Analysis of the 2004-05 Budget Bill
Legislative Analyst's Office
What Is the Deficiency Process? What Problems Has the Misuse of the Process Caused?
The Constitution gives the Legislature the power to appropriate funds. In order to address unexpected expenses (or "deficiencies") that arise during a fiscal year, the Legislature provides the administration with limited authority to spend at higher rates than foreseen in the budget act.
The use of this deficiency process, however, has a history of problems—from being used to establish new programs with no statutory authority to serving as an alternative to the normal state budget process. Given this history, we outline a framework for legislative consideration which identifies a new approach to meet unexpected expenses. In our view, this framework would continue to allow necessary adjustments, while better protecting the appropriation authority of the Legislature.
Due to the severity of the state's budget problem, the Legislature granted the administration new executive powers for the 2003-04 budget. Among these was Control Section 4.10 (discussed in Part IV of this document), which gave the administration the authority to make various reductions in state operations. In addition, the administration was given new powers to address deficiencies. This piece reviews the way the state addresses these unanticipated expenses. First, we provide background on the Legislature's appropriation authority and limited delegations of authority to the executive branch. Then, we review longstanding concerns with the delegated authority, as well as changes that were made to the process this year. Finally, we outline an alternative framework to improve the process—by maintaining necessary administrative flexibility, while increasing legislative oversight.
The State Constitution separates the powers of state government into three branches—legislative, executive, and judicial. The Constitution specifies that each branch is charged with the exercise of certain powers that may not be exercised by either of the other branches. In this way, the Constitution defines the relationship among each branch of government.
Legislature Has Sole Power of Appropriation. One of the powers given exclusively to the Legislature is the power of appropriating funds. Article XVI, Section 7, of the California Constitution provides for this power:
Money may be drawn from the Treasury only through an appropriation made by law and upon a Controller's duly drawn warrant.
In other words, the Controller is bound by the Constitution to only pay those state expenses that have been expressly authorized by the Legislature through an appropriation made by law (or, in limited circumstances, by the Constitution, federal law, or initiatives). The annual state budget is the Legislature's primary method of authorizing expenses for a particular year. Any changes to these budget appropriations, therefore, must also be authorized by the Legislature in statute.
Given the size and diversity of state government, changes to enacted budget plans after the start of a fiscal year are often needed to respond to unanticipated events. These changes may be minor and technical in nature or more significant—such as responding to an earthquake or the receipt of a large federal grant.
How Is Spending Changed? In order to respond to unanticipated needs, the Legislature can always pass a bill subsequent to the enactment of the budget that increases or decreases an existing appropriation or creates a new appropriation. In other cases, the administration can use various "control sections" of the budget act which establish procedures to adjust spending levels.
Why Does the Legislature Delegate Authority? Through the control sections, the Legislature provides the administration limited authority to adjust spending. The Legislature provides this authority in recognition that there can be the need for administrative adjustments to the budget, particularly during the periods when the Legislature is out of session. The challenge for the Legislature is to provide the administration the needed authority and guidance to respond efficiently and adequately to unexpected events without compromising its own appropriation authority.
Legislative Review Periods. In most cases, the Legislature has specified a review period (generally 30 days) before the administration can finalize an action pursuant to the control sections. This provides a brief opportunity for the Legislature to review and comment on the proposed changes. It also provides early notification to the Legislature of any changes occurring to the originally enacted budget plan.
Controller's Responsibilities. The Controller is the state official who oversees the state's spending during the year. As required by Article XVI of the Constitution, it is the Controller's responsibility to monitor a department's spending to ensure that all spending is authorized by a specific appropriation.
There are a number of examples of authority delegated to the executive branch to modify spending, which we describe below.
State of Emergency. The California Emergency Services Act (Government Code Section 8550 et seq.) allows the Governor to declare a "state of emergency" under specified circumstances—including natural disasters. Upon such a declaration, the administration is authorized to redirect existing appropriations to address the emergency.
Control Section 27.00. Section 27.00 is a limited delegation of authority to allow the administration to address unexpected spending needs after the passage of the budget. Through the section (in conjunction with Government Code Section 11006), the administration can be given the authority to spend funds at a rate that will require a subsequent deficiency appropriation by the Legislature. A more detailed description of the deficiency process appears in the nearby shaded box.
Control Section 28.00. This control section provides the administration flexibility to expend unanticipated federal or other nonstate funds. Departments must show a need to spend the unexpected monies in the current year. In addition, Section 28.00 can only be used if the funds are designated for a specific purpose (as opposed, for instance, to a block grant with many possible uses).
Overview of Deficiency Spending
What Is a Deficiency? Each year, the budget act specifies appropriations for state departments to operate and deliver programs, as approved by the Legislature. In some cases after the enactment of the budget, departments may determine that additional funding—above its appropriation level—is needed to deliver the approved programs. These additional needs can be due to a variety of unexpected events—such as changes in caseload or new federal laws. The gap in funding between what was originally appropriated and the revised spending need is known as a "deficiency." In almost all cases, the department would not deplete its original resources until late in the fiscal year. The department, however, is required to notify the Legislature at the point that it anticipates the need to spend funds at a rate that will require an increased appropriation by the end of the fiscal year. In no case can the department spend more than its appropriation. Instead, it must have a supplemental appropriation—typically provided in the annual deficiency bill during the spring.
How Do Section 27.00 and Item 9840 Work? If departments need funding before the passage of a deficiency bill, the administration can access funding appropriated to Item 9840. The amounts appropriated in this item are minimal—including $2 million in General Fund dollars—since most departments have sufficient resources to operate until a deficiency bill is enacted. Figure 1 below illustrates the Section 27.00 process for a typical department. The department learns in December that it will need to spend at a rate for the remainder of the year which While the Legislature delegates authority to the executive branch to make government more manageable, the following discussion illustrates that the use of this authority has created legislative oversight problems.
30-Day Review Is Not Full Oversight. For Section 27.00 and 28.00 authorizations, a 30-day review period for the Legislature is standard. (In cases of emergencies, Section 27.00 also has a provision to notify the Legislature after an action is taken.) In some instances, however, this review period does not provide enough time for the Legislature to gain a complete understanding of the nature of the proposed adjustments. In contrast, during the regular budget process, the Legislature has several months to explore alternative approaches to an administration proposal.
Overview of Deficiency Spending (continued) is higher than assumed in the budget act. It submits a Section 27.00 deficiency request and, if approved, changes its rate of spending. Note, however, that the department would not actually need increased appropriation authority until April, when its budget act appropriation is "used up."
Concerns Can Be Ignored. In those cases when the Legislature develops concerns during the review period, the Legislature advises the administration of these concerns. While the administration has typically abided by the Legislature's wishes, the administration has also ignored legislative concerns on occasion and proceeded with the implementation of a proposal. In such cases, the Legislature has virtually no practical recourse.
Uses Not Consistent With Intent. Section 27.00 is intended to address unanticipated expenses. Yet, past administrations have on occasion attempted to use the process for a variety of expenses that were or should have been anticipated. For instance, a long-standing problem area is the use of Section 27.00 to adjust for a change in program requirements, resulting, for example, from a federal regulatory change that was known by the administration before the budget was enacted. Another problem area is the use of Section 27.00 for expenses that should have been included in the administration's budget estimates (such as salary increases or the full costs to implement a newly approved program). The consequence of using Section 27.00 in this manner means that departments can "low ball" their budget estimates and then supplement them for their true costs through the deficiency process. As a result, the Legislature does not have an accurate picture of the state's expenses when considering its budget priorities. Finally, the process also has been used to initiate new programs that have not been reviewed by the Legislature or for which there is no statutory authority, or to fund bills that were passed without appropriations (thus enabling Governors to fund bills consistent with their priorities, rather than the Legislature's).
Section 27.00 is intended to allow adjustments when program costs exceed budget estimates (such as an increase in the program's caseload) or the state experiences a natural disaster (such as the Southern California fires late last year). In other words, it is intended to allow adjustments to spending amounts, consistent with the Legislature's policy objectives as reflected in the annual budget. It is not intended to provide an alternative to the regular budget process for changing policy decisions. Likewise, Section 28.00 is intended to provide authorization to spend funds when there is no discretion over their use (such as federal funds which supplement an existing program). Section 28.00 is not intended to provide an avenue for the administration to take discretionary federal funds and craft new programs outside of the regular budget process.
To a large extent, the Legislature depends on the administration to police itself to ensure the delegated authority is used appropriately. At various times, however, the executive branch has abused both control sections in efforts to develop programs outside of the budget process and in the absence of statutory authority. For instance, our office raised concerns in 2002 about the prior administration's use of Section 28.00 to preclude the Legislature from developing priorities for federal K-12 education funding. Similarly, in December 1999, our office raised concerns about the executive branch using Section 27.00 for the California Department of Corrections (CDC) to implement new programs not approved by the Legislature.
The magnitude of the state's budget problem this year and ongoing frustration with the Section 27.00 process resulted in the Legislature adding new provisions to the deficiency process. These changes were intended to address some of the past problems described above and to help control costs. Below, we summarize the major changes made in the deficiency process.
New Timing for Deficiency Appropriations. In past years, there was no specific schedule for the passage of the deficiency appropriations bill. This year, Section 27.00 specifically requires the Legislature to approve a deficiency bill by March 1, 2004 for those deficiencies authorized prior to the release of the Governor's budget in January. For those deficiency requests authorized after the release of the budget, the Joint Legislative Budget Committee is to hold a hearing to discuss their merit. These changes are efforts to improve legislative oversight of deficiency requests.
New Limits on Use. This year's revised Section 27.00 language also includes some new specific limitations on its use—clarifying what the Legislature means by "unanticipated expenses." The language specifies that Section 27.00 cannot be used for:
Ability to Transfer Funds. Section 27.00 now also includes the authority for the administration to transfer funds from one appropriation to another in order to avoid the need for a deficiency. Specifically, Section 27.00 (b) allows the administration to transfer up to 5 percent of one item's funds to other items of appropriation. The Legislature intended that this authority be used judiciously so, for example, that such a transfer would not create a new deficiency in the item from which the funds were transferred. As with other actions related to deficiencies, the administration must provide the Legislature 30 days to review the transfers.
The administration reports that it has approved a total of $384.8 million ($378.1 million General Fund) in deficiencies for various departments so far in 2003-04 (excluding the vehicle license fee [VLF] backfill, which we discuss below). Over four-fifths of this amount is due to deficiencies in the CDC.
So far in 2003-04, the administration has approved about $48 million in transfers pursuant to Section 27.00 (b) to avoid deficiencies. The administration has approved an additional $149 million in transfers as part of its VLF actions (discussed below). The administration's use of this transfer provision to date has been a source of legislative concern.
Abiding by Section 27.00's Restrictions. The administration may transfer funds from one item to another pursuant to Section 27.00 (b), only as needed to avoid seeking a deficiency appropriation. As such, Section 27.00 (b) is tied to the meaning of the entire deficiency process. The prohibitions contained in Section 27.00 on starting new programs and funding legislation, therefore, apply to the ability to transfer funds as well. The administration, however, has asserted that Section 27.00 (b) stands alone and provides the administration with broad authority to transfer funds between items. Under the administration's interpretation, then, it could transfer up to 5 percent of any appropriation for any purpose, such as starting a new program or funding a request that was specifically rejected by the Legislature during the budget process. Some of the funding transferred this year has not met the tests for using Section 27.00, and the transfers were made over the objections of the Legislature.
Overstep of Authority.The administration also has proposed transfers of funds pursuant to Section 27.00 (b) that did not comply with the 5 percent limit on such transfers. The administration proposed several transfers of funds from a Department of Health Services budget item. The transfers totaled roughly 9 percent of that appropriation. The administration suggested it was "waiving" the 5 percent limit, even though no such waiver process exists. (In this case, the administration has since amended its proposal to abide by the 5 percent limit.)
In December 2003, the administration notified the Legislature of its intent to increase General Fund payments to local governments (VLF backfill) by $2.652 billion. The administration noted its intention to provide $148.8 million of this amount through reductions from other budgetary appropriations pursuant to Section 27.00 (b). The administration contended that the action required an emergency authorization and, therefore, only notified the Legislature after its decision. As we advised the Legislature in December, this action represented both a flagrant misuse of Section 27.00 and a serious infringement of legislative powers. As an action which far exceeds the authority provided to the executive branch, it is illustrative of how delegated authority can be abused. Our critique of the proposal is discussed below.
Proposal Was Not a Deficiency. Under the basic VLF backfill statute, funds to local governments are provided through a continuous appropriation (eliminating the need for an annual budget appropriation). To prevent this continuous appropriation authority from being exercised in the current year, the Legislature appropriated $1,000 in Item 9100 (Tax Relief) of the budget and specified that the $1,000 was in place of the statutory VLF backfill appropriation. In our view, this action represents the Legislature's policy determination to spend a minimal amount on the backfill in 2003-04 absent further appropriations for this purpose. As such, the administration has not made any case for meeting the requirements of a deficiency authorization. Furthermore, the administration's action to increase funding for this purpose by $2.6 billion represents a major revision to legislative policy, is completely disproportionate to the amount of spending authorized by the budget, and is not necessary to accomplish the purposes of the $1,000 appropriation.
Administration Inappropriately Assumes Legislature's Appropriation Authority. As noted above, appropriating funds is solely the authority of the Legislature. Yet, the administration reported that it had "approved a deficiency appropriation" of $2.5 billion. Given the appropriation of $1,000 in Item 9100, however, we believe the Legislature has not provided to the administration in the budget act or other state law, any appropriation authority which the administration can access to cover this proposed backfill expense.
Controller Has No Authority to Implement. In the absence of a specific appropriation from the Legislature, the Controller has no authority to implement the administration's proposal. The continuous appropriation for the backfill was suspended this year by the $1,000 appropriation. The Controller has not identified another appropriation from which to draw. Yet, the Controller has been authorizing payments for the backfill to local governments since December.
Emergency Criteria Not Met. The emergency provision of Section 27.00 has historically been used to respond to specific and urgent incidents—such as natural disasters. In this case, the administration has not put forth any evidence of specific disaster or peril. Rather, the administration relies on a broad assertion that the reduction of local spending will impair public safety. The administration has provided no analysis of individual local government finances that would suggest an imminent threat to health or safety. If the administration were to provide such an analysis, the Legislature has in the past addressed individual local governments' financial situations through legislation specific to their needs.
Transfers Require 30-Day Notification. As described above, the administration's action fails to meet the tests for a deficiency authorization. However, even if the request were for a legitimate deficiency, the administration appears to believe that it can implement the $149 million in transfers without a 30-day notification period (as part of Section 27.00's emergency provisions). Yet, Section 27.00 (b) provides no such authority to circumvent the 30-day period for transfers. Consequently, the administration is always obligated to wait the 30 days before implementing budget transfers to avoid deficiencies under Section 27.00 (b). As a result, the Controller did not process the transfers immediately as requested by the administration. (It is our understanding as of early February 2004 that the transfers have yet to be made.)
Lawsuits Pending. The state has been sued in two separate cases to stop the administration's actions related to the VLF backfill. As this analysis was prepared, the cases were pending before a superior court and the Supreme Court.
No Changes in Sections 27.00 and 28.00. For 2004-05, the administration proposes the continuation of the current wording of Sections 27.00 and 28.00.
New Control Section 7.50 Proposed. The administration proposes a new Section 7.50 for 2004-05 which relates to federal funding. The new Section 7.50, which contains a 30-day review period for the Legislature, would allow the executive branch broad new authority with regard to the use of federal funds beyond what is currently authorized by Section 28.00. Section 28.00 already provides the administration with the authority to allocate and spend federal funds when the funds are distributed for a specific purpose. In contrast, Section 7.50 would let the administration decide how to spend discretionary and anticipated federal funds. For instance, Section 7.50 would allow the administration to choose how to spend $250 million in expected federal election reform funds using only a notification process. The administration states that it needs the authority of Section 7.50 to use federal funds to offset General Fund costs. The budget assumes $350 million in new federal funds for such a purpose.
Given the concerns expressed above, we believe the Legislature should approach the delegation of spending authority with caution. Such delegations should only be made to the extent essential for the efficient operation of government. When considering delegation, we believe the Legislature should keep the following factors in mind:
While recognizing the need for some administrative authority to make adjustments to the budget, we believe the current powers provided to the administration are overly broad. The result has been recurring problems with the executive branch (the current and past administrations) exceeding the Legislature's intended use of these powers. In order to assist the Legislature in addressing these issues, we outline below a framework for a new approach to meeting unexpected needs. We recognize there are many possible alternatives to address the problems outlined above. In our view, the alternative described below would maintain the needed authority for administrative adjustments, while protecting the appropriation authority of the Legislature. The main components of this new approach are:
This approach would prevent departments from using the deficiency process as a "fall back" plan for departments' budget requests. Over the longer term, we believe the framework instead would encourage departments and the administration to more accurately estimate their needs in the formal budget process prior to the passage of the budget bill.
Under the current system, the deficiency process presumes that the administration is making changes consistent with the Legislature's intent. It forces the Legislature into the position of shouldering the burden of proof to encourage the administration to change course when there is a disagreement. Yet, when the Legislature is in session, there is little reason to delegate such control and authority to the executive branch. Instead, the administration should be able to affirmatively prove its case to the Legislature that additional funding is needed for an unanticipated need. As noted in Figure 2, most of the Section 27.00 requests from the past few years have been concentrated during two periods—the release of the Governor's budget in January and its revision in May. (This is not surprising given DOF is updating budget projections at these times.)
Pay As You Go Budgeting. The new framework would rely on "pay as you go" budgeting. Under current law, upon the expiration of a 30-day review, departments can begin to spend at rates which will lead to a deficiency. Under pay as you go budgeting, departments would not be able to engage in such spending. Instead, departments would have to wait for a supplemental appropriation to begin spending at a rate that would go beyond their budgeted authority. This approach would better protect the Legislature's appropriation authority by always keeping departments within their approved spending levels. This change, over time, should restrict the instances when the Legislature is backed into a corner to approve appropriations for departments (because there is no other feasible alternative at the time the deficiency bill is considered). It also should make the administration budget more honestly in the annual budget act.
Timing of Supplemental Appropriations. The Legislature could approach the timing of supplemental appropriation bills in a variety of ways. For example, the Legislature could handle the majority of unexpected expense requests through two supplemental appropriation bills each year—upon its return in January and later in the spring. New language in Section 27.00 this year is already moving in this direction by requiring a deficiency bill to be passed by March 1 and by requiring hearings to be held for deficiency requests submitted after the January budget.
More Options for the Legislature. The intent of Section 27.00 (b) this year was to avoid unexpected expenses causing net increases in overall state spending. Multiple supplemental appropriation bills would give a similar ability to make mid-year corrections. If for instance the administration requests sizable supplemental appropriations, it could at the same time request downward adjustments to other appropriations. As with the increased spending, the administration would have to make the case that the budget's original spending level for a department or program was no longer justified. In such cases, the Legislature could approve supplemental appropriation bills that did not increase overall state costs.
Increase Appropriation in Item 9840. Item 9840 currently gives the administration a small amount of funding annually to address unexpected needs. For minor adjustments, the administration can access this item without the need for a future deficiency appropriation. In this way, Item 9840 works as a type of reserve for unanticipated expenses. For the fall when the Legislature is out of session, this concept could be expanded. With a higher appropriation level in the item, the administration could address unanticipated needs with funds already appropriated by the Legislature. As with its current use, the appropriated dollars would be transferred from Item 9840 to the department's budget once a request was approved. In expanding this appropriation, the Legislature has a constitutional obligation to establish the parameters for its use, as we discuss below.
Delineating Use of Item 9840 Funds. As discussed earlier, the Legislature this year tightened the language governing the circumstances under which a deficiency is authorized. For instance, Section 27.00 now specifies that it should not be used for expenses that were known at the time of the May Revision, to pay for prior-year costs, or to fund new programs. To ensure that the funds in Item 9840 are used for expenses consistent with the Legislature's policy objectives, this language could be brought into the item to restrict its use. In other words, the funds in Item 9840 could not be accessed to pay for prior-year costs or to fund new programs. Moreover, the Legislature should identify the specific circumstances for which it intends funds appropriated in Item 9840 to be used. The use of Item 9840 could also retain the same notification and review procedures of Section 27.00.
Budgeting for Contingencies. In this manner, the Legislature would be budgeting dollars and setting the parameters for the typical contingencies that occur when it is out of session. Upon its return in January, the Legislature would face a budget that would not have exceeded its original authorized level of total spending.
No Loss in Legislative Oversight. In our view, the use of a revised Item 9840 would result in no loss of legislative oversight. In fact, taken together with the "in session" process we have outlined, we believe oversight would be enhanced.
What's a Reasonable Amount of Funding? The administration has sought an average of about $20 million in General Fund dollars through Section 27.00 for the past five years during September through November. Increasing this amount slightly and appropriating $25 million from the General Fund to Item 9840 should be sufficient to cover unanticipated expenses during the fall. (The special fund appropriations under Item 9840 could also be increased.) If this amount was insufficient to fund all unanticipated needs during the fall, the administration would have to prioritize its use of the funds. Any remaining needs could be addressed upon the Legislature's return.
Section 27.00 Would Be Unneeded. Given the revised process as described above, the authority provided by Section 27.00 would be unnecessary. If the Legislature adopted such an approach, related changes would need to be made in the Government Code.
Controller Should Verify Appropriation Authority. As part of its constitutional duties, the Controller must ensure that every state payment is tied to a specific authorized appropriation. The state`s fiscal accountability systems depend on this occurring. Based on the continued payment of the VLF backfill and subsequent conversations with the Controller's office, however, we are concerned that this has not been the case. It is not clear that a systematic process is in place. We therefore recommend that the Controller report to the Legislature on the specific process used to verify that state warrants are backed by an appropriation. We also recommend that the Controller report on the status of the VLF backfill payments beyond the $1,000 appropriation made by the Legislature for this purpose.
Delete Section 7.50. The proposed Section 7.50 would provide the administration with excessively broad authority to spend federal funds. If California is to receive discretionary federal funds in 2004-05, it is the responsibility of the Legislature, not the administration, to identify the highest priorities for that funding. The administration's stated goal of offsetting General Fund costs with federal funds could be achieved through much more narrow means. (Section 8.25 served a similar purpose in this year's budget.) As such, we recommend that the Legislature delete Section 7.50 from the budget bill.
The Legislature has grappled for many years with delegating sufficient authority to the administration to deal with unanticipated events which impact the budget. This authority must be balanced with the Legislature's own authority to set state policy and appropriate funds. In our view, the current system is out of balance. We have identified one approach the Legislature might take to achieve a better balance.