Gov. Jerry Brown’s latest budget proposal shows that juggling government finances is no simple chore.
The annual Sacramento budget dance is pretty well scripted by now, with the Democrats in supermajority control and fiscally conservative Republicans with limited votes for dramatic change.
Curiously, over the years, Brown has tried to play an awkward middleman, though still leaning toward Democratic thinking.
But this year’s Sacramento budget script has a major, new, unpredictable character – President Donald Trump.
Trump’s “America First” viewpoint is a stark contrast to California’s more global lifestyle and business ways. And the inevitable political friction could translate to serious damage to California’s overall economy and/or its state budget.
That puts the typical state budget arm wrestling into a harsh perspective.
The mix of political and social philosophy merging with economic and political realities shows why budgets are, at best, a perpetual work in progress. Brown’s most recent budget proposal is criticized on both sides of the political spectrum but gets decent reviews from some outside observers for its financial logic.
Some of Brown’s fellow Democrats suggest that spending is too lean for good times. Republicans say the opposite: that even if the business climate is rosy – and they have their doubts – too many current and future fiscal challenges call for deep cuts and/or new spending priorities.
In trying to understand this debate, I’ve learned that there are plenty of difficult to answer questions facing state policymakers – and eventually state voters – on how California will spend what it can get now, and how it will raise revenue and fund programs going forward.
So, with so many unknowns and a surplus of opinion – pro and con – here’s my look at the key questions facing California’s budget-making process.
The “debate” usually centers on the “general fund” – that’s the pool of state revenue and spending that is directly controlled by the Legislature.
On the revenue side of the equation, Brown pegs the general fund portion of the state budget to grow by $3 billion, to $125 billion, primarily because he expects Californians to pay more in income taxes. So-called special funds, typically for targeted spending and not easily shifted by legislators, are projected to take in another $50 billion.
But no budget – whether household, corporate or municipal – is crafted without some underlying principles.
Except for paying the outstanding bills.
It’s not very hard to see Sacramento’s tilt to growing state spending on Democratic pet issues, including social programs and publicly funded education. Unfortunately, making a budget make numerical sense and meeting political expectations isn’t as easy.
California voters have passed several propositions over the years that make it tough for the governor and the Legislature to manipulate and manage spending. Voters have commanded that the state spend on everything from education to rainy day funds to imprisonment rules that shrink prison overcrowding.
Bottom line: California budget-makers have as little financial flexibility as any legislature in the nation.
The proposed budget raises doubts about California’s cash-raising strength.
Brown’s proposal, made public last month, suggests there will be a $1.6 billion hole for the current fiscal year. He blames weak income tax inflows and, as a fix, he proposes $3.2 billion in budget cuts.
Critics blame Brown and his fellow Democrats for carrying on a spending spree. In Brown’s five years, general fund spending has risen by 45 percent, or $40 billion.
But Brown came into office just as the recession was ending, a downturn that smashed the state’s economy and, with it, the state’s budget. If you take a longer term view – looking back to the previous peak of spending, $103 billion in fiscal 2008 – then the rise in the state budget under Brown looks more moderate, about 2 percent a year.
“If you take a step back, you see that California has come a long, long way,” says David Hammer, who watches California issues for the bond-trading giant Pimco.
No matter how you slice it, California’s budget is big money.
The general fund, the major financial spending tool for the nation’s most populous state, is roughly $3,000 per California resident. That’s about the same per capita spending as you’d find in Wyoming, the nation’s least populous state.
And if Brown’s projection of a $1.6 billion deficit in the current year sounds worrisome, remember this: Budgets during the last recession came in with deficit projections running $40 billion.
Brown’s budget – with roughly flat general fund spending – is the result of an improving economy and rising taxes in California.
Critics like state Sen. John Moorlach, R-Costa Mesa, say new taxes, along with stiff regulatory burdens, create a large hurdle for the state to attract new businesses and additional skilled workers. On a per capita basis, California has attracted the fewest residents from other states from 2010 through 2015.
“We need more discipline to attack the challenges,” Moorlach says. “Jerry Brown has done nothing.”
But forget politics for a moment. The bottom line is that California’s budget is directly linked with California’s economy, certainly more than it is to the discipline of any particular governor or legislator. The state has had more cash in recent years, in part because of an upswing in the state’s economy.
Brown’s budget suggests basic revenue will grow by 3 percent. The state’s nonpartisan analysts at the Legislative Analyst’s Office predict the growth will be closer to 5 percent, which is common in economic upswings. By that measure, Brown looks prudent.
Will growth last?
Observers outside the political arena say yes; they predict 2017 will be California’s seventh year of recovery.
Economist Chris Thornberg says, “Brown’s intentionally low-balling the numbers to control the Democrats who are pretending they have unlimited money to spend.”
But there’s a huge caveat to any economic forecast: What about Trump?
On everything from immigration policy and environmental regulation to the view of China as a trading partner, the Trump administration figures to offer policies that could hurt California’s economy and, with it, the state budget.
And what if Trump retaliates against California or its municipalities if they balk at new policies, such as immigration enforcement? Federal spending in the state is estimated to run in the ballpark of $100 billion.
Trump could be California’s rainy day.
“What’s coming out of Sacramento makes pretty good sense to put away dollars for the next downturn,” says economist John Husing of Redlands. “This recovery can’t go on forever.”
To be more specific, California’s budget is a bet on the stock market.
California’s tax collections are volatile because they are directly tied to the success of the state’s wealthiest residents, with incomes that vary widely based on the performance of the stocks they own.
Roughly half of California’s general fund spending is tied to state income taxes, and much of the variation in income tax collections is capital gains.
If the stock market is strong, and wealthy Californians are motivated to sell stock, capital gains will be created and tax revenue will continue to rise. But if the stock market drops, or the wealthy hold stocks longer perhaps due to anticipated federal tax cuts, the state budget will be severely challenged.
“If Trumps puts us into a recession, you know how desperate this state is for capital gains,” Thornberg says. “If markets tank, there will be revenue hell to pay.”
In addition, a large and growing cost to California taxpayers comprises the retirement benefits of its state workforce. Pension finances also rise and fall with investment performance, and Brown’s critics say the state budget doesn’t track with a risk that figures to be a long-running drain.
“Sacramento has kicked the can down the road for so long, now we are at the end of the road,” says Marilyn Cohen, a municipal bond expert from Los Angeles.
“Even nationally, we see more talk about that we can no longer afford these kind of pensions.”
Since California is a major borrower – in recent years simply for long-term projects; not to meet cash concerns – it’s important to know how the bond market views the state’s finances.
Three independent credit-rating agencies have rated California at highs not seen since the turn of the century. Yet, even at that, California’s credit rating remains among the lowest of any state in the nation.
Emily Raimes, a California credit analyst at Moody’s, says California’s rating is still “very high” – Aa3 by Moody’s – and adds that while the state owes “very big” debts it also has “a very, very large economic base to draw from.”
It is worth noting that according to Pimco’s Hammer, bond investors hold California debts in high regard – meaning, these bonds trade better than their credit rating would suggest.
“The bond market has rewarded California for tightening its budget belt,” Hammer says.
If you know the future of the Affordable Care Act, please call California budget-makers.
California has been aggressive in adopting the previous president’s signature health care legislation, and a full repeal of that legislation could blow a huge hole in the state budget.
“California is one of the higher-risk states,” says Moody’s Raimes.
How California will deal financially, and politically, with any changes to Obamacare is the big wild card for the budget – perhaps more in future years.
But should the state start pruning budgets and stashing cash now for future health insurance needs for its citizens?
Maybe.
The $102 billion budget for Medi-Cal, the state’s health program, is largely financed with federal dollars. “Without that cash,” Brown admitted when his budget was released, “it will be extremely painful for California.”
One of the government’s basic roles is to provide a support structure for quality of life and economic prosperity.
That creates tough choices about building and maintaining everything from trains and freeways to water and sewer projects to schools. The budget estimates that California would need $78 billion to completely retool all infrastructure.
Critics of Brown’s budget say not enough is being spent on fixing the state’s aging road system and that too many dollars are going toward mass transit investments. Just thinking about cost-cutting could help.
Moorlach thinks Caltrans, for example, is “badly overstaffed … there’s a lot of room to reduce overhead – do a lot of trimming and do a lot of outsourcing.”
Education spending – $67 billion in Brown’s proposal – draws complaints about being out of touch with today’s student requirements. The Brown budget does not address a new spending mandate: $9 billion in bonds authorized by voters to be spent on school facilities.
“We don’t have an educational system that can train and retrain people for the technical work,” economist Husing says.
Rainy day funds aren’t sexy.
Every dollar stashed in a reserve fund by state government is revenue spent with no immediate bang for the buck.
The rainy day savings math of Brown’s proposed budget is complicated, as all budget matters are, but the basic plan is to grow California’s financial backstops to $7.9 billion by June 2018. Critics say that’s not nearly enough considering the huge swings in state revenue created by the last economic downturn.
Moody’s Raimes takes a different tact; she compliments California for making strides with its rainy day fund.
Still, she points out, “we get reserve levels that are small for a state of this size, and for the level of its budget volatility.”
The future, of course, isn’t registered to vote.
Contact the writer: jlansner@scng.com
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