Analysis of the 2005-06 Budget Bill Legislative Analyst's Office February 2005

Transportation Funding Instability Continues

Introduction

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 TCRP is funded by two 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 2004-05, they will have received about $680 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, TCRP also provides funding for STIP projects, local street and road improvements, and mass transportation programs. Including all of these purposes, TCRP was to provide a total of $7.8 billion to transportation through 2005-06.

Funds Redirected. In the past four years, funds designated for transportation have been redirected annually to help the General Fund. The 2005-06 budget continues this practice. The repeated diversion of transportation funds, while helping the General Fund condition, raises a number of issues regarding the predictability and adequacy of future transportation funding. In the following three sections, we describe the administration's proposals regarding transportation funding, explain the state of transportation funding over the past few years, and discuss the implications of the administration's proposals for transportation funding in both the near and the long term.

Budget Proposes Continued Transportation Aid to General Fund

The 2005-06 budget includes a number of proposals that will affect transportation funding not only in 2005-06, but also in future years.

First, the budget proposes to use transportation funds to provide $1.5 billion in aid to the General Fund in the budget year.

Second, the budget anticipates tribal gaming bonds repaying in the budget year some transportation loans that were scheduled to be repaid in the current year.

Third, the administration proposes to increase the stability of transportation funding in the long run by prohibiting the suspension of Proposition 42 transfers to transportation beginning in 2007-08. However, it also proposes to delay certain loan repayments to transportation in future years.

As Figure 1 shows, the administration's proposals, when added to previous actions taken to aid the General Fund, would result in transportation loans and transfers to the General Fund totaling $4 billion by the end of the budget year. We discuss the details of the Governor's proposals in the following sections.

Budget Proposes $1.5 Billion to Aid General Fund

Proposition 42 Suspension to Provide $1.3 Billion for General Fund. Proposition 42 provides that all sales tax revenues 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 can be suspended under certain circumstances. Proposition 42 was partially suspended in 2003-04 and fully suspended in the current year.

The budget proposes to again suspend the Proposition 42 transfer in 2005-06. This would be the third suspension, in whole or in part, in the first three years of the proposition's existence. The budget estimates that the suspension would save the General Fund $1.3 billion. As Figure 1 shows, when added to the previous suspensions, this action would result in the General Fund retaining a total of $3.4 billion over three years that would otherwise have been available to transportation.

Under current law, the current-year and prior-year suspensions must be repaid to transportation in 2007-08 and 2008-09, respectively. The administration proposes that the amount to be suspended for 2005-06 also be repaid under certain conditions. However, the administration proposes to delay the repayment for all the outstanding Proposition 42 suspensions, as described later.

"Spillover" Transfer to Provide $216 Million. Current law provides that, in years in which revenue from the sales tax on gasoline and diesel fuel is relatively high and revenue from the sales tax on all other goods is relatively low, some of the sales tax that would otherwise go to the General Fund is to be transferred to the PTA. This is known as spillover. Under current law, spillover transfers to PTA would have occurred in 2003-04 and 2004-05, and would again occur in the budget year. However, statute has been changed in each of the past two years to prevent the spillover transfer to PTA. The administration again proposes to retain the spillover in the General Fund in the budget year. The Governor's budget estimates this amount to be $216 million. As Figure 1 indicates, from 2003-04 through 2005-06, spillover revenue retained in the General Fund will total about $570 million if the administration's proposal is implemented.

Tribal Gaming Bonds Deferred to Budget Year

Gaming Compacts Were to Provide $1.2 Billion for Transportation in Current Year. As Figure 1 shows, $1.4 billion was loaned from the TCRF to the General Fund in 2001-02 and 2002-03 combined. Current statute requires repayment of these loans by the end of the budget year. The 2004-05 budget repaid $183 million of the loan from the General Fund and provided repayment of the remaining $1.2 billion from bonds backed by revenue from newly negotiated tribal gaming compacts. Chapter 91, Statutes of 2004 (AB 687, Nuñez), specified how the bond revenue would be distributed among various transportation programs.

Bonds Delayed by Litigation, Budget Assumes 2005-06 Repayment. Due to an ongoing lawsuit that challenges the bonds' legality, the state has not been able to issue the tribal gaming bonds to date. The budget now assumes that the sale of the bonds will occur in the budget year, rather than in the current year. In order to eliminate any General Fund liability to repay the TCRF loans by the June 30, 2006 deadline, the administration is proposing a trailer bill to make the loan repayment explicitly contingent on receipt of the tribal gaming bond proceeds. This means that repayment will only occur after the bonds are issued, and the General Fund would no longer be liable for repaying any portion of the $1.2 billion.

Proposition 42 Protected in Future, But Repayments Delayed

Constitutional Amendment Would Prevent Future Suspension. While the budget proposes suspending Proposition 42 in the budget year, the administration also proposes to prevent suspension of Proposition 42 permanently, after 2006-07. Specifically, the administration proposes to amend the State Constitution to delete the language that provides for suspension, effective 2007-08. This would allow Proposition 42 to be suspended again in 2006-07 if the General Fund condition warrants.

Repayments of Previous Suspensions to Be Spread Over 15 Years. As stated earlier, under current law, the suspended Proposition 42 amounts for 2003-04 and 2004-05 ($868 million and $1.2 billion, respectively) are to be repaid by 2007-08 and 2008-09. These repayments would total $2.1 billion plus interest. In order to reduce the near-term pressure on the General Fund, the administration proposes to spread the repayment of these loans over 15 years. The administration proposes to repay the 2005-06 Proposition 42 suspension in the same manner and, if it occurs, the 2006-07 suspension as well. This means that instead of transportation programs receiving large lump-sum repayments in specified years, they would receive around $320 million per year for 15 years. Also, the Governor's proposal contains no provision for the payment of interest on these repayments, which would reduce the total amount provided to transportation by hundreds of millions of dollars.

State Transportation Funding Is Already Limited and Uncertain

State transportation funding has been limited in recent years due to several factors. These factors have reduced the state's allocations of funding for new projects. As a result, some transportation needs are now being met through borrowing. In addition, some actions taken in the 2004-05 budget, discussed in more detail below, have increased uncertainty for transportation funding in the near term.

Several Factors Have Limited Transportation Funding

General Fund Money for Transportation Has Not Materialized. The TCRP was enacted in 2000 to invest more General Fund money in transportation. As Figure 2 shows, as originally envisioned, it would have provided about $7.8 billion to transportation by the time the program was to expire in 2005-06. (This includes $4.9 billion for TCRP projects, with the remaining $2.9 billion divided among STIP projects, local street and road improvements, and mass transportation programs.) However, with the actions taken in past budgets and proposed in the Governor's budget, the cumulative amount of General Fund money made available to transportation through the budget year will only be $2.3 billion, assuming that the tribal gaming bond revenue is received in the budget year. About $1.7 billion of this amount would be for specific projects and about $600 million for other transportation purposes. This is $5.5 billion less than envisioned in the original statute.

Gas Tax Has Lost Value as Travel Has Increased. The number of miles driven on California roads has steadily increased over the past decade. As Figure 3 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 2005-06 than in 1991-92. However, revenue from the state's primary transportation fund source—namely, the excise tax on gasoline and diesel fuel—has not kept pace with this trend. Figure 3 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 2005-06, however, inflation-adjusted state gas tax revenues are projected to decline 8 percent while vehicle-miles traveled increase by more than 16 percent. The decline in the real value of the gas tax means that the costs of the things the gas tax is used to buy are increasing faster than the gas tax revenue. Thus, even though the state is nominally receiving more dollars from the gas tax each year, current revenue can buy fewer transportation projects than the revenue received in 1998-99.

Other Funding Sources Have Experienced Temporary Decline. Other transportation funding sources have experienced a one-time decline. These are truck weight fees and federal fuel taxes.

Truck weight fees are a major source of revenue 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 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, a total of $223 million in revenue that had been programmed for projects was lost.

Federal gas tax receipts have also experienced a one-time decline. The decline is due to the state's conversion from fuel blended with MTBE to an ethanol blend. At the time the state converted to ethanol-based fuel, that fuel was taxed at a lower rate than nonethanol fuel under federal law. The 2004 STIP projected that the lower tax rate would result in California receiving about $560 million less in federal transportation revenues in 2005-06 and over $700 million less in each year after that. Fortunately, the federal law was amended to make the tax on ethanol-blended fuel equal to the tax on fuel without ethanol. With this change, the impact of ethanol conversion on the amount of federal funding to the state was limited to a one-time decline of about $560 million in the budget year.

Reduced Funding Has Reduced Allocations, Precipitated More Borrowing. Because expected transportation funding did not materialize, CTC temporarily stopped 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. Since that time, CTC has resumed making new allocations, but at a reduced level. The CTC will likely have allocated about $600 million for new STIP projects and $1.5 billion for new SHOPP projects, with no new TCRP allocations, between December 2002 and the end of the current year—a two and one-half year period. By way of comparison, CTC typically allocates more than $2 billion annually for STIP and SHOPP projects alone.

Without a state funding allocation, 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. As a result, a backlog of "ready-to-go" projects has developed. The CTC reports that, as of June 2004, the backlog of STIP and SHOPP projects totaled $800 million, and could grow to $1.3 billion by June 2005 if new allocations remain largely suspended. Similarly, $314 million worth of TCRP projects were ready to go by December 2004 but were held back due to a lack of funding. The CTC's staff have advised us that these figures are actually understated, as project sponsors have little incentive to request funding for additional projects that have no prospect of being funded in the near term. Thus, CTC does not have a complete list of the specific projects that have been delayed.

To minimize project delays, some projects have proceeded with money borrowed from other sources. For example, several local transportation agencies have proceeded with projects using their own funding under laws that allow them to be reimbursed from the state, should funds become available. In this way, local agencies have begun work on $455 million worth of STIP projects and $269 million worth of TCRP projects that would otherwise have to wait for state funding to be available. However, to proceed with these projects, local agencies are using money that could have otherwise been used for other transportation projects. Thus, while advancing projects using local funding reduces the effect of funding shortfalls on the STIP and TCRP, this practice simply spreads the effect of the shortfalls to other areas of transportation.

The state has also borrowed 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 $658 million. These bonds are accelerating some transportation projects, but they will reduce the funding available for other projects for the 12-year duration of the debt service.

Unresolved Current-Year Issues Create Additional Uncertainty

In addition to the issues mentioned above that limit and destabilize transportation funding, additional actions taken in the 2004-05 budget to aid the General Fund have added uncertainty to the state's transportation funding.

Diversion of Non-Article XIX Funding in Question. The 2004-05 Budget Act transferred to the General Fund $108 million in miscellaneous revenue that would otherwise go to the PTA. The money was to be used to pay part of the debt service on general obligation bonds that the state has issued for transportation purposes. This revenue, which includes $96 million in income from the rental and sale of state property, is not restricted by Article XIX of the State Constitution to be used exclusively for transportation.

However, some of the properties that generated the sale and rental revenue were purchased with federal transportation funds. The Federal Highway Administration (FHWA) has informed the state that revenue from those properties may not be transferred to the state's General Fund under federal law, even if it is used for debt service payments on transportation bonds. According to FHWA, if this money were transferred to the General Fund, the state would have to repay the federal government the entire amount of federal funds that were used to purchase the properties, which could be many times the amount of revenue to be transferred.

Because Caltrans has not been able to determine the type of funds that were used to purchase each property, it cannot determine what portion of the $96 million is at issue. Therefore, it has not transferred this revenue to the General Fund because of the FHWA decision. The administration is attempting to resolve its difference of opinion on this matter with FHWA. However, until the issue is resolved, none of the $96 million can be transferred to help the General Fund. At the same time, the money cannot be used for transportation purposes.

Tribal Gaming Bonds Will Likely Provide Less Money. As mentioned earlier, the administration expects that the tribal gaming bonds will not be issued until 2005-06 to repay a $1.2 billion transportation loan. However, even if the bonds can be issued, the total amount would most likely be lower than $1.2 billion. This is because, according to the Department of Finance (DOF), gaming revenue generated from the five compacts that are the source of this funding would provide no more than $1 billion in bonding capacity. Furthermore, the State Treasurer has indicated that these bonds will be more expensive to sell than the administration first assumed, reducing the amount of bonding capacity to around $850 million.

Thus, unless similar compacts are negotiated with additional tribes in the current or budget years and the lawsuit is resolved favorably, the transportation community should not expect to receive the amount of money assumed in the Governor's budget.

Governor's Proposals Raise Further Transportation Issues

The administration's 2005-06 proposals to use transportation funding to aid the General Fund will further constrain near-term funding of transportation programs and increase program uncertainties in the short term. Over the long run, the proposal to prohibit the suspension of Proposition 42 transfers to transportation would provide added stability at the expense of the General Fund. However, another component of the administration's proposal to reform the state budget, namely the across-the-board reduction provisions, could lessen that stability and increase the volatility of Proposition 42 funding.

Proposals Further Constrain Near-Term Transportation Funding

Proposals Would Remove Funds From Several Programs. Figure 4 summarizes the programmatic impact of the Governor's budget-year proposals. As the figure shows, the largest effect would be a reduction of $678 million for TCRP projects, due to the suspension of Proposition 42. The suspension would also reduce funding for local street and road improvements, STIP projects, and mass transit programs. Additionally, mass transit programs and certain STIP projects (namely, transit and rail capital improvements) would also lose money due to the proposed retention of spillover money in the General Fund, instead of being transferred to the PTA.

Allocations for New Projects Would Have to Be Reduced. Caltrans estimated that if transportation were to receive $1.2 billion from the tribal gaming bonds and Proposition 42 were not suspended in the budget year or the following years, over $3 billion could be allocated in 2005-06 for new STIP and SHOPP projects. The CTC would also be able to restart allocations for new TCRP projects, which have been suspended since December 2002. However, with the Governor's proposal for 2005-06 and suspension of Proposition 42 uncertain (but highly likely) in 2006-07, the level of project funding in 2005-06 would be greatly curtailed.

Slower Loan Repayment Would Further Delay Projects. The impact on project funding would be compounded if the repayment of the loans due in 2007-08 and 2008-09 ($2.1 billion plus interest) were instead spread over 15 years as proposed. This is because projects typically take several years to expend their allocations, so that allocations made in one year depend not only on funding available in that year, but subsequent years as well. Thus, the less money that is available in the next few years, the less funds CTC will be able to allocate.

Analyst's Recommendation. At the time this analysis was prepared, Caltrans had not estimated how much further near-term allocations for STIP, SHOPP, and TCRP would have to be reduced by spreading repayment of Proposition 42 suspensions over 15 years. The expected level of allocations will in turn drive the size of Caltrans' capital outlay support budget in the budget year. As we discuss in our Caltrans budget analysis, Caltrans will revise its capital outlay support budget request in May 2005.

The Legislature would benefit from having a better understanding of the effect of the Governor's proposals on STIP, SHOPP, and TCRP allocations relative to other possible funding scenarios, as well as having a basis from which to evaluate Caltrans' capital outlay support request in the spring. Therefore, we recommend that Caltrans, in coordination with CTC, provide the Legislature by April 1 with an updated projection of near-term allocations under several different scenarios, including:

• Best Case. Assume no Proposition 42 suspension after the current year, repayment of the full TCRF loan (by tribal gaming bonds) in the budget year, and repayment of previous Proposition 42 suspensions per current law.
• Governor's Proposal Assuming Gaming Bond Revenue. Assume Proposition 42 suspension in 2005-06 and 2006-07 only, repayment of the full TCRF loan in the budget year, and repayment of all Proposition 42 suspensions over 15 years.
• Governor's Proposal Assuming No Gaming Bond Revenue. Assume Proposition 42 suspension in 2005-06 and 2006-07 only, no repayment of the TCRF loan, and repayment of all Proposition 42 suspensions over 15 years.
• Worst Case. Assume continued Proposition 42 suspension in every year through 2008-09, no repayment of the TCRF loan, and no repayment of any Proposition 42 suspensions.

Budget-Year Funding for TCRP Is Uncertain

Temporary TCRP Shutdown Should Be Avoided. The TCRP relies on Proposition 42 transfers and repayment of past loans to the General Fund for continued program funding. Absent these funds, work on TCRP projects would have to stop unless local agencies were able to use more of their money to continue work on these projects. Stopping work on projects would result in the state incurring extra costs in order to close out contracts for ongoing work. While this extra expense would be unavoidable if the state intended to shut down the program permanently, it would not make sense to incur closeout costs if TCRP funding were going to be provided in the future.

Even though Proposition 42 transfers were suspended in 2003-04 (partially) and the current year (wholly), the Legislature continued the program by requiring that suspended amounts be repaid in future years. To avoid incurring closeout costs, the Legislature provided sufficient funding in each of the past two years to allow TCRP projects that had already received allocations from CTC to continue. If the Legislature intends to fund TCRP in the future, it should ensure that it provides enough funding in the budget year to continue work on projects with existing allocations.

Receipt of Tribal Gaming Bond Revenue Is Uncertain. Of the amount anticipated from tribal gaming bonds, $290 million would be for TCRP projects. If the tribal gaming bonds are sold as anticipated by the Governor's budget, there will be enough funding available to continue work on TCRP projects that already have allocations. However, if the bonds cannot be sold for reasons discussed earlier, the Legislature may have to provide additional funding so that projects with existing allocations can continue in 2005-06 without work stoppage.

TCRP Budget Display Is Incorrect; Administration Intends to Revise. In order to ensure that sufficient funding is available for TCRP projects in the budget year, the Legislature needs to know how much program expenditures are expected to be in the current and budget years, as well as the balance in the TCRF. Unfortunately, the administration has confirmed that information presented in the Governor's budget for TCRF is incorrect. For instance, the budget shows no capital outlay or local assistance expenditures from TCRF in the current year, but $343 million for such expenditures in the budget year. The DOF now indicates that $269 million of the expenditures shown in the budget year are actually expected to occur in the current year. The DOF indicates that it plans to make the appropriate revisions to the Governor's budget in April.

Even Corrected Expenditures Are Out of Date; CTC and Caltrans Should Update. Our review shows that adjusting for the errors in the budget display alone would not provide an accurate picture of the condition of TCRF and thus, how much is available to fund projects in 2005-06. This is be cause, according to Caltrans, the current-year and budget-year expenditure levels shown in the budget are based on information that has not been updated since April 2004, and actual TCRP project expenditures could be very different from those assumed last year. Recognizing this, Caltrans and CTC have started to survey all TCRP project sponsors to update project expenditures. Without this information, the Legislature cannot determine the amount of funding that will be required to continue work on ongoing TCRP projects. We recommend that the Legislature direct CTC and Caltrans to provide the survey results to the Legislature by April 1, 2005. Based on this information, and pending DOF's revision to the TCRF condition in the budget, the Legislature can determine how much additional funding is needed in the budget year to continue work on TCRP projects with existing allocations or to provide funding to new projects.

Long-Term Funding Stability Is Still Paramount

As we stated in our Analysis of the 2004-05 Governor's Budget, funding stability is of paramount importance to transportation. Uncertainty in funding for transportation projects makes long-term planning difficult and results in money being wasted due to stopping and restarting projects. Unfortunately, transportation funding remains unstable due to several factors, which we have discussed in this analysis. The Governor's budget adds to this uncertainty in the near term while proposing to address the primary source of instability—Proposition 42—in the long term.

Uncertain Funding Delays Projects, Causes Waste. Large transportation projects typically take years to complete. If a transportation project is begun without sufficient funding available to complete it, it may need to be stopped and restarted, wasting time and money. 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. In order to avoid situations such as these, the state funds transportation projects based on a long-term projection of available funding.

Funding Uncertainties Remain. Unfortunately, transportation funding has fluctuated greatly in recent years, as described earlier. Several uncertainties remain for transportation funding in the near future. 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.
• Toll Bridge Seismic Cost Increases May Affect STIP. Yet another uncertainty for future STIP funding is the cost of toll bridge seismic retrofit projects. As we mention in our write-up on this topic, the state must find several billion dollars in additional funding for the seismic retrofit of toll bridges. One option to provide the money is to use existing state transportation funding sources. Doing so, however, would reduce available funding for STIP projects. (Please see "Toll Bridge Seismic Retrofit: Hard Decisions Before the Legislature" in this section.)
• Federal Funding Level After Reauthorization Is Uncertain. The federal government reauthorizes transportation funding on a six-year cycle. Congress, however, did not reauthorize the federal act when it expired in October 2003, and it has yet to do so to date. Instead, it has extended transportation funding at the existing level several times, with the latest extension set to expire in May 2005. While the reauthorization seems certain to increase federal transportation funding, the amount and timing of the increase are uncertain.

Governor Proposes to Add Stability to Transportation Funding at Expense of General Fund, But Uncertainties Remain. The administration's proposal to remove the ability to suspend Proposition 42 beginning in 2007-08 would remove the primary source of uncertainty for transportation funding and allow more projects to be completed more quickly than if Proposition 42 could continue to be suspended.

Our review, however, shows that the proposal may not eliminate all uncertainties. This is because the Governor is also proposing various measures to reform the state budget, including a measure that calls for automatic across-the-board reductions in General Fund expenditures during a fiscal year under specified conditions. If this proposal is adopted, Proposition 42 funding could be subject to unplanned fluctuations. This is because Proposition 42 transfers to transportation are counted as General Fund expenditures and would be subject to any across-the-board reductions in a fiscal year. This could, depending on the magnitude of the required reduction, create unanticipated volatility in the funding of transportation projects and make long-term planning more difficult.

At the same time, the Governor's proposal reduces policymakers' discretion to set expenditure priorities for General Fund money. By requiring the Proposition 42 transfer to transportation under any circumstance, the Governor's proposal permanently increases General Fund expenditures and removes an option to address General Fund shortfalls.

LAO's Recommendation Would Stabilize Funding Without Affecting General Fund. In our discussion of transportation funding in the 2004-05 Analysis, we recommended an alternative means of stabilizing transportation funding that would not require transferring money from the General Fund. Our recommendation was to repeal Proposition 42, raise the gas tax by six cents per gallon, and adjust the gas tax for inflation in future years. These actions would provide about the same amount of money to transportation as Proposition 42 while freeing General Fund revenues to be used for nontransportation purposes. Additionally, because gasoline tax revenue is restricted by the State Constitution to be used for transportation only, it would not be subject to uncertainties created by fluctuations in the state's fiscal condition. (Please see the 2004-05 Analysis for more details.)

Conclusion

Transportation funding has been limited and uncertain in recent years due to several factors, including actions taken in the 2004-05 Budget Act that have not produced the expected results.

The Governor's budget proposals would further restrict transportation funding and increase uncertainty in the near term. The TCRP would be particularly affected, and it is uncertain whether there will be sufficient funding in the budget year to continue work on TCRP projects. We recommend that the administration provide information to the Legislature that would allow it to determine (1) the effect of the Governor's proposals on the size of the transportation program and (2) TCRP project funding needs in 2005-06.

The proposed protection of Proposition 42 in the future would increase transportation funding stability at the expense of the General Fund, though funding uncertainties will remain. We have previously recommended a means of stabilizing transportation funding without affecting the General Fund.