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2010

Other Budget Issues

Further Detail

This proposed budget trailer bill addresses the state’s interest and penalty obligations for specified late payments. Such interest and penalty obligations can become especially significant in periods, such as February 2009, when the state must delay payments to address serious cash flow problems. (Other laws not addressed in this trailer bill govern the state’s issuance of registered warrants, which are also known as IOUs.)

Background

California Prompt Payment Act. Chapter 916, Statutes of 1998 (AB 2275, Kuykendall), as amended, is known as the California Prompt Payment Act (PPA). The PPA sets a goal for state departments to pay properly submitted, undisputed invoices within 45 days of receipt or, else, pay late penalties established in the law. In general, PPA establishes a late payment penalty at a rate of 1 percent above the rate earned in the prior year by the state’s Pooled Money Investment Account (PMIA)—the state’s short-term cash operating account. (As of December 2009, the PMIA’s effective yield was under 0.6 percent.) The PPA waives penalty payments for these businesses if the penalty is $75 or less on a claim.

For specified small businesses and nonprofit organizations, PPA requires state departments to make late payments with a penalty of 0.25 percent of the amount due per calendar day from the required payment date. This equates to an over 90 percent annual interest rate for these small businesses and nonprofit organizations. Nonprofit organizations, however, are eligible for these penalty payments only if they have been awarded a contract or grant in an amount less than $500,000.

Section 926.19 of the Government Code. Chapter 941, Statutes of 1996 (AB 1368, Knowles), added Section 926.19 to the Government Code, which subsequently has been amended. Section 926.19 generally provides that state departments are liable for interest on late disbursements of undisputed payments or refunds. The interest must accrue at the PMIA interest minus 1 percent beginning on the 31^st day after the department notifies a person the payment is owed by the state or after the department receives notice from the person that an undisputed payment is due. In cases of a dispute over the payment amount, interest begins to accrue on the 31^st day after the dispute has been settled according to Section 926.19. Interest does not accrue under Section 926.19 during any period when a passage of the annual budget act is delayed past July 1 or as a result of delay in federal funding. Section 926.19 does not apply to income tax refunds, Medi-Cal reimbursements, health or social service benefits, and certain other payments.

Proposal

The proposed trailer bill revises and recasts PPA, Section 926.19, and related provisions of the Government Code. Among other changes, the proposed legislation would:

• Reduce PPA penalties owed to specified small businesses and nonprofit organizations from an annual interest rate of over 90 percent to a rate equal to 10 percent above the U.S. “prime rate” as of June 30 of the prior fiscal year, except for penalty payments totaling $10 or less, which would be waived. (The prime rate currently is 3.25 percent per year.)
• Shift the requirements to make refunds and undisputed payments to individuals from Section 926.19 (which would be repealed) into PPA. In general, this would make these payments subject to the 45-day payment provisions of PPA.

LAO Recommendation

We recommend that the Legislature approve the proposed trailer bill. The legislation would consolidate code provisions, thereby reducing potential administrative confusion about the state’s late payment penalties. Penalties owed to certain small businesses and nonprofit organizations for late payments would remain substantial and still deter late payments by state departments, but these payments would be reduced to a much more reasonable level.