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

Pro Rata (9900)

Pro rata is the recovery of statewide general administrative costs from special funds. Recently, the Department of Finance (DOF) has made a number of changes to the recovery of these costs. We recommend DOF report on the revised methodology.

The DOF is charged with the accurate assessment and recovery of costs incurred by the General Fund to administer state government. Beginning in 2002-03, the DOF made a number of changes to its methodology for cost recovery. We offer our preliminary assessment of these changes below.

Background

What Is Pro Rata? Pro rata is the recovery from special funds of costs incurred by central service agencies for the overall administration of state government. Central service agencies, such as DOF, the State Personnel Board, and the State Controller, provide services to all state departments. The costs of central service agencies are initially paid by the General Fund. The services provided by these agencies benefit not only General Fund programs, but also programs supported by special funds. Consequently, the state recovers a share of the costs from special funds through the pro rata process. The DOF determines the amount of the costs to be recovered and which special funds to charge.

How Are Departments' Overall Pro Rata Costs Determined? The central service agencies report to DOF the amount and cost of workload conducted to support other state departments. Based on this information, DOF determines the costs to be allocated to state departments benefiting from these services. For example, the State Controller manages the payroll system for state departments. The costs of providing these payroll services are distributed to those department benefiting from these services (by their share of total paychecks issued, for instance).

Which Funds Are Billed? Once the amount to distribute to a particular department is determined, this overall pro rata charge is distributed to the various funds in support of that department. At the department level, no effort is made to determine each fund`s actual share of workload (such as the number of paychecks by fund). Instead, each fund gets a proportionate share of the total department charge based on its share of total expenditures. The rationale is that each fund would tend to use services in rough proportion to its total expenditures.

For the purposes of pro rata, these funds are then determined either "billable" or "non-billable." The billable funds will reimburse the General Fund for pro rata allocations. Billable funds have special revenue sources such as fees, licenses, penalties, assessments, and interest. For other funds, General Fund appropriations provide the source of revenue. As a result, there is no reason for these non-billable funds to reimburse the General Fund for their share of state administrative costs. So this share of the pro rata charge is not recovered. To the extent that more funds are determined to be billable, the greater the reimbursement to the General Fund.

How Much Is Recovered by Pro Rata? As shown in Figure 1, the costs annually recovered from the special funds are significant—totaling more than $256 million in 2001-02. While the total amount of costs recovered has increased steadily over the past few years, the percentage of costs recovered has consistently remained about 30 percent. In other words, about 70 percent of control agency charges are determined to be non-billable. 

Change in Pro Rata Assessment Methodology. In the past, only special funds with state operations appropriations were assessed for administrative costs. Beginning in the current year, DOF notified state agencies that the pro rata plan had been revised to include additional assessments to special funds with local assistance and capital outlay appropriations. The DOF also began charging some bond funds. While these funds have not been assessed in the past, according to DOF, they should have been assessed. Since these additional special funds receive state services from the central service agencies, DOF believes they should share in the cost of these services.

Concerns About the Revised Methodology

Is the New Methodology Reasonable? Changes to the cost recovery methodology can have significant impacts on both the state's bottom line and individual program spending within special funds. Given the complicated and technical nature of pro rata, there are multiple legitimate approaches to developing a methodology. During the course of our preliminary review of the recent changes to the methodology, we identified two concerns, outlined below.

Are Assessments to Bond Funds Appropriate? General obligation (GO) bonds are a form of long-term borrowing in which the state issues debt and pledges its full faith and credit for repayment. These funds are repaid by the General Fund over time. As noted above, DOF has recently begun to charge some GO bond funds for pro rata charges. To date though, DOF has been unable to provide a consistent rationale as to why some bond funds are being charged, but not others. It is unclear to us why these funds would be treated differently than General Fund accounts, which are nonbillable.

How Should Local Assistance Be Charged? We believe it is reasonable for local assistance funds to be charged pro rata. As with other funds, they impose costs on central service agencies for budget oversight, accounting, and other services. However, we are concerned with the method used by the department to determine the share of costs to be charged local assistance in relation to a department's other funds.

As with state operations funds, DOF reports that the amount to be assessed to local assistance funds is determined by the amount of the expenditures from the fund. We question whether the value of a local assistance fund is an accurate indicator of costs incurred by central service agencies.

For instance, the California Children and Families Commission is the state's entity for implementing the provisions of Proposition 10, passed by the voters in 1998. While the commission has a number of its own state operations duties, local assistance dollars also pass through its budget to county commissions. Of the commission's proposed budget expenditures of $572 million, $452 million flows to counties as local assistance. The state commission has an estimated pro rata charge of $4.3 million in 2003-04 for its share of state administrative expenses. The DOF's pro rata methodology allocates 64 percent ($2.8 million) of that amount to the county allocation fund. While the distribution and accounting of funds to counties obviously incurs some state administrative costs, it is unclear to us that a charge based on total dollars is reasonable.

Recommend DOF Report on Methodology. Based on our review of the information provided by DOF, we are concerned with the changes made in the pro rata methodology. We, therefore, recommend that DOF report during the spring and respond to the concerns outlined above.