California  Spending Plan 2001-02 Chapter 1

The 2001-02 Budget Act and Related Legislation

Introduction and Overview

The 2001-02 Budget Act was signed into law by Governor Davis on July 26, 2001. Together with its related implementing legislation, the budget authorizes total spending from all funds of $103.3 billion. As indicated in Figure 1, this total includes $78.8 billion from the General Fund, $21.3 billion from special funds, and $3.2 billion from bond funds. The large special funds' increase reflects the combination of budgetary accounting changes involving various programs and increased vehicle license fee relief.

The General Fund Condition

Figure 2 summarizes the General Fund's condition for 2000-01 and 2001-02.

2000-01. In 2000-01, revenues were $78 billion (an 8 percent increase from 1999-00), while expenditures were $80.1 billion (a 20 percent increase from the prior year). The rate of spending growth in part reflects one-time expenditures associated with unanticipated revenues received late in 1999-00. After accounting for $708 million in encumbrances and a set-aside for litigation, 2000-01 is estimated to have ended with a reserve of $6.3 billion.

2001-02. Revenues in 2001-02 are projected to be $75.1 billion (a 3.7 percent decrease from 2000-01) while expenditures are estimated to be $78.8 billion (down 1.7 percent from 2000-01). The budget includes a $100 million set-aside for litigation and $701 million for encumbrances. This leaves a 2001-02 year-end reserve of $2.6 billion, or about 3.3 percent of expenditures for the year.

It should be noted that these figures reflect the budget package signed by the Governor in late July. They do not reflect the fiscal impact of legislation that was pending when this report went to press.

Spending in the Budget Year

General Fund spending in the 2001-02 budget is summarized in Figure 3, by major program area. The budget contains moderate ongoing funding increases in education, health, and social services. The large decline in the "all other" category is due to several factors, including the two-year deferral ($1.1 billion in 2001-02 and $1.2 billion in 2002-03) for the Traffic Congestion Relief Program, nearly $1 billion in one-time appropriations in 2000-01 for energy conservation and generation programs, as well as fewer one-time expenditures in 2001-02 for various resources and environmental protection programs.

General Fund Spending Over the Past Decade

Figure 4 (see next page) shows General Fund expenditures from 1990-91 through 2001-02, both in current dollars and as adjusted for population and inflation (that is, in real per-capita terms). The figure shows that the 2001-02 budget represents the first decline in spending since the early 1990s' recessionary period, when policymakers closed large budget shortfalls through spending cuts, funding shifts to local governments, spending deferrals, and tax increases. It also shows the large spending increases that have taken place over the latter part of the 1990s during the state's strong economic expansion. Total expenditures over the entire period have increased by 96 percent, while real per-capita spending has grown by 28 percent to $2,243 per person.

Evolution of the Budget

Challenges Faced in Developing the 2001-02 Budget

Economic and Revenue Slowdown. The Governor and Legislature faced two major challenges in developing the 2001-02 budget. The first was related to the economy and revenues. After several years of extraordinary growth, the state's economy slowed more abruptly than expected during the first half of 2001 as the budget was being considered by the Legislature. As shown in Figure 5, the deterioration led to a two-year downward revision of $4.3 billion to the state's revenue outlook in May 2001, the first downward revision in five years.

Electricity Crisis. The second major challenge related to the state's electricity crisis. In addition to creating additional uncertainty regarding the state's economic and revenue outlook, the crisis specifically affected the budget in two ways. First, in response to the crisis, the Legislature passed measures authorizing $1 billion in General Fund resources for various conservation and rebate programs. Second, following the insolvency of the state's two largest utilities, the state began purchasing electricity for customers of the major utilities beginning in January 2001. As of June 30, total purchases had reached about $7 billion.

Estimates of the state's budgetary condition assume that the General Fund will be fully reimbursed for this $7 billion with proceeds from the sale of long-term electricity bonds. However, uncertainties over the timing and marketability of the bonds created uncertainty throughout the 2001-02 budget process.

Governor's January Proposal

In January 2001, the Governor proposed total state spending of $104.7 billion for 2001-02, of which $82.8 billion was from the General Fund. The General Fund amount represented a 3.9 percent increase from 2000-01. The initial budget proposal assumed that available resources would exceed current law spending requirements by $8 billion. While the budget assumed that revenue growth would be modest in 2001-02, it also assumed that the state would have a large carry-in balance from 2000-01 (estimated to be nearly $6 billion) to finance programs in the budget year.

The January budget proposed that about $5.5 billion of the $8 billion in uncommitted resources be allocated to new spending initiatives, $0.1 billion be used for tax reductions, and $2.4 billion be put in budgetary reserves. Of the $5.5 billion in spending, about $1.2 billion was proposed for ongoing increases, mostly in education, and $3.3 billion was for one-time expenditures, including a $1 billion set-aside for electricity-related initiatives.

Education. As in previous years, the budget contained significant new ongoing funds for K-12 education for such purposes as teacher and principal training, student achievement at middle schools (including a lengthened school year), and the settlement of a mandated cost claim for special education. The budget also included significant new funds for each of the three higher education segments, as well as monies for increased financial aid, student outreach, and part-time instructor salary increases.

Electricity Set-Aside. The budget also included a $1 billion set aside for energy-related initiatives related to the electricity crisis. These funds were to be available for programs directed at energy conservation and increased supplies.

Other One-Time Spending. The budget also included about $2.3 billion in other one-time expenditures for such purposes as capital outlay, local government fiscal relief, new housing initiatives, and various resources projects.

Developments Following the January Proposal

Conditions Worsened. Following the introduction of the January budget proposal, the budget outlook worsened, due to a sharper-than-expected economic slowdown and continued deterioration in the stock market (which affects capital gains and stock options-related revenues). Given these developments, the Legislature took the unusual step of withholding consideration of most of the Governor's major proposals outside of K-12 education until the May Revision.

In a special session, legislation was adopted (AB 29x and SB 5x) which allocated the Governor's $1 billion energy set-aside for such purposes as appliance rebates, peak demand-reduction programs, low-income energy assistance, and various other grant and loan programs.

By April, it was clear that the state's two-year revenue trend was falling significantly below the January budget projection. Revenues associated with past 2000 economic activity remained strong, with personal income tax final payments in April exceeding their estimate by nearly $2 billion. However, revenues associated with 2001 economic activity were slowing sharply, with withholding and sales tax payments falling below their year-ago levels.

The May Revision

Large Downward Budget Revision. The May Revision reported a $5.7 billion deterioration in the state's fiscal condition for the current and budget years combined compared to the January forecast. The primary factor behind the deterioration was a $4.2 billion downward adjustment to revenues (reflecting a $1.2 billion increase in 2000-01 swamped by a $5.5 billion decrease in 2001-02), as well as about $1.5 billion in added expenses for a variety of state programs (including prior-year Proposition 98 requirements, retirement costs, and energy-related expenses).

Proposed Solutions. The Governor's proposal to deal with the shortfall included a two-year redirection of monies from transportation funds into the General Fund, saving $1.3 billion in 2001-02 and $1.2 billion in 2002-03. The May Revision also proposed a reduction in one-time spending of about $1.3 billion, a transfer of special funds balances to the General Fund totaling $500 million, and a $255 million reduction in ongoing Proposition 98 spending. It also eliminated most of the tax relief measures proposed in January. The revised budget plan also included reserves of $1.1 billion, down from the $2.4 billion proposed in the January budget.

Large Out-Year Operating Deficit Still Existed. Despite maintaining a positive projected reserve balance for 2001-02, however, the May Revision proposal was not a comprehensive solution to the budget shortfall that had emerged. Following the May Revision, our office indicated that the year-end reserve of $1.1 billion was not sufficient to offset a projected operating shortfall of over $4 billion in 2002-03. The out-year shortfall was deepened as a result of the passage of federal tax reform, which resulted in the phase out of the state's estate tax.

Senate and Assembly Versions of the Budget

The two houses both adopted many of the Governor's May Revision proposals, including the redirection of transportation funds, revised tax relief, and the aggregate level of Proposition 98 funding. However, there were also a variety of differences in the two versions of the budget. For example, while funding Proposition 98 at the same aggregate spending levels as proposed by the administration, the Senate and Assembly differed significantly in many program allocations for K-12 education. Significant differences also existed with regard to funding for senior citizens' tax relief and health-related programs.

Conference Committee Actions

The Assembly and Senate versions of the budget were sent to the legislative Budget Conference Committee for reconciliation in early June. Given the heightened concern about the economy and the longer-term budget imbalance, the committee—in consultation with the Governor's office—adopted cuts that were significantly deeper than those included in the two legislative versions or the May Revision, with the goal of building the 2001-02 reserve to more than $2 billion. The most significant spending reduction was a $689 million cut in proposed K-12 Proposition 98 spending, including funds for the Governor's proposal for an expanded school year for middle schools. The Conference Committee version also reduced spending in higher education, health, and general government, and transferred a greater amount of special fund monies to the General Fund than did the May Revision. The compromise version of the budget was passed by the Budget Conference Committee on June 23, 2001.

Post Conference Committee Negotiations

The Conference Committee version of the budget failed to receive a two-thirds majority in either house. After several weeks of negotiations, provisions were added to the budget involving school district equalization, a package of agricultural and rural tax assistance, and an increase in senior citizens' tax relief. The revised budget was enacted on July 23 and sent to the Governor.

Governor's Vetoes

Before signing the budget, the Governor used his line-item veto authority to eliminate about $540 million in total spending, including $499 million from the General Fund. These vetoes were concentrated in community colleges ($124.6 million), primarily in the areas of maintenance and instructional equipment. Other programs with significant reductions included
K-12 education ($130 million), and health and social services (slightly over $100 million).

Major Features of the Final Budget

The 2001-02 budget provides spending increases that cover population and inflation increases, as well as some new programs and program expansions. Specifically:

• Education. The budget includes full funding for inflation and enrollment growth for K-12 education. Spending in the K-12 area also includes targeted increases for low-performing schools, expanded child care, a settlement of the special education lawsuit, and before/after school programs. In higher education, the budget provides full funding for enrollment growth, avoids any fee increases, and includes funding for increases in Cal Grant awards stemming from legislation enacted in 2000.
• Health. The budget fully funds projected Medi-Cal caseloads, as well as increased funding for long-term care rate increases, and a $191 million litigation settlement (Orthopaedic Hospital v. Belshé). In addition, the budget adopts the Governor's proposal to use tobacco settlement funds to support expanded coverage for adults under the Healthy Families Program.
• Social Services. The budget fully funds caseload and cost-of-living adjustments for the California Work Opportunity and Responsibility to Kids program, and the Supplemental Security Income/State Supplementary Program. The budget also includes new initiatives for foster youth, extensions of assistance programs for immigrants, and provider wage increases for In-Home Supportive Services providers.
• Transportation. The budget adopts the Governor's May Revision proposal to defer the transfer of gasoline sales tax revenues to the Traffic Congestion Relief Program. This refinancing plan results in a two-year deferral of $2.3 billion, including $1.1 billion that was proposed to be spent in 2001-02. In addition, the budget includes a proposed constitutional amendment to permanently dedicate the sales taxes levied on gasoline to transportation-related projects beginning in 2003-04.
• Other Programs. The budget also provides full funding for the inmate and ward populations for the Departments of Corrections and Youth Authority, respectively. In the resources area, the budget contains funds for various projects, including the CALFED Bay-Delta Program and various state and local park acquisitions.
• Tax Reductions. The 2001-02 budget agreement revised the formula that provides for the triggering on and off of a one-quarter cent General Fund sales tax originally adopted in 1991. Specifically, as discussed in more detail in the following chapter, it lowered—from 4 percent to 3 percent of annual revenues—the reserve threshold for triggering on and off this rate. The budget also includes a permanent 45 percent increase in the senior citizens' property tax assistance program. In addition, the budget contains an agricultural and rural tax relief package which includes sales tax exemptions for agricultural and forestry equipment, liquified petroleum gas, and diesel fuel.

State Appropriations Limit

Background. Article XIII B of the State Constitution places limits on the appropriation of taxes for the state and each of its local entities. Certain appropriations, such as capital outlay and subventions to local governments, are specifically exempted from the state's limit. As modified by Proposition 111 in 1990, Article XIII B requires that any revenues in excess of the limit that are received over a two-year period be split evenly between taxpayer rebates and increased school spending.

State's Position Relative to Its Limit. After exceeding the limit by $975 million in 1999-00, state appropriations fell below the limit by an estimated $2.1 billion 2000-01. This decline in appropriations relative to the limit was largely related to a large amount of exempt appropriations enacted in the 2000-01 budget for such purposes as vehicle license fee reimbursements, school district apportionments, local subventions, and capital outlay. In
2001-02, state appropriations are expected to be nearly $9.8 billion below the limit. This widening gap between appropriations and the limit is due to a combination of declining General Fund appropriations and a rapid increase in the per-capita personal income factor used to adjust the limit during the year.

Budget-Related Legislation

In addition to the 2001-02 Budget Act, the budget package includes a number of related measures enacted to implement and carry out the budget's provisions. Figure 6 lists these bills.

Continue to California Spending Plan 2001-02 Chapter 2--Tax Relief Provisions

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