Legislative Analyst's Office, November 20, 1997

California's Fiscal Forecast The LAO's Economic and Revenue Projections 1997-98 Through 1999-00

Chapter 1: The Budget Outlook

Given the significant fiscal effects associated with these agreements, an important question is whether California's General Fund will be able to fully accommodate these commitments in future years, without policymakers having to find savings in other areas of the state budget.

The "Bottom Line"--Positive Budgetary Outlook

Figure 1
Key Features of LAO Outlook
	Overall Budget Outlook Is Positive
	Despite a major tax cut and significant new spending commitments, the General Fund budget will remain in balance through 1999-00.
	Key reasons include continued healthy economic and underlying revenue growth, and declining Medi-Cal and CalWORKs caseloads.
	Current Year to End With Reserve of Nearly $770 Million
	Reserve up $657 million from 1997-98 Budget Act estimate, due primarily to higher state revenues and to lower costs in the Medi-Cal program.
	1998-99 and 1999-00 Budgets Remain Balanced
	Revenues sufficient to fully fund requirements of current law--even with tax reduction and recently enacted program increases.
	One-time PERS payment in 1997-98 creates "room" for tax cut, trial court funding increase, employee pay raise, and increases to other programs.
	Reserve shrinks in 1999-00, but state still ends with a positive balance.
	Major New Proposals Will Involve Fiscal Trade-Offs
	Given a declining reserve over time, significant new proposals would come at the expense of current-law requirements.

Figure 2
LAO Projections of General Fund Condition 1996-97 Through 1999-00
(In Millions)
	1996-97	1997-98	1998-99	1999-00
Prior-year fund balance	$444	$896	$1,220	$1,287
Revenues and transfers	49,325	53,038	55,769	58,356
Total resources available	$49,769	$53,934	$56,989	$59,643
Expenditures	$48,873	$52,714	$55,702	$58,887
Ending fund balance	$896	$1,220	$1,287	$755
Other obligations	$451	$451	$451	$451
Reserve	$445	$769	$836	$304

As indicated in the two figures, we estimate that the current year will end with a reserve of $769 million, or $657 million more than the 1997-98 Budget Act estimate. We further estimate that the budget will remain in balance in the future, with the reserve rising slightly to $836 million in 1998-99, before declining to $304 million in 1999-00. There are three main reasons for this favorable outlook:

• Healthy California Economy. The favorable economic outlook has resulted in healthy underlying revenue increases. As the result of the stronger-than-expected economy and recent federal law changes affecting capital gains taxation, we estimate that revenues will exceed the 1997-98 Budget Act amount by over $500 million. During the next two years, revenues are forecast to increase by about 5 percent--despite the phase-in of the recently enacted tax reduction.

• Falling Caseloads in Health and Welfare. We expect caseloads in Medi-Cal and CalWORKs to continue declining over the next two years, holding down growth in overall General Fund spending during this period.
• One-Time PERS Payment. Program spending in the current-year budget was reduced in order to accommodate the one-time $1.2 billion payment to the state's Public Employees' Retirement System (PERS). Since the PERS payment was a one-time obligation, funds that were devoted to this payment will be available in 1998-99 and 1999-00 for other purposes, including the spending and tax-related measures passed this year.

KEY FEATURES OF THE LAO OUTLOOK

The Economy and Revenues

Revenue Outlook--Moderate Growth. As noted in Chapter 3, our revenue forecast for 1997-98 assumes that this year's weakness in quarterly estimated tax payments is largely transitory, and that the stronger near-term economy will result in higher revenue collections over the balance of 1997-98. Specifically, we forecast that revenues during 1997-98 will total $53 billion, or $507 million above the 1997-98 Budget Actestimate. Our forecast takes into account the projected impacts of federal reductions in the maximum tax rate on capital gains, which are expected to translate into $450 million in additional state personal income tax receipts in 1997-98.

For the budget year and year following, we project that California's ongoing economic expansion will result in revenue increases of 5.1 percent in 1998-99 and 4.6 percent in 1999-00.

Our revenue projections reflect the impact of California's recently enacted tax reduction package, which will lower revenues by an estimated $189 million in 1997-98, increasing to over $1 billion when fully phased in during 1999-00.

Budget Outlook for 1997-98

• Higher Revenues. As noted above, we estimate that current-year revenues will exceed the budget estimate by $507 million, even after taking account of passage of the state's 1997 tax reduction package. We also note that there have been a number of accrual changes affecting 1996-97 and prior years, which have been largely offsetting.
• Medi-Cal Spending Reductions. Based on significantly lower caseloads and lower costs per eligible beneficiary, we estimate that Medi-Cal expenditures fell below the budget estimate for 1996-97 by $100 million, and that they will fall below the 1997-98 estimate by an additional $281 million, for a two-year savings of $381 million. This lower Medi-Cal spending trend also has a positive impact on our budget estimates for future years.

Partially offsetting these factors are:

• Increased K-14 Education Funding. Our higher revenue estimates translate into a $63 million increase in the Proposition 98 minimum funding guarantee in 1996-97 and a $220 million increase in 1997-98.
• Other Costs. Based on final Congressional actions, our current estimates reflect lower federal reimbursements for undocumented felons. We also assume additional expenses for fire suppression in 1997-98.

Budget Outlook for 1998-99 and 1999-00

In the remainder of the budget, we have made specific adjustments to reflect recent agreements reached in the areas of welfare reform, trial court funding, and the Healthy Families Program. Continuation of the higher education "compact" is assumed through 1998-99. And, as noted above, our revenue estimates include the impact of the state's 1997 tax reduction package passed in September.

Our current-law estimates also include the fiscal impacts of the restoration of the renters' credit in 1998, the restoration of certain welfare grant levels and cost-of-living adjustments during the budget year, and a 3 percent cost-of-living adjustment (COLA) for state employee compensation in both 1998-99 and 1999-00. Finally, our spending estimates for 1998-99 assume the payment of the interest portion of the court-ordered PERS payment (estimated to be approximately $300 million).

It is important to note that our fiscal estimates are not predictions of what the Legislature and Governor will adopt as policies and funding levels in coming budgets. Nor are they our recommendations of what tax and spending policies ought to be. Rather, our estimates are a "baseline" projection of what would happen if current policies were allowed to run their course. We believe that by using this approach, our projections provide a meaningful starting point for the Legislature's evaluation of the state's fiscal condition, and its assessment of any necessary or desired future changes to California's spending and taxing levels.

Budget Remains in Balance. We estimate that revenue growth during the next two years, in conjunction with available reserves, will be sufficient to cover current-law expenditure increases. As a result, the state's General Fund budget would remain in balance.

The Situation in 1998-99. As indicated in Figure 2, revenues and expenditures in 1998-99 are expected to total $55.8 billion and $55.7 billion, respectively, and the year is projected to close with a reserve of $836 million. As indicated above the budget is affected by numerous factors in 1998-99, including the tax reduction (which will lower revenues by $591 million), the restoration of the renters' credit ($530 million cost), trial court restructuring ($450 million cost), the Healthy Families Program ($88 million cost), and an assumed 3 percent employee pay increase ($150 million cost). However, these factors are largely offset by: reasonably healthy revenue growth; the "room" created by expenditure reductions made in the current year to accommodate the one-time $1.2 billion PERS payment; and declining caseloads in the state's Medi-Cal and CalWORKs (formerly Aid To Families With Dependent Children) programs.

1999-00 Budget Gets Tighter. As shown in Figure 2, current-law expenditures grow about 1 percent faster than revenues in 1999-00, leading to a decline in the size of the year-end budgetary reserve. Revenue growth continues to be affected by the phase-in of the 1997 tax reduction package. The phase-in of welfare-reform-related job and child care services, as well as COLAs and certain grant restorations, cause CalWORKs spending to jump by nearly 16 percent during the year. The net result of these revenue and expenditure changes is that the budget experiences an operating deficit in the year of about $530 million, which explains why the year-end reserve shrinks.

It should be noted that expenditures for CalWORKs are projected to peak in 1999-00 and decline from 2000-01 through 2004-05. Partly for this reason, the operating deficit in 1999-00 is not necessarily indicative of an emerging structural problem.

What If Economy Underperforms?

IMPLICATIONS OF OUR PROJECTIONS

Given the modest reserve, major new proposals would require making trade-offs within the current-law budget. We believe it is important to focus on issues having significant implications for the state's long-term fiscal health. Among these are investment in new capital facilities, maintenance of the existing public infrastructure, restructuring of the state-local fiscal relationship, and maintenance of an adequate budgetary reserve fund.

Continue to Chapter 2: Economic and Demographic Projections

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