Legislative Analyst's Office The 2002-03 Budget Bill: Perspectives and Issues

Major Expenditure Proposals in the 2002-03 Budget

In this section, we discuss several of the most significant spending proposals in the budget. For more information on these spending proposals and our findings and recommendations concerning them, please see our analysis of the appropriate department or program in the Analysis of the 2002-03 Budget Bill.

Education

Education programs account for 53 percent of General Fund spending in the 2002-03 Governor's Budget. Below, we provide an overview of the budget for K-12 and higher education, beginning with a focus on Proposition 98.

Proposal—K-12

Background. Proposition 98 establishes a minimum funding level that the state must provide for public schools and community colleges each year. K-12 education receives about 90 percent of total Proposition 98 funds.

Governor's Budget-Year Plan. The budget proposes $41.2 billion in total K-12 Proposition 98 funding in 2002-03 (consisting of state General Fund and local property tax allocations). This is an increase of about $1.2 billion, or 3.1 percent, compared to the 2001-02 revised amount. Pupil attendance is projected to increase by 1.07 percent, resulting in funding of $7,058 per pupil, an increase of $136 (2 percent) from the revised 2001-02 amount.

The major 2002-03 budget proposals include:

• $843 million for a 2.15 percent cost-of-living-adjustment (COLA).
• $438 million for projected 1.07 percent growth in average daily attendance (ADA).
• A major child care reform proposal that would modify current eligibility rules, reimbursement rates for child care providers, and family fees.
• A major restructuring of instructional materials and library materials programs, including $250 million for an instructional/library materials block grant and $375 million of one-time funds for three separate grants for instructional materials, library materials, and science lab equipment.

Proposal—Higher Education

The University of California (UC) and the California State University (CSU). The budget proposes General Fund support for UC and CSU of $6.1 billion in 2002-03. This represents an increase of $68.5 million, or 1.1 percent, above estimated current-year expenditures. Budgeted enrollment would increase by 7,100 full-time equivalent (FTE) students at UC and 12,030 FTE at CSU—a 4 percent increase in enrollment for each system. The Governor's budget provides UC and CSU with a 1.5 percent base increase totaling $85.3 million. The budget proposal also includes various programmatic reductions totaling $65 million.

California Community Colleges (CCC). The budget proposes $2.7 billion in General Fund support for CCC in 2002-03. All but $11.6 million of this amount counts as Proposition 98 spending. The 2002-03 General Fund request represents a decrease of $80.1 million, or 2.8 percent, from the current-year estimate. When all funding sources are considered, including student fee revenues and local property taxes, the 2002-03 budget proposal would increase funding for CCC by $101.6 million, or 1.7 percent.

The Governor's budget proposal includes $88.8 million for a 2.15 percent COLA, $120.2 million for enrollment growth of 3 percent, and $91.2 million to replace one-time funds in the current year for ongoing program costs. The budget also would reduce various categorical programs by $121.7 million.

Student Aid Commission. The Governor's budget proposes a General Fund increase of $162 million, or 28.4 percent, for the Student Aid Commission. The majority of this increase ($155 million) is due to an estimated increase in the number of Cal Grant awards in 2002-03.

Issues for Legislative Consideration

Budget Could Understate Proposition 98 Minimum Requirement. The Governor's budget proposes Proposition 98 spending of $46 billion for 2002-03—the administration's estimate of the minimum guarantee. Of this total, an estimated $14.6 billion is provided by local property tax revenues and the remaining $31.4 billion is provided by the General Fund. The administration's estimate of the General Fund amount needed to meet the guarantee is driven by three key factors: its estimate of property tax revenues ($14.6 billion), its estimate of K-12 ADA growth (1.07 percent), and its estimate of growth in California per capita personal income (negative 3 percent). Our estimates depart from the administration's estimates on two factors:

• Property Tax Revenues. Our estimate of the property tax revenues that will be allocated to school districts, county offices of education, and community college districts is $110 million less than the administration's estimate. This difference would not affect the overall amount guaranteed for K-14 education programs, but would affect the amount of General Fund money needed to supplement property tax revenues in order to meet a given guarantee level. Thus, our estimate implies that the state will need to "find" $110 million from the General Fund to make up for a shortfall in property tax revenues.
• Per Capita Personal Income. The Governor's budget assumes that California per capita personal income will decline 3 percent. Based upon more recent information, our best estimate is that the decline will be 1.5 percent. If our estimate is correct, the guarantee will be $715 million higher than the budget, with the entire amount due from the General Fund.

Combining our property tax revenue estimate and the impact of per capita personal income, we think the budget could understate General Fund needs for meeting the Proposition 98 guarantee by a total of $825 million.

In the "K-14 Education Priorities" section of the education chapter in the Analysis, we discuss ways for the Legislature to act strategically in response to the challenge posed by an increased General Fund demand from Proposition 98. These ways include exercising still-viable options to save current-year Proposition 98 monies (an estimated $161 million), substituting monies available from the Proposition 98 reversion account for other current-year Proposition 98 funding (saving $535 million), and "moving" certain education expenditures budgeted from non-Proposition 98 sources to Proposition 98 (potentially hundreds of millions of dollars).

Need for Greater Local Flexibility—K-12 Education. The 2001-02 Budget Act allocated approximately 31 percent of K-12 Proposition 98 funds, or about $12 billion, for over 70 categorical programs. (The remaining 69 percent of funding is available for local education agencies to spend for general educational purposes.) Programs range from the very large ($2.7 billion in special education funding during 2001-02) to the small ($250,000 for civic education). The main rationale for categorical programs is to address program areas where local school boards may have incentives to under-invest. An example is special education, where high per-pupil costs could lead districts to provide less service than needed.

As we have discussed in previous publications, including A Special Session Guide to K-12 Reform (January 1999) and A K-12 Master Plan: Starting the Process (May 1999), the existing system of categorical programs causes many problems for the state and local school districts including:

• No conclusive evidence on the success of categorical programs.
• State rules restrict needed local flexibility.
• A fragmentation of local programs.
• Funding formulas create negative incentives.
• Blurred accountability for meeting student needs.

Consolidating categorical programs maximizes local control for districts in order to best meet their particular needs and, if structured well, shifts the focus from process to educational results. Specifically, the benefits of categorical reform include: (1) increased local control, (2) more efficient allocation of program funds, (3) clearer program directives, and (4) clearer lines of accountability.

To increase local flexibility, eliminate negative incentives, and provide a more cohesive system for categorical programs, we recommend that the Legislature consolidate 51 programs into five categorical block grants—Academic Improvement, Compensatory Education, Alternative Education, School Safety, and Teacher Support and Development.

Adopting a Higher Education Fee Policy. For the eighth straight year, the Governor's budget for higher education proposes no increase in student fees, and the share of educational costs covered by fees continues to decline. However, in a departure from recent practice, the budget does not include an increase in General Fund support to compensate for the lack of a fee increase. In the Analysis we recommend that the Legislature enact in statute a consistent fee policy which provides for an appropriate sharing of educational costs between students and the state and which preserves student access to higher education.

Expand Competitive Cal Grant Programs. In the Analysis we recommend expansion of the competitive Cal Grant program by redirecting state funds from certain financial aid programs at UC and CSU. This would help create a statewide financial aid system that is more efficient and objective. A total of $294 million in General Fund monies would be shifted to the competitive Cal Grant programs from UC's and CSU's institutional aid programs.

Combine Community Colleges' Categorical Programs. The Governor's budget would reduce funding for several of CCC's categorical programs by a total of $121.7 million. We recommend, however, that these reductions be accompanied by a consolidation of funding for 12 categorical programs into two block grants in order to allow greater flexibility in directing available resources where they are the most needed.

CalWORKs Program

The federal welfare reform legislation of 1996 replaced the Aid to Families with Dependent Children (AFDC) program with the Temporary Assistance for Needy Families (TANF) program. The Legislature subsequently enacted Chapter 270, Statutes of 1997 (AB 1542, Ducheny, Ashburn, Thompson, and Maddy), which created the California Work Opportunity and Responsibility to Kids (CalWORKs) program to replace the state's AFDC program. The CalWORKs program provides cash grants and employment and training services to eligible families.

Proposal

The CalWORKs Budget System. Funding for CalWORKs employment services, child care, and program administration are provided to the counties in a block grant known as the "single allocation." Within the block grant, counties have the discretion to move funds among programs in order to address local priorities.

The budgeting system for the employment services and administrative cost components of the single allocation is based on county projections of costs. Under this system, known as the proposed county administrative budget (PCAB) process, the Department of Social Services (DSS) reviews the counties' PCAB requests for consistency with state law and workload needs and adjusts the county funding requests accordingly. The budget proposes three significant changes to the CalWORKs budgeting system:

• PCAB Suspension. Due to funding pressures in the CalWORKs program, the budget proposes to suspend the PCAB process for 2002-03, thereby funding county administrative and employment services costs at their current-year funding levels, adjusted for caseload changes. Current funding levels will not be adjusted for inflation.
• New County Block Grant. The Governor proposes to replace the county single allocation with a new county block grant, to be known as the "county program grant." In addition to funding for employment services, administration, and child care, the county block grant will include $109 million in funding currently earmarked for mental health and substance abuse treatment and $201 million in funding currently earmarked for probation camps and juvenile treatment facilities. Rolling these allocations into a county block grant will increase county flexibility to move funds across program purposes as needed.
• Holdback of County Allocations. The Governor proposes to retain up to 5 percent (approximately $95 million) of the county block grant allocations to cover potential cost increases for assistance payments in CalWORKs or the Kinship Guardianship Assistance Payment Program (Kin-GAP)—a program that enables children to exit the foster care system and live with a relative guardian. Because assistance payments from these programs are "entitlements," unanticipated cost increases in these programs due to caseload growth or changes in federal law would be funded automatically with either TANF or General Fund resources. Under the Governor's proposal, such program cost increases would instead be funded first from the 5 percent holdback funds, which would otherwise support employment services and program administration. In other words, the Governor proposes to use up to approximately $95 million of county program grant funds to mitigate the potential General Fund impact of unanticipated caseload growth.

Issues for Legislative Consideration

Expanding the County Block Grant. We believe that counties are in the best position to weigh the educational and employment service needs of their CalWORKs caseloads against various competing county priorities, both within and outside of the CalWORKs program. Thus, we recommend that the Legislature build on the Governor's county block grant proposal by including additional TANF categorical allocations. Currently, $44 million in TANF funds are allocated to the California Community Colleges, the State Department of Education, the Department of Health Services, and local Boys and Girls Clubs. We recommend that these categorical allocations, which provide (1) employment and educational services to CalWORKs recipients and (2) teen pregnancy prevention services, should instead be incorporated into the county block grant. Counties would have the flexibility to contract with local colleges, universities, and community-based organizations as needed.

Holdback Is Disruptive. While we recognize the need to limit the risk to the General Fund in the budget year given the state's fiscal condition, we believe that the Governor's 5 percent holdback proposal is disruptive to the counties' planning process and their ability to budget for employment services and administrative costs. This is because the actual amount of county funds that will ultimately be redirected for grant payments is unspecified.

A less disruptive approach for the counties, while also protecting the General Fund in the event of unanticipated caseload growth, would be to establish a larger TANF reserve. This could be accomplished either through an outright program reduction (for example, reducing the level of employment services), or by retaining a portion of the proposed $431 million reappropriation for performance incentives. In our view, these incentive funds are not as necessary for core program services as the basic allocation for employment services. We therefore recommend that the Legislature reject the Governor's 5 percent holdback of the county block grant. To the extent the Legislature wishes to augment the TANF reserve for the purpose of protecting the General Fund, we recommend that the Legislature retain a portion of the proposed reappropriation for performance incentives.

CalWORKs Needs Long-Term Budget Plan. Since its enactment in 1997, CalWORKs funding has remained essentially stable, due primarily to a fixed amount of TANF block grant funds and the state's decision to limit its share of funding to the minimum maintenance-of-effort (MOE) requirement. This funding level was sufficient to support the CalWORKs program in its early years. However, our most recent review finds that in 2001-02, the welfare-to-work allocations for 11 counties (representing approximately 50 percent of the statewide caseload) were underfunded. The cost of bringing all counties up to a minimum funding level (without redistributing funding from the higher-funded counties) would be approximately $125 million.

The Legislature has recognized the likelihood that funding pressures would continue to intensify in future years. Accordingly, it directed DSS to develop a new budgeting methodology for both CalWORKs and non-CalWORKs programs funded with TANF funds. The department has not yet submitted a new budgeting methodology to the Legislature.

To address the growing fiscal pressures in the CalWORKs program, we have identified three issues for legislative consideration in developing a long-term budget plan:

• Should the Legislature Fund CalWORKs Above the MOE Floor? Since CalWORKs was enacted, the Legislature has taken steps to maintain General Fund spending at the MOE floor. Prior to the current year, this budgeting approach was possible without funding reductions in core program elements. However, as caseloads increase and available resources decrease, maintaining General Fund spending at the MOE floor will require reductions in either the level of employment services or assistance payments. The decision about whether to exceed the minimum state spending requirement therefore involves balancing the benefits of budgetary savings against the impact on time-limited CalWORKs families.
• How Should the Legislature Weigh Funding of Grants Versus Services? The decision about the appropriate funding level for CalWORKs also involves weighing the relative importance of two primary goals of a welfare-to-work program: (1) providing an adequate level of cash assistance to enable needy families to maintain a minimum standard of living and (2) providing an adequate level of employment services to enable recipients to gain the skills needed to work and eventually become self-sufficient. Investing in employment services is especially important given the lifetime limit on cash assistance for adult recipients. However, the costs of this investment must be balanced against the costs of ensuring that needy families are provided with sufficient income maintenance. We note that if the Legislature elected to reduce grants, about 45 percent of any such reduction would be offset by an increase in federal food stamp benefits.
• How Should Funds Be Allocated to Counties? Finally, developing a long-term budget plan requires consideration of how funding for employment services and administration is allocated among counties. Current funding allocations per aided adult vary widely across the counties. Such variation in allocations raises concerns about equitable access to employment services. In order to ensure more equitable access to services, the Legislature should consider allocating all funding for employment services and administration on a per-aided-adult basis (because adults receive the employment services). Final allocations could be adjusted for high- and low-cost regions and for small counties with high fixed costs. In order to avoid unnecessary disruption, this change could be phased in over two to three years.

Criminal Justice and Judiciary

State and local governments spend more than $18 billion annually to fight crime. Local governments are largely responsible for crime fighting and, thus, spend the bulk of total criminal justice monies for law enforcement activities. State expenditures have grown significantly in recent years, however, particularly for support of the state's largest criminal justice department, the California Department of Corrections (CDC). The CDC is responsible for the incarceration, training, education, and supervision in the community of adult criminals. Other state entities spend large sums of money on criminal justice activities as well, including the Departments of the Youth Authority and Justice; the trial courts; and the Office of Criminal Justice Planning.

Proposal

The budget proposes about $8.2 billion from the General Fund and other state funds for support of criminal justice programs in the budget year, a decrease of 1.4 percent below estimated current-year spending.

The CDC accounts for the largest share of this funding, $4.8 billion, or about 1 percent below the current-year amount. The budget provides full funding for the number of prison inmates and parolees under current law. The budget proposes to deactivate approximately 1,850 low-level offender community facility beds for modest budget savings. The budget does not propose new spending initiatives, but rather maintains recent criminal justice program augmentations, such as for the War on Methamphetamine, and grants to local law enforcement agencies.

Issues for Legislative Consideration

Crime Rates Increase Slightly. The crime rate dropped dramatically through the 1990s, reaching an all-time low in 1999. However, the most recent data reported by the California Department of Justice indicates that the overall California crime rate rose by 1 percent in 2000 after nine years of decline. The increase occurred in four out of six major crime offense categories. These include homicide, forcible rape, property crimes, and aggravated assault. The most significant change occurred in the forcible rape category, which increased by 2.5 percent over 1999. The robbery rate decreased slightly (1 percent), bringing it to its lowest level since 1967. Overall, violent crime remained at about the same level after declining for seven consecutive years.

There are probably many reasons for this slight increase, including growth in the crime-prone age bracket (ages 16 to 49), higher reporting of crimes, and improvements in policing and other law enforcement techniques. Another factor which is usually considered, but which does not seem to be at play here, is the economy. All the economic indicators were strong throughout most of 2000 suggesting that the economy was not a factor in the rising crime rate during the reporting period. However, the more recent downturn in the California economy could have the effect of further pushing the crime rate upward.

Cost Reduction Measures Needed in Corrections. The CDC is the largest state corrections agency in the nation. With over 45,000 employees and a total budget of about $4.8 billion, the CDC manages over 156,000 prison inmates, and more than 121,000 parolees. During the past ten years, CDC's average annual growth rate has been about 8 percent, although during the last couple of years the rate of growth has slowed somewhat. Nevertheless, overall CDC's growth during this period was significantly faster than most other departments. Given the magnitude of the state's fiscal problem, the Legislature may wish to consider ways to reduce the inmate and parole populations. Because CDC is a caseload-driven budget, it will not be possible to significantly reduce expenditures for the department without taking action to control inmate and parole population growth.

In considering measures to control the inmate and parole populations, the Legislature should focus on two target groups: nonviolent offenders and short-term offenders. The state prison system has a significant number of inmates who are serving time for nonviolent offenses such as property and drug offenses. Similarly, there is a sizeable number of offenders with short prison terms, some with terms as short as six months or less. The state incurs significant costs to process these inmates. Targeting reductions on these two groups could result in budgetary savings while not jeopardizing public safety.

It should also be noted that maintaining an offender in the community under supervision is significantly less costly than incarceration in prison. For example, inmates who are released from prison early or who are redirected from prison could be placed in the community with more intensive supervision. Electronic monitoring devices could be used to ensure that individuals remain within a confined area. This could work particularly well with certain inmates, including those who are nonviolent, chronically ill, and elderly. In our report, Options for Addressing the State's Fiscal Problem, we provide estimates of the impact of such options on the prison population and CDC's budget.

Question of State Support for Trial Courts Needs Resolution. The state General Fund now contributes over $1.2 billion toward the cost of trial court operations. This is a result of recent legislation that transferred responsibility for court operations and personnel systems from the counties to the state. One issue which remains unresolved is whether, and under what circumstances, responsibility for court facilities should be transferred to the state. In our view, state responsibility for those facilities would be consistent with prior legislative actions in the area of court operations and personnel.

This issue of facility responsibility is one which deserves legislative attention for several reasons. First, until this issue is resolved, some counties are likely to continue to backlog deferred maintenance, thereby resulting in continued facility deterioration. Second, facility transfer poses a potentially huge funding liability to the state's General Fund. The current annual cost of supporting court facilities is estimated at $140 million (which would be offset by $80 million to $90 million in county maintenance-of-effort agreements). The larger cost, however, is the estimated future capital funding needs which are estimated in the multibillion dollar range over the next 20 years.

Because of the fiscal implications and complexity of the task, we recommend that Judicial Council report at budget hearings on the status of its plan to transfer trial court facilities to the state. We believe that such a plan should (1) address the timing for state assumption of responsibility for these facilities, (2) streamline the facility transfer process, (3) include court facilities in the state's existing capital outlay planning process, and (4) count court facility funding from the state as fiscal relief in the context of the state-county fiscal relationship.

Transportation

California's state transportation programs are funded by a variety of sources, including special funds, federal funds, and general obligation bonds. These funds include the following:

• The State Highway Account (SHA) provides the largest share of ongoing state revenues for transportation.
• The Traffic Congestion Relief Fund (TCRF) funds projects in the Traffic Congestion Relief Program (TCRP) enacted in 2000.
• The Toll Bridge Seismic Retrofit Account (TBSRA) funds the ongoing seismic retrofit of state-owned toll bridges.

Proposal

The Governor's budget proposes shifting transportation funds to provide money to the General Fund in the budget year. This proposal has several components:

• A $672 million loan from TCRF to the General Fund in the budget year, to be fully repaid over the following three years.
• A $474 million loan from SHA to TCRF in the budget year to prevent TCRF cash-flow problems, also repaid over three years.
• Deferral of a current-year transfer of $342 million from SHA to TBSRA. This transfer must eventually occur to fulfill SHA's commitment to the seismic retrofit of state-owned toll bridges.
• "Interim financing" of $210 million into TBSRA in the budget year, to be repaid by a later bond issuance. The bonds in turn will be repaid by toll revenues.

Issues for Legislative Consideration

Actual TCRF Balance Likely to Be Higher Than Projected. Based on our review of the department's cash-flow needs for TCRP projects, the proposed TCRF loan to the General Fund will most likely not have an adverse impact on project delivery. In fact, over the past seven years, the Department of Transportation has consistently overestimated its capital outlay expenditures. This past experience suggests that budget-year TCRF expenditures in all likelihood will be lower than projected. We believe TCRF expenditures by the end of the budget year could be about $300 million lower than the budget projects, leaving a higher balance by a like amount in the fund.

TCRF May Not Need Large Loan from SHA; More Money May Be Available for General Fund. To the extent TCRF expenditures are lower than the budget projects, the Legislature would have flexibility in determining how to use the money not needed for projects in 2002-03. For instance, part of the proposed loan from SHA to TCRF may not be needed. Reducing the SHA loan would allow Caltrans to use the money for other purposes, such as transferring the funds for toll-bridge seismic retrofit. Additionally, due to a higher fund balance in the TCRF, the Legislature could transfer more of these monies to the General Fund, if needed.

Analyst's Recommendation. To provide Caltrans with maximum flexibility and not commit it to needless transfers, we recommend the adoption of budget bill language limiting the transfer from SHA to TCRF to only what is needed for cash-flow purposes. Similarly, to provide the Legislature with the flexibility to transfer more from TCRF to the General Fund, if necessary, we recommend the adoption of budget bill language to allow the Department of Finance, after notification to the Legislature, to transfer more than $672 million if TCRF expenditures are lower than projected.

Resources

Proposal

Funding for Resources and Environmental Protection Programs. For 2002-03, the budget proposes that the General Fund contribute substantially, if not entirely, to funding a number of resources programs:

• Fire Protection. The budget proposes $282 million from the General Fund for the California Department of Forestry and Fire Prevention (CDFFP) to provide fire protection services to property owners in "state responsibility areas" (SRAs). Property owners do not currently pay a fee to the state for these services.
• Water Quality Regulation. The budget proposes $68.3 million ($22.5 million General Fund) for the State Water Resources Control Board's (SWRCB's) core regulatory program overseeing dischargers of waste into the state's waters.
• Air Quality Regulation. The budget proposes $43.1 million ($24.9 million General Fund) for the Air Resources Board's (ARB's) stationary source program in 2002-03. Fees support less than 10 percent of the program, and are levied mainly on high-emitting polluters. Statute currently caps total fee revenues collected from these polluters at $3 million.
• Timber Harvest Plan (THP) Review. The budget proposes about $22 million (almost all General Fund) for state agencies to review and enforce THPs in 2002-03. A THP covers such matters as harvest volume, cutting method, and wildlife habitat protection. The CDFFP and other agencies reviewing and enforcing THPs currently do not have the authority to charge fees to cover their costs for these activities.

The Department of Parks and Recreation's (DPR's) Land Acquisitions. The budget proposes a limited amount of funding to develop existing acquisitions and acquire new lands, reflecting the near depletion of available Proposition 12 bond funds for this purpose. Proposition 40, if approved by the voters at the March 2002 election, will provide $225 million for state park improvements and acquisitions, of which no more than 50 percent can be used by DPR for land acquisitions. If Proposition 40 is approved, the Governor could propose expenditures of these bond funds at the time of the May Revision.

Tahoe Environmental Improvement Plan (EIP). The 2002-03 budget proposes $26.6 million of state funds for various state departments to implement the Tahoe EIP. Funds are appropriated for capital outlay projects and local assistance to achieve environmental standards in the Lake Tahoe basin. The majority of the expenditures are to be funded from bonds, with less than 25 percent from the General Fund and special funds.

Issues for Legislative Consideration

Funding for Resources and Environmental Protection Programs. We think that several opportunities exist to create additional General Fund savings by shifting funding for resources and environmental protection programs from the General Fund to fees. Fees are an appropriate funding source in these cases, either because the state is providing a service that directly benefits an identifiable person or business (such as fire protection services) or administering a pollution control program that should be funded on a "polluter pays" basis. Under the polluter pays principle, private parties that benefit from using public resources are responsible for paying the costs imposed on society to regulate such activities.

Specifically, these opportunities for General Fund savings are:

• Fire Protection. We think that property owners in SRAs directly benefit from CDFFP's fire protection services and that they should share in funding the department's costs. Several other western states assess fees on property owners benefiting from state-provided firefighting services. There are a number of options available to structure the fees.
• Water Quality Regulation. All of the activities conducted under SWRCB's core regulatory program involve controlling water pollution created by dischargers of waste that operate under board-issued permits. It is appropriate that fee-based support fully replace the General Fund on the basis of the polluter pays principle. This would result in a General Fund savings of $22.5 million.
• Air Quality Regulation. A majority of the General Fund expenditures proposed for ARB's stationary source program is for planning and monitoring activities that provide a basis in science and technology for air quality-related permits. These activities prevent permit requirements from being arbitrary or unduly burdensome on the holder of the permit. As such, they provide a benefit to the permit holder and therefore should be funded from fees. By shifting funding for these activities to fees, the General Fund would save $18.7 million.
• THP Review. We think that fees levied on timber operators should cover the total state agency costs to review and enforce THPs. This is because there is a direct link between the THP review and enforcement and those who directly benefit from it through harvesting of timber. Enacting timber harvest fees as we recommend would save the General Fund $21.5 million.

The DPR's Land Acquisitions. The DPR's land acquisitions can create future development and operating obligations for the department. However, in many cases, these obligations have not been provided for or identified as part of the acquisition process. To the extent that these obligations are unaccounted for in the funding decision, neither the full benefits to the public associated with the acquisition are likely to be achieved nor are the stewardship needs of the acquisition likely to be met.

In order that the Legislature can assess the extent of obligations created by recent park acquisitions, we recommend that the Legislature direct the department to identify the costs associated with developing and providing access to these acquisitions as well as potential funding sources. Once the Legislature has reviewed the department's funding plan, it may wish to give funding priority to future capital outlay appropriations that would be used to develop timely public access to existing acquisitions.

We also recommend a number of statutory actions the Legislature can take to ensure that the development and ongoing operating costs associated with future state park acquisitions are better identified and addressed. Specifically, we recommend the enactment of legislation requiring DPR to submit funding plans for future land acquisitions and set aside bond funds for future development of bond-funded acquisitions. In addition, the Department of Finance should be required to approve the general plan proposal for new park acquisitions or significant revisions to existing parks. We also recommend the Legislature set specific limits in future bond measures on the proportion of funding allocations to DPR to be spent to acquire lands.

Tahoe EIP. Because of the state's potentially large financial commitment to the EIP effort in coming years, and because of a recent status report conducted by the Tahoe Regional Planning Agency showing that the program was failing to meet most of its short-term goals, we think that legislative oversight of the Tahoe EIP is needed. Such legislative oversight would be enhanced by holding joint hearings, in each house, of the environmental quality, natural resources, and budget committees. These hearings would give the Legislature the opportunity to be informed of the policy choices and funding priorities inherent in the budget proposal, as well as to be apprised of the progress being made in the program.

We also find that the Legislature's oversight of the Tahoe EIP has been complicated by the lack of a clear identification of Tahoe EIP expenditures in the Governor's budget document. We recommend that future budgets separately identify these expenditures.

Energy-Related Activities

Due to the state's markedly different energy situation this year versus last, the Governor's budget proposes significantly less total expenditures for energy-related activities in 2002-03 than in 2001-02. The various agencies directly involved in these activities include the: (1) California Energy Commission (CEC); (2) California Public Utilities Commission's Energy Division; (3) Electricity Oversight Board; (4) California Consumer Power and Conservation Financing Authority (California Power Authority, or CPA); (5) California Energy Resources Scheduling (CERS) division within the Department of Water Resources (DWR); and (6) Division of Oil, Gas, and Geothermal Resources within the Department of Conservation.

Budget Proposal

Spending Down Significantly. The Governor's budget proposes roughly $314 million to support the state's energy-related activities carried out by the different boards, commissions, and departments identified above. This is about $157 million less than estimated current-year expenditures of roughly $471 million. Prior-year expenditures totaled around $680 million.

Reasons for the Decline. The reduction in budget-year expenditures from the current-year amount reflects two factors. About three-quarters of the reduction involves lower CEC expenditures, primarily in the energy conservation area for various loans, grants, rebates, efficiency standards, and technical assistance to deal with the 2001 electricity crisis. The remaining quarter largely reflects reduced CERS administrative expenditures associated with managing the state's power purchasing program (see below regarding projected electricity purchases). In contrast, there are relatively few new budgetary proposals for 2002-03 in the energy area, and General Fund spending levels in many of the energy-related boards, commissions, and departments have returned to their pre-crisis levels.

New Entities Now Operational. During 2001, two new state energy-related entities were created—the CPA and CERS:

• CPA. The CPA was created by Chapter 10x, Statutes of 2001
• (SB 6x, Burton), to finance the building or acquisition of new generation capacity so as to assure a reliable supply of power to Californians at just and reasonable rates. Currently, the CPA's start-up activities are being funded by a General Fund loan authorized in the current year and allocated in the current and budget years. However, both this loan and the CPA's ongoing operating expenses are to be covered in the future by revenue bond proceeds.
• CERS. The CERS division, created by Chapter 4x, Statutes of 2001 (AB 1x, Keeley), purchases electricity for the state on behalf of the investor owned utilities (IOUs). To date, CERS has entered into over $40 billion in long-term contracts to purchase electricity over the next 10-plus years. While its actual electricity purchasing activities are technically "off budget," CERS' administrative costs are subject to budget act appropriation. The DWR's Electric Power Fund, which is the depository of payments from ratepayers for the use of electricity purchased by DWR, supports the costs associated with administering CERS' power purchasing activities.

State Electricity Purchasing Activities. The administration projects "off-budget" 2002-03 expenditures of $5.1 billion for the purchase of electricity and related needs associated with DWR's activities, down from $7.6 billion in the current year.

The significant drop in amounts to be spent for electricity reflects three factors. First, when DWR began purchasing electricity on behalf of the IOUs in 2001, it had to buy largely on the spot market and prices there were extremely high. In the future, however, a large share of DWR's electricity purchases—estimated at as much as 75 percent by 2004—will be made under existing contracts at prices well below the spot market prices previously incurred. For example, prices under these long-term contracts average $84/megawatt hour (MWh) over the next five years and $74/MWh over the next ten years. This compares to previous spot market prices that at one time were well over $400/MWh.

The second reason for the lower projected budget-year electricity expenditures is the fact that, when the state does need to buy on the spot market, prices there are now much lower than earlier—currently around $40/MWh. The third factor is that the budget-year expenditure figure reflects only a half-year cost for purchasing the state's "net short" amount of electricity, since DWR's existing authority to do this expires at the end of 2002.

Reorganizing the State's Energy-Related Activities

Given deregulation and the state's 2001 energy crisis, the question has been asked: Should the state reorganize its energy-related entities and activities? In "Part V" of this volume, we describe the state's various energy-related entities and activities and discuss certain observed problem areas associated with them. We then suggest steps and organizational principles that may be helpful to the Legislature as it considers how to most effectively and efficiently organize and coordinate the state's energy-related activities.

State Retirement Contributions

The state contributes annually to the Public Employees' Retirement System (PERS) and the State Teachers' Retirement System (STRS). Contributions to PERS cover state employees and nonteacher school employees. About 55 percent of the contributions towards state employees' retirement are paid from the General Fund, with the other 45 percent coming from various special funds. Contributions towards nonteacher school employees' and public school teachers' retirement come entirely from the General Fund.

Proposal

The Governor's budget proposes to postpone payment of the state's retirement contributions to both PERS and STRS in exchange for the administration's support of increased retirement benefits. The objective of these proposals is to achieve one-time savings, largely in the current year and budget year, to help address the state's General Fund shortfall. (Some savings would also occur in 2003-04.) In the aggregate, the two proposals would result in $2 billion of savings, including $1.6 billion to the General Fund, over three years.

Deferral of PERS Contribution. The proposed PERS deferral would reduce the state's contribution amount for the budget year by $1.029 billion, resulting in General Fund savings of $621 million. In exchange for lowering the state's retirement contributions earlier than scheduled, the administration has agreed to support legislation that would maintain the purchasing power protection of retirees' pensions at 80 percent of the initial amount, instead of the current 75 percent. Both the deferral and the benefit increase would require the state to pay higher contributions in the future.

Deferral of STRS Contribution. The provisions of the STRS agreement had not been finalized at the time this analysis was prepared. Under the current tentative agreement, however, the state would defer payment of nine quarters of its contributions for public school teachers' retirement benefits. This results in current-year and budget-year General Fund savings of $508 million. Additional savings in 2003-04 are estimated at $441 million. In exchange for deferring these contributions, the administration has agreed to support an as-yet-undetermined increase in benefits. Both the deferral and the benefit increase would require the state to pay higher contributions in the future.

Issues for Legislative Consideration

As part of its review of the deferral proposals, the Legislature should consider the following.

Deferral Proposals Are Extremely Costly. Our review shows that the state would have to pay a high price for the amount of General Fund flexibility it gets with the PERS and STRS agreements. These costs as currently structured would total over $13 billion and would last for the next 30 or so years, thereby reducing the state's fiscal flexibility for a long time to come. In present value terms (that is, adjusted for cheaper dollars in the future and foregone investment returns), this is equivalent to getting about $2 billion worth of fiscal flexibility at a cost of over $4 billion.

State Will Pay Interest Rates Higher Than the Market Rate. The interest rates charged to pay off the deferrals—8.25 percent for PERS and 8 percent for STRS—equal the rates of return the retirement systems assume they can achieve from investments. These rates are significantly higher than what the state would have to pay to borrow the funds in the private market (currently about 5 percent), and are higher than the Pooled Money Investment Account rate (currently about 3 percent). Thus, even if the state did not have to provide any additional benefits under either the PERS or the STRS proposal, the state would still be paying a premium to achieve the budget-year savings in state retirement contributions.

Special Funds Would Incur Cost for Deferral. The state's revenue problem principally affects the General Fund. However, the retirement proposals would result in budget-year savings to special funds as well, even though these funds do not face a budgetary shortfall. While the deferred special fund contributions would not benefit the state's fiscal condition in the budget year, the additional cost that results could necessitate increases in the future in the various fees and taxes that support these funds.

Proposals Will Tie Up Future Funds. The PERS and STRS proposals would commit General Fund revenues for decades to come in order to solve a relatively short-term fiscal problem. We estimate that beginning in 200607, the state would have to pay at least $312 million for the proposals, including $228 million from the General Fund. (This amount would likely increase when the STRS benefit change is determined.) These ongoing costs would reduce the state's fiscal flexibility by hundreds of millions of dollars for many years to come.

Analyst's Recommendation. Given these concerns, we recommend that the Legislature reject the proposed deferral of state retirement contributions to PERS and STRS and the additional retirement benefits as proposed. Instead, the Legislature should investigate other means of freeing up General Fund resources or reducing expenditures in 2002-03 that are less costly or have less impact on future revenues. Our office has presented recommendations in our Analysis of the 2002-03 Budget Bill for the Legislature's consideration and also identified additional expenditure and revenue options in a companion publication.

Capital Outlay

The state owns a vast amount of infrastructure—including nearly 2.5 million acres of land, 180 million square feet of building space, and 15,000 miles of highways. Much of this infrastructure is aging. For example, 55 million square feet in the three public higher education segments was built or renovated over 30 years ago and most of the 9.5 million square feet of buildings in the state hospitals and developmental centers was built over 40 years ago.

Proposal

Budget Bill Proposal. The budget includes nearly $1.7 billion for the state's infrastructure (excluding highways and rail programs). As shown in Figure 8, over 56 percent of the proposal is for higher education, with the next largest amount in resources. Virtually all of the budget-year capital outlay program is financed from bond proceeds. This spending totals $1.5 billion, consisting of general obligation bonds ($637 million) and lease payment bonds ($875 million). The proposed general obligation bonds primarily finance projects for higher education ($511.5 million) and resources ($103.7 million). Only 9 percent of the amount proposed in the budget is for pay-as-you-go funding. (This compares to nearly 50 percent in the 2001-02 budget.) Of this amount about $65 million is from the General Fund, with the balance from special funds and federal funds.

Bond Debt. The state's debt payments on bonds will be about $3.1 billion in the budget year. This is an increase of slightly less than 1 percent over current-year payments. The payments include $2.6 billion for general obligation bonds and $555 million for lease-payment bonds. We estimate that the amount of debt payments on General Fund-backed bonds as a percent of General Fund revenue (that is, the state's debt ratio) will rise modestly from its current level of 4 percent to just over 5 percent in 2007-08 if (1) the Governor's proposed $30 billion in school bonds were approved over the next three election cycles, (2) the $2.8 billion in resources and voter equipment bonds on the March 2002 ballot were approved and, (3) the new bonds were sold off rapidly.

Issues for Legislative Consideration

California Infrastructure Plan. Existing law requires the Governor to submit, beginning in 2002, a five-year infrastructure plan in conjunction with the budget. The plan, however, was not submitted with the 2002-03 Governor's Budget. Without this plan, the Legislature does not have information it needs to make informed decisions about capital outlay proposals in the budget. Accordingly, we recommend the Legislature defer approval of new capital outlay projects until the infrastructure plan has been submitted and the Legislature has had an opportunity to review it.

We also recommend the Legislature establish a select committee to address procedural changes that could be adopted to allow the Legislature to proactively address California's infrastructure needs and respond to the Governor's future infrastructure plans.

Project Management Fees. The Department of General Services (DGS) is currently managing in excess of 350 major capital outlay projects with a total value of approximately $4 billion. In its role as the state's capital outlay project manager, DGS assesses client agencies' various project management fees. Our review of the capital outlay program proposals for 2002-03 has identified many instances where the fees assessed to a project appear to be either excessive, unnecessary, or inconsistently applied. We also found there is a lack of justification and accountability for the methods used to calculate the fee included in the capital outlay project cost estimates. As such, there is currently no way to accurately determine or evaluate the cost of a given project using the DGS method of assessing project fees.

To address these concerns, we recommend that the Bureau of State Audits be commissioned to conduct a performance audit of the DGS relative to capital outlay project cost estimates in order to evaluate (1) the appropriateness of fees charged, (2) the method of determining fee levels, and (3) the quality control process in place for budget development.

Funding Higher Education Capital Outlay. As in previous years, we recommend the Legislature provide funding for higher education capital outlay based on statewide priorities and criteria, using reasonable construction cost guidelines, and based on year-round operation. This year we examined how intensively the segments are utilizing their existing facilities and found that improvements were needed. We found that the University of California (UC) does not use its facilities as intensively as required by current standards and that the California State University (CSU) and community colleges do not report their utilization to the Legislature. We therefore recommend the Legislature direct the segments to utilize their facilities at least as intensively as required by current standards, and that CSU and the community colleges report their actual utilization at least biennially. (The UC already reports this information.) Also, because of limited state resources for capital outlay, we recommend the Legislature authorize UC to use Garamendi bonds (revenue bonds backed by UC research revenue) to fund the construction of research space. This would allow state resources to be used for improvements to instructional facilities.