Crosscutting Issues

Capital Outlay

Financing Priority

Capital Outlay Projects


California's economic growth and quality of life are in part dependent on the adequacy of the state's public infrastructure. Moreover, providing adequate facilities is integral to the success of programs and services funded with state resources. In addition to the state's transportation, water, and parks systems, the state has an immense inventory of other physical facilities. For example, the three segments of higher education alone have about 120 million square feet of building space. About 55 million square feet of this space was built or renovated more than 28 years ago. Given the magnitude of the public infrastructure in California, decisions about building or renovating facilities, acquiring and selling property, or expanding and replacing utility systems should be considered with a long-term perspective.

If the state is to get the "biggest-bang-for-its-buck" in addressing state infrastructure needs, the state must adopt a more deliberate capital outlay planning and financing process. In our view, this requires development of an integrated five-year state capital outlay plan, which sets priorities and identifies financing alternatives, and presentation of this plan as part of the annual budget. This approach would provide a statewide context of needs and priorities, and highlight the financing tradeoffs to meet the state's highest priorities.

The state generally finances its infrastructure projects in one of two ways: "pay-as-you-go" or bonds. Pay-as-you-go is the least costly method of financing. Under this approach, direct appropriations to fund a project or acquisition are made on an annual basis. Bonds, on the other hand, generally allow the state to acquire expensive assets that it could not afford on a pay-as-you-go basis. Under this financing method, the state borrows money and then repays the borrowed money (principal) plus interest, over a period of years. These are the state's debt service payments.

In recent years, the state has placed before the voters single-purpose bond issues; the proceeds of which can only be used for a given program (for example, higher education). For certain projects outside these program areas, the state commonly has relied on lease-payment bonds authorized by the Legislature for a specific purpose, such as the construction of a state office building. To a far lesser extent, the state has used direct appropriations (pay-as-you-go funding). For example, over the previous five years, less than 0.1 percent of total General Fund expenditures have been used in this manner for capital outlay. The lack of a predictable funding source and a coordinated set of priorities for all capital outlay programs has meant that some high priority projects have been deferred.

Achieving a Better Balance For Infrastructure Finance

We recommend that the Legislature dedicate a portion of annual General Fund revenues to a special account to provide a "pay-as-you-go" funding source for capital outlay. We further recommend that in 1998-99 the Legislature substitute General Fund appropriations for the new lease-payment bonds proposed in the budget for specific capital outlay projects.

Given the large demand for new capital outlay projects to serve a growing population and the inventory of existing state infrastructure, the state will probably always rely to some extent on bond financing for capital outlay. We believe it is important, however, to have a better balance between bond funding and pay-as-you-go financing than the state has had in recent years. Increasing pay-as-you-go funding would allow the Legislature to address more higher priority infrastructure needs across program areas, in a more timely and cost effective manner.

The Legislature used direct appropriations for many years to fund higher education facilities. Specifically, a large portion of tidelands oil revenues was transferred to the Capital Outlay Fund for Public Higher Education to address capital needs of the higher education segments. More recently, as discussed in the Crosscutting Issues section of the Resources chapter in this Analysis,the Legislature has transferred tidelands revenues to the Natural Resources Infrastructure Fund to meet program needs in that area.

As discussed in our companion publication, the 1998-99 Budget: Perspectives and Issues, we estimate that General Fund revenues, in the current and budget year combined, will be approximately $1 billion higher than the Governor's budget estimate. This situation gives the Legislature an opportunity to allocate a portion of these additional revenues to fund a greater portion of capital outlay through direct General Fund appropriations rather than through bond financing. Accordingly, we recommend that the Legislature use this opportunity to dedicate a portion of annual General Fund revenues to a special account for capital outlay to provide a stable funding source for priority capital outlay projects. The Legislature would then have a reliable funding source to annually address the state's highest priority infrastructure needs rather than be overly dependent on bonds.

This approach would have several advantages compared to bond financing.

Future Savings From Budget Year Investments. In the budget year, we recommend that the Legislature substitute General Fund appropriations for the new lease-payment bonds proposed in the budget for specific capital outlay projects. Our recommended cost for these projects is $165 million. By using direct General Fund appropriations, the state would save the additional future interest costs of around $180 million associated with bond financing. For future years, we recommend that the Legislature gradually increase the amount of annual revenues set aside in a capital outlay account. As discussed in the Capital Outlay Overview in this chapter of the Analysis, the state's debt service ratio will begin to decline after 1999-00 as approved bonds are paid off. The Legislature could dedicate some or all of this reduced debt burden for this purpose.

Funding Higher Education

Capital Outlay

The state is faced with the challenge of providing adequate facilities for higher education enrollment growth with limited funds. To address these needs, it is essential that the Legislature establish criteria for ranking capital outlay proposals in order to fund the highest priority projects. We recommend such criteria, and rank the budget proposals using them. In addition, to avoid starting projects that cannot be completed, the Legislature should consider their full cost and the availability of funds at the time the first commitments are made to fund projects.

The Governor's budget proposes $471 million of capital outlay for the three segments of public higher education. The future cost to complete these projects is $176 million. In addition, it would cost $569 million to complete projects previously approved by the Legislature (but which are not funded for additional phases in the budget). Thus, over $1.2 billion is needed to complete all proposed and previously approved projects. With only $65 million in existing bond funds available, the Legislature will have to provide new funding sources to finance these projects. Given this demand and the projected growth in undergraduate enrollments, it is essential that the Legislature establish criteria to carefully evaluate all capital outlay proposals.

Establishing Priorities

For several years, the administration and the Legislature have adopted a general policy of allocating one-third of all higher education bond funds to each of the segments. The Governor's budget would continue this approach. On the surface, this policy has the appearance of being equitable to each segment. However, it fails to consider differences among the segments in the overall condition of their existing facilities, and their capacity to accommodate current and future undergraduate enrollment. Undergraduate enrollments in higher education are expected to increase at a moderate, but manageable pace, over the next several years. While demand for graduate education is also expected to increase, the degree to which the state addresses that demand is a policy decision separate from the state's commitment to supply undergraduate educational opportunity. If the state is to meet this commitment, however, it must focus its capital outlay resources on providing instructional facilities to meet undergraduate needs.

The state currently does not evaluate and fund all higher education capital outlay proposals on a priority basis. Instead, each system has an internal process for determining its priorities. The process used by the California Community Colleges (CCC) is based on fairly explicit criteria adopted by the Board of Governors. The California State University (CSU) uses very general guidelines to set priorities. The University of California's (UC's) criteria for setting priorities is unclear (it appears to use a per-campus allocation of anticipated state funds).

We believe that the state needs a "common yardstick" with which to judge capital outlay proposals across the segments. Only in this way can the Legislature be assured that the state is (1) getting the "biggest-bang-for-its-buck" for the investments made in higher education facilities and (2) meeting undergraduate enrollment demand. As discussed below, we have developed a specific priority list for funding all higher education projects. We hope that this will assist the Legislature in upcoming budget deliberations.

Given the above, we therefore recommend that the Legislature:

Recommended Priorities

Our recommended funding priorities are summarized in Figure 9 and discussed in more detail below. Using these priorities, available funds for higher education would first be used to assure the safety of existing facilities and their operability. After addressing these basic requirements, highest priority would go to accommodating the facility needs of the undergraduate student.
Figure 9
LAO Recommended Priorities for Funding

Higher Education Capital Outlay Projects

PriorityOrder Description of Priority
1 Critical Fire, Life Safety, and Seismic Deficiencies
2 Necessary Equipment
3 Critical Deficiencies in Utility Systems
4 Improvements for Undergraduate Academic Programsa
New construction or renovations that increase instructional capacity.
Renovation of existing instructional buildings.
  • Enrollment shifts in wet laboratories.
  • Enrollment shifts in other instructional spaces.
  • Buildings 30 years or older (that no longer can accommodate the academic program).
  • Instructional program changes.
5 Integrity of Operationally Important Facilities
6 Administrative, Research, and Support Facilitiesa
Faculty and administrative offices.
Research facilities.
aProjects in these ranks are recommended for funding in the order of priority listed.

The following is a brief description of the types of projects that would fall within each priority.

Priority No. 1: Critical Fire, Life Safety and Seismic Deficiencies.These projects correct critical fire, life safety and seismic deficiencies where there is an immediate threat of personal injury. Critical seismic deficiencies are those that would be rated as a level V or VI risk using the evaluation methods developed by the Department of General Services. (Please see "Assessing Seismic Risk in Higher Education Buildings" also in this Crosscutting Issues section.) Projects for seismic strengthening in this priority address seismic deficiencies and directly related building code corrections only. This category also includes satisfaction of legal claims based on judgments or settlements.

Priority No. 2: Necessary Equipment. Projects in this rank fund equipment purchases needed to complete and make operational newly constructed projects. In effect, these proposals "finish off" prior commitments.

Priority No. 3: Critical Deficiencies in Utility Systems. These projects correct utility system deficiencies that have rendered, or pose the immediate threat of rendering, a significant part of a campus inoperable.

Priority No. 4: Improvements for Undergraduate Academic Programs.Projects of this priority are intended to achieve facilities improvements for undergraduate academic programs by providing new and renovated buildings. Projects would not be funded if they increase a campus' instructional capacity (classrooms and laboratories) to more than 95 percent of that justified by campus (or community college district) enrollment at the time the project is planned for completion. Libraries would be addressed on a case-by-case basis because library standards are in a state of transition due to changes in information technology.

Priority No. 5: Integrity of Operationally Important Facilities. These projects would upgrade important facilities to assure they continue to meet the needs of the campus. Examples would be upgrading of libraries, central plants, data processing centers, and utility systems.

Priority No. 6: Administrative, Research, and Support Facilities. We recommend first priority in this category be given to faculty and administrative offices, then research facilities, and then other support facilities. In view of the high cost of research facilities and competing needs for undergraduate enrollments, we recommend that new research facilities be funded only to the extent that existing campus research space is below 90 percent of that justified by campus enrollments at the time the project is planned for completion, or if existing space is 30 years old or older and no longer can accommodate the research activities.

We believe the consistent use of these priorities would not only focus funding on meeting the state's need to provide adequate facilities for projected undergraduate enrollment growth, but would also provide a stable and rational framework within which the three segments can undertake their capital planning.

LAO Assessment of Projects in Governor's Budget

Figure 10 summarizes our evaluation of how the projects in the Governor's budget meet these priorities. As shown in Figure 10, the vast major-ity of proposed projects (65 out 91) meet the priority criteria, and we therefore recommend approval. There are also four CSU and nine UC projects that we have recommended the segments reevaluate. All of the UC projects and two of the CSU projects are seismic retrofit projects that should be reevaluated to determine their seismic risk and to assure that the work consists of structural corrections only. The other two CSU projects are discussed in detail under our analysis of the CSU capital outlay program. There are, however, 26 major projects totaling $182 million in budget-year costs that do not meet these priorities. A discussion of these projects and our recommendations are provided under the capital outlay program for each segment.
Figure 10
Evaluation of Higher Education

Capital Outlay Proposals Using Proposed Priorities

(Dollars in Thousands)
Priority Number ofProjects Budget BillAmount Cost toComplete
Projects Satisfying Criteria
Priority No. 1--Critical Fire, Life Safety, and Seismic Deficiencies
CSU 2 $1,270 $0
UC 0 0 0
CCC 0 0 0
Subtotals, Priority No. 1 2 $1,270 $0
Priority No. 2--Necessary Equipment
CSU 6 $8,677 $0
UC 3 2,167 0
CCC 15 11,715 0
Subtotals, Priority No. 2 24 $22,559 $0
Priority No. 3--Critical Deficiencies in Utility Systems
CSU 1 $19,618 $0
UC 0 0 0
CCC 1 2,119 0
Subtotals, Priority No. 3 2 $21,737 $0
Priority No. 4--Undergraduate Academic Improvements
New buildings and renovations that increase instructional capacity
CSU 0 $0 $0
UC 0 0 0
CCC 11 54,425 20,155
Subtotals (11) ($54,425) ($20,155)
CSU 0 $0 $0
UC 0 0 0
CCC 2 11,442 9,145
Subtotals (2) ($11,442) ($9,145)
Renovation of instructional space--enrollment shifts (other than wet labs)
CSU 0 $0 $0
UC 0 0 0
CCC 2 2,423 4,608
Subtotals (2) ($2,423) ($4,608)
Renovation of existing instructional buildings--buildings 30 years or older
CSU 3 $38,921 $2,026
UC 1 712 10,257
CCC 1 14,443 2,128
Subtotals (5) ($54,076) ($14,411)
Subtotals, Priority No. 4 20 $122,366 $48,319
Priority No. 5--Operationally Important Facilities
CSU 5 $23,425 $0
UC 5 12,557 0
CCC 0 0 0
Subtotals, Priority No. 5 10 $35,982 $0
Priority No. 6-- Administrative, Research, and Support Facilities
Administrative and Support Facilities
CSU 1 $30,915 $3,574
UC 0 0 0
CCCa 2 3,933 0
Subtotals (3) ($34,848) ($3,574)
Research Facilities
CSU 0 $0 $0
UC 4 $50,281 $27,664
CCC 0 0 0
Subtotals (4) ($50,281) ($27,664)
Subtotals, Priority No. 6 7 $85,129 $31,238
Totals 65 $289,043 $79,557
Projects Requiring Reevaluation
CSU 4 $22,039 $0
UC 9 41,654 64,302
CCC 0 0 0
Totals 13 $63,693 $64,302
Projects Not Meeting Criteria
CSU 2 $16,438 $1,049
UC 4 43,672 24,749
CCC 7 57,945 7,899
Totals 13 $118,055 $33,697
Grand Totals, All Projects 91 $470,791 $177,556
aIncludes one support facility that is a lower priority than the research facilities.

Funding the Capital Program

Limited Remaining Bond Funds

Since 1986, capital outlay programs for the three segments of higher education have been financed with $3.3 billion in voter-approved general obligation bonds and $2.5 billion in lease-payment bonds authorized by the Legislature. There is approximately $65 million of unobligated funds remaining in the 1996 and 1992 higher education general obligation bond funds. We recommend reserving about $10 million of this amount for augmentations, interest, and costs of bond issuance, which leaves about $55 million to fund completion of some of the proposals in this budget.

The Governor's budget proposes $471 million in new spending--$450 million from a proposed 1998 bond, $10 million from the 1996 bond and $11 million from proceeds of lease-payment bonds that were authorized by the Legislature and sold for other purposes.

Total Cost of the Governor's Proposal

Failure to consider the cost to complete projects results in more projects being approved than there are funds available to complete them. The cost to complete projects in the 1998-99 budget is about $176 million. To complete projects that have been partially funded in earlier years (but not proposed for other phases in 1998-99) would cost an additional $569 million. Many of these projects were funded in 1991 through 1994. Given the considerable passage of time since these projects were initiated, we recommend that the systems reevaluate them to determine their priority in light of current needs.

Considering the future costs of all prior projects and those proposed in the budget, there is a $1.2 billion shortfall (see Figure 11). If the Governor's proposal for a $1 billion general obligation bond (of which $100 million is proposed to be set aside to match Federal Emergency Management Agency [FEMA] grants) is approved, the funding shortfall would be about $262 million. Under this scenario, a large number of approved projects could not be completed. In our analysis of the capital outlay program for each segment, we have recommended that the Legislature reduce the budget requests by a total of $182 million (with additional future savings of $98 million). If these recommendations are approved, there would be sufficient funds to complete all approved projects, leaving a balance of about $18 million. Even under this situation, there would essentially be no funds available for any new projects in 1999-00.
Figure 11
Higher Education Capital Outlay

Funding Shortfall

(In Millions)
Cost of projects in 1998-99 Governor's budget $470.8
Cost to complete projects in Governor's budget 176.5
Cost to complete projects approved in earlier years 569.5
Subtotal $1,216.8
Available general obligation bond funds -55.0
Funding shortfall $1,161.8
Proposed Higher Education Capital Outlay Bond Fund of 1998 -900.0a
Funding shortfall if 1998 bond approved $261.8
Recommended reductions in Governor's budget -181.7
Future cost savings from recommended reductions in

Governor's budget

Funds available after recommended reductions $18.3
aThe Governor's higher education capital outlay bond proposal is for $1 billion, but $100 million is designated to match federal funds for hazard mitigation.

Our concern is that the state has in essence "overcommitted" itself by starting projects without having the funding resources to complete them. To address this problem, we recommend that the Legislature budget higher education capital outlay so that an available fund source is identified to complete projects before approving the initial phase of any project. (We also recommend this for all other state capital outlay programs.) The Legislature should not initiate higher education projects that are dependent on a future bond in order to complete the project. In keeping with this recommendation, we have recommended that existing bond funds be used to complete the highest priority projects included in the budget across the three segments and that the balance of the projects approved by the Legislature be funded from the proposed bond issue. The bond measure should be of sufficient size to complete all projects approved by the Legislature--plus any amount that the Legislature wishes to reserve for new projects in 1999-00. Further, we recommend that the Legislature appropriate $55 million from existing general obligation bonds (leaving $10 million in reserve) rather than the $9.5 million in the Governor's budget.

Assessing Seismic Risk

In Higher Education Buildings

A high percentage of capital outlay funding is going to retrofit buildings for seismic safety. To prioritize buildings for funding, it is important that the Legislature have information to assess the risk posed by each building based on a uniform procedure and risk assessment system applied to all buildings. The Department of General Services (DGS) has developed such a system that is used to evaluate the seismic risk for all state buildings except those for California State University (CSU) and University of California (UC) campuses. Both CSU and UC use their own individual systems. In order to assess the seismic risk of all state buildings on a comparable basis, we recommend that prior to funding any seismic retrofit projects at CSU and UC, the buildings be evaluated using the DGS system.

Comparison of Seismic Risk Evaluation Methods

DGS Method. Under the provisions of Proposition 122 (approved by the voters in 1990) the State Architect (within the DGS) was required to establish criteria for assessing the life safety risk of state buildings in the event of an earthquake. These criteria were to be used to determine which state buildings to structurally strengthen within the $250 million in bonds provided by Proposition 122. The criteria and five-step evaluation process that was developed have been used by the Legislature to assess relative risk of state buildings and to fund those buildings that pose a risk to the occupants during a major earthquake.

These criteria identify seven levels of seismic risk (I lowest, VII highest). Based on the DGS evaluation of state buildings using these criteria, the Legislature decided to seismically strengthen all buildings rated at risk levels VI and V (level VII buildings are unstable and no state buildings that were evaluated fall into this category). Buildings rated lower than risk level V are not considered a high life safety risk and have not been funded under this program. Figure 12 summarizes the DGS seismic risk levels III through VI.
Figure 12
State Building Seismic Safety Program

Risk Level Characteristics for a 7.0 Magnitude Earthquake

Level III Level IV Level V Level VI
Risk to Life
Minor. Moderate. Substantial. Extensive, but not imminent; extrication protracted and difficult.
Building Structural System
Minor damage; repairable. Moderate damage; substantial repair. Substantial damage; repair may not be cost-effective. Extensive damage; collapse likely.
Other Building Systems
Disrupted for days to months. Disrupted for months to years. Total disruption; repair may not be cost-effective. Total disruption; repair probably not cost-effective.
Within weeks, with minor disruptions. Partially to totally vacated during repairs. Totally vacated

during repairs.

Totally vacated during repairs (if repairable).

UC Method. The UC uses a ranking system of its own device. In the UC rating system, buildings are characterized as good, fair, poor, and very poor. The lesser number of ranks and the words used to describe projects that fit them tend to give some projects the appearance of being of sufficient seismic risk as to warrant funding, when such may not be the case. The seven levels of rank in the DGS system allow more refinement in classifying buildings than the four used by UC. In characterizing a building's life safety risk, the UC system requires the evaluator to classify it at one key point as "low" or "appreciable" with no intermediate ranking such as "moderate" allowed.

An additional concern is that it appears the UC system considers only the structural condition of the building and does not take into account the presence or absence of people in a building in a meaningful way in evaluating life safety risk. The length of time people are in a building is as important as the number present. The five-step evaluation process developed by the DGS does a better job of addressing this consideration, although there is still room for improvement. We believe the UC rating system is less useful than that of the DGS and does not give the Legislature the information it needs to assess the relative life safety risk of buildings in the UC system and the CSU system.

CSU Method. The CSU uses a well documented process to guide the engineers who evaluate the seismic risk of CSU buildings. The CSU process also involves peer review of the engineer's evaluation. Thus, the CSU system is technically sound. An important weakness, however, is that it results in a listing of buildings from highest to lowest risk without identifying the level of risk. Consequently, it is possible only to know that one project is of higher priority than another, but the ranking says nothing about whether one, both, or neither are of sufficient seismic risk to warrant funding.

DGS Method Should Be Used For Higher Education Buildings

We recommend that prior to funding any further seismic retrofit projects, the Legislature direct the University of California and the California State University to evaluate all projects for seismic retrofit using the Department of General Services method.

The driving consideration in retrofitting a building for seismic safety is the risk to human life--property damage is secondary. In order to have a high degree of confidence that the evaluation of buildings will identify the highest risk buildings the evaluation system must include (1) clear guidance on the evaluation process, (2) common definition of risk levels, (3) consideration of building occupancy, and (4) a common method for placing the buildings in relative priorities based on life safety risks. The DGS method contains all these elements whereas the UC and CSU methods do not. Lacking a common evaluation system, the Legislature does not have the information it needs to weigh the relative merits and risks of projects when making funding decisions. The DGS system of evaluation is not a burdensome procedure and the UC and CSU should be able to undertake this reevaluation within existing resources and in a short period of time. Consequently, we recommend that prior to funding any further seismic retrofit projects, the Legislature direct the UC and CSU to evaluate all projects for seismic retrofit using the DGS method.

Return to 1998-99 Budget Analysis Table of Contents
Return to LAO Home Page