Legislative Analyst's Office Analysis of the 2003-04 Budget Bill

Assembly Constitutional Amendment 11

Introduction

Infrastructure funding has become an increasingly important issue for the Legislature. The state faces a significant challenge in addressing both the deficiencies of an aging public infrastructure and the need for new infrastructure to sustain a growing economy and population. To effectively meet this challenge, the state needs a well-defined process for planning, budgeting, and financing necessary infrastructure improvements.

Assembly Constitutional Amendment 11 (ACA 11, Richman), which will appear on the March 2004 statewide ballot, would establish the California Twenty-First Century Infrastructure Investment Fund (Infrastructure Fund) to provide a dedicated fund source for capital outlay. The measure requires that moneys in the Infrastructure Fund be allocated by the Legislature for capital outlay purposes, of which 50 percent would be for state-owned infrastructure and 50 percent would be for local government infrastructure (excluding school districts and community college districts).

Should the voters pass ACA 11, the measure could have a major impact on the way the state funds its infrastructure. In this primer, we provide the following:

• Background on capital outlay planning and funding.
• An explanation of how the measure works.
• A sense of the measure's potential fiscal impact.
• Issues the Legislature will need to address should ACA 11 be approved by the voters.

Background on Infrastructure Planning and Funding

Assembly Constitutional Amendment 11 would commit a percentage of the General Fund to pay for state and local infrastructure projects. In order to fully understand what the measure attempts to achieve, it is important to have knowledge of the infrastructure the state has funded, how it plans for infrastructure, and how it currently funds infrastructure projects.

What Kind of Infrastructure Has the State Previously Funded?

The state has hundreds of billions of dollars invested in infrastructure. In addition to funding capital development to support various departmental missions, the state has also historically provided funds for local infrastructure in the areas of K-12 school construction, community college construction, local streets and roads, local parks, wastewater treatment, flood control, and jails. Figure 1 (see next page) shows the major areas of state infrastructure.

As the state's population continues to increase, the need for investment in new capital facilities will grow commensurately. Compounding the challenge will be the need to renovate and replace existing facilities in order that they can continue to serve their purposes.

How Does the State Plan for Infrastructure?

The California Infrastructure Planning Act—Chapter 606, Statutes of 1999 (AB 1473, Hertzberg)—requires the Governor to annually submit to the Leg islature a statewide five-year infrastructure plan along with a proposal for its funding. The plan is intended to provide the Legislature with a comprehensive picture of the state's long-term infrastructure needs. The first plan was submitted to the Legislature in June 2002. Figure 2 summarizes the basic information that must be included in the annual plan.

How Are Infrastructure Projects Funded?

Highway construction and renovation is the only state infrastructure program that has reliable and dedicated revenue sources (state gas taxes and federal funds). Most other infrastructure programs, however, require either direct General Fund appropriations or bond appropriations whose related debt service is repaid from the General Fund (this covers both general obligation and lease-revenue bonds). Figure 3 shows recent history on state capital outlay spending from these two sources. (The figure excludes spending on transportation and K-12 schools.) It shows that very little infrastructure spending is supported from direct appropriations—an annual average of 0.2 percent of total General Fund spending over the period shown. More spending has been supported from bonds, averaging $1.2 billion a year or about 2 percent of total General Fund spending for the period shown.

Given this financing situation, there is really no stable funding source year-in and year-out for most state infrastructure projects. Those programs which typically have been funded through general obligation bonds must wait to see if a bond authorization is placed on the ballot and then wait further to see if voters approve the measure. (Some state projects use lease-revenue bonds, which do not need voter approval.) Many state facilities, however, are not funded from bonds. As a result, there have been little or no funds routinely available for projects to, for example, upgrade or replace various facilities in the state hospitals, developmental centers, and prisons. This, in turn, has contributed to an under investment in certain components of the state's infrastructure.

An Overview of ACA 11

What Is the Main Purpose of ACA 11?

Assembly Constitutional Amendment 11 would increase the amount of General Fund revenue committed to pay-as-you-go capital outlay projects. According to the measure, the creation of the Infrastructure Fund is intended to assure continual capital outlay funding to address ongoing infrastructure needs. Assembly Constitutional Amendment 11 specifies that the Infrastructure Fund be allocated by the Legislature for capital outlay purposes, of which 50 percent would be for state-owned infrastructure and 50 percent would be for local government infrastructure (excluding school and community college districts). Figure 4 summarizes the main provisions of the measure.

While the goal of committing a portion of General Fund revenue annually to capital outlay projects is a simple one, ACA 11 contains a number of relatively complicated provisions that can change the annual amount of General Fund revenue transferred to the Infrastructure Fund.

How Would Transfers to the Infrastructure Fund Be Made?

Beginning with the 2006-07 fiscal year, ACA 11 would transfer 1 percent of General Fund revenue to the Infrastructure Fund. The amount of the transfer is scheduled to increase by 0.3 percent annually until reaching a maximum of 3 percent of General Fund revenues in 2013-14 (see Figure 5).

Also, ACA 11 specifies that the annual amount to be transferred to the Infrastructure Fund will be made in four installments: August 1 (or 30 days after enactment of the budget), November 1, February 1, and May 31.

Assembly Constitutional Amendment 11 contains provisions to slow and accelerate the annual amount to be transferred to the Infrastructure Fund depending on the condition of the General Fund. For example, in response to the possibility of revenue growth, ACA 11 specifies that the initial transfer in 2006-07 can only occur if General Fund revenue for that year increases by at least 4 percent in real terms (that is, after adjusting for inflation) over the prior year, as determined by the Department of Finance (DOF). (If the recent inflation rate of about 3 percent a year were to persist, that means revenues would have to grow by at least 7 percent for the transfer to occur.) In subsequent fiscal years, the scheduled 0.3 per cent increases in the annual transfer to the Infrastructure Fund also would occur only if General Fund revenues were projected to grow by 4 percent (in real terms). Conversely, to take advantage of periods of strong revenue growth, the schedule would be accelerated by an additional year, or another 0.3 percent, when General Fund revenues increase by 8 percent or more after adjusting for inflation.

By limiting the annual growth of the Infrastructure Fund transfer, the measure attempts to minimize the impact on other state programs. Although the transfer schedule set forth in ACA 11 envisions transferring 3 percent of General Fund revenues to the Infrastructure Fund in the 2013-14 fiscal year, it would likely take several more years to reach this maximum 3 percent transfer. This is due not only to the provisions discussed above, but also to various adjustments triggered by fluctuations in General Fund revenue growth, to which we now turn.

What Happens if General Fund Revenues Slow or Decline?

The measure contains a variety of adjustments or triggers that would reduce or eliminate the transfer to the Infrastructure Fund when General Fund revenue performance is less than estimated. These adjustments would ensure that, during difficult budgetary times, infrastructure funding shares in the pain of reduced resources. These adjustments, which are based on estimates by the DOF, fall into two categories that are summarized in Figure 6.

Year-to-Year Revenue Changes

The first set of adjustments is based on changes in General Fund revenues from the prior year. Specifically, if there is a dollar decrease in estimated General Fund revenues, or a decrease of more than 4 percent after adjusting for inflation, ACA 11 requires that any transfer to the Infrastructure Fund be suspended for that year. In addition, when there is such a suspension, any scheduled transfer for the subsequent year is reduced by half. Declining General Fund revenues usually mean the state is experiencing a difficult budget situation. That may explain why the measure includes this two-tiered reduction to the Infrastructure Fund.

Revenue Declines Within the Year

This set of adjustments compares estimated General Fund revenue at the time the budget is enacted with subsequent estimates made for that same fiscal year. Specifically:

• If the mid-year revenue estimate (January 10 Governor's budget) falls by more than 5 percent from the estimate reflected in the enacted budget, the third quarter transfer to the Infrastructure Fund is suspended.
• If the revenue estimate in the May Revision is more than 5 percent below the revenue estimate in the enacted budget, the third and fourth quarter transfers are suspended. (If, however, this estimate falls between 2 percent and 5 percent of the original estimate, only 75 percent of the annual transfer will be made.)

The adjustment for revenue declines within a fiscal year is more modest than the year-to-year adjustments. This seems reasonable, however, as the state may not be in as difficult a budget problem. For example, if estimated revenue growth at the start of the fiscal year was 10 percent, a 5 percent decline (as estimated later in the year) still would mean the state was experiencing revenue growth.

What Other Special Adjustments Are in ACA 11?

Assembly Constitutional Amendment 11 contains two special adjustments that could result in reductions in the annual revenue transferred to the Infrastructure Fund. These special adjustments are independent of the transfer adjustments to General Fund revenue discussed earlier.

Proposition 98

Assembly Constitutional Amendment 11 specifies that if the percentage growth in the Proposition 98 guarantee exceeds the percentage growth in General Fund revenues, the transfer amount pursuant to ACA 11 will be reduced. The measure provides that the amount of the reduction will be one-half of the difference between the current-year Proposition 98 requirement and the past-year Proposition 98 required amount, adjusted for the percentage growth in General Fund revenues from the prior year. This calculation would result in a specific dollar amount that would reduce an otherwise-required transfer to the Infrastructure Fund. Moreover, ACA 11 states that this reduction can only occur if no other triggered reductions or adjustments are in effect that year.

Generally, this trigger would occur only when school attendance is growing faster than the California population. Given that attendance is projected to grow more slowly than the state's population for many years, it does not appear that this provision would soon be a factor.

Debt Service

Assembly Constitutional Amendment 11 contains a provision limiting the percentage of revenues transferred to the Infrastructure Fund to the difference between 7.5 percent and the percentage of General Fund revenue devoted to prior-year debt payments for infrastructure-related bonds. For example, when the scheduled maximum transfer of 3 percent is achieved, this provision would require a reduction in the 3 percent transfer rate in years when the debt service ratio exceeded 4.5 percent.

While the debt service ratio is currently below that level, a variety of factors—sale of recently approved general obligation bonds, passage of measures on the March 2004 ballot, and current revenue performance—could result in a debt service ratio in the 6 percent range by 2006-07, the first year ACA 11 would be in effect.

As noted earlier, the state supports infrastructure spending through direct General Fund spending and through debt service payments on bonds. A possible rationale of the ACA 11 debt service provision is that it may serve a role similar to other ACA 11 triggers. It would protect existing programs by reducing the General Fund commitment to direct capital outlay appropriations when bond debt payments increase significantly.

What Would Be the Fiscal Impact of ACA 11?

Given all of the various triggers and schedule adjustments intended to protect other General Fund programs, a reasonable question is: How much General Fund money would ACA 11 actually transfer into the Infrastructure Fund each year? Due to the many ACA 11 adjustments and the number of economic and fiscal variables that would have to be forecast, it is not possible to give specific estimates of future transfers into the Infrastructure Fund. We have, however, attempted to illustrate the potential fiscal effect of ACA 11 by examining the impacts if it had been in effect over the recent past.

In Figure 7 we have applied the actual changes in General Fund revenue and other ACA 11 factors for the 20-year period 1982-83 through 2001-02. The figure provides a very general example of how the various triggers and adjustments in ACA 11 would have played out over that time period. The figure shows, for instance, increasing transfers of General Fund revenue to the Infrastructure Fund (growing from $113 million in the second year of the period to $2.4 billion at the end of the period). It also shows that such transfers would generally occur more often than not.

Figure 7 indicates that the transfers to the Infrastructure Fund can fluctuate significantly from year to year (for example, going from $756 million in 1989-90 to zero the following year). These fluctuations are primarily the result of the various triggers in ACA 11 which are based on changes in General Fund revenue. For example, there are five years in which there is no transfer of General Fund revenue to the Infrastructure Fund because of the year-to-year adjustment factor. In three of these years (1982-83, 1993-94, and 2001-02), the suspension occurs at the beginning of the fiscal year and in the other two years (1990-91 and 1992-93), the suspension is triggered later in the year. Additionally, there are three years (1985-86, 1987-88, and 1989-90) in which the scheduled 0.3 percent increase in the annual transfer is delayed because General Fund revenue did not grow by at least 4 percent (in real terms), and there is one year (1991-92) in which it is accelerated because General Fund revenue grew by at least 8 percent.

With respect to the bond debt service special adjustment described earlier, there are three years (1995-96, 1996-97, and 1997-98) when the scheduled revenue transfer to the Infrastructure Fund is reduced because the prior-year bond debt service percentage and the amount scheduled for transfer exceeded the 7.5 percent cap set by ACA 11. (We would note that the figure does not show any adjustments related to Proposition 98. As stated earlier, it is unlikely that school attendance will grow faster than the California population for many years, therefore, it does not appear that this provision would be a factor in the near future.)

In summary, Figure 7 suggests that ACA 11 would likely result in General Fund revenue transfers to the Infrastructure Fund. It also shows that the various triggers and adjustments in ACA 11 do work to protect other General Fund programs by reducing transfers to the Infrastructure Fund when General Fund revenues slow or decline.

What Issues Would the Passage of ACA 11 Raise?

Passage of ACA 11 would raise a number of issues related to how the state currently plans and finances its infrastructure. Below, is a brief discussion of some of these issues.

Impact on Capital Outlay Planning and Budgeting. As we have described above, passage of ACA 11 would provide a reliable and significant source of funds for state infrastructure needs. This could serve to greatly enhance the five-year infrastructure planning process established by Chapter 606. With a steadier funding source for new projects, the plan might be viewed as the means by which the state's highest priority projects are identified and funded.

The Infrastructure Fund and the Financing "Mix." The existence of the Infrastructure Fund would allow the Legislature to fund more capital outlay as pay-as-you-go projects. As noted above, this would bring greater certainty to the state's infrastructure planning and budgeting processes. With greater pay-as-you-go resources, the Legislature could lessen its reliance on bond financing. To the extent it did so, it would reduce overall infrastructure costs, as bond-funded projects are more costly than pay-as-you-go projects because of interest payments and financing costs. The Infrastructure Fund could also be used to change the way the state funds individual projects. For example, the Infrastructure Fund could pay for the preconstruction phases (preliminary plans and working drawings) of a project to avoid having to pay for bond-related interim financing costs, and the construction phase of the project could be funded later using general obligation or lease-revenue bonds.

Managing Resources in the Infrastructure Fund. Assembly Constitutional Amendment 11 would present the Legislature with options as to how it chooses to allocate monies from the Infrastructure Fund. For example, the Legislature could choose to fully fund (that is, provide funding for all phases of projects—including construction) as many projects as monies in the Infrastructure Fund would allow in a given year. Alternatively, in an effort to start as many projects as possible, it could choose to provide initial funding for a far greater number of projects. The Legislature could also choose to hold back a portion of the Infrastructure Fund each year to establish a reserve for use in those years when there is little or no transfer of General Fund revenue to the Infrastructure Fund.

Allocating Local Government's Share of the Infrastructure Fund. Assembly Constitutional Amendment 11 requires that half of the Infrastructure Fund be allocated for local government infrastructure, excluding school districts and community college districts. The measure requires subsequent legislation to set forth the approach and method to be used in the annual allocation of these funds. Accordingly, if ACA 11 is approved by the voters, the Legislature will need to establish how the Infrastructure Fund will be allocated for local infrastructure projects. For instance, the Legislature could decide that the Infrastructure Fund should be limited to funding new local government projects that serve regional purposes (such as parks, open space acquisitions, and flood control projects), or it could decide to use these funds as a substitute fund source for current local assistance programs involving infrastructure. Alternatively, the Legislature could opt to provide a portion of the funds to locals on a per capita basis (that is, not project-specific spending). In any case, passage of ACA 11 would compel a reconsideration of basic state and local infrastructure funding responsibilities.