Departmental Issues

General Government

Department of Insurance (0845)

Insurance is the only interstate business that is regulated entirely by the states. In California, the Department of Insurance (DOI) is responsible for regulating insurance companies, brokers, and agents in order to protect businesses and consumers who purchase insurance. Currently, there are about 1,600 insurers and 299,000 brokers and agents operating in the state.

The budget proposes total expenditures of $129.9 million for DOI in 1999-00. This is a net $0.6 million, about 0.5 percent, more than estimated current-year expenditures. The changes proposed for the budget year include:

Consumer Protection--A net reduction of $2.3 million, mainly due to a one-time expenditure of $4 million for the Holocaust Claims Program, as well as augmentations totaling $1.3 million for market conduct examinations and underwriting activities.
Earthquake Grants and Loans--A $2.3 million increase in local assistance to provide grants and loans to retrofit high-risk residential dwellings owned or occupied by low- or moderate-income households to minimize the risk of future earthquake damage.
Regulation of Insurance Companies and Insurance Producers--A $0.6 million increase for regulatory activities.

Required Plan Has Not Been Sent to the Legislature

We withhold recommendation on the request for a $1 million General Fund loan to the Insurance Fund to review, investigate, and resolve insurance claims relating to the Holocaust, pending receipt and review of the reimbursement plan as required by the legislation that established this program.

Chapter 963, Statutes of 1998 (SB 1530, Hayden), required DOI to implement a program to review, investigate, and resolve unpaid insurance claims for losses resulting from the activities of the Nazi-controlled German government and its allies for insurance policies written before and during World War II by insurers that currently have California affiliates. If an insurer or its affiliate has not paid a valid claim from Holocaust survivors, DOI must suspend the insurer's certificate of authority, which licenses the company to operate in California, until the insurer or the affiliate pays the claim.

Chapter 963 appropriated $4 million to DOI for expenditure during 1998-99 for this program. The legislation stipulates that funding for subsequent years is subject to the budget act and based on a plan submitted by the Commissioner to the Legislature outlining the plan for reimbursement of expenses of the department by affected insurers. The statute also requires DOI to submit to the insurance and budget committees of the Legislature a biannual report on its (1) progress implementing the program, (2) results in identifying and resolving insurance claims, and (3) current and anticipated program expenditures.

Reimbursement Plan Required by Chapter 963 Not Available. As noted above, Chapter 963 requires DOI to submit its plan for reimbursement of program expenditures to the Legislature as a basis for receiving additional funds after 1998-99. When this Analysis was written, this plan had not been sent to the Legislature. In addition, DOI has not spent most of the current-year $4 million appropriation. The DOI staff have advised us that the department is nearing completion of a comprehensive plan for the Holocaust Claims Program. This document will include (1) a plan for program implementation, (2) the plan for reimbursement of expenditures required by Chapter 963, and (3) total proposed funding for the program. According to DOI staff, the comprehensive plan should be available at the time of budget hearings.

Consequently, we withhold recommendation on the request for a $1 million loan from the General Fund to the Insurance Fund pending receipt and review of the reimbursement plan required by Chapter 963.

California State Lottery Commission (0850)

The California State Lottery (lottery) was established by the Lottery Act, an initiative statutory and constitutional amendment approved by the voters in 1984. Revenues from lottery sales are deposited in the State Lottery Fund and are continuously appropriated to the California State Lottery Commission. The commission's budget is displayed in the Governor's budget for informational purposes only and is not included in the budget bill.

The lottery act provides that sales revenue is to be distributed annually as follows: 50 percent returned to the public in the form of winnings, at least 34 percent for public education, and no more than 16 percent for administrative costs. Figure 1 shows the distribution of lottery sales revenue since 1994-95.

Figure 1

Distribution of State Lottery Sales Revenue

1994-95 Through 1999-00

(Dollars in Millions)

1994-95 1995-96 1996-97 1997-98 Estimate 1998-99 Proposed 1999-00

Annual Sales $2,166 $2,292 $2,063 $2,294 $2,600 $2,700

Distribution

Prizes $1,075 $1,128 $1,031 $1,182 $1,352 $1,418

Education^a 755 812 712 786 884 918

Administration 336 353 321 327 364 365

Percentage

Prizes 50% 49% 50% 52% 52% 53%

Education 35 35 35 34 34 34

Administration 16 15 16 14 14 14

a This total does not include interest income, unclaimed prizes, or other miscellaneous income distributed to education because these amounts are in addition to the minimum 34 percent allocation mandated by law.

Bridge Project

We recommend that the commission provide the Legislature with information demonstrating that the Bridge Project and associated recent changes in administrative expenses and revenue distribution have furthered the purpose of the Lottery Act by providing increased revenue to education.

In 1997, the lottery implemented the Bridge Project, a three-year strategic management plan to streamline lottery operations, decrease administrative expenses and staff, and increase sales. The budget year will be the third year of the project. The Bridge Project represents a fairly significant administrative restructuring of the lottery. The project's major initiatives have been to:

Hold administrative expenses at no more than 13.5 percent of sales. It is our understanding that the lottery intends administrative expenses to remain at the 13.5 percent level, with further reductions if possible. Allocate all the difference between the statutory 16 percent maximum for administration and actual costs to prizes.
Reduce staffing levels. The commission cut 219 permanent positions (out of 853) in 1997-98.
Increase retailer compensation. Retailer commissions are, by law, set at a minimum 5 percent of sales. Under the Bridge Project, commissions will be set at about 6.9 percent of sales in 1999-00 (this compares to a level of about 6.5 percent in 1994-95). Based on estimated sales revenue, this rate increase represents $25 million more in commissions.

Legislative Review. As mentioned above, the Bridge Project is a significant restructuring of the lottery that for several reasons warrants legislative review.

First, the project institutes a change in the revenue distribution--shifting reductions in amounts allocated to administration to prizes rather than education. In the past, and consistent with the Lottery Act, amounts below the maximum 16 percent have been distributed to education at the end of the fiscal year. In 1997-98, however, increasing prize payouts from 50 percent to 51.5 percent resulted in about $35 million of these savings going to prizes, not education. In the budget year the distribution to prizes would be 52.5 percent, resulting in $67.5 million going to prizes rather than education. The lottery believes that offering larger prizes will increase sales and thus result in increased revenue to education. Now that the lottery is in the third year of the Bridge Project, it should have sufficient data to present to the Legislature to substantiate this conclusion. Essentially the lottery needs to be able to substantiate that the increase in sales--related to the additional prize payout--is sufficient to offset the amount education otherwise would have received (for example, the $67.5 million in the budget year).

Second, the Bridge Project increases commissions to retailers. According to the Lottery Act retailer commissions are to be set at a minimum 5 percent of sales. However, for several years the lottery has been steadily increasing this percentage and in the budget year commissions will reach almost 7 percent. This additional 2 percent represents $54 million in the budget year. Similar to the revenue distribution shift mentioned above, the lottery believes increasing retailer commissions will ultimately result in increased sales by providing a larger financial incentive to retailers to promote the games. Since the Lottery has been increasing retailer commissions since 1988-89, we recommend the lottery provide information to the Legislature to demonstrate the beneficial effect to sales.

Legislative Oversight of The Commission's Administration Budget

We recommend that the Legislature include the commission's administration budget in the annual budget bill as an informational item identifying the planned budget-year expenditures, similar to the informational item currently included in the budget bill for the Public Employees' Retirement System.

The Lottery Act provides the commission certain flexibilities not normally granted to state agencies, such as the continuous appropriation of lottery funds for administrative expenses without external review, and the authority to establish its own procurement policies.

In order to give the Legislature a degree of oversight on the state lottery in the budget year, we recommend that the Legislature hold hearings on the commission's proposed 1999-00 budget and add an informational item to the budget bill identifying planned budget-year expenditures for administration, similar to the informational item for the Public Employees' Retirement System. The informational item also should be included in subsequent budget bills. With this action, the Legislature will have some degree of oversight of the lottery. Holding hearings on the lottery's proposed administrative expenditures will enable the Legislature to review initiatives such as the Bridge Project and determine if the organizational restructuring and associated changes in administrative costs and revenue distribution are indeed furthering the purpose of the Lottery Act--to generate revenues for education.

Consumer Affairs (1110-1600)

The Department of Consumer Affairs (DCA) is responsible for promoting consumer protection while supporting a fair and competitive marketplace. The department includes 28 semiautonomous regulatory boards and nine bureaus and programs that regulate various professions. The nine bureaus and programs are statutorily under the direct control of the department. The 28 regulatory boards are administered by appointed consumer and industry representatives.

Expenditures for the support of the department and its constituent boards are expected to total $360 million in 1999-00, a $524,000 decrease from the current year. Included in the total are $761,000 in expenditures from the General Fund for support of the Athletic Commission--a $2,000 increase from the current year.

During 1998-99 budget hearings, one of the most contentious departmental issues was the Smog Check program administered by the DCA's Bureau of Automotive Repair. Below, we discuss the program's main components and related budget-year proposals.

Overview of the Smog Check Program

The original framework for a statewide biennial Smog Check program was implemented in 1984 by the Bureau of Automotive Repair. Under this program, both smog (emission) testing and needed vehicle repairs were permitted at any privately owned smog test-and-repair station.

The 1990 federal Clean Air Act amendments required a somewhat different smog program in states with the worst air quality, including California. Federal regulations define a region's air quality in one of two ways:

A geographic area that meets or exceeds a national ambient air quality standard is referred to as an attainment area. An area that does not meet this standard is a nonattainment area. These nonattainment areas are the focus of the federal Environmental Protection Agency (EPA).

Under the 1990 act, the EPA mandated a centralized, state-owned smog check program. Under this scenario virtually all vehicles would have been initially tested at a state-owned test-only facility. Any vehicle failing the test would go to a second facility to be repaired and then, back to the test-only facility to be retested. If the vehicle failed the retest, the process would then begin again with the vehicle traveling back and forth between the test and repair facilities.

California negotiated with the federal government to adopt a modified program. This alternative program focuses on the highest polluting vehicles but is intended to be less cumbersome to the customer. The Smog Check program components as agreed to by California and the federal government are laid out in the State Implementation Plan (SIP).

The SIP was adopted by the Legislature in 1994 and approved by the federal EPA in 1996. The SIP divides California into three types of program areas based on air quality--enhanced, basic, and change of ownership. The smog test required varies by area (see Figure 1).

In addition to the requirements in the SIP, the bureau administers several smog-related programs that have been adopted by the Legislature. These other nonmandated programs are the Low-Income Repair Assistance Program (LIRAP) and the Voluntary Retirement Program (VRP). The state's Smog Check program is funded from two funds--the Vehicle Inspection Repair Fund (VIRF) and the High Polluter Repair and Removal Account (HPRRA). The VIRF funds the SIP-mandated program and the HPRRA funds the other programs. A discussion of the separate elements of the state's Smog Check program and our recommendations for legislative action follows.

SIP-Mandated Components

The SIP-mandated program includes the smog testing and repair stations as well as the bureau's administrative activities (such as enforcement staff, technician licensing, remote sensing, public relations, and general administration). The 1999-00 Governor's Budget proposes $71 million from the VIRF for the bureau's activities related to the SIP.

In addition to the bureau, two other state entities, the Inspection and Maintenance Review Committee and the Air Resources Board, have responsibilities under the SIP. Both these entities monitor the progress of the bureau in implementing the SIP and the overall effectiveness of the program in bringing California into compliance with federal air standards.

Is California on Track to Meet Clean Air Requirements?

We recommend the Legislature not approve the requested $71 million for the Smog Check program until the bureau reports to the Legislature on the status of the program and whether it is still on track for meeting the requirements of the State Implementation Plan as agreed to by the state and the federal Environmental Protection Agency. Since the Air Resources Board and the Inspection and Maintenance Review Committee are both responsible for monitoring the Smog Check program, we recommend that each provide the Legislature its assessment of the program as well.

To monitor California's performance, the SIP includes performance standards and deadlines for implementation of key SIP components. Essentially, the SIP calls for entire state to meet federal air quality standards by 2010.

California agreed to have its complete program in place by December 31, 1997. However, some components of the program have been amended by state statute, others were not implemented by the December deadline, and still others had not been implemented at the time this Analysis was written.

The major program elements of the SIP are discussed below, along with the status of how the state has responded to the SIP requirements. Figure 2 provides a glossary of common smog check terms.

Figure 2

Smog Check Program: Common Terms

Vehicle. Most gasoline powered automobiles and light-duty trucks must undergo a smog check biennially, at the time of registration. The major exemptions to this requirement are vehicles four model years old or newer and pre-1974 vehicles. In addition, most out-of-state vehicles registered in California for the first time must undergo a smog check. Currently, approximately 14 million vehicles are subject to the Smog Check program.

State Implementation Plan (SIP). Smog Check program agreement between California and the federal Environmental Protection Agency.

Gross Polluting Vehicle. A vehicle that emits excessive amounts (three to ten times the allowable rate) of hydrocarbons, carbon monoxide, or oxides of nitrogen. Gross polluting vehicles represent only about 15 percent of the vehicles in California but are responsible for more than half of the smog produced by vehicles.

High Emitter Profile (HEP). Database of vehicles and associated information on vehicle make, model, and emissions. Data are used to compose "profiles" of vehicles most likely to be gross polluters.

Low Emitter Profile (LEP). Same database as used to compile HEPs. However, in this instance the data are used to profile vehicles with low emissions--that is, "clean" cars.

Remote Sensing. Device that uses an infrared beam to scan a vehicle's exhaust to test for pollutants.

Dynamometer. Treadmill-like machine used to test vehicles in enhanced areas. Most closely simulates actual driving conditions and can test for all three smog components--hydrocarbons, carbon monoxide, and oxides of nitrogen.

BAR-90 Test. Smog test used in basic and change-of-ownership areas. Tests only for hydrocarbons and carbon monoxide, using a two-speed idle test and tail pipe sensor.

Smog Test Stations

The SIP requires California to implement a hybrid testing program that includes test-only stations and the conventional test and repair stations. The California system includes four station designations:

Test-Only stations can only perform smog tests.
Gold Shield Certification stations can test, repair, and retest all vehicles.
Gold Shield Guaranteed Repair stations can test and repair vehicles. These stations also guarantee repairs on gross polluting vehicles.
Test and Repair stations can test, repair, and retest vehicles--but cannot retest gross polluting vehicles. (A gross polluter must go to a test-only station to have the final test conducted.)

Status of Smog Test Stations. The major change resulting from the SIP was establishing the test-only network. Under the SIP, the test-only network of stations was to begin in 1995 and a percent of vehicles, as determined by the bureau, in the enhanced areas were to be sent to test-only stations. The network did not begin until September 1998. Currently about 15 percent of the vehicles in enhanced areas of the state are directed to test-only stations.

Remote Sensing

The SIP requires an on-road testing program using remote sensing devices. The program is designed to monitor vehicles as they are driven on the state highways. According to the SIP, the sensing units would be set up at various points throughout the enhanced areas. If a vehicle driving past the sensing unit was tested as gross polluting, the vehicle would be pulled to the roadside and tested using a BAR-90 machine. If the BAR-90 test confirmed that the vehicle was a "gross polluter" the vehicle owner would be required to repair the vehicle and pass a smog test.

In addition, the data compiled from this program was to be incorporated into the high- and low-emitter profiles. The bureau was to use the high-emitter profile to direct vehicles to the test-only stations for the biennial test and use the low-emitter profile to exempt vehicles from the biennial test.

Status of Remote Sensing. During 1996, the bureau conducted an on-road testing pilot program. The program did not require that the vehicle undergo a BAR-90 test. The bureau has not been operating any remote sensing devices for the past two years in part because the bureau was not satisfied with the device accuracy from the pilot program. The bureau is currently using the high-emitter profile to direct vehicles to test-only stations but has not used the low-emitter profile.

Oxides of Nitrogen

Under the SIP, the program in the enhanced areas must test for three different pollutants: carbon monoxide, hydrocarbons, and oxides of nitrogen (NOx). The NOx is a key component of smog and ozone formation. Therefore, reducing NOx emissions is crucial to meeting the federal air quality requirements.

Status of Testing for NOx. Testing for NOx was to be implemented by December 31, 1997. However, the testing was delayed until September 1998. Also, once NOx testing began, the level at which a vehicle would fail was set very high to avoid failing a large number of vehicles. We understand the bureau is gradually adjusting the failure points toward the level necessary to meet the federal requirements.

Annual Testing

The SIP requires annual testing of gross polluters and vehicles that are found to have tampered emission systems. Most other vehicles are tested biennially when registering with the Department of Motor Vehicles.

Status of Annual Testing. The authority for the bureau to require annual tests was repealed.

Legislature Needs Update on Program

Based on the discussion above, we believe the bureau, in conjunction with the Air Resources Board and Inspection and Maintenance Review Committee, should report to the Legislature on the status of the Smog Check program and whether the program is still on track for meeting the requirements of the SIP. Further, we recommend the Legislature not approve funding for these elements of the Smog Check program until this information is received and reviewed.

Non-SIP Program Components

We withhold recommendation on the $62 million and 91 personnel- years for the Low-Income Repair Assistance and Voluntary Retirement programs pending receipt and review of an evaluation report.

The non-SIP program consists of two legislative initiatives--the LIRAP and the VRP. These programs are funded from the HPPRA. This account is funded by revenue received from the smog impact fee--a $300 fee paid when an out of state vehicle is registered in California for the first time. The 1999-00 Governor's Budget proposes $62 million from the HPRRA for these programs. The bureau is planning to submit evaluation reports for both programs prior to budget hearings.

The LIRAP. Chapter 804, Statutes of 1997 (AB 57, Escutia) authorizes the bureau to offer a repair-assistance program to qualifying low-income motorists. The program was established to provide state-funded repair assistance to certain vehicle owners. The program began in a test region (Sacramento County) in November 1998. Vehicle owners must meet the following criteria to be eligible for participation in this program:

California vehicle owners at or below 175 percent of federal poverty.
Vehicle has failed a biennial smog check.
Vehicle owner has contributed at least $250 toward repairs.

If the vehicle owner meets the above criteria the state will contribute up to an additional $450 towards the necessary repairs.

At the time this Analysis was written, three motorists had participated in the LIRAP. The bureau was planning to expand into the San Diego and Los Angeles areas by February 1, 1999 and statewide by Spring 1999.

The VRP. The VRP was authorized by Chapter 28, Statutes of 1994 (SB 198, Kopp). This program provides vehicle owners with another option if their vehicle fails its biennial smog check and is a gross polluter. That is, the state will pay participants up to $450 to retire their vehicle. Essentially if a vehicle owner decides to participate in the VRP, the vehicle is sold to a private scrap dealer and must be scrapped. There are no income restrictions on VRP participation. The VRP began statewide in November 1998. At the time this Analysis was written, program data were not available.

We withhold recommendation on the $62 million requested for these programs pending receipt and review of the bureau's evaluation reports.

Remote Sensing Funding and Transfers

We recommend the Legislature not approve any funding for remote sensing until the bureau provides (1) an accounting of the current-year remote sensing appropriation and (2) a complete plan for the uses of and schedule for remote sensing.

In our 1998-99 Analysis (see page G-26) we raised issue with the bureau's continual budget redirections from remote sensing to other uses and the time frame for implementing remote sensing. The Legislature partially addressed that concern by scheduling (under Provision 1 of the budget act item) the remote sensing appropriation for the current year and adopting supplemental report language specifying the purpose of the remote sensing program. However, the bureau does not have any remote sensing units in operation and does not plan to have any in operation until the budget year. Despite this, the Governor's budget indicates that the entire current-year appropriation ($5.3 million) will be spent. If the bureau is not implementing remote sensing, it should provide a detailed accounting of those funds. In addition, the bureau needs to provide the Legislature with a detailed plan for the uses of and schedule for implementation of remote sensing. We recommend the Legislature not approve any funding for remote sensing until this information is received and reviewed.

Bureau Enforcement Program

We recommend the bureau provide information regarding the enforcement activity (such as undercover audits and licensee investigations) it currently performs. This information should include a discussion of the bureau's assessment of the necessary level of enforcement and justification for the requested 20 percent increase.

The bureau investigates and enforces violations of the Smog Check program by motorists and licensed stations and technicians. One of the tools it uses is covert performance audits of smog check stations and technicians. Similar to remote sensing, the enforcement appropriation was scheduled in the 1998-99 Budget Act. The Governor's budget proposes $17.9 million for enforcement, a 20 percent increase over the current-year appropriation. We recommend the bureau provide information regarding the enforcement activity (such as undercover audits and licensee investigations) it currently performs. This information should include a discussion of the bureau's assessment of the necessary level of enforcement and a justification for the requested increase.

Legislative Oversight and Program Accountability

We recommend the Legislature add separate items to the budget bill for the Smog Check program appropriations, including the Low-Income Repair Assistance and Voluntary Repair Program, to enhance legislative oversight and improve visibility and accountability of the programs.

The bureau's funding from both the VIRF and HPRRA was scheduled in the 1998-99 Budget Act. However, this schedule is not provided in the 1999-00 Budget Bill. Instead the appropriations from these two funds are shown as lump-sum amounts and are then transferred, with appropriations from several other funds, to the DCA under the DCA Fund.

Consistent with legislative action last year to improve oversight and accountability of the program, we recommend that the Legislature add new items to the budget bill for the programs. Because the two funds are available exclusively for the various components of the Smog Check program, the appropriations should be kept separate from the department's other appropriations and the current authority to transfer the schedule should be deleted. Therefore, we recommend the Legislature add items 1111-001-0421 and 1111-001-0582 to the budget bill. Once the budget committees have taken action on the bureau's budget, we will develop the item schedules to reflect those actions.

Department of Alcoholic Beverage Control (2100)

The Department of Alcoholic Beverage Control (ABC), established by constitutional amendment in 1954, administers the Alcoholic Beverage Control Act. Under the act, the ABC has the exclusive authority, in accordance with laws enacted by the Legislature, to license and regulate the manufacture, sale, purchase, possession and transportation of alcoholic beverages in California, and to collect licensing fees. The ABC also has the authority to deny, suspend, and revoke licenses.

The Governor's budget proposes $33.3 million for support of the ABC in 1999-00 from the ABC Fund ($32.1 million) and reimbursements ($1.2 million). Included in this amount is $1.5 million for local assistance which is the same as the current year. In total, the proposed budget is less than a 1 percent increase.

ABC Fund Condition

We recommend the Legislature enact legislation allowing the Department of Alcoholic Beverage Control to increase license fees to sustain current enforcement levels and avoid budgetary shortfalls.

The Alcohol Beverage Control Fund receives revenues from 61 different types of manufacturer, importer, retail, and wholesale liquor licenses. The ABC currently monitors over 70,000 licensees. Estimated net revenues to the fund in 1999-00 are $31.1 million.

Based on current-year and proposed budget-year expenditures and revenues, the ABC Fund will end the budget year with approximately $2.7 million in reserve. This represents approximately one month's operating expenses for ABC. This is substantially less than the $8 million that would be needed to maintain what is usually considered to be a prudent special fund reserve of three months' operating costs. Furthermore, by 2001-02 the amount in the fund will not cover the department's projected expenditures.

Consequently, based on current revenue and ABC enforcement activities the department needs either to (1) increase operating revenue or (2) reduce expenditures to remain solvent in future years. The Legislature has recently acted to increase the department's enforcement activities. If the Legislature wants to sustain this level of activity, then license fees will have to be increased.

History of ABC License Fees. The license fee revenue deposited in the ABC Fund is the total of a base license fee established in 1955 and four increases since 1955:

In 1978--a 10 percent surcharge to account for inflation.

In 1983--a 6 percent surcharge to pay for administrative hearings.
Also in 1983--a 3 percent surcharge to fund the Alcoholic Appeals Board. These funds go directly to the board and are not available to the ABC. In 1991--a $5 assessment against most licensees was added to fund designated driver education programs under the California Highway Patrol. These funds are used exclusively by the highway patrol.

Figure 1 depicts the current license fee schedule for the nine ABC license categories that represent 94 percent of all ABC licensees. The fees are paid on an annual basis and are the same for original and renewal licenses.

Fee Adjustment. The ABC, as a regulatory agency, is appropriately funded by industry fees. Periodically, regulatory agencies must evaluate their fee schedule and adjust fees upward (for example, to account for inflationary pressures and new budget initiatives) or downward (for example, when a fund balance gets too high). In the ABC's case, operating costs have increased because of inflation and increased enforcement activities yet the license fees have not kept pace with these costs. As discussed above, these fees have not been adjusted for inflation since 1978. To illustrate the impact of that on the department, we estimate that if license fees were adjusted solely to reflect inflation since 1978, the department currently would have about $54 million in additional revenues.

Figure 1

Alcoholic Beverage Control

Selected License Fees

License Type Base Fee Amount Total Increase Since 1955 Total

Beer and wine wholesaler $56 $16 $72

Retail package off-sale beer and wine 24 10 34

Retail package off-sale general 350 72 422

On-sale beer 168 37 205

On-sale beer and wine 168 37 205

On-sale beer and wine--public premise 168 37 205

On-sale general license--eating place^a 360-580 74-115 434-695

On-sale general license--public premise^a 360-580 74-115 434-695

Caterer's permit--club^a 360-580 74-115 434-695

^a License fees vary by city population.

Ideally, the ABC fee structure should generate sufficient operating revenue to fund needed ABC operations and establish a reasonable reserve. In addition, because ABC fees are set in statute, the fees should be structured with sufficient flexibility to periodically adjust the fees to match the enforcement activities and associated budget approved by the Legislature.

Given the department's current tight budgetary situation, we recommend that the Legislature amend the Alcoholic Beverage Control Act to permit the ABC to increase fees. We would suggest giving the department the ability to raise fees up to 20 percent over a multiyear period. Clearly, only a small increase would be needed in the near term. We further recommend that any fee increase be conditioned on the need to increase fees only to meet the budget expenditure level approved by the Legislature and necessary to maintain a prudent operating reserve.

Office of Real Estate Appraisers (2310)

The Office of Real Estate Appraisers (office) was established in 1990 when the Legislature enacted the Real Estate Appraisers' Licensing and Certification Law. However, this program is markedly different from other state licensing programs because real estate appraisers are not required to be licensed in order to practice in California. The licensing program was established to respond to a federal mandate that appraisals for federally related transactions be completed by a state licensed or certified appraiser and that the state certification and licensing program meet certain requirements. In addition, the office is responsible for investigating complaints against licensees and certificate holders.

The 1999-00 Governor's Budget proposes $4.2 million from the Real Estate Appraisers Regulation Fund for support of the office. This is $200,000, or 0.5 percent, above current-year expenditures. The majority of the revenue to this fund is from license and examination fees.

Fund Balance and Revenue

We withhold recommendation on the proposed budget for the Office of Real Estate Appraisers pending receipt and review of a strategic budget plan.

Based on current expenditures and revenues, the office is projected to end the budget-year with a fund reserve of slightly more than $500,000. For special fund agencies it is important to maintain a fund balance equal to approximately three months operating expenses. A prudent reserve of this amount would provide an agency sufficient resources to meet cash flow needs and to cover unexpected expenses. For the office a three-month reserve would total slightly more than $1 million.

As mentioned above, the majority of the revenue to the Real Estate Appraisers Regulation Fund is license and examination fees. Licenses are renewed on a four-year cycle. Our analysis indicates that the Real Estate Appraisers Regulation Fund is currently operating with a budget imbalance. Essentially, revenues are not sufficient to keep pace with expenditures. For example, over the period 1996-97 to 1999-00 (a complete license cycle) revenue to the fund totaled $9.3 million and expenditures from the fund totaled $15.5 million--a substantial imbalance. The office has managed to remain solvent during this time because it had a large fund reserve from which to draw. As we indicate above, this reserve will almost be depleted by the end of the budget year.

Since the bulk of licensees were licensed in the original year of the program, the office receives a disproportionately large share of its revenue every fourth year. This will next occur in 2000-01 when the office is projected to receive approximately $4.8 million in revenue. Based on current expenditure trends, the office will spend about half the total renewal revenue in that fiscal year. This would leave the office with insufficient revenue to operate over the subsequent three years.

It is our understanding that the administration is currently preparing a proposal for the office that will address this budget imbalance. The proposal should be available for review by the Legislature during budget hearings. We recommend the office include a five-year strategic budget plan in its proposal. The budget plan should include, at minimum:

A cash flow analysis of the proposed budget for 1999-00 and subsequent years.

A five-year (1999-00 as the first year) budget showing expenditure and revenue levels sufficient to meet the office's mission. This is a crucial component of the plan. At this time it appears that the office's current fee structure does not generate revenues sufficient to fund the office's current level of activities. However, we are not certain what staffing and related resource levels are needed for the office to fulfill its mission.

If the office's proposal includes a fee increase, the office should provide adequate justification for that increase, including a comparison of California fees with other states. We withhold recommendation on the 1999-00 proposed budget until receipt and review of a strategic budget plan, as described above.

1998 Audit Report and Findings

The office should, prior to budget hearings, provide a detailed update of the office's progress in responding to the concerns raised in the March 1998 State Auditor report.

In March 1998, the State Auditor released a report that raised issue with several practices within the office. The major problems found were that the office (1) had a large backlog of complaints that it had been unable to resolve promptly, (2) certain personnel practices violated state and federal rules, and (3) some investigatory procedures needed to be improved.

As a result of the issues raised by the Auditor, the Legislature adopted several supplemental reporting requirements for the office. The office also was required to submit quarterly reports tracking its progress in responding to the Auditor's finding. The first two quarterly reports have been received and the issues raised by the Auditor have been addressed as described below.

Complaint Backlog. The Auditor found that as of January 1, 1998, the office had 641 open complaints. Some of these complaints had been open for as long as four years. The Auditor found that a major contributing factor to the office's inability to process complaints was that the office did not establish the enforcement division in a timely manner. Also, once established, the enforcement division was not fully staffed and was staffed with limited-term employees rather than the permanent employees authorized by the Legislature.

Based on information in the second quarterly report compiled by the office, vacancies in the office have been filled with permanent employees. Furthermore, as of December 1, 1998 the office had closed out 567 of the 641 outstanding complaints. In addition, the office has closed out 93 of the complaints that were received in 1998.

Personnel Practices. The Auditor found that (1) the office's use of limited-term appointments was not in accordance with State Personnel Board rules and (2) the office's overtime practices violated provisions of the Fair Labor Standards Act. As mentioned above, the office has now filled all vacant positions with permanent employees and has paid all current employees entitled to overtime compensation in accordance with Department of Personnel Administration rules. However, the office has been named in a civil suit filed by two former employees alleging violations of the Fair Labor Standards Act. At the time this Analysis was prepared, the case was pending in federal district court.

Investigatory Procedures. The State Auditor found that the office was not recording the necessary investigatory information and the investigators needed training to ensure the office was investigating complaints using consistent methods. In response, the office has provided all investigators with training on proper record keeping, has established procedures for investigation of complaints, and implemented oversight safeguards to ensure staff comply with the new procedures.

It appears from the information received in the first two quarterly reports that the office is being responsive in addressing the issues found by the Auditor. The third quarterly report is due to be submitted March 1, 1999--during budget hearings. We recommend the office report to the appropriate budget subcommittee regarding its progress in responding to the issues raised in the 1998 State Auditor's report.

Energy Resources, Conservation And Development Commission (3360)

The Energy Resources, Conservation and Development Commission (commonly referred to as the California Energy Commission) is responsible for forecasting energy supply and demand, developing and implementing energy conservation measures, conducting energy-related research and development programs, and siting major power plants.

The budget proposes commission expenditures of $227.7 million from various state and federal funds in 1999-00. This is $10.8 million, or 4.5 percent, less than current-year estimated expenditures. This reduction is due in part to one-time expenditures in the current year for a variety of projects that are not carried forward to the budget year. These reductions are partially offset by increased expenditures in the budget year of (1) $2.5 million for the Energy Facilities Siting Program and the Public Interest Energy Research (PIER) Program and (2) $0.6 million in the Energy Technology Development Program.

Legislature Needs to Review Energy Facilities Siting Program

We withhold recommendation on the request for a $1,247,000 augmentation and ten positions for the Energy Facilities Siting Program until the Legislature reviews the commission's role in siting energy facilities under the deregulated market for electricity generation. We further withhold recommendation on the existing staffing level and funding (75 positions and $9.5 million) for the siting program, pending the Legislature's review of the commission's siting role.

The budget proposes $1,247,000 from the Energy Resources Programs Account for the commission's Energy Facilities Siting Program. These funds would be used to establish ten permanent positions and provide $400,000 for consultant contracts, $60,000 for travel expenses, and $20,000 for overtime expenses. The proposal is based on the commission's projection of increased workload related to reviewing energy facility siting applications the commission currently expects to receive through December 2000.

This request would permanently establish the ten positions and the $400,000 in consulting funds the Director of Finance proposed in a December 1998 deficiency proposal submitted to the chairs of the appropriations committees in each house and the Chair of the Joint Legislative Budget Committee. The proposal, submitted pursuant to Section 27.00 of the 1998-99 Budget Act, was to address an increase in siting workload the commission expected to occur before the end of the current year. The Chair of the Joint Committee did not concur with the Director's proposal. Instead, the Chair advised the Director to increase the commission's expenditure authority only for the current year with the conditions that (1) the ten positions not be permanently established and (2) the commission be given the flexibility to use the entire amount for consultants if this would facilitate its review of siting applications. The Chair indicated that this would give the commission the resources needed to continue its current responsibilities in 1998-99 while providing the Legislature an opportunity to reassess the commission's role in and funding for the siting activity during the budget hearings.

The Warren-Alquist Act requires the commission to approve the construction of electricity-generating power plants, unless the plant generates less than 50 megawatts of electricity or is a hydroelectric, wind, or solar facility. After approving a proposed power plant, the act requires the commission to ensure that the facility is in compliance with all applicable federal, state, and local laws, as well as any conditions of certification required by the commission. The commission must approve any modifications to these plants. For plants not subject to its jurisdiction (such as those that predate the siting approval process), the commission must approve plant modifications unless the modifications meet the megawatt or type-of-facility exclusions outlined above.

In 1996 and 1997, the Legislature significantly changed the way the electricity industry is regulated in California. These changes included deregulation of the generation of electricity and creation of statewide entities to ensure the availability of electricity and the reliability of the statewide electricity system. The changes did not deregulate the transmission or distribution of electricity.

In the newly deregulated environment for electricity generation, the state's regulatory interest in approving the construction and modification of facilities may have changed. Therefore, it is not clear which, if any, of the commission's siting activities are still necessary or what benefits these activities continue to provide. Until the Legislature reviews the commission's role in siting energy facilities under the deregulated market for electricity generation, the appropriate funding level for these activities is uncertain. Consequently, we withhold recommendation on the request for ten positions and $1,247,000 for the Energy Facilities Siting Program. We also withhold recommendation on the existing staffing level and funding--75 positions and $9.5 million--dedicated to the Energy Facilities Siting Program, pending the Legislature's review of the commission's siting role. Prior to the budget hearings, the commission should submit to the Legislature a report that (1) discusses each of the commission's siting activities; (2) discusses which siting activities should continue, be amended, or be eliminated; and (3) justifies the commission's conclusions.

Department of Food and Agriculture (8570)

The California Department of Food and Agriculture promotes and protects the state's agriculture industry through industry inspections and marketing support; develops California's agricultural policies; assures accurate weights and measures in commerce; and provides financial oversight to county, district, and citrus fairs.

The 1999-00 Governor's Budget proposes $201 million for the department, which is about $600,000 higher than current-year expenditures. The proposed budget includes $70.5 million from the General Fund, a 1 percent decrease from the current year.

California Veterinary Diagnostic Laboratory System

The budget proposes $11.5 million, including $9.7 million General Fund, for operations of the California Veterinary Diagnostic Laboratory System. The laboratory was established in 1918 and was operated as a program within the department until 1987-88, when the University of California at Davis took over responsibility for its management. The department contracts with the laboratory for services and separately displays the General Fund amount for the laboratory in the Governor's budget but not in the budget bill.

Fee Structure

We recommend the Legislature require the department to implement a fee schedule that provides for 100 percent cost recovery for the testing services provided by the Veterinary Diagnostic Laboratory for (1) regulated industries (this action would result in a decrease in needed General Fund support of an unknown amount) and (2) private veterinarians and producers (this would result in a decrease in needed General Fund support of $93,000 annually). (Reduce Item 8570-001-0001 by $93,000.)

Currently, laboratory operations are funded through a combination of General Fund, fee revenue, and federal funds. The majority of the budget, 84 percent, is funded by the General Fund. The fee revenue, estimated to total $1.6 million in 1999-00, is generated by testing services provided to private veterinarians and producers. In recent years, issues have been raised regarding the payment for these laboratory services.

In the Supplemental Report of the 1998-99 Budget Act, the department was required to submit information on how the state should recover the cost of the contract with the laboratory. In December 1998, the department submitted the required report, detailing the current fee and workload structure and providing funding alternatives and recommendations. The laboratory's workload structure is based on the different clients served by the laboratory. Basically, the laboratory performs both regulatory and nonregulatory or diagnostic testing services.

Regulatory services are those provided to the department for state and federal regulatory programs (such as tests for food quality, animal diseases, and human pathogens). These tests are primarily funded by the General Fund. Nonregulatory or diagnostic services are those provided primarily to practicing veterinarians and agricultural producers and are generally paid for through user fees.

Regulatory Programs. The laboratory performs testing as a part of several regulatory programs. These programs vary from equine postmortem examinations to E. coli and Salmonella monitoring for the department's milk quality assurance program. As with other regulatory programs, it would be appropriate for the regulated industries to pay these costs. Thus, these testing services should be entirely funded through industry fees rather than the General Fund. We recommend the Legislature require the department to establish a fee schedule for the regulatory programs to provide for 100 percent cost recovery. Since these services are currently supported by the General Fund, this action would result in a reduction in the needed General Fund support for the department. The department should provide an estimate of this amount prior to budget hearings.

Nonregulatory Programs. According to information submitted by the department, approximately 80 percent of the cost for tests performed primarily for benefit of agricultural producers is currently recovered by fees. Thus, the General Fund is subsidizing about 20 percent of these costs. One of the recommendations in the department's December report is to "implement a plan to recover 100 percent of the costs from tests which primarily benefit producers." We concur with this recommendation. The laboratory estimates that doing this would have resulted in approximately $93,000 of additional fee revenue in 1997-98. Thus, we recommend the Legislature direct the laboratory to make the needed adjustment in fees and consequently reduce the budget to reflect the resulting reduction in General Fund support needed for current laboratory operations. (Reduce Item 8570-001-0001 by $93,000.)

Legislative Oversight of Veterinary Laboratory Budget

We recommend that the Legislature create a new budget bill item under the Department of Food and Agriculture in order to separately identify the laboratory's operating costs and to enhance legislative oversight. (Delete $9,709,000 from Item 8570-001-0001 and add Item 8570-0004-0001 in the amount of $9,616,000.)

The General Fund appropriation for the laboratory, while displayed in the Governor's budget, is not identified in the budget bill. Because of legislative concern over recent cost increases and to increase the visibility and accountability of the laboratory budget, we recommend the Legislature add a separate item to the budget bill to appropriate funds for the laboratory budget. Thus, we recommend the Legislature add the following item to the budget bill (the amount shown reflects a $93,000 reduction, as discussed above).

8570-004-0001--For support of the Department of Food and Agriculture for the California Veterinary Diagnostic Laboratory, pursuant to Food and Agriculture Code Section 520, et. seq..........$9,616,000.

Fair Political Practices Commission (8620)

The Fair Political Practices Commission (FPPC) was established in 1974 to implement and administer the Political Reform Act (PRA), an omnibus measure designed to improve the elections process in California for candidates for state and local office. The act (1) established rules for the disclosure of money received and spent by candidates seeking political office, (2) required state ballot pamphlets to have useful and understandable information, (3) established lobbyist activity disclosure regulations, and (4) required the disclosure of assets of public officeholders and barred conflicts of interest with their official decision making. The California Political Reform Act of 1996 (CPRA), established by Proposition 208, among other provisions established specific limits on the amount and source of campaign contributions and established voluntary campaign spending limits for candidates.

The provisions of the PRA and CPRA are carried out by four state agencies, including the FPPC (the other agencies are the Secretary of State, Department of Justice, and the Franchise Tax Board). The FPPC adopts regulations, establishes procedures to monitor compliance, and provides advice to officeholders regarding the requirements of the PRA and CPRA. The FPPC also investigates alleged violations of the laws and imposes sanctions on violators.

The PRA provided a $1 million annual appropriation to the FPPC. The CPRA provided an additional $500,000 annual appropriation to the commission. By law, the amounts are to be adjusted each year for changes in the cost of living. The PRA further directs that the Legislature shall provide such additional amounts as may be necessary to the FPPC and other state agencies to carry out the political reform laws.

The budget proposes total expenditures of $5.1 million for the FPPC in 1999-00. This is almost exactly the same amount the commission is estimated to spend in the current year.

Further Efforts Needed To Comply With Audit

The Fair Political Practices Commission (FPPC) has made significant progress toward implementing the recommendations of a May 1998 Bureau of State Audits (BSA) report to make its operations more efficient and effective. However, the FPPC has not yet fully complied with legislative directives to carry out the BSA recommendations to strengthen its political reform enforcement efforts. We recommend that the FPPC provide additional information to the Legislature by April 1, 1999 on how it will do so. We further recommend enactment of legislation that would allow the FPPC to more narrowly focus its enforcement efforts on the most serious violations of political reform laws and to strengthen the penalties that it can impose when such violations occur.

Last year, the Legislature directed the BSA to examine the operations of the FPPC and report on how well it was performing its duties. In its May 1998 response, the BSA found that the FPPC was reasonably interpreting the PRA in its regulation and advice to candidates and public officeholders, but that its process for investigating complaints was flawed and could result in inconsistent treatment of violators. The BSA report also found problems in the way the FPPC provided assistance to persons seeking information about political reform laws, determined that the FPPC lacked meaningful goals and a system to measure progress toward meeting those goals, and concluded that financial disclosure and conflict-of-interest laws for state and local officeholders enforced by the FPPC contained overly restrictive financial limits that should be modified.

The Legislature adopted 1998-99 Budget Act and supplemental report language directing the FPPC to implement BSA's recommendations for remedying these problems. The language further directed the FPPC to complete a plan by December 1, 1998 identifying how it would implement each specific recommendation and the additional funding and staffing, if any, necessary to carry out the audit recommendations.

Progress Seen in Audit Compliance. Based upon our analysis, the FPPC has taken some significant steps toward improving its operations as recommended by the BSA:

Prioritized Case Reviews. The cases being considered for investigation are being reviewed using standard criteria to determine which are a high priority and warrant immediate assignment and which are a lesser priority.
Auditing Regulations. New regulations have been written so that the Franchise Tax Board, charged by state law with conducting audits of candidate and lobbyist financial disclosure statements, will refer only the most significant law violations it has found to the FPPC for enforcement action and will not be required to perform audits unlikely to discover significant violations.
Local Filing Oversight. A plan is being written to provide oversight for an estimated 7,000 officials responsible for ensuring that local government officeholders comply with financial disclosure requirements.
Tracking Customer Needs. Coding devices were installed on FPPC phones so that staff members responsible for assisting persons with obtaining forms or clarifying the meaning of political reform laws could track what kind of help they needed most from the FPPC so that customer service could be improved.

Partial Compliance. As directed by the Legislature, the FPPC submitted a plan to the Legislature on December 1, 1998, outlining the steps taken so far to comply with the BSA audit recommendations. As the Legislature also directed, the FPPC identified the staffing and funding it believes are needed to implement certain audit recommendations--in all, 13 positions and $840,000.

However, our analysis indicates that the FPPC has not yet fully complied with legislative directives to carry out the BSA recommendations to strengthen its political reform enforcement efforts.

In a few cases, the FPPC failed to identify the staffing or funding it says are needed for fulfillment of BSA recommendations. This was the case for new computerized management information system that FPPC asserted was needed so that achievement of its goals can be tracked and measured.

In other cases, the FPPC reported how much staffing or funding it wanted for BSA compliance activities, but failed to document exactly how the money would be used and the workload justification for requesting additional resources. For example, the FPPC said it would need six additional staff and $437,000 for its Enforcement Division, but could not document how its workload was determined or why it could not be handled with its existing complement of investigators. Without this information, the Legislature cannot easily determine whether additional appropriations to FPPC are justified to carry out its directive for improving the enforcement of the political reform laws. The proposals contained in the report were requested by FPPC for inclusion in the 1999-00 budget, but were rejected.

Financial Limits Too Low. As noted earlier, the 1998 BSA audit report also recommended modification of the dollar limits established for state or local officeholders who must disclose their financial interests or refrain from decision-making in which they might have a conflict of interest.

For example, an officeholder may not participate in a governmental decision if he or she received more than $250 from a party with an interest in the matter. The $250 limit was part of the original 1974 PRA and has never been adjusted for inflation. The BSA concluded that the public interest would be served if the limit were adjusted for inflation, because it would allow the FPPC to more narrowly focus on the enforcement of the most serious violations instead of a large number of complaints involving minor violations. A measure to change these financial limits (AB 1864, Papan) passed the Legislature last year but was vetoed by the Governor because of his objection to an unrelated provision.

Meanwhile, the maximum administrative or civil fine that can be imposed for a single violation of the PRA also remains at the original $2,000 level established 25 years ago. If the limit were adjusted for inflation, it would now be a maximum of about $7,000 per violation. We are advised by the FPPC that, because this penalty has not been adjusted for inflation, the fine level may be insufficient to deter some candidates and officeholders from complying with political reform laws.

Focusing Audit Activities. In response to the BSA audit, the FPPC has identified two other proposed statutory changes that would focus political reform auditing activities on the cases most likely to discover violations of political reform laws. The first measure would allow fewer audits each year of lobbyists and lobbyist employers so that more such audits could be conducted of political campaigns, where political reform law violations are more frequently found. The other would eliminate some audits of candidates' prior campaign disclosure statements that are now mandatory but that the FPPC believes should be conducted only if there is evidence of past misconduct.

Analyst's Recommendation. We believe that additional appropriations proposed by the FPPC to carry out the recommendations of the BSA have not yet been justified. Accordingly, we recommend that by April 1, 1999, the FPPC provide the Legislature with the following information: (1) identification of the funding and staffing needed for compliance with all of BSA's recommendations, (2) its methodology for calculating the workload and additional resources needed for each of these funding and staffing requests, and (3) an estimated timetable for completing the implementation of the BSA recommendations. Once the Legislature has received this information, it can determine whether the 1999-00 budget for the FPPC should include additional resources needed to fulfill its policy goals of strengthening enforcement of the PRA.

We also believe that the Legislature should enact legislation to make three changes to the PRA that would likely result in more efficient enforcement of the act and help deter individuals from violating the political reform laws. Specifically, we believe that the Legislature should adjust various financial limits contained in the PRA for inflation since 1974. Similarly, the maximum fine for a single political reform law violation should be adjusted from the present level of $2,000 to $7,000 to account for inflation over the same period. The additional fine revenues generated would go to the state General Fund, not to the FPPC directly, but could help offset the potential cost of improving the FPPC's operations.

Public Utilities Commission (8660)

The Public Utilities Commission (PUC) is responsible for the regulation of privately owned "public utilities," such as gas, electric, telephone, and railroad corporations, as well as certain passenger and household goods carriers. The commission's primary objective is to ensure adequate facilities and services for the public at equitable and reasonable rates. Throughout its various regulatory decisions, the commission also promotes energy and resource conservation.

The budget proposes total expenditures for PUC in 1999-00 of $83.7 million from various state special funds ($70.9 million), federal funds ($1 million), and reimbursements ($11.8 million). This is about $26.9 million, or 24 percent, less than estimated current-year expenditures. This decrease results from a one-time current-year appropriation of $28 million from the General Fund for electric utility purposes in San Diego and San Francisco and an increase of $1.1 million in rate regulation activities funded by the Public Utilities Commission Utilities Reimbursement Account.

Funding for Compliance With "Cramming" Statutes

We withhold recommendation on the $1,035,000 augmentation and 19 positions requested to comply with Chapter 1041, Statutes of 1998 (SB 378, Peace) and Chapter 1036, Statutes of 1998 (AB 2142, Brown), which address the problem of "cramming," pending receipt and review of additional workload data to justify the requested staffing level and associated funds.

The budget proposes expenditures of $1,035,000 and the addition of 19 two-year limited-term positions to support PUC workload resulting from Chapter 1041 and Chapter 1036. This legislation addressed the problem known as "cramming," or the inclusion of unauthorized charges on telephone bills. The legislation requires PUC to document consumer complaints and investigate companies that receive a specified level of complaints. The legislation also allows PUC to investigate companies below this complaint threshhold at the commission's discretion.

Initial information provided by PUC with the request did not provide sufficient data to support the need for the requested 19 positions and related costs. The PUC staff subsequently submitted more detailed information to justify the request, but we received this information too late to thoroughly review it prior to writing this analysis. Consequently, we withhold recommendation on the request pending further analysis and review.

Board of Equalization (0860)

The Board of Equalization is one of California's major tax collection agencies. The board (1) collects state and local sales and use taxes and a variety of business and excise taxes and fees (including those levied on gasoline, diesel fuel, cigarettes, and hazardous wastes) and (2) is responsible for allocating tax proceeds to the appropriate local jurisdiction(s). The board oversees the administration of the property tax by county assessors and assesses property owned by public utilities. The board is also the final administrative appellate body for personal income and bank and corporate taxes, as well as for the taxes it administers. The agency is governed by a five-member board--four-elected members and the State Controller.

The 1999-00 Governor's Budget proposes approximately $291 million in support of the board's operations, of which $184 million is from the General Fund. The total proposed budget expenditures are about 2 percent above current-year expenditures.

Audit and Collections Program Augmentation Not Justified

We withhold recommendation on the proposed $6 million ($4.9 million General Fund) augmentation and 116 new audit positions until the agency provides sufficient justification for this increased audit effort. (Reduce Item 0860-001-0001 by $4,898,000 and Item 0860-501-0995 by $1,076,000.)

The Governor's budget proposes the addition of 116 audit positions and $6 million ($4.9 million General Fund). According to information prepared by the Department of Finance (DOF), the proposed augmentation would result in an additional $12.9 million in state and local tax revenue in the budget year. Our analysis indicates that this level of additional revenue is overstated. The DOF has not fully discounted the projected revenue to account for the delay in hiring new auditors, training the new auditors, and the costs and delays associated with collections. Taking these factors into account, we estimate that budget-year collections would total $9 million to $10 million.

In the past we have raised concerns with the board justifying audit staff augmentations based on potential revenue gains, noting that the Legislature has not had sufficient information to review the validity of the methodology used by the board to make revenue impact calculations. The State Auditor, at the request of the Legislature, is evaluating the revenue (assessments and collections) benefit of additional tax auditors. This report should be available for review within a few months.

At this time, we withhold recommendation on this proposal. As noted above, the benefits to the state may be considerably less than stated and the auditor's report may offer important information to help the Legislature make decision on these requests. There is an additional issue that, in our view, deserves more attention: the level of audit exposure for taxpayers. The Legislature should take into account whether the costs of the additional audit activity is worth the improvement in taxpayer compliance and whether the greater audit "presence" in the state is appropriate. We recommend that the agency also explicitly address these issues.

Franchise Tax Board (1730)

The Franchise Tax Board is one of the state's major tax collecting agencies. The department's primary responsibility is to administer California's Personal Income Tax and Bank and Corporation Tax laws. The department also administers the Homeowners' and Renters' Assistance programs and the Political Reform Act audit program. In addition, the department administers several nontax programs, including collection of (1) child support, student loan, and motor vehicle registration delinquencies; and (2) court ordered payments. A three-member board--the Director of Finance, the Chair of the State Board of Equalization, and the State Controller--oversees the department. A board-appointed executive officer is charged with administering the day-to-day operations.

The 1999-00 Governor's Budget proposes $378 million for support of the department, including $354 million from the General Fund. Both the total budget and General Fund support for the department are approximately 3 percent decreases from current-year expenditures. This decrease is mainly the net effect of: (1) a budget proposal to suspend the business tax reporting mandate resulting in a decrease of $16.3 million, (2) a $5 million reduction in the bank and corporation tax program area, and (3) a $10 million increase in the personal income tax program area.

Augmentations Not Justified

We recommend the Legislature delete the proposed augmentations totaling $8.2 million and 73.2 personnel-years (PYs) from various funds for support of the Franchise Tax Board because these augmentations have not been justified. Reduce various items by a total of $8,242,000 ($8,056,000 General Fund) and 73.2 PYs.

The Governor's budget proposes three augmentations totaling $8.2 million for the department as summarized in Figure 1 (see next page). As discussed below, we recommend the Legislature delete the additional funds and associated new positions.

Figure 1

Franchise Tax Board Proposed Augmentations

1999-00

(In Thousands)

Description Funding Source

General Fund Reimbursements Motor Vehicle Account License Fee Account Court Fund Totals

Limited liability

companies
$1,792 -- -- -- -- $1,792

Audit and collection

activities
3,350 -- -- -- -- 3,350

Merit salary

adjustment
2,914 $113 $25 $41 $7 3,100

Totals $8,056 $113 $25 $41 $7 $8,242

Limited Liability Companies. The budget proposes $1.8 million and 18.1 PYs to address workload related to limited liability companies. At the time this Analysis was prepared, the department and administration had provided no information on this augmentation. The only information available was the descriptions of the augmentation contained in the Governor's budget document and summary which indicated that this augmentation would result in increased tax revenues in 2000-01. Because this augmentation has not been justified, we recommend the Legislature delete the funds and personnel.

Audit and Collections. The budget also proposes $3.4 million and 55.1 PYs to increase audit and collection activities. At the time this Analysis was prepared, the department and administration had not provided justification for this augmentation. The only information available was the descriptions of the augmentation contained in the Governor's budget document and summary which indicates that this augmentation would result in increased tax revenue collections in the budget year. Lacking any information, we recommend deletion of the augmentation.

Merit Salary Adjustments. The Governor's budget includes $3.1 million ($2.9 million General Fund) to fund merit salary increases provided by the department to employees. (It is our understanding that no other department received an augmentation for employee merit salary adjustments.) In the past, the department has submitted budget change proposals for merit salary adjustments provided to employees. This year, however, the budget-year augmentation was simply added as a baseline adjustment, without either justifying or identifying the increase. Under the circumstances, we recommend that the Legislature delete the $3.1 million added to the budget for merit salary adjustments. (Reduce various items by $3,100,000, [$2,914,000 General Fund].)

Performance Audit

We recommend the department provide the Legislature with detailed information on why tax program reductions recommended by a performance audit have not been implemented. Pending receipt and review of this information, we withhold recommendation on $7.4 million in the department's budget.

In 1998, the board contracted with an independent auditor to conduct a performance audit of the department. The preliminary audit results were presented to the board in October 1998. The board requested the auditor review specific recommendations, and provide further analysis and detail. The auditor presented the final report in December 1998. The report found several areas in the department's operations that need improvement and made recommendations accordingly. The auditor suggested a five-year action plan to implement the recommended changes. The auditor classified the recommendations as high, medium, or low priority based on several factors. We highlight the four high-priority recommendations that affect the department's tax programs. The total savings associated with these reductions, based on the audit's five-year plan, is an estimated $37 million. Assuming that savings would be realized equally over all five years, the first year savings would total $7.4 million, as shown in Figure 2 (see next page).

A brief discussion of the recommended reductions follows.

Span of Control and Management Structure. The auditor reviewed the department's span of control and management structure. The auditor found that the layers of management are appropriate but, based on several factors, the span of control is too low (that is, each manager supervises, on average, too few staff). The auditor concluded that the targeted span of control ratio for the department should be one manager for every ten staff (1:10). For 1997-98, the department's average span of control was one manager for every 9.1 staff. Thus, according to the audit, a slight increase in the span of control is warranted. Specifically, the auditor recommended the department reduce filled management positions by 10 percent (55 positions) and eliminate 60 vacant positions to achieve an overall average span of control ratio of 1:10.

Figure 2

High Priority Recommendations

Affecting Tax Programs

(In Thousands)

Description Reductions

Budget-Year^a Five Year Total Reduction

Span of control $1,640 $8,198

Filing system assessment and reductions 513 2,564

Information technology positions 4,587 22,935

Customer service 643 3,215

Totals $7,383 $36,912

^a LAO estimate based on equal phase in of total reduction recommended by independent auditor.

Filing System Assessment and Reductions. The department processes over 13 million personal income tax returns annually. Currently, the majority (91 percent) of those returns are filed using traditional methods--paper returns manually prepared and mailed to the department. However, the department has seen dramatic increases in both electronic filing and telephone filing over the past three years. These filing methods are much less staff intensive than traditional methods and as such should result in reductions in department staff and resource levels. Based on estimated growth in both electronic and telephone filing, the auditor estimated that the department will be able to reduce a total of 89 filing staff and realize budget savings totaling $2.6 million over five years. The auditor further recommended that these reductions be phased in to coordinate with the increases in alternative method filing. Although the department concluded in its response to the audit that increased alternative filing will result in a reduction totaling 72.4 PYs and $2.1 million over the next five years, no reduction is included in the Governor's budget.

Information Technology Positions. The auditor conducted an analysis of the department's information technology personnel and concluded, based on several factors, that the department should reduce a total of 417 PYs over the next five years. According to the auditor, the department currently has 894 information technology personnel. Accepting the auditor's recommendation would result in a 46 percent reduction in information technology staff.

Customer Service. The auditor made several recommendations that affect the department's numerous customer service functions. However, only two recommendations had any savings associated with them. They are to:

Discontinue mailing tax booklets to filers who use either a tax preparer or automated software to file the previous year's taxes.

Realize budget savings resulting from elimination of the Employee Confirmation Report.

The auditor estimated five-year savings of $3.2 million from these actions.

Given the potential for improving the department's operations and the associated savings, we believe the Legislature should be given the opportunity to consider the suggested changes. Consequently, we recommend the department provide detailed information on why reductions recommended by the performance audit have not been implemented. Pending receipt of this information, we withhold recommendation on $7.4 million.

Integrated Nonfiler Compliance Project

We withhold recommendation on the $6.9 million General Fund request for the Integrated Nonfiler Compliance project. The project has not yet been approved by the Department of Information Technology.

The Governor's budget includes a $6.9 million General Fund augmentation for the department to redesign and begin implementation of the Integrated Nonfiler Compliance project. The current nonfiler program consists of a variety of automated and manual processes to achieve tax filing compliance from individuals and corporations not currently filing returns. The program currently includes 47.5 PYs and $3.1 million.

The department received a current-year augmentation totaling $2.7 million and 28.5 PYs to begin system redesign and the procurement for a new system. It is our understanding that the department is still in the design stage. In addition, the required feasibility study report (FSR) for the new system has not been approved by the Department of Information Technology. The department is not permitted to continue with the project unless it receives all necessary approvals. Consequently, we withhold recommendation pending approval by the Department of Information Technology and review of the approved FSR. Presumably the approved FSR will be available prior to budget hearings.

Business Tax Reporting Mandate

If the Legislature determines that suspending the business tax reporting mandate is appropriate, then we recommend that the Legislature also delete the positions associated with program workload. The department should identify these positions prior to budget hearings.

Pursuant to Chapter 1490, Statutes of 1984 (AB 3230, Hannigan), every city in California which assesses a business tax and maintains a computerized record keeping system is required to annually furnish specific information to the department. The department then uses this information to identify self-employed individuals for tax enforcement purposes. Cities that maintain a computerized system may file a claim to have certain costs--administrative and operational--associated with providing the data to the department reimbursed by the state.

The administration is proposing to suspend the tax reporting mandate and, therefore, eliminate the state's financial responsibility to the cities. Accordingly, the Governor's budget shows a decrease of $16.3 million for the program. However, the budget does not include a corresponding decrease in positions associated with this program.

This is the same proposal that has been submitted to the Legislature in recent budget bills. In each instance the Legislature has denied the proposal and funded the program. However, if the Legislature determines that the mandate should be repealed or suspended at this time, we would recommend that the Legislature also delete the positions associated with program workload. The department should identify these positions prior to budget hearings.

Unnecessary Budget Control Language

We recommend that the Legislature delete proposed budget language that would add administrative controls over the Franchise Tax Board. (Delete Provision 1 under Item 1730-001-0001.)

The budget bill includes language that would require Department of Finance (DOF) approval before the board could take the following administrative actions :

Any reduction of expenditures or redirection of either funding or personnel from tax return processing, auditing, and collecting taxes owed. The DOF could not approve any such proposal before 30-day notification is provided to the Chair of the Joint Legislative Budget Committee.
Any transfer of positions between organizational units as assigned in the 1999-00 Governor's Budget and the 1999-00 Salaries and Wages Supplement as revised by legislative budget action.

There is no explanation of the need for this language in the Governor's budget document.

To our knowledge all departments are required to implement the budget as approved by the Legislature and signed by the Governor. Various control sections in the annual budget act give the administration flexibility in implementing various programs throughout the year. For example, Control Section 26.00 provides for intraschedule transfers where necessary for the efficient and cost-effective implementation of the budget. The control section establishes specific parameters within which the administration can take these actions. We are not aware of any reasons to add additional administrative controls solely for the Franchise Tax Board. Lacking any such information, we recommend that the Legislature delete the proposed budget language. (Delete Provision 1 under Item 1730-001-0001.)

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Figure 1
Distribution of State Lottery Sales Revenue
1994-95 Through 1999-00 (Dollars in Millions)
	1994-95	1995-96	1996-97	1997-98	Estimate 1998-99	Proposed 1999-00

Annual Sales	$2,166	$2,292	$2,063	$2,294	$2,600	$2,700
Distribution
Prizes	$1,075	$1,128	$1,031	$1,182	$1,352	$1,418
Education^a	755	812	712	786	884	918
Administration	336	353	321	327	364	365
Percentage
Prizes	50%	49%	50%	52%	52%	53%
Education	35	35	35	34	34	34
Administration	16	15	16	14	14	14

a This total does not include interest income, unclaimed prizes, or other miscellaneous income distributed to education because these amounts are in addition to the minimum 34 percent allocation mandated by law.

Figure 2
Smog Check Program: Common Terms

	*Vehicle*. Most gasoline powered automobiles and light-duty trucks must undergo a smog check biennially, at the time of registration. The major exemptions to this requirement are vehicles four model years old or newer and pre-1974 vehicles. In addition, most out-of-state vehicles registered in California for the first time must undergo a smog check. Currently, approximately 14 million vehicles are subject to the Smog Check program.
	*State Implementation Plan (SIP)*. Smog Check program agreement between California and the federal Environmental Protection Agency.
	*Gross Polluting Vehicle*. A vehicle that emits excessive amounts (three to ten times the allowable rate) of hydrocarbons, carbon monoxide, or oxides of nitrogen. Gross polluting vehicles represent only about 15 percent of the vehicles in California but are responsible for more than half of the smog produced by vehicles.
	*High Emitter Profile (HEP)*. Database of vehicles and associated information on vehicle make, model, and emissions. Data are used to compose "profiles" of vehicles most likely to be gross polluters.
	*Low Emitter Profile (LEP)*. Same database as used to compile HEPs. However, in this instance the data are used to profile vehicles with low emissions--that is, "clean" cars.
	*Remote Sensing*. Device that uses an infrared beam to scan a vehicle's exhaust to test for pollutants.
	*Dynamometer*. Treadmill-like machine used to test vehicles in enhanced areas. Most closely simulates actual driving conditions and can test for all three smog components--hydrocarbons, carbon monoxide, and oxides of nitrogen.
	*BAR-90 Test*. Smog test used in basic and change-of-ownership areas. Tests only for hydrocarbons and carbon monoxide, using a two-speed idle test and tail pipe sensor.

Figure 1
Alcoholic Beverage Control Selected License Fees

License Type	Base Fee Amount	Total Increase Since 1955	Total

Beer and wine wholesaler	$56	$16	$72
Retail package off-sale beer and wine	24	10	34
Retail package off-sale general	350	72	422
On-sale beer	168	37	205
On-sale beer and wine	168	37	205
On-sale beer and wine--public premise	168	37	205
On-sale general license--eating place^a	360-580	74-115	434-695
On-sale general license--public premise^a	360-580	74-115	434-695
Caterer's permit--club^a	360-580	74-115	434-695

^a License fees vary by city population.

Figure 1
Franchise Tax Board Proposed Augmentations
1999-00 (In Thousands)
Description	Funding Source
Description	General Fund	Reimbursements	Motor Vehicle Account	License Fee Account	Court Fund	Totals

Limited liability companies	$1,792	--	--	--	--	$1,792
Audit and collection activities	3,350	--	--	--	--	3,350
Merit salary adjustment	2,914	$113	$25	$41	$7	3,100
Totals	$8,056	$113	$25	$41	$7	$8,242

Figure 2
High Priority Recommendations Affecting Tax Programs
(In Thousands)
Description	Reductions
Description	Budget-Year^a	Five Year Total Reduction

Span of control	$1,640	$8,198
Filing system assessment and reductions	513	2,564
Information technology positions	4,587	22,935
Customer service	643	3,215
Totals	$7,383	$36,912

^a LAO estimate based on equal phase in of total reduction recommended by independent auditor.