Analysis of the 2004-05 Budget Bill Legislative Analyst's Office February 2004

Funding for Transportation Programs

In recent years, transportation funding has been both constrained and uncertain due to various factors including the use of transportation funds to help the General Fund. The Governor's mid-year and budget-year proposals include $2 billion in transfers and loans from transportation funds to the General Fund. These proposals would delay many state and local transportation projects. They would also increase the uncertainty regarding future transportation funding, which adds risk to ongoing projects and makes planning for new projects difficult. 

We make several recommendations intended to stabilize transportation funding. Specifically, we recommend the Legislature (1) ask the voters to repeal Proposition 42 and (2) increase the gas tax to provide the same amount of revenue as would be generated under Proposition 42. We also recommend that the gas tax be indexed to prevent future erosion of transportation funding relative to travel demand.

California's state transportation programs are funded by a variety of sources, including special funds, federal funds, and general obligation bonds. Two special funds—the State Highway Account (SHA) and the Public Transportation Account (PTA)—have traditionally provided the majority of ongoing state revenues for transportation. Additionally, in 2000, the Legislature enacted the Traffic Congestion Relief Program (TCRP), which created a six-year funding plan for state and local transportation needs. Later statutes have delayed much of the funding for this program, so that funding for TCRP projects now extends through 2008-09. The program is funded by two fund sources—the Traffic Congestion Relief Fund (TCRF) and the Transportation Investment Fund (TIF)—from a combination of General Fund revenues (one-time) and ongoing revenues from the sales tax on gasoline. In March 2002, voters passed Proposition 42, which permanently extended the transfer of gasoline sales tax revenues into the TIF and dedicated the funds to various transportation programs. These programs include local street and road improvement, the State Transportation Improvement Program (STIP), State Transit Assistance, and other mass transportation activities funded by the Department of Transportation (Caltrans).

The STIP. The state's primary program for the construction of new transportation projects is the STIP. Funding comes primarily from the SHA and federal funds. In addition, under Proposition 42, a portion of TIF money will annually be made available for the STIP. Each even-numbered year, the California Transportation Commission (CTC) programs new projects to receive STIP funding based on an estimate of the funds available over the next five years. Statute allows Caltrans to spend 25 percent of the available STIP funds on interregional transportation improvements, with the remaining 75 percent going to designated regional transportation planning agencies for regional transportation improvements. The regional funding is further allocated to counties based on statutory formula.

The TCRP. The TCRP is the second major project construction program. It mainly consists of 141 statutorily-defined projects located throughout the state, with each project receiving a specified amount of money. Collectively, TCRP projects are to receive about $4.9 billion through 2008-09 from the General Fund and the sales tax on gasoline. Through 2003-04, they will have received about $500 million from these sources, in addition to loans from other transportation accounts. Because TCRP does not provide full funding for all of the projects, many of them are funded from multiple sources, including STIP money.

In addition to funding specified projects, the TCRP also provides funding for STIP projects, local street and road improvements, and mass transportation programs. In total, the TCRP was envisioned to provide $7.6 billion to transportation through 2005-06.

Funds Redirected. In the past three years, funds designated for transportation have been redirected annually to help the General Fund. The 2004-05 budget continues this practice. The repeated diversion of transportation funds, while helping the General Fund condition, raises a num ber of issues regarding the predictability and adequacy of funding for transportation over both the near and the long term. In the following three sections, we discuss the Governor's proposals for the use of transportation funds from several angles. The first section covers the Governor's proposals and their effect on the General Fund only. The second section discusses the immediate implications of the Governor's proposals on transportation in the current and budget years. In the third section, we discuss the actions' longer-term implications and provide broader recommendations.

Governor Proposes $2 Billion in Transportation Aid to General Fund

In both the mid-year cuts submitted in November 2003 and in the 2004-05 Governor's Budget, the administration has proposed to use a number of transportation funds to provide about $2 billion in one-time General Fund aid over the current and budget years. This section discusses the proposal's key elements and its General Fund effects.

Transportation to Provide a Large Portion of Proposed Mid-Year Cuts

In November, the administration proposed to use about $920 million in transportation funds to aid the General Fund. This amount is about one-quarter of the administration's proposed mid-year General Fund savings. Most of this money would be made available through a change in accounting for federal transportation funds. Other sources of funding include a transfer to the General Fund of additional Transportation Congestion Relief Program money and certain funds that are normally deposited in the Public Transportation Account.

In November 2003, the administration proposed a number of mid-year savings proposals to aid the General Fund, totaling about $3.9 billion in the current and budget years. Of this amount, $920 million, or about one-quarter of the total package, is to come from transportation funds. Figure 1 lists the proposed loans and transfers, which we describe in more detail below.

"Cashing In" Federal Money Sooner Through Change in Accounting. Most of the $920 million would be made available from a change in how the state accounts for federal money that it gives to local transportation agencies. Each year, the state sets aside about $900 million of its federal expenditure authority to be used by local transportation agencies for their own projects. The rest is used for state purposes, including the STIP.

Local governments do not expend all of the federal money in the year it is provided. Typically, the full amount of federal funding needed for a project is set aside at the beginning of the project, even if it will take several years to expend those funds as the project goes from engineering to construction. This leaves several hundred million dollars in federal funds waiting to be expended at any given time. The administration proposes to cash in this amount, which it estimates at $800 million over two years, and deposit it in the SHA, to be used as follows:

• Debt Service on Transportation Bonds. $406 million would be transferred to the General Fund to pay the debt service on three existing general obligation bonds for transportation.
• Loan to General Fund. $200 million would be loaned to the General Fund under the provisions of Article XIX of the State Constitution. Repayment would be required by June 30, 2007.
• General Transportation Purposes. The remaining $194 million would remain in SHA for statewide transportation purposes.

From the budget year onwards, the state would provide the cash needed each year to cover the expenditures incurred on local projects. The state would then seek reimbursement from the federal government out of the state's annual share of federal money.

Our review shows that Caltrans can administratively change its accounting methodology and cash in the $800 million in federal money without the Legislature's approval. However, action by the Legislature is required to transfer and loan the proposed amounts to the General Fund. Our review further shows that the accounting change and the use of the funds for General Fund purposes could have negative effects on local transportation projects, as the proposal increases the uncertainty of their funding source. We discuss this issue later in the section on long-term transportation effects of the Governor's proposals.

Funding for TCRP to Be Eliminated; Money Reverted to the General Fund. The administration also proposes to transfer $189 million from TCRF to the General Fund in the current year. As part of the 2003-04 budget, Proposition 42 was partially suspended. As a result, only $289 million (out of a projected $1,145 million) from the sales tax on gasoline would be transferred to TCRF in the current year. Of this amount, $100 million would repay a loan from SHA. The remaining $189 million would be used to pay for the current-year costs of some TCRP projects. The mid-year proposal would eliminate the current-year funding for TCRP projects, and instead revert the amount to the General Fund.

PTA Income to Be Transferred to General Fund. The administration also proposes in its mid-year cuts to transfer several sources of PTA income to the General Fund. First, the administration proposes to transfer certain miscellaneous income, totaling $108 million in the current and budget years, from SHA to the General Fund. This income, which includes such sources as sales of documents and rentals and sales of state property, is normally transferred to PTA each year to support transportation planning and public transportation programs.

Second, the administration proposes to retain in the General Fund all "spillover" revenue of extra gasoline sales tax money that would normally be deposited in PTA. The 2003-04 budget provided up to $87 million of the spillover amount to the General Fund, with any excess amount to be transferred to the PTA. The administration now proposes to keep in the General Fund the additional $17.5 million that it projects will be available. (When the mid-year cuts were proposed in November, the administration estimated that this extra spillover revenue would total $30 million in 2003-04, but it has since revised its estimate downward to $17.5 million.)

Suspension of Proposition 42 Proposed for Budget Year

The budget proposes to suspend in 2004-05 the transfer of $1.1 billion derived from the sales tax on gasoline to the Transportation Investment Fund.

Proposition 42, passed by the voters in March 2002, provides that all sales tax on gasoline that would otherwise be deposited in the General Fund shall be used for specified transportation purposes beginning in 2003-04. However, the transfer of this money to transportation may be suspended under certain circumstances. Proposition 42 was partially suspended as part of the 2003-04 budget.

Proposition 42 Suspension to Provide $1.1 Billion to General Fund. The budget proposes to again suspend the Proposition 42 transfer in 2004-05. As noted above, this would be the second suspension, in whole or in part, in the first two years of the proposition's existence. The budget estimates that the suspension would save the General Fund about $1.1 billion. Unlike the current-year suspension, which requires the suspended amount ($856 million) to be repaid by June 30, 2009, the budget-year suspension would be permanent, with the suspended amount never returning to transportation.

Transportation Funds Provide One-Time General Fund Aid

The Governor's proposals would provide about $2 billion to the General Fund over the current and budget years. This would bring to about $4.3 billion the total amount of transportation funds loaned or transferred to the General Fund since 2001-02. The use of transportation funds to help the General Fund provides only a one-time fix, while adding to future-year General Fund obligations for loans which must be repaid. After 2004-05, the General Fund obligations covered by these transfers will have to be addressed by new cuts, transfers, or revenue enhancements.

Proposed Transportation Aid to General Fund Is Substantial. The Governor's mid-year proposals together with the Proposition 42 suspension in 2004-05 would provide about $2 billion in transportation funds to the General Fund in the current and budget years. This is about 13 percent of the administration's total proposed solutions of about $16 billion to balance the General Fund over the two years.

General Fund Has Already Borrowed a Large Amount of Transportation Funds. Since 2001-02, the General Fund has borrowed about $2.2 billion from TCRF and TIF. As Figure 2 shows, this includes loans from TCRF of $238 million and $1,145 million in 2001-02 and 2002-03 respectively, and $856 million from TIF in 2003-04. The Governor's mid-year and budget-year proposals would bring the total aid to the General Fund from various transportation funds to about $4.3 billion over the four-year period.

Transfers and Loans Do Not Address General Fund Structural Deficit. While significant in magnitude, the proposed transportation transfers and loans are all one-time actions. As such, they do not provide an ongoing solution to address the state's structural imbalance between current law General Fund revenues and expenditures. Indeed, the loan proposal would add to the General Fund's future expenditure obligation. Absent ongoing solutions, the General Fund's structural budget problem will remain, even in the face of an improving statewide economic outlook. This means that, even if the transportation proposals are adopted, the General Fund obligations that they cover will have to be addressed by new cuts, transfers, or revenue enhancements in the future.

Governor's Proposals Reduce Already Limited Near-Term Funding

The Governor's proposals not only have a significant General Fund impact, they also have a substantial impact on transportation programs, in both the near and long term. This section discusses the Governor's proposals in the context of the funding difficulties faced by transportation in the near term—the current and budget years. We also identify several issues the Legislature should consider when weighing the Governor's proposals to help the General Fund and addressing near-term transportation funding.

Expected Transportation Funding Has Dropped Precipitously

During the past few years, a large influx of funding was expected in transportation, but this influx has not materialized. Funding promised in the Traffic Congestion Relief Program has been delayed and loaned back to the General Fund, the federal government has delayed reauthorization of its six-year transportation funding legislation, and other revenues such as truck weight fees have been lower than anticipated.

Promised General Fund Money for Transportation Has Not Materialized. The TCRP was enacted in 2000 to invest more money in transportation, primarily from the General Fund. As Figure 3 shows, as originally envisioned, it would have provided about $5.2 billion to transportation by 2003-04. About $7.6 billion would have been provided by the time the program was to expire in 2005-06. (This includes $4.9 billion for TCRP projects, with the remaining $2.7 billion divided among STIP projects, local street and road improvements, and mass transportation programs.) However, as mentioned earlier, most of the funding has been deferred to later years or loaned back to the General Fund. With the actions taken in the 2003-04 Budget Act, the cumulative amount of General Fund money made available to transportation through the current year would only be $906 million, including about $500 million for specific projects and $400 million for local street and road improvements. This is $4.3 billion less than envisioned in the original statute.

Federal Funding Reauthorization Is Delayed, Reducing Current-Year Funding. The federal government reauthorizes transportation funding on a six-year cycle. The last reauthorization (TEA-21) in 1998 provided more than a 40 percent increase in annual funding over the prior transportation funding act. The next reauthorization is almost certain to provide a large increase as well. In fact, each of the three versions of the next transportation act being debated in Congress represents a marked increase in funding over the current level. In adopting the 2002 STIP (covering the five years from 2003-04 through 2006-07), the state anticipated a 20 percent increase in annual federal funding after the new reauthorization, and transportation projects were programmed for funding based on that anticipated increase.

Reauthorization of the federal act was due in October 2003. However, Congress did not pass a bill at that time; instead it extended transportation funding at the existing level through February 2004. Current indications are that this deadline will be extended again and it is likely that reauthorization will not occur in time to increase federal transportation funding in 2003-04. As a result, current-year federal funding would be $366 million lower than expected. The total impact of the delay in federal reauthorization is unknown as it would depend on when a new federal transportation act is adopted.

Weight Fee Revenues Have Declined. Revenues from truck weight fees are a major source of income to the SHA. As we discussed in the Analysis of the 2003-04 Budget Bill, weight fee revenues declined sharply in 2002-03 following the passage of Chapter 861, Statutes of 2000 (SB 2084, Polanco), which changed how truck weight fees are collected. Although the change was intended to be "revenue neutral," weight fee revenues in 2002-03 were $124 million lower than was anticipated prior to the change. Chapter 719, Statutes of 2003 (SB 1055, Committee on Budget), subsequently increased weight fees as of January 1, 2004 to correct the decline. Nonetheless, about $223 million of transportation funding has been permanently lost since the adoption of Chapter 861.

Reduced Funding Means Fewer New Projects, Project Delays

The decline in expected funding severely restricted the state's capacity to fund new capital projects, thereby causing project delays. Project delays, in turn, can have negative effects on the state's economy. The state plans to proceed with some projects using borrowed funds.

New Allocations Severely Curtailed. The reduction in expected transportation funding caused CTC to stop all allocations for new capital projects in December 2002. This included both STIP and TCRP projects, as well as projects in the State Highway Operation and Protection Program (SHOPP), which funds capital projects that improve the state highway system without expanding capacity. Throughout 2003, CTC only allocated $600 million for new STIP projects and $500 million for new SHOPP projects, with no new TCRP allocations. By way of comparison, CTC typically allocates more than $2 billion annually for STIP and SHOPP projects alone. Without an allocation from CTC, a project that is ready to begin a new phase of work is unable to continue unless the regional or local agency can come up with alternative funding.

Without fund allocations, a backlog of "ready-to-go" projects has developed. These projects, which are in various phases of development, are all ready to begin a new phase of work, but must wait until the funding becomes available. The CTC reports that, as of the end of December 2003, the backlog of STIP and SHOPP projects totaled $672 million, and could grow to $1.6 billion by June 2004 if new allocations remain suspended. Similarly, over $150 million worth of TCRP projects were ready to go by December but were held back due to a lack of funding.

Project Delay Harms the Economy. Constraining the delivery of transportation projects can cause negative economic consequences. Most obviously, if the transportation system—whether roads or transit—fails to keep pace with the state's population and travel demand, traffic congestion will increase rapidly. This in turn wastes billions of dollars worth of time and fuel used by California drivers each year. These costs are incurred by both businesses and individuals. As Figure 4 shows, by the year 2000, over 1,800 miles of the state's urban freeways were congested, resulting in about 530,000 vehicle-hours of delay. Caltrans estimates that this delay cost California drivers $4.7 billion in wasted time and fuel that year. Delays in upcoming transportation projects will only worsen this trend.

Delaying the construction of transportation projects also affects employment in the state. The Federal Highway Administration estimates that $1 billion spent on projects generates an equivalent of 26,000 jobs.

Some Projects Progressing With Borrowed Money. To minimize project delays, some projects have proceeded with money borrowed from other sources. For example, several local transportation agencies have received "Letters of No Prejudice" from CTC. Created by Chapter 908, Statutes of 2001 (AB 1335, Cohn), a letter of no prejudice allows a local agency to use its own funds to continue work on phases of TCRP projects that do not have TCRP allocations. These letters indicate that, should TCRP funds become available, the local agencies will be reimbursed for the local funds they have spent. Local agencies are advancing $270 million worth of TCRP projects in this manner.

The state is also planning to borrow money to advance certain projects. Federal legislation allows states to issue Grant Anticipation Revenue Vehicle (GARVEE) bonds, which are repaid with future federal transportation revenue. In January 2004, CTC approved the issuance of GARVEE bonds for eight STIP projects worth $632 million, with bond issuance expected in February. Because the bonds are secured only by federal funds and are not a debt of the state, they are expected to achieve a higher investment rating and carry lower interest rates than state general obligation bonds. 

Governor's Proposals Further Reduce Available Funding

By reducing near-term transportation funding in the current and budget years, the administration's proposals would further slow transportation projects. Traffic Congestion Relief Program (TCRP) projects would be hardest hit. Work on many projects would have to stop completely, resulting in unknown closeout costs. Furthermore, if TCRP projects are to compete for State Transportation Improvement Program (STIP) funding, they would crowd out some existing STIP projects as well.

Governor's Proposals Would Remove Funds from Several Programs. Figure 5 summarizes the programmatic impact of the Governor's mid-year and budget-year proposals. As the figure shows, the largest effect would be a reduction of $867 million for TCRP projects. This amount includes $189 million transferred to the General Fund in the current year and $678 million that otherwise would be available from TIF in 2004-05. Local street and road improvements and mass transit programs would also lose money due to the suspension of the Proposition 42 transfer. Also, mass transit programs would lose additional money due to the proposed transfers of PTA revenues.

Suspending Proposition 42 also reduces STIP funding. The administration, however, expects this loss to be offset by funds to be generated from shifting local projects from an accrual to a cash basis. On balance, the Governor's proposals would result in a net increase of $14 million for the STIP, as shown in Figure 5.

However, Caltrans is still assessing the status of local projects to determine how much it can realize by making the proposed accounting change. Until that assessment is complete, it is not known whether $800 million is in fact available. To the extent the available amount is lower, STIP funding would be reduced in the budget year.

Stopping All TCRP Projects Would Result in Unknown Closeout Costs. The Governor's proposals would halt all expenditures on TCRP projects as of February 1, 2004. This would leave a number of projects—those for which work is being done under contract—unable to complete outstanding contracts. The administration proposes to examine these existing contracts and determine for each whether it would be cheaper to complete work on the contract or terminate it, possibly paying a penalty to the contractor. However, Caltrans has not yet performed this assessment and does not know what the costs would be to the SHA.

Furthermore, the administration's proposal would rescind all letters of no prejudice already granted by CTC. This would likely cause local agencies that are currently spending their own money on TCRP projects to stop work on some of these projects, as they would no longer have reason to expect reimbursement from the state.

TCRP Projects Would Crowd Out STIP Projects. In addition to removing TCRP funding, the administration proposes to repeal the statutory funding guarantee for the 141 projects included in the program. Without a dedicated funding source, TCRP projects would have to compete with other projects for state funding in the STIP. This would cause a reprioritization of projects in many regions of the state, with some existing STIP projects being pushed back in favor of TCRP projects. In this way, the proposal would delay not only TCRP projects, but STIP projects as well.

Near-Term Funding: Issues and Options for Legislative Consideration

We recommend that the California Transportation Commission and Caltrans report expected Transportation Congestion Relief Program (TCRP) project closeout costs to the Legislature by April 2004. We also note that the Legislature can allow work to continue on a subset of TCRP projects, if it chooses to do so, by providing partial funding. In addition, the Legislature should consider whether a certain number of engineering staff resources should remain in the agency to work on a "shelf" of transportation projects to be delivered in the future.

Closeout Costs Should Be Estimated. As was the case last year, the Legislature is again faced with determining whether TCRP projects should continue in the near term, and if so, at what level of funding. A key piece of information required to make this determination is what the expected TCRP project closeout costs would be if all TCRP funding were terminated. Without this information, the Legislature cannot compare the potential fiscal impacts of all of the options before it. Because this vital information was not yet available at the time this analysis was prepared, we recommend that CTC and Caltrans, in consultation with local transportation agencies, review TCRP project status to estimate project closeout costs and report the findings to the Legislature by April 2004.

Legislature Must Decide Level of TCRP Funding. The more significant near-term transportation funding decision facing the Legislature is whether to suspend all TCRP funding and repeal the program, as proposed by the administration, or to continue funding the program at some level. If the Legislature decides not to terminate the program, it can consider various funding options to allow the program to proceed.

Figure 6 presents four options.

• Repeal TCRP, as Proposed. This option would reduce expenditures on TCRP projects in the current year and remove them altogether in the budget year, but would also result in unknown closeout costs.
• Fund Only Projects With Existing Allocations. This option would require not transferring $189 million to the General Fund in the current year, and would also require an additional transfer of $163 million into TCRF in 2004-05. This option is similar to the Legislature's decision in the 2003-04 Budget Act to fund only projects with existing allocations.
• Fund Projects With Existing Allocations and Projects With Letters of No Prejudice. This option would require $258 million in 2004-05 in addition to retaining the $189 million in the current year.
• Fund All Expected Costs of TCRP Projects in the Current and Budget Years. This option would allow new TCRP allocations to begin in the budget year. This would cost $498 million in 2004-05, in addition to retaining the $189 million in TCRF in the current year.

Of course, using General Fund money for TCRP projects, as described in three of the four options listed, would require additional General Fund expenditure savings or revenue to make up the difference.

Staff Resources Can Be Retained to Work on Shelf Projects to Provide Steady Project Delivery. As funding of projects fluctuates, project delivery workload also fluctuates. This causes Caltrans' capital outlay support staffing, which is based on estimated project delivery workload, to fluctuate as well. Another near-term issue the Legislature should consider is whether project delivery staffing should remain more stable than available project funding in order to ensure that a steady stream of shelf projects is being readied for construction, in anticipation of increased funding in the next few years as past loans to the General Fund are repaid and federal reauthorization is finalized. Retaining more staff may help to prevent a loss of expertise, ensuring the department's ability to deliver projects when sufficient funding returns. We discuss this issue in greater detail in our Caltrans (Item 2660) write-up. 

Transportation Needs Stable Long-Term Funding

While the Governor's proposals will affect total transportation funding mainly in the current and budget years, the impact on transportation programs will extend beyond 2004-05. This section discusses the longer-term funding problems faced by transportation and how they are affected by the Governor's proposals. In particular, the section discusses the need for stability in transportation funding and makes recommendations to provide long-term funding stability.

Long-Term Funding Outlook Is Limited and Uncertain

While annual vehicle travel continues to increase, inflation-adjusted state transportation revenues have declined over the past decade. In addition, the level of future transportation revenues is highly uncertain due to several factors, including unknown Proposition 42 commitments and the federal funds consequences of the state's conversion to ethanol- blended fuel. Some of these factors are reflected in the 2004 State Transportation Improvement Program (STIP) Fund Estimate, which will add no new transportation projects over and above those planned in the 2002 STIP.

Real State Transportation Funding Has Not Kept Pace With Increasing Travel. The number of miles driven on California roads has steadily increased over the past decade. As Figure 7 indicates, vehicle-miles traveled on all California roads increased 20 percent between 1991-92 and 2001-02. This trend is projected to accelerate through the budget year, with vehicle-miles traveled expected to be over 30 percent higher in 2004-05 than in 1991-92. However, state transportation funding has not kept pace with this trend. At the state level, transportation is funded primarily by the excise tax on gasoline and diesel fuel. Figure 7 shows that revenues from this tax roughly kept pace with miles traveled throughout the 1990s, as the tax rate was gradually increased in that period from 9 cents to 18 cents per gallon. From 1998-99 through 2004-05, however, inflation-adjusted state gas tax revenues are projected to decline 8 percent while vehicle-miles traveled increase by more than 16 percent.

As Funding Has Declined, Requirements Have Increased. In 1999, SR 8 (Burton) required CTC, in consultation with Caltrans and regional transportation agencies, to produce a ten-year assessment of the funding requirements of the state's transportation system. The resulting report identified over $100 billion in unfunded transportation needs over the following decade. The TCRP and Proposition 42 would have addressed a relatively small portion of this need, but to date they have not provided significant additional funding to do so. While the SR 8 study has not been updated since 1999, the lack of significant additional state funding to date and the declining value of the gas tax suggest that the state's unfunded transportation requirements are still of this magnitude.

Several Factors Add Uncertainty to Future Funding. Many transportation funding sources are highly unpredictable, adding uncertainty to the future transportation funding picture. For example:

• Proposition 42 Revenue Is Not Guaranteed. The largest uncertainty for long-term transportation funding in California is how much money to expect from Proposition 42. The ability to suspend the transfer of Proposition 42 funds to transportation on an annual basis, combined with the General Fund's ongoing funding problems, calls into question future scheduled transfers and makes long-term planning based on this funding source impossible.
• Timely Repayment of General Fund Loan Is Highly Uncertain. Another uncertainty is whether the General Fund will repay on schedule the loans it has received from transportation. As currently scheduled by statute, the General Fund is to repay almost $1.4 billion to TCRF in 2005-06, with another payment of $856 million due to TIF in 2008-09, of which $389 million is to go to TCRF. These loan repayments represent significant General Fund obligations that contribute to the projected General Fund shortfall in future years beyond 2004-05. Given our estimates of the state's fiscal condition, even if all of the Governor's solutions are adopted, we believe repayment of the loans on this schedule is highly unlikely.
• Toll Bridge Seismic Cost Increases May Affect STIP. Yet another uncertainty in future STIP funding is the cost of toll bridge seismic retrofit projects. Current statute provides no more than $5.1 billion to complete the seismic retrofit of seven state-owned toll bridges. As of October 2003, Caltrans estimates that total retrofit costs will equal $4.9 billion. However, work is still ongoing on two bridges, and several large contracts for the east span of the San Francisco-Oakland Bay Bridge have not yet been awarded. If the cost of ongoing work increases, or if bids come in higher than expected, more funding may be required for these projects. This increase in funding would likely come at the expense of STIP projects.
• Federal Funding Level After Reauthorization Is Uncertain. As mentioned in a previous section, reauthorization of the federal transportation funding bill was due in October 2003, but appears unlikely to occur for at least several months. While this reauthorization seems certain to increase federal transportation funding, the amount and timing of the increase are uncertain.
• Conversion to Ethanol Will Reduce Funding Under Current Law. Complicating the federal funding picture is uncertainty regarding the federal tax on ethanol-blended fuel. The state recently completed its conversion from fuel blended with MTBE to an ethanol blend. Because the federal tax on ethanol-blended fuel is about 29 percent less than on fuel with no ethanol content and a portion of the revenue is directed to the federal General Fund, federal funding for transportation would be less than before the conversion. Due to a lag between federal gas tax collection and the distribution of funding to the states, this decrease in funding will not materialize until 2005-06. However, it is projected to be quite substantial, decreasing expected federal revenue to California by $563 million in 2005-06, and by more than $700 million annually thereafter. Figure 8 shows the impact of the ethanol conversion on federal transportation funding available to the state, as projected in the 2004 STIP Fund Estimate.

It is expected that the federal government will take some action to address this funding drop, but until reauthorization occurs, it is not yet known whether the full impact of the conversion will be mitigated. Thus, the funding level remains uncertain.

2004 STIP Fund Estimate Reflects Reduced, Uncertain Funding. Primarily because of the delay in the reauthorization of the federal transportation bill and the projected impact of ethanol on federal revenues to the state, the 2004 Fund Estimate, approved by CTC in December 2003, projects significantly less funding over the next five years than previously assumed. Compared to the five years covered by the 2002 STIP, the 2004 Fund Estimate projects $4.5 billion less in funding. Funding through 2008-09 is expected to be just enough to cover the costs of the projects already programmed in the 2002 STIP through 2006-07. As a consequence, the 2004 Fund Estimate expects to provide no new programming capacity through 2008-09 over and above those projects that are already programmed in the 2002 STIP.

The longer-term funding picture could worsen considerably from that projected by the 2004 Fund Estimate. This is because the fund estimate projects revenues based on current law. Specifically, it assumes that the annual Proposition 42 transfers will occur as provided by current law. If these transfers do not occur throughout the five-year period, $1.7 billion-worth of projects will have to be deleted from the STIP.

Uncertain Funding Delays Projects, Causes Waste

Large transportation projects are funded from multiple sources, which makes them particularly vulnerable to funding fluctuations. If expected funding does not materialize after a project is started, it may have to be cancelled or delayed, incurring potentially large costs in the process. In addition, fluctuations in Caltrans' project delivery staffing due to funding changes can add delay and additional costs to projects.

Projects With Multiple Funding Sources Need Predictability. Large projects with high costs often must be funded from multiple sources. If expected funding from a given source does not materialize, the project could be delayed while awaiting replacement funding. Also, some funding sources are contingent on other funding sources remaining in place. For example, much federal transportation funding requires matching funds. If the matching funds are lost on a project, the federal funds are too. Thus, a project's funding is only as stable as its least-predictable funding source.

Stopping and Restarting Projects Increases Cost, Causes Waste. Perhaps more serious for a project is the loss of funding while work is being performed. If the project is only in its early stages and work is being performed by Caltrans staff, then project work can stop with potentially minimal cost impact. If work under contract has to cease before the contract is complete, however, there could be financial penalties to the state to stop work. This problem is exacerbated if the project is under construction, as there would likely be additional costs to bring the partially completed project to a state in which it can safely be left unattended for an indefinite period of time. Some of the closeout costs associated with stopping TCRP projects are of this nature.

Staffing Changes Can Worsen the Effects of Funding Fluctuations. Much of the design and engineering work performed by Caltrans staff is on projects that will not incur significant expenditures until several years into the future when they are in the middle of construction. If Caltrans cuts back work on projects too severely during lean funding years, it could significantly reduce the delivery of projects in future years when more funding is available. This would lead to large fund balances that sit idle for some time until project delivery catches up. Conversely, if project delivery capability is increased too quickly in good times, too many projects may be ready in the future, when the funding situation may have worsened. This would cause projects to have to wait in line for funding. The ideal way to address this problem would be to stabilize transportation funding, as we recommend at the end of this section. Even if funding is not stabilized, the problem could be addressed by stabilizing project delivery staffing. We address this possibility in our analysis of Caltrans' budget (Item 2660).

Transportation Funding Should Be Stabilized

We recommend the Legislature take several actions to stabilize ongoing transportation funding. These actions include (1) asking the voters to repeal Proposition 42, (2) increasing the gas tax to replace the Proposition 42 funding, and (3) indexing the gas tax to adjust for inflationary cost increases.

Stability Is Paramount for Transportation Funding. Uncertainty in funding for transportation projects makes long-term planning difficult. Large fluctuations in funding result in money being wasted due to stopping and restarting projects. Thus, stabilizing transportation funding would increase the efficiency of transportation expenditures. However, actions taken in the current year and proposed for the budget year, together with projections of ongoing General Fund shortfalls in future years on a current law basis, suggest that Proposition 42 cannot be relied upon as a predictable ongoing fund source for transportation. The Legislature has primarily two options to reduce this uncertainty, both requiring a change in the State Constitution.

• Firewall Proposition 42. This change would entail removing the provision within Article XIX B of the State Constitution that allows for the suspension of Proposition 42. This would ensure that transportation projects receive all the funds that are expected from this source. However, this would eliminate a means for the state to address any significant future General Fund problems.
• Repeal Proposition 42. This change would remove Article XIX B from the State Constitution and remove all statutory references to TCRP. This would allow the sales tax on gasoline (roughly $1 billion annually) to remain in the General Fund, as was the practice prior to Proposition 42. However, transportation funding, while more predictable, would be at a lower level unless alternative sources are provided.

While both options would contribute toward long-term transportation funding predictability, they differ in terms of the amount of transportation funding they provide. As noted in a previous section, identified transportation funding requirements far outweigh available funding. In adopting Proposition 42, voters recognized that state funding for transportation ought to be higher than the level provided by the existing 18-cents-per-gallon gas tax. If the Legislature chooses to ask voters to repeal Proposition 42, we believe the lost transportation funding should be replaced from a different source.

Gas Tax Is a Logical Transportation Funding Source. Transportation spending has traditionally been funded by an excise tax on gasoline and diesel fuel. This tax has several qualities that make it a logical source for transportation funding:

• Roughly a User Fee. The gas tax is charged to drivers only, in rough proportion to the amount of driving they do. The relationship is not exact due to the fact that gas mileage varies according to vehicle type and driving conditions, but the amount of tax paid does vary closely with the amount of mileage driven. Thus the gas tax approximates a fee charged for the provision of a service—that is, the road used by the driver. Most other potential transportation funding sources, such as local sales taxes, bear no relationship to miles driven. Only direct tolls for road use are closer to a user fee for driving than the gas tax.
• Simple to Collect. Collection of the gas tax is relatively efficient. Drivers are not inconvenienced, as they pay the tax whenever they stop for fuel. Collection at the state level is simple as well, as the state collects the tax directly from fuel distributors, which are few in number.
• Economically Efficient. Gas taxes can also result in greater economic efficiency by reducing the amount of gasoline consumption to a more "optimal" level. Gas usage results in "external" costs (such as pollution and congestion), and an excise tax results in a higher price that reflects these additional social costs. This in turn can have the effect of decreasing gasoline consumption to a more acceptable level.

Because of the qualities noted above, we believe that the state should rely on the excise tax on gasoline and diesel fuel as the main source of transportation funding as it has in the past. We estimate that an increase of 6 cents per gallon in this tax would generate about the same amount of revenue that otherwise would be provided by Proposition 42. In addition, since Proposition 42 revenues increase with inflation over time, a per-gallon excise tax meant to replace this revenue would also need to grow over time.

Legislature Should Raise and Index Gas Tax to Provide Stable Transportation Funding. In order to stabilize transportation funding at a level equivalent to that envisioned under current law, we recommend that the Legislature take actions to (1) ask the voters to repeal Proposition 42 and (2) increase the state gas tax to provide an equivalent amount of revenue as would be generated under Proposition 42. Furthermore, to prevent the future erosion of transportation funding relative to road use, we recommend that the gas tax be indexed to the California consumer price index.

Governor's Proposals Raise Additional Long-Term Funding Issues

The Governor's proposal to manage local projects on a cash basis (instead of accrual) increases the risk that future funding may not be sufficient to cover project expenditures. If the Legislature concurs with this proposal, we recommend that the Legislature specify in statute the priority of cash expenditures to ensure local projects are not delayed due to a shortage of cash. We further recommend that Caltrans be directed to report periodically to the California Transportation Commission on the use of state cash for local projects.

Furthermore, we note that the proposal to pay debt service with transportation funds removes $406 million in transportation funding in the long run. Finally, while the Governor's proposal addresses some of the long-term uncertainty surrounding Traffic Congestion Relief Program projects, several funding issues must still be addressed.

Changing Accounting Basis of Locals' Federal Funding Puts Local Projects at Risk. The Governor's proposal to free up $800 million in federal funding by managing local projects on a cash basis would remove the guaranteed federal funding locals now get at the front end of their projects and replace it with a commitment from the state to provide cash for the projects on an as-needed basis. This proposal could theoretically have no impact on the local agencies' ability to deliver projects if (1) Caltrans and local agencies can accurately project the future cash flow needs of projects, (2) future funding amounts are predictable without big fluctuations (particularly, drops) and state cash is available when needed, and (3) other demands on future funding can be anticipated. However, if local expenditures occur at a higher level than projected in a given year, such as when a project progresses faster than expected, the state may run short of cash to meet the local project's need, while funding all other activities including state projects. Also, Caltrans may face unanticipated demands for state cash that compete with the needs of local projects. In such instances, Caltrans would have to determine the priorities for the use of state cash. Depending on the priorities set by Caltrans, local projects could be delayed, potentially causing cost increases and defaults on ongoing contracts.

Recommend Priority Setting for Cash Use. If the Legislature concurs with the Governor's proposal to cash in federal funds to help the General Fund, we think action should be taken to minimize the funding risk to local projects. Accordingly, we recommend the enactment of legislation specifying priorities for the use of state cash to meet local project needs. We further recommend that Caltrans be directed to review local projects' cash flow needs and report to the CTC on a quarterly basis information on the use of state cash for local projects. This would provide oversight to ensure that the progress of local projects is not hindered in the long run by the proposal to shift the management of federal funds from accrual to cash. In our analysis of Caltrans' budget, we further review Caltrans` capability to manage cash for local projects and make related recommendations.

Payment of Bond Debt Service Reduces Transportation Funding by $406 Million Over the Long Run. By cashing in federal funds via a change in accounting methodology, the Governor proposes to generate one-time funds to provide $606 million for the General Fund. Of this amount, $200 million would be a loan that would be repaid by June 30, 2007. The remaining $406 million would be a direct transfer to the General Fund to make the debt service payments on transportation bonds. Thus, in the long-run, total transportation funding is reduced by $406 million. If the state were to retain this amount for transportation uses instead of paying the General Fund for debt service on transportation bonds, additional transportation projects could be funded more quickly.

Proposal Signals No Commitment to TCRP Projects; Long-Term Funding Should Be Addressed. Given the General Fund condition in recent years, funding of TCRP has been highly uncertain from year to year. Terminating the program, as proposed by the Governor, would eliminate that element of uncertainty for the program. However, it would require individual TCRP projects to find new funding sources, which would increase the funding risk for other STIP projects. This is because high priority TCRP projects, under the proposal, would compete for funding under the STIP process. As we mentioned earlier, some STIP projects would be crowded out. If STIP funding is not augmented, this would force local agencies to reprioritize their projects, pushing some further into the future. Additionally, some large TCRP projects might never be constructed. This is because currently some TCRP projects are designated to receive state funds far exceeding the share of STIP money that is allotted to the county in which the project is located. Funding such projects may mean that the county would not have any STIP funds for other transportation priorities for many years. To the extent that these TCRP projects are still of high priority to the Legislature, it may have to separately provide funding for them.