Legislative Analyst's Office

The 2002-03 Budget Bill:
Perspectives and Issues

State Fiscal Picture

For the first time since the early 1990s, the state is experiencing a substantial budget shortfall. Its primary cause is two-fold—a moderate economic downturn and an accompanying sharp drop-off in taxable income from stock options and capital gains. In this challenging environment, the Legislature faces the difficult task of developing a budget plan that both preserves funding for its highest priorities but also addresses the large projected deficit.

In this part, we summarize the Governor's 2002-03 budget proposal and present our own perspective on the budget outlook. We then discuss key decisions and additional options that the Legislature may wish to consider in addressing the state's projected budget shortfall, both as alternatives to the Governor's proposals and as additional actions that will be needed if the more negative budget outlook we are forecasting emerges.

Overview of the Governor's Budget

Total State Spending

The 2002-03 Governor's budget proposes total state spending of $97.9 billion (excluding expenditures of federal funds and selected bond funds). This represents a slight decrease of about $400 million, or 0.4 percent, from the current year. About 80 percent of proposed total spending is from the General Fund, while the remainder is from special funds.

General Fund Condition

Under the Governor's budget proposal, the General Fund would end both the current and budget years in balance. Specifically, Figure 1 shows that:

Figure 1

Governor’s Budget General Fund Condition

(Dollars in Millions)










Prior-year fund balance





Revenues and transfersa





  Total resources available










Ending fund balance















a   Reflects $6.2 billion General Fund loan to Electric Power Fund in 2000-01 with repayment in 2001-02.

     Detail may not total due to rounding.


How the Budget Addresses the Shortfall

The budget identifies a cumulative shortfall of $12.5 billion as of year-end 2002-03, consisting of a current-year year-end deficit of $3 billion, a budget-year imbalance between expenditures and revenues of about $9 billion, and a rebuilding of the reserve to $511 million. (The administration's shortfall amount is similar in overall magnitude to the $12.4 billion estimate included in our November 2001 fiscal outlook re port, although the components of the shortfall are somewhat different.) The budget proposes to close the $12.5 billion funding gap through a variety of actions, which are summarized in Figure 2. These include:

Economic and Revenue Assumptions

The budget forecast assumes the consensus view that the U.S. and California economies will emerge from the current recession in spring 2002. The administration assumes that income from capital gains and stock options declined in 2001 by about 47 percent from their peak level of just under $200 billion in 2000, and will remain basically flat in 2002.

Based on these assumptions, the budget forecasts that total revenues will grow from $71.4 billion in 2000-01, to $77.1 billion in 2001-02, and to $79.3 billion in 2002-03. These figures are affected by a variety of policy related factors, including the budget's treatment of the electricity loans and the tobacco securitization proposal. Excluding these factors, under lying revenues are projected to decline by 10.5 percent in 2001-02, before partially rebounding by 8.5 percent in 2002-03.

Figure 2

How the Governor “Bridges the Gap”

(In Millions)



Major Spending Reductions


November Revision reductions


Budget-year reductions


Reserve for litigation


Fund Shifts


Shifts proposed in November Revision


Other shifts


Federal Funding Increases


Federal share for Medi-Cal


Security/bioterrorism funding


Child support system penalty relief


Undocumented felon incarceration


All others




Securitization of tobacco settlement funds


Loan from Traffic Congestion Relief Fund


Loans from various other special funds


STRS payment deferral/benefit improvement


PERS payment deferral/benefit improvement


All others





Key Features of the Governor's Expenditure Plan

Total Spending by Program Area

Figure 3 shows the proposed distribution of General Fund spending in 2002-03 by major program area. It indicates that:

Programmatic Features

The budget's main programmatic features are summarized in Figure 4. In general, while the budget contains a variety of current-year and budget-year reductions, it maintains most of the core programs. The budget funds K-12 education at the minimum guarantee level, providing for a modest 2 percent increase in per-pupil funding relative to the current year. In other areas, the budget funds enrollments and caseloads. It does not change major subventions for local governments. Finally, it reduces or eliminates COLAs in most non-Proposition 98 areas of the budget.

Figure 4

Key Programmatic Features of the Governor’s Budget


ü  K-12 Education

·     Funds Proposition 98 at minimum guarantee level.

·     Provides funding to cover enrollment and general cost-of-living adjustment (COLA) for general apportionments and most categorical programs.

·   Includes reforms related to state-assisted child care.

ü  Higher Education

·     All three segments receive funding to cover enrollment increases.

·     Community colleges receive additional funding for 2.15 percent COLA, while UC and CSU receive funding for 1.5 percent general increase.

ü  Health and Social Services

·     Funds caseload for most core programs.

·     Medi-Cal includes savings from cuts in certain provider rates and reforms involving drug purchases.

·     Statutory and discretionary COLAs suspended for social services programs.

ü  Local Governments

·     Does not change major local government subventions.

·     Existing criminal justice grant programs are continued.


The LAO's Budget Outlook

In this section, we examine the implications of the Governor's proposal on the near-term and longer-term General Fund condition, using our own estimates of revenues and expenditures that would occur under the Governor's proposal. Our estimates do not reflect any of the policy recommendations that we make in our Analysis of the Budget Bill. The causes for our differences from the administration's projected General Fund con dition are limited to (1) contrasting assumptions about the economic and revenue outlook and (2) estimation differences relating to the level of expenditures that would occur under the Governor's budget plan. The latter includes assumptions about the Proposition 98 minimum funding guarantee, the level of caseloads and school enrollments, and other factors affecting state program costs. We provide these estimates to give the Legislature an indication of the magnitude of additional spending and revenue adjustments that will likely be needed to address the budget shortfall.

Treatment of Federal Funds and Electricity Loans. To help facilitate a direct comparison between the administration's and our own estimates, we have assumed in making our projections that the state receives the entire $1.1 billion in new federal funds assumed in the budget. Our projections also reflect the budget's treatment of the electricity loan in 2000-01 and its assumed repayment in 2001-02.

With these assumptions in mind, our key budget-related findings are highlighted in Figure 5, while the implications of our revenue and expenditure estimates for the General Fund's condition are shown in Figure 6.

Figure 5

Key LAO Budget Findings


ü  Additional Budget Solutions Totaling $5 Billion Needed

·     Revenues down by $3.9 billion in current and budget years combined.

·     Expenditures up by about $1.1 billion during current and budget years combined.

·     Loss of anticipated federal funds would add to problem.

ü  Ongoing Budgetary Imbalance Would Persist

·     Annual operating shortfall in range of $7 billion in 2003-04 and 2004-05.

ü  Need to Evaluate Tradeoffs Involved in Budget Solutions

·     Impact on programs.

·     Impact on state’s future fiscal condition.


Additional Solutions of $5 Billion Likely Needed

Based on our projections of revenues and expenditures, adoption of the Governor's spending policies would result in a year-end deficit of about $4.5 billion in 2002-03. This represents a $5 billion deterioration in the budget condition relative to the administration's estimate, which assumes a $511 million reserve. About three-fourths of this deterioration relates to our lower revenue projections, and about one-fourth relates to our higher expenditure estimates.

Figure 6

The LAO’s General Fund Condition
Assuming Governor’s Policy Proposals

(In Millions)





Prior-year fund balance




Revenues and transfersa




  Total resources available








Ending fund balance












a   Reflects $6.2 billion General Fund loan to Electric Power Fund in 2000-01 with repayment in 2001-02.

     Detail may not total due to rounding.


Lower Revenues. While we generally agree with the administration's forecast of an economic recovery beginning this spring, we believe that revenues will fall substantially below the administration's revenue forecast. Specifically, based on our estimate of much steeper declines in capital gains and stock options in 2001, as well as recent evidence of much-lower-than-expected cash receipts, we project that revenues will fall below the budget forecast by $2.8 billion in the current year and another $1.1 billion in the budget year—for a two-year shortfall of about $3.9 billion. The detail behind our forecast, and how it differs from the administration's projections, are provided in "Part III" of this document.

Higher Expenditures. We estimate higher expenditures in the current year and budget year combined of $1.1 billion. Most of this is due to our higher estimate of the General Fund portion of the Proposition 98 minimum guarantee, which exceeds the budget forecast by $825 million in 2002-03.

Additional Risks Exist Related to Federal Funds Shortfalls

As indicated above, we have incorporated the Governor's budget assumptions regarding the amount of new federal funds that the state will receive in 2002-03. However, while we believe that the state will receive some additional funds, the actual amount is likely to be considerably less than the full $1.1 billion. For example, while the Governor's budget assumes a $50 million increase in federal funding to reimburse California for its costs of incarcerating undocumented felons, the President's new federal budget contains no funds for this program.

Impact On General Fund Could Vary. The implications of federal funding shortfalls for the state's General Fund condition will depend on where the shortfalls occur. Specifically:

Budget Shortfall Would Persist in Future

The $5 billion shortfall for 2002-03 that we have identified in the Governor's budget plan is of particular concern in light of the fact that we also estimate that expenditures would continue to exceed revenues in the future. As we indicated in our November fiscal forecast, the state currently faces a large, ongoing underlying operating deficit (that is, expenditures in excess of revenues). Since the budget relies primarily on one-time solutions, a large underlying operating shortfall—which we estimate would be in the range of $7 billion in both 2003-04 and 2004-05—would persist. This means that the state would face the risk of another large cumulative budget shortfall in 2003-04.

Considerations for the Legislature

The Governor and Legislature have acted early and taken important first steps toward addressing the current large budget shortfall. Our estimates suggest, however, that the state still has a long way to go to reach a balanced budget in 2002-03. Thus, in addition to evaluating Governor's proposals in terms of how they compare to its own priorities, the Legislature will face the challenging task of working with the administration to find additional solutions in order to bring the budget into balance.

To assist the Legislature in finding such additional solutions, our office has released, along with this document and our annual Analysis of the Budget Bill, a compendium of budget options. These options, in total, would save several billion dollars in 2002-03. The specific options provide savings from caseload reductions, funding shifts, improved efficiencies, service reductions, federal tax conformity, and elimination or reduction of tax expenditures.

Out-Year Implications Are Important

Given the out-year imbalances that we project under the Governor's plan, it will be important that the Legislature keep in mind the longer-term implications of the various budget solutions it considers. For example, a mix of one-time and multi-year solutions should be considered which, at a minimum, does not exacerbate the budget's underlying imbalance between revenues and expenditures. Otherwise, the state will likely face a formidable budget shortfall again in 2003-04.

Return to 2002-03 Perspectives and Issues Table of Contents