supply of available providers. In the meantime, this case has been appealed to the U.S. Supreme Court, and the Legislature adopted a statute that postpones the wage reduction. Despite these prior actions, the Legislature may be reenacted in a way that allows a reduction down to $10.10 contingent on the results of a state study now under way to determine the potential impact on the supply of available providers. PROPOSITION 1O EARLY CHILDHOOD DEVELOPMENT PROGRAMS Major Proposal Ballot Measure. Proposition 10, enacted by the California voters in the November 1998 elec- tion, imposed a 50-cent increase in excise taxes on cigarettes and other tobacco products to fund early childhood development programs. The Governor's budget proposes to place a measure before voters in a June 2011 special election to allow the use of Proposition 10 funds for Medi-Cal coverage for children in a way that would reduce state General Fund costs. Specifically, the proposed ballot measure would (1) sweep $1 billion on a one-time basis from state and local commissions' fund reserves to pay for Medi-Cal services for children up to age five and (2) redirect on an ongoing basis 50 percent of state and local commissions' future revenues to fund various state children's ''""*4 programs. This proposal would result in General Fund savings of $1 billion in 2011-12 and approxi- mately $215 million in 2012-13. This amount would decline gradually in the out-years in accordance with an ongoing trend of declining tobacco product consumption. 32 Legislative Analyst's Office www.lao.ca.gov `~„., Key Issues 2G11-1t BUDGET Amount Available for Sweep Uncertain. The administration has cited 2009 data as the basis for its conclusion that $1 billion in Proposition 10 state and local commission fund reserves are available tc be swept. Under this proposal, the actual amount available for the one-time sweep would depend on the commissions' fund balances as of June 30, 2011. Governance of Proposition 10 Funds. Although the state and local commissions provide some important services to young children, they are in accordance with their priorities, which may differ significantly from the Legislature's priorities, especially in times of fiscal distress. Moreover, the commissions have separate staff and govern- ing boards. Eliminating the commissions would remove this layer of bureaucracy. Alternatives for Legislative Consideration Governor's Proposal Could Be Modified. The Legislature could go further than the Governor's proposal by seeking elimination of the state and local commissions and use those funds to pay for General Fund-supported children's programs. Alternatively, the Legislature could use these revenues as part of any realignment of health and social services programs. These options would also require voter approval. MEDICAL Major Proposals Governor Proposes Alternative Funding Sources and Reductions. The Governor's spending plan shifts $1 billion in funding from Proposition 10 and $840 million in local redevelop- ment agency funds to offset state Medi-Cal costs. (We discuss these proposals in more detail in earlier sections of this report.) The Governor also proposes atwo-quarter extension of the existing hospital fee for additional General Fund relief of $160 million in the current year. In addition, the budget plan proposes to achieve almost $1.7 billion in General Fund savings in the Medi-CaI Program. This would be achieved through a combination of copayments, caps on benefit utilization, elimination of benefits, and payment reductions to certain pro- viders, as shown in Figure 11 (see next page). Governor Pursues Provider Rate Reductions. The spending plan assumes that the courts will rule in favor of the state regarding prior rate reductions and let it go forward with a 10 percent rate reduc- tion to certain types of Medi-Cal providers, for savings of $537 million to the General Fund. The administration anticipates that the U.S. Supreme Court will decide to hear the state's appeals of lower-court rulings that enjoined these prior budget reductions bymid-January 2011 and will rule by July 1, 2011. In addition to the favorable court outcome, the spending plan also assumes that net savings of $172 million General Fund can be achieved by reducing certain long-term care pay- ments by 10 percent. Governor Proposes copayments, Hard Caps, and Benefit Eliminations. The governor proposes to achieve almost $1 billion in General Fund savings in Medi-Cal through the imposition of copayments,.caps on the utilization of certain ben- efits, and the elimination of certain benefits, such as Adult Day Health Care (ADHC). Key Issues Merit in the Governor's Approach. Given the state's difficult fiscal condition and the significant growth that would otherwise occur in the General Fund budget of the Medi-Cal Program, we believe the Legislature should carefully consider the Governor's proposals for budget reductions in Medi-Cal as well as other alternatives to achieve savings. We note that the administration's options www.lao.ca.gov Legislative Analyst's Office 33 2011-12 BUDGE- to control costs ire Medi-Cal through reductions in eligibility are limited by requirements imposed by the federal Affordable Care Act (also known as health care reform). While some savings could be achieved by scaling back eligibility for state-only benefits, other major eligibility reductions that could save hundreds of millions of dollars are not permissible because of the federal legislation. Some Medi-Cal Budgetary Savings Risky or Overstated. In recent years, the Legislature has adopted a number. of different measures to contain costs in the Medi-Cal Program that. have been blocked as a result of legal challenges. Given prior court injunctions in recent years, for example; Figure 11 Medi-Cal Program Selected Budget Solutions there is a significant risk that the courts will rule against the state in regard to the previously enacted provider payment reductions. If so, the state would lose significant savings assumed in the 201 I-I2 budget plan. The newly proposed payment reduction for long-term care facilities also could be subject to legal challenge. Furthermore, federal approval maybe required in order to implement several of the Governor's proposals, including rate reductions. Recent actions by federal Medicaid authorities suggest that the reductions proposed in the Governor's budget could receive close scrutiny. We caution that some of the Governor's savings estimates maybe somewhat overstated because (General Fund Benefif, in Millions) Impose Caps Physician and clinic visits at ten per year (adults) - $196.5 Drugs at six prescriptions (adults) - 11.0 Durable medical equipment at 90m percentile (adults) - 7.4 Medical supplies at 90'" percentile (adults) - 2.0 Hearing aids at 90'" percentile (adults) - 0.5 Subtotals (-) ($217.4) Impose Copayments $5 copayment for visits to physicians and certain clinics - $152.8 $100 copayment per hospital inpatient day - 151.2 $3 and $5 pharmacy Copayments - 140.3 $50 copayment for nonemergency emergency room (ER) visits - 73.2 $50 copayment for emergency ER visits - 38.4 $5 copayment for dental office visits (adults) $0.2 1.3 Subtotals ($0.2) ($557.2) Reduce Benefits Eliminate Adult Day Health Care services $1.5 $176.6 Limit nutritional supplements 0.5 14.4 Eliminate selected over-the-counter drugs 0.1 2.2 Subtotals ($2.1) ($193.2) Implement Provider Payment Reductions Assume courts will allow certain provider payment reductions $9.5 $537.0 Impose a 10 percent payment reduction on long-term care facilities - 172.3 Subtotals ($9.5) ($709.3) Totals $11.8 $1,677.1 ._.~~;,. 34 Legislative Analyst's Office www.lao.ca.gov 10 i ~-1~ BUDGE they do not capture the net effect of the proposal. For example, savings from the elimination of the ADHC benefit would be offset by additional costs in Medi-Cal and other state programs; such as the DDS. and service providers and through the implementa- tion of statewide service standards. The statewide standards would set guidelines to promote consis- tency in the array of services provided by RCs and would be developed with input from stakeholders. Alternatives for Legislative Consideration Copayments and Caps on Services Could Be Modified. In the event that the Legislature does not wish to adopt in full some of the specific budget reductions contemplated in the Governor's budget plans, options are available to the Legislature that would still achieve some measure of state savings. For example, the Legislature could imple- ment copayments for certain Medi-Cal services in smaller dollar amounts than the copayments proposed by the governor. Similarly, the Legislature could adopt the proposed caps on the utilization of certain benefits, but with allowance for exceptions, thereby allowing Medi-Cal beneficiaries to access critical care. DEPARTMENT OF DEVELOPMENTAL SERVICES Major Proposals Major Reductions in Regional Center (RC) Programs. The governor's budget plan proposes to achieve $750 million in Genera] Fund savings in DDS. About $125 million of the savings will come from alternative funding sources, such as the continuation of $50 million in funding from Proposition 10 and three separate proposals to draw down a combined total of $75 million in federal funds. Another $92 million in savings would come from the continuation of a 4.25 percent reduction to RC operations and provider payments. The remaining $533 million in savings would lie achieved by a proposal described as increasing the accountability and transparency for the use of state funds for the administrative expenditures of RCs Key Issues More Information Needed to Assess Whether Savings Are Achievable. The administration's pro- posals to achieve savings in the DDS program have merit in concept, given the significant historical increases in spending and caseload for community programs. However, we believe the Legislature requires additional detail to evaluate the proposal for $533 million in savings in RC operations and programs. HEALTHY FAMILIES PROGRAM Major Proposals Plan Would Implement Premium Increases, Benefit Eliminations, and Copayments. The Governor's budget plan would achieve $39 million in General Fund savings in the Healthy Families Program (HFP) through benefit eliminations, premium increases, and the implementation of copayments for certain services. Specifically, the plan proposes to eliminate the vision benefit and increase premiums by between 75 percent and 88 percent based upon family income levels. The plan also would increase copayments for emergency room visits from $15 to $50 and inpatient hospital stays from $0 to $100 per day with a maximum of $200 per stay. Managed Care Tax Would Be Extended. The tax assessed on managed care plans provides rev- enues that are used to fund rate increases in Medi- cal and provide health coverage in HFP. This tax expires on June 30, 2011. The budget plan proposes to make the tax permanent and use the revenues to fund Medi-Cal and HFP for savings of $97 million. www.lao.ca.gov Legislative Analyst's Office 35 2Gli-i2 BUDGES Key Issues Federal Approval of Tax Measure Uncertain. We caution that the managed care tax is subject to federal approval and, based upon our review, there is some risk that it may not be approved. Alternatives for Legislative Consideration Some of the Governor's Proposals for HFP Could Also Be Modified. Similar to the options presented under Medi-Cal, the Legislature could adopt more moderate reductions than the ones proposed by the Governor, albeit at a reduced savings level. For example, the Legislature could adopt lesser premium increases or copayments than proposed by the administration. JUDICIAL AND CRIMINAL JUSTICE Major Proposals Public Safety Realignment. As we discussed Similarly, the proposed budget assumes that the full $200 million from an unallocated inmate population-related reduction will not be achieved in either 2010-11 or 2011-12. Increased Funding for CDCR Salary and Other Costs. The budget provides an additional $395 million in General Fund support for the California Department of Corrections and Rehabilitation (CDCR) for expenses that the department indicates have exceeded its budgeted authority in previous years. These expenses include correctional officer salaries and wages, overtime for correctional officers, and costs associated with transporting and guarding inmates at health care facilities outside prison walls. CDCR Workforce Cap Adjustment. As a result of an unallocated 5 percent reduction to the per- sonnel budgets of most state departments (referred to as the workforce cap), the 2010-11 budget assumed a total of about $292 million in personnel earlier in this report, the administration proposes to realign several public safety programs to coun- ties. These programs include adult parole, jurisdic- tion of lower-level adult offenders and all juvenile offenders, court security, and various local public safety grant programs (such as the Citizens' Option for Public Safety program and local detention facility subventions or booking fees). Redevelopment Fund Shift to Trial Courts. The Governor's budget proposes to offset $860 million in trial court costs in 2011-12 with redevelopment funding. (Please see the "Redevelopment" section of this report for a more detailed discussion of the Governor's proposal.) Revised Corrections Savings. The enacted 2010-11 budget includes an $820 million unal- located reduction to the Receiver's inmate medical services program. The Governor's budget includes additional funding based on the assumption that only about $177 million in these savings will be achieved in 2010-11 and $257 million in 2011-12. savings for CDCR. The Governor's budget assumes that the department will only be able to achieve $20 million of these savings in the current year. However, the proposed budget assumes that the full $292 million in savings will be achieved in 2011-12. Unallocated Reduction to Trial Courts. The proposed budget includes an unallocated reduction of $200 million to the General Fund support budget of trial courts. Key Issues Significant Risk in Fully Achieving Assumed CDCR Savings. At this time, the administration has not presented specific plans as to how the savings related to inmate medical care services and the workforce cap proposal will be achieved. Given the absence of such plans, we believe that assuming the level of savings contained in the Governor's budget poses significant risks. For example, in order to achieve the magnitude of savings proposed in the inmate medical care budget, the Receiver 36 Legislative Analyst's Office www.lao.ca.gov 2Gii-i~ BUDGET would need to identify and begir, to implement major operational changes now. Moreover, CDCR's ability to achieve the workforce cap savings appears to be limited since the department's personnel costs are largely tied to the operations of the state prisons-which must be staffed on a 24-hour basis. Funding for CDCR Salary and Other Costs Raises Some .Concerns. Although CDCR has exceeded its budget authority in recent years, the administration's approach to address the problem may not be fully justified. For example, the depart- ment requests an augmentation of $36 million to its base level of funding for correctional officer overtime of $104 million, in order to account for higher costs that have resulted from increases in correctional officer salaries over the past decade. However, CDCR reports that it spent a total of about $416 million on overtime for correctional officers in 2009-10-over $300 million above the level for which the department is budgeted. This suggests that much of the requested funding is related to excessive overtime costs. The department has not presented a plan to reduce these high costs on an ongoing basis. Consider Specific Cost-Savings Options for the Courts. Although the state's court system-and in particular the trial courts-have had reductions. in General Fund support in recent years, much of these reductions have been offset by fund shifts and revenue from court-related fee increases. As a result, these reductions have not resulted in substantial decreases in the total level of funding for the courts. Thus, the Governor's proposal to achieve $200 million in court savings merits legislative consideration. While the administra- tion has not identified how these savings would be achieved, we believe that the Legislature should work with the courts to determine what specific actions are needed to achieve these, and potentially even greater, savings, in a way that minimizes impacts on access to the courts. For example, the Legislature could direct the trial courts to imple- ment electronic court reporting and to utilize com- petitive bidding to reduce costs for court security. TRANSPORTATION Major Proposals Transportation Funds Would Provide General Fund Relief. The 2010-11 Budget Act assumed that the state would achieve roughly $1.6 billion in General Fund relief under a fuel tax swap that per- mitted significant changes in the use of transporta- tion funds. However, the enactment of Propositions 22 and 26 on the November 2010 ballot could prevent the state from fully achieving this budget solution. Proposition 22 restricts the use of certain transportation funds and Proposition 26 could be interpreted to repeal the fuel tax swap legislation as of November 2011. The Governor's budget proposes to address these problems in several ways. First, it would reenact the prior fuel tax swap. The Governor's package would allow $262 million in vehicle weight fees to be used to pay transportation debt in the current year, and permit roughly $800 million in State Highway Account (SHA) monies (primarily from weight fees) to pay transportation debt in 2011-12. Also, some transportation funds would be loaned to the General Fund. Altogether, these actions would achieve $1.6 billion in General Fund relief in the current year and $944 million in 2011-12 under this proposal. Key Issues Maximize General Fund Benefit. Our analysis indicates that these proposals, similar to ones proposed by the former Governor in the December 2010 special session but not yet adopted, are reasonable and could achieve the level of sayings proposed. However, as we noted in December, the proposal does not maximize the use of weight fee revenues for potential benefit to the General Fund. www.lao.ca.gov Legislative Analyst's Office 37 X01 i-i~ BUDGET We believe the amount of General Fund benefit in the current year could b.e increased by at least $50 million and potentially by a similar amount in the budget year; z~~hile still maintaining an adequate reserve in the SHA. Alternatives for Legislative Consideration Develop Comprehensive Fix for the Future. The Governor's proposal would help to ensure that transportation funds could be used for General Fund relief in the future. We believe this is appropriate. In addition, we think this is a good time for the Legislature to consider a more com- prehensive approach that would provide additional General Fund relief and address other problems in the current transportation funding system. For example, we believe the Legislature should examine the current fragmentation of funding into various special funds that each allows only limited uses. We are exploring what steps the Legislature and the voters could take to allow for more flexible and effective use of these funds. STATE OPERATIONS Major Proposals Savings From Collective Bargaining and Administrative Actions. Currently, 6 of the state's 21 employee bargaining units (about 25 percent of its workforce) are working under expired con- tracts. The budget assumes that new memoranda of understanding (MOUs) and/or administrative actions related to these employees will generate $308 million in General Fund savings in 2011-12. This amount is equivalent to a 10 percent salary reduction for these employees. The current three- day a-month furlough, in~contrast; is equivalent to a 14 percent salary cut. Health Plan Savings. The state's contribution to employee health coverage is based on the average cost of the four health plans with the most enrolled state employees. Beginning in the 2012. calendar year, the administration proposes adding a new health plan that provides somewhat less compre- hensive coverage at a somewhat reduced cost to employees electing the plan. The budget assumes that this plan will attract enough employees so that the state would realize $72 million in General Fund savings in the budget year. Unallocated Cut. The budget includes a $200 million General Fund unallocated cut to state operations to be achieved through various efficiencies. Key Issues Erosions of Current-Year Savings. While the 2010-I1 Budget Act assumed $1.5 billion of General Fund savings in employee compensation costs, the budget indicates that the state will not realize more than a third of this amount. The shortfalls include: $281 million from state departments not reducing employment costs fully pursuant to the ongoing state workforce cap, $166 million from lower-than-anticipated savings associated with the ratified MOUs and administrative actions, and $100 million from unrealized operating expenses and equipment savings. The budget assumes, however, that the state will realize virtually all of the workforce cap savings in 2011-12. Assumed Budget-Year Savings Unrealistic. The proposed savings associated with health plans and the unallocated cuts are not realistic. The new health plan is not likely to attract enough employees to substantially reduce state costs, and the state's experience with across-the-board cuts suggests that they are not likely to generate the . anticipated savings. Alternatives for Legislative Consideration Greater Savings From Employees With Expired Contracts. Given that the state is not likely to achieve all of the savings associated with. the health plan and unallocated cut proposals, the 38 Legislative Analyst's Office www.lao.ca.gov 2Qi i-.c BUDGE? Legislature and administration could consider increasing the Level of proposed savings associ- ated with employees with expired contracts. For example, approving MOUs or authorizing admin- istrative actions that continue the current level of savings associated with these employees (14 percent of salary costs) could reduce General Fund costs by over $100 million in 2011-12. Extend Personal Leave Program. The Legislature could authorize administrative actions that extend the one day a month "personal leave program," beginning November 2011, for employees represented by Service Employees International Union Local 1000 and for employees not represented by a union. (Extending this program to the six other bargaining units with active MOUs, in contrast, is not permitted under the terms of their MOUs.) OTHER PROPOSALS Debt Service Proposal: Delaying Spring General Obligation Bond Sale. The state typically sells general obliga- tion bonds in the spring and fall, but the admin- istration plans to eliminate the spring sale in the current year. This one-time pause in the issuance of new bonds, combined with the Governor's proposal to use weight fees and other revenues to cover a portion of transportation debt-service costs, would slow the growth of General Fund debt-service obli- gations. General Fund debt service would.increase in the budget year by approximately $60 million or 1 percent under the proposal. This is a modest increase compared with earlier projections. (The previous administration's assumptions included issuing $7 billion in bonds this spring, which would have increased debt costs by about $475 million in 2011-12.) projects and bond programs through the bond sale in the fall. New projects or local assistance grants, however, could be delayed depending upon departments' remaining balances. The Governor's proposal did not include details on projects or programs that could be affected by the delay. We recommend the Legislature request details on the potential effects of the pause in bond sales in order to ensure that available funds are directed toward its highest priorities. Savings Represent Temporary Solution. Given the state's fiscal condition, it is reasonable to con- sider the delay of the spring bond sale. The avoided debt-service costs would reduce pressure on the General Fund in 2011-12. Such relief, however, is temporary. The state still has roughly $50 billion in authorized but unsold bonds, most of which would be sold and spent over the next few years under current practices. The delayed spring sale simply defers the debt-service costs associated with these bonds to future years. Alternative: Permanently Eliminate or Reduce Some Bond Programs. The planned sale of the remaining authorized bonds would add more than $3 billion annually to the state's debt-service obliga- tions. The Legislature and voters approved many of these programs when the state was on more sound fiscal footing. In light of the state's current fiscal condition, the Legislature may wish to evaluate whether these programs remain state priorities. For example, some bond programs support func- tionsthat are not traditionally state responsibilities and the Legislature may wish to focus the state's resources on its core infrastructure responsibilities. CalFire Eliminate the Fourth Firefighter on CalFire Most Departments Have Su,~cient Funds Engines. In addition to the proposal to shift some to Operate Bond Programs Through the Fall. wildland firefighting responsibility to the local According to the administration, most depart- level, as described in the "State-Local Realignment" , ments have sufficient funds to continue existing section of this report, the administration proposes ~ www.lao:ca.gov Legislative Analyst's Office 39 2011-12 BUDGE? $30.7 million in 2011-"t2 General Fund savings in CalFire from eliminating the fourth firefighter on CalFire fire engines, returning to the pre-200? level ofper-engine staffing. \ATe have previously recommended this approach on the basis that the department has not demonstrated that this level of increased staffing is cost-effective. ~' LAO Rublicafiians The Legislative Analyst's Office (LAO) is a nonpartisan office which provides fiscal and policy information and advice to the Legislature. To request publicotions call (916) 445-4656. This report and others, as well as an E-mail subscription service, are available on the LAO's website at www.lao.ca.gov: The LAO is located at 925 L Street, Suite 1000, «~:. Sacramento, CA 95814. 40 Legislative Analyst's Office www.lao.ca.gov INTRODUCTION Californians pay over $45 billion in property taxes annually. County auditors distribute these revenues to local agencies-schools, community colleges, the counties, cities, and special districts- pursuant to state law. Property tax revenues typically represent the largest source of local general purpose revenues for these local agencies. More than 60 years ago, the Legislature established a process whereby a city or county can declare an area to be blighted and in need of redevelopment. After this declaration, most property tax revenue growth from the "project area" is distributed to the city or county's redevel- opment agency, instead of the other local agencies serving the project area. During the early years of California's redevelopment law, few communities established project areas and project areas typically were small-usually 10 to 100 acres. Over the last 35 years, however, most cities and many counties have created project areas and the size of project areas has grown-several cover more than 20,000 acres each. Partly as a result of this expansion in number and size of project areas, redevelopment's share of total statewide property taxes has grown six fold (from 2 percent to 12 percent of total statewide property taxes). In some counties, local agencies have created so many project areas that more than 25 percent of all property tax revenue collected in the county are allocated to a redevelopment agency, not the schools, community colleges, or other local governments. California's expansive use of redevelopment has engendered significant controversy. Advocates of the program contend that it is a much needed tool to promote local economic development in blighted urban areas. Program critics counter that redevelopment diverts property tax revenues from core government services and increases state education costs, and that the scale and location of many project areas bear little relationship to the program's intended mission. The Governor's 2011-12 budget includes a plan for dissolving redevelopment agencies and distrib- utingtheir funds (above the amounts necessary to pay outstanding debt) to other local agencies. To assist the Legislature in reviewing this proposal, this report explains how redevelopment redis- tributes and uses property tax revenues. The report then evaluates redevelopment, summarizes and assesses the Governor's proposal, and offers sugges- tions for legislative consideration. 2011-12 BUDGET HOW REDEVELOPMENT REDISTRIBUTES AND USES PROPERTY TAXES Property Tax Allocation in Areas Not Under Redevelopment After property owners pay property taxes, county auditors distribute them to schools and other local agencies in the county. While the laws controlling allocation of the base 1 percent property tax rate are complex, they can be summa- rized inthree steps. Step 1. Every year, each local agency receives the same amount of property tax revenues that it received the year before. Step 2. Each local agency receives a share of any growth (or loss) in property tax revenues that occurred within its juris- fee (the "VLF swap"). Each city and county receives funds equal to its current sales tax losses and its 2004 VLF losses, adjusted by the agency's change in assessed valuation since 2004. Property Tax Allocation in Areas Under Redevelopment If a community establishes a redevelopment project area, the amount of property tax revenues flowing to local agencies serving the area is frozen. K-14 districts, the counties, cities, and special districts continue to receive all of the property tax revenues they had received up to that point. This amount is known as the frozen base. diction. (The share an agency receives is As shown in Figure 1, all of the growth in based on historical factors and is often property taxes in the project area-over the frozen referred to as its "AB 8 share" after the 19791aw that Figure 1 established the Allocation of Property Tax Revenues After formula to create Redevelopment Project Is Established these shares.) Step 3. Each city and county receives additional revenues (shifted from the schools' property tax revenues) to offset its losses from the state's reduction of the local sales tax rate (the "triple flip') and vehicle license Property Tax Revenue Tax Increment (for redevelopment) Year 2 Legislative Analyst's Office www.lao.ca.gov 2011-12 BUDGET base-is allocated to the redevelopment agency as tax-increment revenue. In other words, local agencies receive the same amount of property tax revenues they received in the past, but none of the growth. This redirection of property tax revenues lasts for the life of the redevelopment project-typically 50 years, although some older projects have longer planning and marketing programs. As shown in Figure 2 (see next page), however, not all of the property tax increment revenue is available for broad redevelopment purposes. State law requires redevelopment agencies to spend 20 percent of tax-increment funds for low- and moderate-income housing. Additionally, in order to lifetimes. (A nearby box provides some information partially offset the loss of growth in property tax about how this element of California's redevel- revenues for other local agencies, state law requires opment law compares with other states with similar redevelopment agencies to "pass through" to other programs.) agencies a portion of their tax-increment revenues. Viewed from the county auditor's perspective, Steps 1 and 3 of the property tax allocation system (described previously) stay the same. Step 2, however, is revised so that the auditor distributes all revenue growth in the project area to the redevel- opment agency-and not to other agencies. How Redevelopment Uses Property Tax Revenues State law allows redevelopment agencies to use property tax increment revenues to finance a broad array of projects. Redevelopment agencies typically use these revenues-often in conjunction with private developer funds or other governmental resources-to finance capital improvements, land and real estate acquisitions, affordable housing, and Statewide, redevelopment agencies pass through an average of about 22 percent of their property tax increment revenues. This pass- through percentage varies across project areas, based on the date the redevelopment project area was formed and other factors. (Redevelopment law was amended in 1993 to establish a statewide formula for sharing property tax increment revenue derived from newly created redevelopment project areas. This formula increases the pass-through share over time. In redevelopment areas established prior to 1993, redevelopment agencies and affected local agencies typically negotiated the amount of revenues contained in apass-through agreement.) COMPARISON WITH OTHER STATES California's redevelopment law provides fora 50-year diversion of all property tax revenue growth in redevelopment areas. This feature of California law is somewhat unusual in comparison with other states with redevelopment programs (often called "tax increment financing" elsewhere in the country). Many other states, for example, authorize some local agencies to "opt out" of the redevelopment program (that is, to not have their property tax revenue growth included in the diversion) or statutorily exclude school property taxes from the program. Still other states limit to shorter periods how long redevelopment agencies may redirect property taxes. California redevel- opment law partially mitigates the fiscal effect of its program design by requiring redevelopment agencies to "pass through" a portion of the revenues diverted from other local agencies. www.lao.ca.gov Legislative Analyst's Office 3 2011-12 BUDGET Figure 2 Use of Tax Increment Revenues 2008-09 Tax Increment Revenues $5.7 Billion Redevelopment Local Agency Agency Pass Through 22% -Counties 12% - K-14 Schools 6% -Special Districts 3% Redevelopment Affordable -Cities 1 Activities Housing 58% 20% Figure 3 Estimated Statewide Allocation of Property Taxes When Redevelopment Projects End K-12 So Community ~oneges County Property Taxes After Redevelopment Projects End After a redevelopment project ends, the county auditor distributes all of the revenues that formerly were considered "tax increment revenues" to local agencies in the area. F,ach agency serving the area receives a portion of the revenues as determined by its AB 8 share. From a county auditor's standpoint, these revenues do not trigger additional allocations pursuant to Step 3 (the triple flip and VLF swap adjustments) because the end of a redevelopment project does not affect a local agency's sales tax revenue losses or calcu- lation of the VLF swap amount. As shown in Figure 3, we estimate that schools and community colleges would receive over half of the revenues made available after a redevelopment project ends. While very few redevelopment projects have ever ended to date, a significant number are expected to end within next 15 years. 4 Legislative Analyst's Office www.lao.ca.gov Special Districts r:ity 2017-12 BUDGET EVALUATING REDEVELOPMENT The Governor's proposal to end redevelopment raises fundamental questions regarding the extent to which this program benefits the state. To help the Legislature evaluate redevelopment programs, we reviewed available academic studies on their effectiveness. In addition, because published academic articles on California redevelopment programs are rare, we reviewed studies on other states' tax-increment financing districts-the common term for redevelopment finance nationwide. Finally, we reviewed state agency and other reports on redevelopment performance producing affordable housing and compared the key elements of accountability for redevelopment and other programs. Figure 4 summarizes our findings, which we discuss in more detail below. Figure 4 Redevelopment: Findings From Research and Studies Positive Flexible tool that can improve targeted areas. Helps build affordable housing. Negative No evidence that redevelopment increases overall regional or statewide economic development. Diverts revenues from other local governments and increases state education costs. Has limited transparency and accountability. Flexible Tool to Improve Targeted Areas Under the powers granted to them in redevel- opment law, cities can target areas within their jurisdiction for economic development. (Although counties also form redevelopment agencies, we focus on cities in this report because they account for more than 90 percent of active redevelopment areas.) While cities have other tools to encourage economic development, establishing a redevel- opment area is one of the easiest ways tb raise significant sums. Most other local options for generating revenue for economic development- such as issuing general obligation bonds or estab- lishing abusiness improvement district-require approval by voters and businesses and/or residents to pay increased sums. Redevelopment requires neither. The use of redevelopment has improved many areas of the state through the revitalization of downtown and historic districts, improvements in public infrastructure, and increased commercial investment. Many of these investments have improved the quality of life for residents in specific areas. In terms of quantifiable measures, most of the academic literature indicates that property values within project areas increase more than comparable areas within a region. This is not surprising as we would expect areas receiving public subsidies to outperform those that do not. Funds Affordable Housing As mentioned above, state law requires redevel- opment agencies to deposit 20 percent of their tax increment revenues into low- and moderate- income housing funds and spend these funds on affordable housing. Redevelopment agencies are authorized to spend housing funds to acquire property, rehabilitate or construct buildings, provide subsidies for low- and moderate-income households, or preserve public subsidized housing units at risk of conversion to market rates. While other federal, state, and local programs also provide funds for affordable housing efforts, redevelopment represents one of the largest funding sources. In terms of housing production efficiency and effectiveness, we are not aware of any studies that compare redevelopment agencies' results in producing affordable housing with other financing approaches. We note, however, that state audits www.lao.ca.gov Legislative Analyst's Office 5 2011-12 BUDGET and oversight reports frequently conclude that No Reliable Evidence That Redevelopment a significant number of redevelopment agencies Increases Regional or Statewide take actions that have the effect of reducing their Economic Development housing program productivity, including: While redevelopment leads to economic devel- • Maintaining large balances of unspent housing funds. (The Department of Housing and Community Development's most recent report indicates that the agencies collectively had an unencumbered balance of more than $2.5 billion.) opment within project areas, there is no reliable evidence that it attracts businesses to the state or increases overall regional economic development. Instead, the limited academic literature on this topic finds that-viewed from the perspective of an entire city or region-the effect of this program on property values is minimal. That is, redevel- Using most of their housing funds for opment may cause some geographic shifts in planning and administrative costs. economic development, but does not increase the Spending housing funds to acquire land for overall amount of economic activity in a region. housing, but not building the housing fora Studies in Illinois and Texas> for example, found decade or longer. that their redevelopment programs did little more CRA Report Inaccurately Calculates Employment Effects of Redevelopment The California Redevelopment Association (CRA) recently circulated a document asserting that eliminating redevelopment agencies would result in the loss of 304,000 jobs in California. We find the methodology and conclusion of CRA's report to be seriously flawed. In our view, it vastly overstates the economic effects of eliminating redevelopment and ignores the positive economic effects of shifting property taxes to schools and other local agencies. The CRA's job loss estimate is based on a consultant's report using data from 2006-07. To estimate the number of jobs resulting from redevelopment agencies, the report calculated the total expenditures on construction projects completed within a sample of redevelopment areas for 2006-07, as well as for any projects completed outside the area with agency participation. Based upon that sample, the report then estimated the total construction expenditures for redevelopment agencies statewide in 2006-07 and used a computer model to calculate through various multipliers the total effect of those expenditures on the state's economy and employment. The report concluded that redevelopment was responsible for the creation of about 304,000 full and part-time jobs in 2006-07. Therefore, the CRA asserts that the elimination of redevelopment would result in the loss of 304,000 jobs. To our knowledge, the consultant's study has never been subjected to any independent or academic scrutiny. Our review indicates that the report has three significant flaws that cause it to vastly overstate the net economic and employment effects of redevelopment agencies. Assumes Redevelopment Agencies Participate in All Project Area Construction. The study's calculation of construction expenditures includes all construction completed in a redevelopment project area in 2006-07, even if the redevelopment agency was not a participant. We find implausible 6 Legislative Analyst's Office www.lao.ca.gov 2011-12 BUDGET than displace commercial activity that would have occurred elsewhere in the region. In addition to examining the effect of redevel- opment on property values in a region, some research has focused on the effect of this program on jobs. The independent research we reviewed found little evidence that redevelopment increases jobs. That is-similar to the analyses of property values-the research typically finds that any employment gains in the project areas are offset by losses in other parts of the region. We note that one study, commissioned by the California Redevelopment Association, vastly overstates the employment effects of redevelopment areas (please see nearby box). Diverts Revenues From Other Local Governments and State Redevelopment agencies receive over $5 billion of tax increment revenues annually. Lacking any reliable evidence that the agencies' activities increase statewide tax revenues, we assume that a substantial portion of these revenues would have been generated anyway elsewhere in the region or state. For example, a redevelopment agency might attract to a project area businesses that previously were located in other California cities, or that were planning to expand elsewhere in the region. In either of these cases, property taxes paid in the project area would increase, but there would be no change in statewide property tax revenues. the report's implicit assumption that no construction with solely private financing would have occurred within a redevelopment area in the absence of the redevelopment agency. This is particu- larlytrue, given the large geographic scale of California redevelopment project areas. In our view, it is likely that much of the new business or residential construction (and the associated jobs) would have occurred independently of the redevelopment agency. Assumes Private and Public Entities Participating in Redevelopment Agency Projects Would Not Invest in Other Projects. Most redevelopment agency projects include significant financing from private investors or other public agencies. By asserting that all of the jobs associated with redevelopment construction would be lost if redevelopment agencies were eliminated, the CRA implicitly assumes that these private and public partners would not invest in other economic activ- ities in the state. The report provided no explanation for this assumption that the existing private capital and public agency grants would remain unused without redevelopment agency participation. In most cases, we would expect developers, investors, and public agencies to find alternative projects to pursue-either within the redevelopment area or elsewhere in the state. Assumes Other Local Agencies' Use of Property Tax Revenues Would Not Yield Economic Benefits. Under the Governor's proposal, the property tax revenues that currently support redevel- opment would flow over time to schools and other local agencies in the county. By asserting that all of the jobs associated with redevelopment construction would be lost if redevelopment agencies were eliminated, the CRA implicitly assumes that these other local agencies' use of property tax revenues would not result in any economic activity. The report provided no explanation for this assumption. In our view, spending by school districts, counties, and other local agencies also would yield signif- icant economic and employment benefits. www.lao.ca.gov Legislative Analyst's Office 7 2011-12 BUDGET To the extent that a redevelopment agency receives property tax revenues without gener- ating an overall increase in taxes paid in the state, the agency reduces revenues that otherwise would be available for local agencies to spend on non-redevelopment programs, including law enforcement, fire protection, road maintenance, libraries, and parks. The fiscal effect of redevelopment on K-12 schools and community colleges, in contrast, is somewhat different. This is because, under California school finance laws, the state is respon- sible for ensuring that each district receives suffi- cient total revenues (from state and local sources) to meet a statutorily defined funding level. Thus, property tax revenues redirected to redevelopment agencies usually are replaced by increased state aid. In this way, K-14 districts are largely unaffected by redevelopment, but state education costs increase. Fiscal Effect on Local Agencies and the State. Based on the available evidence, we estimate that the amount of property tax revenues diverted from non-school local agencies (principally, counties and special districts) is about $1.5 billion annually net ofpass-through payments. We further estimate that the increased cost to the state associated with the diversion of K-14 district property taxes is over $2 billion annually net ofpass-through payments. In addition to these amounts, we note that some K-14 districts with unusually high property tax revenues per pupil ("basic aid" districts) also sustain property tax revenue losses associated with redevelopment, but we are not able to estimate the magnitude. Limited Transparency and Accountability Redevelopment agencies lack some of the key accountability and transparency elements common to other local agencies. Specifically, unlike other local agencies, redevelopment agencies can incur debt without voter approval. Redevelopment agencies can also redirect property tax revenues from schools and other local agencies without voter approval or the consent of the local agencies. In addition, although redevelopment programs are authorized in state law and increase state costs, redevelopment programs lack the key accountability elements that are common to state- supported local assistance programs. Specifically, no state agency reviews redevelopment economic development activities or ensures that project areas focus on the program's mission. We also note that use of redevelopment is not limited to communities with low property wealth-some of California's most affluent cities have declared large sections of their jurisdictions "blighted:' GOVERNOR'S PROPOSAL The administration proposes to dissolve the state's redevelopment agencies. Tax increment revenues that currently go to redevelopment agencies would be redirected to retire redevel- opment debts and contractual obligations and to fund other local government services. In place of redevelopment, the administration indicates that it will propose a constitutional amendment purposes by a 55 percent majority. While many of the details of the Governor's proposal still are under development, we outline its key elements below. Successor Agency Assumes Debt Obligations Redevelopment agencies currently have the authority to issue debt, own and lease property, and to allow local voters to approve tax increases and enter into other long-term contractual obligations. general obligation bonds for economic development While enactment of the Governor's proposal as 8 Legislative Analyst's Office www.lao.ca.gov 2011-12 BUDGET urgency legislation would prohibit redevelopment agencies from entering into additional obligations, existing debts would need to be paid. The Governor proposes to transfer the responsibility for managing these obligations to a local successor agency- most likely the city or county that authorized the redevelopment area, guided by an oversight board. The successor agency would receive the redevel- opment agency's existing balances and future shares of tax increment revenue to pay the agency's debts. Any funds above the amounts needed to pay these debts would be used for other purposes as described below. The one exception is that the successor agencies would shift any unspent redevel- opment housing funds to local housing authorities to use for low- and moderate-income housing. Use of Redevelopment Funds in 2011-12 The Governor's budget assumes that tax increment revenues from dissolved redevel- Figure 5 opment areas would be approximately $5.2 billion in 2011-12. (The most recent report from the State Controller's Office identifies $5.7 billion of redevelopment tax increment revenues in 2008-09. The Governor's lower tax increment estimate reflects its assumptions regarding the decline of property values statewide.) Of this amount, an estimated $2.2 billion would be used to pay redevelopment debts and obligations during the first year. As outlined in Figure 5, the remainder of the tax increment revenues ($3 billion) would provide funding to local govern- ments and offset state General Fund costs. The Governor's proposal would continue to provide redevelopment's existing pass-through payments to local agencies. It would also offset $1.7 billion in state Medi-Cal and trial court costs and distribute $200 million to cities, counties, and special districts in proportion to these agencies' AB 8 shares of the property tax. Use of Redevelopment Funds In Subsequent Years Beginning in 2012-13, any property tax revenues remaining after the successor agencies pay redevelopment debt would be distributed to other local governments in the county. Instead of offsetting state costs or continuing pass- through payments as in 2011-12, distributions of Governor's Proposal for Use of Redevelopment Revenue in 2011-12 Tax Increment Revenue $5.2 Billion Redevelopment Offset State Debt Costs $2.2 Billion $1.7 Billion Proposed Distribution - Trial Courts $860 Million -Medi-Cal $840 Million ~~ Local Pass Through $1.1 Billion Local Governments $210 Million Estimated Distribution - Counties $580 Million - K-14 Schools $290 Million - Special Districts $155 Million -Cities $75 Million Estimated Distribution - Counties $110 Million - Cities $75 Million - Special Districts $25 Million www.lao.ca.gov Legislative Analyst's Office 9 2011-12 BUDGET these revenues to local governments generally would follow provisions in existing law. One exception is that property taxes that otherwise would be distributed to enterprise special districts (primarily fee-financed water and waste disposal districts) would be allocated instead to counties. As shown in Figure 6, we estimate more than half of the remaining revenue would be distributed to schools. (The exact allocation of property tax revenues, however, varies signifi- Figure 6 Governor's Proposal for Use of Redevelopment Revenue in Future Years Tax Increment Revenue Redevelopment Local Governments According to Debt Property Tax Allocation Lawsa K-14 Schools Counties Cities Special Districts 57% 21% 12% 10% aEStimated statewide percentages. Counties would also receive a small portion of funds allocated to special districts. Specifically, property tax revenues that would currently be allocated to enterprise special districts would instead go to counties. cantly across the state.) As redevelopment debts are repaid over time, the amount of revenue available to local governments would steadily increase. Economic Development Could Continue at Local Level While the Governor's plan would phase out the existing redevelopment system, it also proposes a constitutional amendment to allow local voters to approve tax increases and general obligation bonds LAO ASSESSMENT In our view, the Governor's proposal merits consideration. The proposal places the respon- sibility to pay for local economic development activities with the level of government benefiting from these policies. The proposal also heightens local accountability for its economic development policies and provides local governments increased for economic development purposes by a 55 percent majority. At this time, details on this portion of the proposal are not available. As we understand it, cities and counties would retain the powers granted to them under redevelopment law except for the use of property tax increment revenue. In the place of tax increment revenue, the proposal would lower the voter threshold for other financing mecha- nisms that local governments could use to pursue economic development activities that are currently carried out by redevelopment agencies. general purpose revenues. Finally, the proposal would make a significant contribution towards helping the state address its serious fiscal diffi- culties in 2011-12. We discuss these advantages, as well as some additional considerations related to the proposal, below. 10 Legislative Analyst's Office www.lao.ca.gov 2011-12 BUDGET Links Program Control, Benefit, and Costs Redevelopment agencies determine the types of projects they undertake. Decisions regarding spending tax increment revenues-to remedy local infrastructure problems, provide amenities for an auto mall, or subsidize business relocation-are made at the local level. In addition, the research on tax increment financing indicates that it provides localized economic benefits, but does not neces- sarily increase statewide economic development. Given these factors-local control over the use Redirects Funds to Local Governments Under the Governor's proposal, schools, counties, special districts, and cities would receive increased property tax revenues. While existing property tax increment revenues are restricted to redevelopment purposes, local governments would have the flexibility to direct these new revenues to their highest priority programs, including public safety, education, health, or social services. Local governments also could elect to use these increased funds for economic development activities. of tax increment funds and local benefits-we see little reason for the state to continue its financial support for this program. The Governor's proposal adheres to a key policy principle that, whenever possible, beneficiaries should pay for services that do not have larger societal benefits. Improves Government Accountability And Transparency Local residents and elected officials can best assess the advantages and disadvantages of raising new funds for economic development activities versus shifting funds from other government programs. Under the current system, however, local residents and most elected local officials do not have a role in making these decisions. This is because a redevelopment agency's decision to form a project area can divert property tax revenues from other agencies without their consent or voter approval. The agency forming a project area also does not have to confront the tradeoffs associated with diverting property tax revenues from its local schools because the state backfills virtually all of these property tax losses. Ending state-assisted redevelopment would require individual commu- nities to confront the full policy implications of funding economic development within their borders, thereby improving transparency and accountability. Provides a One Year State Fiscal Benefit The proposal would help address the state's 2011-12 budget problem by offsetting state General Fund costs for Medi-Cal and trial courts by $1.7 billion. While there is little policy rationale for using property taxes permanently for these purposes, we think this one-time use is reasonable in recognition of the magnitude of the state's prior- year subsidies for redevelopment. Additional Factors and Considerations At the time this brief was prepared, the admin- istration was still developing the statutory provi- sions to implement its proposal. While we cannot provide the Legislature with a detailed assessment of the proposed plan, we highlight below three issues that merit the Legislature's consideration. Early Plan Complicated School Funding and Property Tax Allocation Systems. Early versions of the Governor's plan provided a special allocation system for the additional property tax revenues to schools. Instead of being allocated as property taxes to K-14 districts where the revenues were generated, the administration's plan allocated these revenues to K-14 districts countywide as a supplement to their existing funds. In our view, this approach does not make sense and would further complicate the already complicated K-14 district finance and www.lao.ca.gov Legislative Analyst's Office 11 2011-12 BUDGET property tax allocation systems. This approach also would increase state costs over the long term (relative to current law) because the state would not receive the financial relief associated with the expected expiration of redevelopment projects. The state also would forgo considerable ongoing state savings because the increased K-14 property taxes would not offset the state's spending for schools. In our view, any property tax revenue from the former redevelopment areas-above the amounts needed to pay existing debt-should be allocated as property taxes pursuant to existing laws. Should the Legislature wish to provide increased support for K-14 districts or to modify the AB 8 property tax allocation system, it could do so separately. Few Other Options for Ongoing Redevelopment Relief. In some ways, the Governor's proposal is similar to many previous actions of the Legislature. Specifically, ten times over the last two decades the Legislature has required redevelopment agencies to shift funds to schools, thereby partly mitigating the state's increased education costs associated with redevel- opment. In 2009-10, for example, the Legislature required redevelopment agencies to shift $2 billion of redevelopment funds to schools over two years. The voter's recent approval of Proposition 22, however, prohibits the Legislature from enacting these types of revenue shifts in the future. Thus, the Legislature has few options for mitigating the major ongoing costs of redevelopment other than dissolving the program. In the future, the Legislature could consider creating an alternative, more targeted, economic development program. Dissolving Redevelopment Will Be Complicated and Disruptive. Program changes of this magnitude inevitably pose administrative, policy, and legal difficulties. Ending redevelopment, a program that California local governments have used for decades, will not be an exception. Many communities have significant numbers of people and projects currently funded through redevelopment revenues, as well as plans for additional redevelopment expenditures over the coming months. In addition, a significant portion of redevelopment agency funds are committed to the payment of bonded indebtedness, and three voter approved measures-Proposition 18 (1952), Proposition lA (2004), and Proposition 22 (2010)- contain provisions limiting the state's authority to shift property taxes andlor redirect tax increment revenues. Drafting a plan for local governments to carefully unwind their redevelopment programs and successfully navigate the many legal, admin- istrative, and financial factors will be complex. The Legislature will need to weigh the costs and benefits of dissolving redevelopment agencies versus the costs and benefits of other major budget alternatives. CONCLUSION Given the significant policy shortcomings of California's redevelopment program, we agree with the Governor's proposal to end it and to offer local governments alternative tools to finance economic development. Under this approach, cities and counties would have incentives to consider the full range of costs and benefits of economic devel- opment proposals. In contrast with the administration's proposal, however, we think revenues freed up from the dissolution of redevelopment should be treated as what they are: property taxes. Doing so avoids further complicating the state's K-14 financing system or providing disproportionate benefits to K-14 districts in those counties where redevel- opment was used extensively. Treating the revenues 12 Legislative Analyst's Office www.lao.ca.gov 2011-12 BUDGET as property taxes also phases out the state's ongoing costs for this program and provides an ongoing budget solution for the state. Ordinarily, we would recommend that the state phase out this program over several years or longer to minimize the disruption an abrupt ending likely would engender. Given the state's extraordinary fiscal difficulties, however, the Legislature will need to weigh the effect of this disruption in comparison with other major and urgent changes that the state would need to make if this budget solution were not adopted. www.lao.ca.gov Legislative Analyst's Office 13