Executive Summary

This report discusses some key issues facing the Legislature in the general government section of the budget. The state’s dire fiscal condition means that the Legislature may need to reject or defer funding for many general government programs in order to help balance the budget.

Balancing the 2009–10 Budget

Employee Compensation Reductions. The Governor’s proposal includes various measures to reduce state personnel costs, including a two–day–per–month furlough of nearly all state workers (with an accompanying pay reduction of about 9 percent through June 2010) and a limited number of layoffs. The proposals would result in an 11 percent drop in General Fund personnel costs and savings of $1.7 billion over the next 17 months. We believe that employee compensation reductions are necessary due to the magnitude of the budget problem. Nevertheless, we observe that the administration’s plans—especially savings from the furlough—will be difficult to achieve. Such large reductions probably cannot be achieved through the collective bargaining process without resulting in costly future pay or benefit promises for employees that the state cannot afford to make.

Budget Overspends on Inflation. The Governor’s budget includes a 3.2 percent inflationary adjustment for state departments’ operating expenses. This adjustments results in a General Fund cost of $136 million in 2009–10. Due to the sagging economy and falling energy prices in recent months, our forecast for inflation is much lower—0.4 percent in 2009–10. We recommend the Legislature reject the price increase and direct departments to absorb any increases in operating expenses.

Increase State Revenues by Making Changes to Tax Programs. In order to generate additional tax revenue, we describe ways to change the administration of tax collection at the Franchise Tax Board (FTB) and the Board of Equalization (BOE), and to modify California’s tax laws relative to federal laws. Combined, these changes would result in increased General Fund revenues in the low hundreds of millions of dollars over time.

Reject Funding Most of the Governor’s Emergency Response Initiative. The 2009–10 budget proposes increased spending in the California Emergency Management Agency of about $18 million to enhance the state’s emergency response capabilities and $2 million in the Military Department for aviation firefighting equipment. These new expenditures would be funded by an insurance surcharge. We recommend against funding most of these expenditures because they do not address a critical and immediate need.

Other Issues

Unemployment Insurance (UI) Fund Faces Insolvency. The UI fund is facing insolvency and, absent corrective action, would remain insolvent for the foreseeable future. The Governor proposes to restore solvency—largely by increasing the taxes employers pay for each covered worker. We find that the Governor’s approach has merit because it restores solvency and the proposed employer tax burden would be near the median for all states. We also recommend eliminating the Employer Training Tax to partially offset the Governor’s proposed UI employer tax increase.

Retirement Costs to Increase. The budget assumes roughly 10 percent growth in General Fund retirement costs, with retiree health and dental costs being the fastest–growing component. The outlook for the state’s pension contributions after the budget year is grim. Large investment losses in the state’s pension systems during 2008–09 are likely to result in significant new unfunded liabilities that may increase state costs by hundreds of millions of dollars per year beginning in 2010–11.

Major Information Technology Projects Face Challenges. Both the 21st Century Project—which would modernize the state’s payroll system—and the Financial Information System for California (FI$Cal)—which would replace the entire state’s aging automated fiscal systems—are facing significant difficulties. Regarding the 21st Century Project, we recommend that the Legislature carefully consider whether the risks and costs associated with completing the failed work of a prior vendor by hiring a new vendor (as proposed) outweigh the costs of starting clean on the software configuration portion of this project. With respect to FI$Cal, we recommend that the Legislature delay the release of the proposed request for vendor bids by at least six month and consider reducing the initial scope of the project.

Indian Gaming Special Distribution Fund (SDF). As a result of recently amended compacts between the state and tribes that own some of the state’s major casinos, revenues of the SDF have dropped dramatically. This has produced a structural deficit in the fund that the Legislature will need to address over the next few years. We make recommendations designed to limit future pressures on the General Fund to pick up existing SDF costs.