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

Augmentation for Employee Compensation (9800)

A significant portion of state government's operating costs is for compensation of state employees. Figure 1 displays a breakdown of 2002-03 estimated state payroll (without additional benefits expenditures for items such as health insurance and retirement). As shown in the figure, higher education (consisting of the University of California [UC] and California State University [CSU] systems) represents approximately one-third of state employment. The Departments of Corrections and Transportation combined represent an additional one-fifth of state payroll.

The Governor's budget projects $17 billion in salary and wage expenditures for 325,000 authorized personnel-years (PYs) in 2003-04 (including $6.1 billion and almost 118,000 PYs in higher education). In addition, the state pays for benefits such as health insurance and retirement. These additional employment costs are generally around 25 percent of salary expenditures. Thus, when benefits are included, total estimated expenditures for employee compensation are projected to approach $22 billion for the budget year, about half of which is supported from the General Fund.

Employee Pay and Benefit Increases

The budget does not include funding for the general salary increases—5 percent for most state employees—effective July 1, 2003, as negotiated in current memoranda of understanding. The budget, however, does include $12 million ($11 million General Fund) for some additional cost provisions negotiated in two contracts. 

Most State Employees Scheduled for 5 Percent Salary Increase. Under current memoranda of understanding (MOUs) (contracts that govern terms and conditions of employment), the employee retirement contribution was cut in half during 2001-02 and then eliminated for 2002-03—in order to increase take-home pay without incurring additional state costs for an increase in base salaries. (The Public Employees' Retirement System approved this reduction in pension system revenue, which will increase state retirement contributions beginning in 2003-04.) Employees will be required to make their full contributions again beginning in 2003-04.

These MOUs include a 5 percent general salary increase effective July 1, 2003 for employees in 19 of the state's 21 collective bargaining units. This offsets the reinstatement of the employee retirement contribution, which is almost 5 percent of salary for most state employees. The administration approved a similar package for supervisors, managers, and other employees not subject to collective bargaining.

Figure 2 shows a history of general salary increases for state civil service employees and the consumer price indices for the United States and California since 1991-92. 

Longer-Term Contracts for Four Bargaining Units. Most MOUs expire at the beginning of the budget year. Four bargaining units, however, have contracts that extend beyond this period. Specifically, these MOUs stretch through 2003-04 for Unit 12 (Craft and Maintenance) and through 2005-06 for Unit 5 (Highway Patrol), Unit 6 (Corrections), and Unit 8 (Firefighters).

Employees in Unit 8 and Unit 12 also will receive the 5 percent salary increase discussed above. The MOUs for Unit 5 and Unit 6 include the first of four annual pay raises, effective July 1, 2003. The budget-year salary increases are approximately 6 percent and 3.5 percent for Unit 5 and Unit 6, respectively. These multiyear salary increases are designed to eliminate the state's pay differential with particular local law enforcement agencies, as specified in current law. Supervisors and managers of these employees will receive a similar package. By the final pay raise effective July 1, 2006, the cumulative salary increase for employees in the two units is estimated to be approximately 33 percent. 

Future Cost of Negotiated Pay Raises Increases Significantly. Figure 3 shows the projected ongoing cost of the negotiated general salary increases through 2006-07, when all pay raises would be fully implemented. These costs are estimated to be $532 million in the budget year, growing to an annual cost of $1.3 billion by 2006-07. More than half of these costs are attributable to the General Fund. As shown in the figure, the key factor driving this growth is the multiyear raises negotiated for the Highway Patrol and correctional officers. 

Proposal for Employee Compensation Budget Item. In the annual budget act, Item 9800, Augmentation for Employee Compensation, includes a lump sum for any additional compensation items that take effect in the budget year. (Baseline costs are already included in department budgets.) During the fiscal year, the Department of Finance (DOF) allocates to department budgets, from the lump-sum appropriation, the amounts necessary to fund these additional cost items.

The budget does not include funding for the salary increases effective July 1, 2003 under current MOUs. It is our understanding that this is because of the budget's proposed reduction in employee compensation expenditures to be negotiated for 2003-04, as discussed below. Specifically, it is possible that the negotiated general salary increase may be one part of the proposed reduction package to be determined through collective bargaining. Thus, the Governor's budget does not include this funding.

The budget does propose $12 million for additional cost provisions negotiated in the longer-term MOUs—senior, educational, and flight pay increases for Unit 6 employees ($3.2 million) and overtime-related provisions for employees in Unit 8 ($8.7 million). Almost all this amount—$11 million—is from the General Fund.

Employees in Higher Education. Employees of the UC and CSU systems are not part of the 21 bargaining units discussed above. Instead, they negotiate with the universities to determine terms of employment. The Governor's budget does not propose any additional General Fund expenditures for employee salary and benefit increases, but includes $17.2 million from the General Fund for additional health benefits costs for annuitants. 

Reduction in Employee Compensation Expenditures Proposed

The Governor's budget proposes an $855 million ($470 million General Fund) reduction in employee compensation expenditures in the budget year, to be determined through collective bargaining.

Proposed Reduction Equivalent to 8 Percent Salary Cut. The Governor's budget proposes an $855 million ($470 million General Fund) reduction in employee compensation expenditures in 2003-04. The proposal also includes budget control language—Control Section 4.10—authorizing the Director of DOF to reduce departments' budgets to "reflect employee compensation savings either negotiated through the collective bargaining process or as a result of layoffs, furloughs, and other similar personnel actions." The DOF has indicated that these reductions would be negotiated through (1) new MOUs for most bargaining units, with contracts expiring at the beginning of 2003-04, and (2) reopening the longer-term MOUs that do not expire this summer.

The $855 million in savings is roughly equivalent to an across-the-board 8 percent salary reduction. These savings, however, could be achieved through any combination of pay cuts (including deferral of the general salary increases effective July 1, 2003), reduced benefits, or other actions like furloughs or layoffs.

To the extent that any negotiated reductions are not implemented at the beginning of the budget year, greater cuts would be necessary to realize the proposed savings. For example, if salary reductions were not effective until October 1, 2003, the three-month delay would require a 10 percent salary reduction to generate $855 million in savings in the budget year.

Collective Bargaining Process Provides Framework for Determining Cuts

The state's collective bargaining process is governed by the Dills Act. The act requires the state and employee unions to meet and confer in good faith on employment-related issues at the request of either party. In general, anything that affects terms and conditions of employment is subject to collective bargaining. This includes pay and benefits, as well as all personnel-related actions except layoffs. Whether layoffs occur is not subject to negotiation. The state has the freedom to determine the need for layoffs. The MOUs, however, do include provisions for how layoffs proceed if they do occur. The Dills Act requires funding for all new expenditures negotiated in MOUs to be approved by the Legislature. 

Proposed Budget Language Does Not Include Legislative Oversight

As discussed previously, negotiated pay and benefit reductions, as well as nonlayoff personnel actions, would be adopted in new or revised MOUs. In the past, the Legislature has received MOUs for approval late in the legislative session, after completion of the budget (contrary to provisions of the Dills Act). In these cases, there have sometimes been incomplete or unavailable assessments of the total cost of the MOUs. It will be important for the Legislature to have sufficient time for a meaningful review of the proposed cuts, since securing reductions now may be achieved by negotiating additional benefits—with additional costs—for future years.

In addition, the proposed budget language in Control Section 4.10 includes no approval—or even review—by the Legislature of proposed reductions, despite the significant ramifications the $855 million in savings would have for state employment. Although compensation reductions would be negotiated in new MOUs, the administration could independently determine how much savings to generate through layoffs. Thus, with the Governor's proposed language, the Legislature faces the prospect of approving a total amount of savings in the budget and having no input on the reductions.

Legislative Options for Exercising Control Over Compensation Reductions

The Governor's proposal has the administration leading the determination of employee compensation reductions. Specifically, the administration would negotiate cost-saving provisions with the employee unions, and DOF would reduce departments' budgets accordingly. Given the state's fiscal condition, we believe it is appropriate to consider reductions in employment costs. But the Legislature need not defer to the administration in determining or allocating negotiated reductions. We lay out below options at key decision points for the Legislature to exercise some control over the proposed $855 million reduction.

Does the Legislature Want to Cut Compensation Costs? First, the Legislature must determine whether to reduce employee compensation expenditures to help balance the budget, as the Governor has proposed. If not, then the budget requires a $532 million (all funds) augmentation to implement the July 1, 2003 general salary increases.

If the Legislature does opt for compensation reductions, then the desired level of cuts would need to be determined. After considering the programmatic and employment impacts associated with various levels of cost savings, the Legislature could choose whether to approve $855 million in savings, as the Governor has proposed, or some greater or lesser amount.

Establish Parameters for Negotiations? Following a decision to reduce employee compensation expenditures, the Legislature could consider the relative merits and drawbacks of various types of cuts and set parameters to direct the administration's negotiating efforts. For example, the Legislature may wish to focus on savings from particular types of adjustments—for instance, reduced salaries, reduced state contributions for health insurance, and layoffs.

Alternatively, the Legislature may wish to leave the determination of cost-saving provisions entirely to collective bargaining. This would leave to the administration and the unions the determination of how to achieve the proposed savings. This option conforms with the Governor's proposal.

How Much Time to Review? As discussed above, the proposed budget control language includes no legislative review or approval of compensation reductions. However, it will be particularly important for the Legislature to be aware of any additional costs from future provisions negotiated in exchange for savings today. As a result, the Legislature may want to amend the proposed language to add 30-day notification so that the fiscal and policy implications of cuts in employee compensation expenditures can be fully understood.