Analysis of the 2006-07 Budget Bill Legislative Analyst's Office February 2006

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 2006-07 Governor’s Budget proposes to reverse this trend. Specifically, it proposes to fully fund Proposition 42 and partially repay a previous loan of transportation funds to the General Fund. In addition, as part of his Strategic Growth Plan, the Governor proposes to provide $12 billion in general obligation bond funding and $14 billion in revenue bond funding for state transportation over the next ten years. Furthermore, he proposes to permanently firewall Proposition 42 funds after 2006-07 by prohibiting suspension of the transfer from the General Fund.

In aggregate, these proposals would provide additional investment in transportation over the next decade and make the funding more predictable. The Governor’s proposed methods for project selection and fund allocation, however, stray from established processes and lack detail in how bond funds would contribute to congestion relief. Accordingly, we highlight a number of policy issues that the Legislature should consider.

California’s state transportation programs are funded by a variety of sources, including special funds and federal funds. 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. The SHA is funded through revenues from an 18 cent per gallon excise tax on gasoline and diesel fuel (generally referred to as the gas tax), in addition to weight fees. The PTA is funded by sales tax on diesel fuel and a portion of the sales tax on gasoline.

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 2007-08. The program 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 to the TIF and dedicated the funds to various transportation programs. These programs include local street and road improvements, the State Transportation Improvement Program (STIP), State Transit Assistance, and other mass transportation activities.

The STIP. The state’s primary program for construction of new transportation projects is the STIP. Funding comes primarily from the SHA, PTA, TIF and federal funds. 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 the Department of Transportation (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, these projects are to receive about $4.9 billion through 2007-08 from the General Fund and sales tax on gasoline. Through 2005-06 they will have received about $2.4 billion. (This amount assumes $1 billion in tribal gaming bond funds arrive in the current year which, as discussed later, is not likely to occur until the budget year.) 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 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 by 2005-06. Because of loans to the General Fund and Proposition 42 suspensions, TCRP will have only received $3.4 billion through 2005-06. (This amount again assumes $1 billion in tribal gaming bond funds arrive in the current year.)

Funds Redirected. In the past five years, funds designated for transportation have annually been redirected to help the General Fund. The repeated diversion of transportation funds has led to delay and additional costs in many STIP and TCRP projects.

In the following sections, we discuss the condition of transportation funding in the current year, describe the Governor’s proposals for transportation funding in 2006-07 and later years, and discuss the implications of these proposals for transportation funding in both the near and the long term.

Funding Condition Improved Substantially In Current Year

A year ago, in our review of the 2005-06 Governor’s Budget, we noted that transportation funding in California faced substantial uncertainties in four major areas. These included:

• The Governor’s budget proposed to suspend the Proposition 42 transfer of funds to transportation.

• The receipt of tribal gaming proceeds to repay past-year loans to transportation was uncertain.

• The future demand on state funds to complete the toll bridge seismic retrofit program was unknown.

• Congress had not yet reauthorized federal funding for transportation.

Funding Outlook Has Significantly Improved. Since then, the state transportation funding picture has improved significantly. First, the adopted 2005-06 budget provides the full amount of Proposition 42 money to transportation. Second, legislation was enacted in July 2005 to address the long-term funding for the seismic retrofit of toll bridges. Third, in August 2005, the federal government reauthorized a multiyear transportation funding act. Together, these actions have increased the total funding level for state transportation programs and substantially reduced the uncertainties regarding future funding levels.

Bay Bridge Funding Settled; Demand on State Funds Certain

Legislation adopted in 2005 provided an additional $3.6 billion in funding for the completion of the toll bridge seismic retrofit program, and specified that any excess costs above the amount provided would be borne by the Bay Area Toll Authority. This provides certainty that any excess costs for the program would not create an additional burden on future state transportation funding.

Chapter 71, Statutes of 2005 (AB 144, Hancock), provided $3.6 billion in additional funding to complete the state toll bridge seismic retrofit program, including the replacement of the east span of the San Francisco-Oakland Bay Bridge. Figure 1 summarizes the major provisions of Chapter 71. Together with previously committed funding, the added funds represent a total funding commitment of $8.7 billion for the program. The funding provided by Chapter 71 will come mostly from new toll and bonding authorization, as well as from redirection of other transportation funds. Chapter 71 also specified that any future cost overruns would be paid by the Bay Area Toll Authority through raising bridge tolls or issuing bonds. As a result, if costs for the program exceed $8.7 billion, there would be no additional draw from state transportation funds. Thus, Chapter 71 reduces the uncertainty of future demands on state funds.

New Federal Transportation Act Provides Funding Through 2009

The new federal act will provide $23.4 billion to California through 2009, including $18 billion for highways, $5 billion for transit, and $452 million for safety. The new act also presents opportunities for financing transportation through nontraditional sources and expediting project delivery.

There are a number of issues for the Legislature to consider and areas where further legislative actions are warranted to facilitate implementation of the act in California. These issues and our recommendations for legislative actions are detailed in our January 2006 report regarding the new federal act.

Key Features of the Federal Act. The federal government enacted the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU) in August 2005. It provides federal funding for transportation through 2009. Figure 2  summarizes the key provisions of SAFETEA-LU. The act authorizes $241 billion nationwide for transportation between 2005 and 2009. This represents a 42 percent increase in average annual funding over the previous program, the Transportation Equity Act for the 21st Century (TEA-21). The general structure of SAFETEA-LU is relatively similar to TEA-21. The act also guarantees “donor” states such as California a minimum rate of return on state fuel tax contributions annually, with the rate increasing from 90.5 percent in 2006 to 92 percent in 2009. Additionally, the act includes a number of provisions that influence the way that transportation facilities are planned, built, and administered. Specifically, SAFETEA-LU encourages private investments and partnerships in constructing transportation facilities, in addition to providing opportunities for environmental streamlining, design-build contracting, and private toll projects.

Funding to the State. Figure 3 lists California’s funding authorization by purpose. The new federal act will provide $23.4 billion to California through 2009, including about $18 billion for highways, $5 billion for transit, and $452 million for safety improvements. Funding for highways accounts for 76 percent of all funding allocated to California, with formula grant programs comprising the majority ($15 billion) of highway funding. The remaining $2.4 billion in the state’s highway allocation will come from earmarked funding (from discretionary programs).

California will receive about $5 billion for transit purposes. This amount includes approximately $3.9 billion in formula grant programs and $1.3 billion earmarked in discretionary grants. The transit funding level represents 22 percent of California’s total transportation funding allocation under SAFETEA-LU. This share, however, could increase as the state applies for and receives additional funding for transit projects from discretionary programs like High Priority Bus and New Starts.

Funding for safety improvement programs accounts for a relatively small portion of the state’s total authorization. The majority of California’s federal safety funds will flow through the Highway Safety Improvement and Safe Routes to School programs.

High Level of Earmarks. While formula funds provide the most flexible source of funding for addressing state priorities, these funds experienced only modest growth over TEA-21 levels. However, earmarked funds to the state are substantially higher under SAFETEA-LU. Specifically, $3.7 billion (16 percent) of California’s authorization are earmarked for more than 500 specific projects. This more than quadruples the total amount of earmarked funds received by the state ($877 million) under TEA-21.

Many Earmarks Provide Partial Funding for Large Projects. About two-thirds ($2.5 billion) of the state’s earmarked funds are associated with large highway, transit, and goods movement projects. The act authorizes funding of $20 million or more for each of 24 projects around the state. However, in few cases do the earmarked amounts cover the full project costs. As such, state and local agencies must identify substantial additional funding from other sources to fully cover project costs. For example, the $130 million earmarked for carpool lanes on I-405 does not come close to meeting full project costs, which recently were estimated to exceed $500 million.

State Has Little Discretion in Use of Earmarked Funds. While earmarked funds infuse the state with federal dollars, these grants are not very flexible. Specifically, the state has little discretion to transfer earmarked funds to other projects that it may deem to have higher priority. In cases where earmarked funds are for projects that are a high statewide priority this lack of flexibility may be less of an issue. Some earmarks, however, are tied to projects less crucial from the state‘s perspective. If an earmarked project is not a state priority, dedicating state funding to fully pay for the project would limit the state’s ability to address higher priority demands.

Need to Assess How Earmarks Align With Priorities, Resources. In order to utilize California’s allotment of earmarked funds, significant additional funding must be made available. While many of the earmarked projects are high in statewide priority, others may not be so. Providing all of the additional resources to fully fund earmarked projects could potentially skew the state’s priorities, resulting in state funds being directed to lower priority projects.

To address this issue, we recommend the enactment of legislation that directs CTC, in cooperation with Caltrans and local transportation agencies, to estimate the remaining funds required to fully finance the state’s earmarked projects. Additionally, CTC should provide an assessment of which earmarked projects rank higher in state priorities and which earmarks rank lower. With this information, the state would be able to make better decisions regarding the allocation of state funds to supplement the earmarked projects.

(For more detailed information about SAFETEA-LU, please see our report Funding of Transportation: What the New Federal Act Means for California, January 19, 2006, which is reprinted in “Part V” of our companion volume, The 2006-07 Budget: Perspectives and Issues.)

2006-07 Budget Proposals

The 2006-07 Governor’s Budget includes a number of proposals related to transportation funding, which in aggregate, would result in significantly higher levels of transportation funding in 2006-07 than in recent years. Specifically, the budget proposes the following:

• Transfer to transportation the full amount required by Proposition 42. For the budget year, this amount is projected to be $1.4 billion.

• Repay early a portion-$920 million (including principal and interest)-of a loan due in 2007-08 from the General Fund.

• No “spillover” for the PTA as required by existing law.

• Transfer $9.3 million in non-Article XIX revenue in the SHA to the General Fund.

The Governor’s budget assumes $1 billion in tribal gaming bond revenues to be available in the current year for transportation.

Proposition 42 to Be Fully Funded in 2006-07. The budget proposes to transfer $1.4 billion of gasoline sales tax revenues to the TIF, the full amount required under Proposition 42. Of these funds, $678 million will be available to fund construction of TCRP projects, $146 million will be allocated to the PTA for public transportation, and $582 million will be used for STIP projects. Consistent with current law for the budget year, none of the revenues will be allocated for local streets and road purposes.

Early Repayment of Previous Suspension. In 2004-05, due to the state’s fiscal condition, the entire Proposition 42 transfer was suspended. The suspended amount of about $1.3 billion must be repaid with interest by 2007-08. The Governor’s budget proposes to repay early a portion of the loan-$920 million (principal and interest)-in the budget year. The balance, approximately $430 million (including interest), would be repaid in 2007-08.

Early Repayment Not Guaranteed. According to Caltrans staff, the timing of the $920 million in repayment of the 2004-05 suspension depends on the fiscal health of the General Fund and therefore may not occur until late in 2006-07. To the extent that this repayment occurs before 2007-08 (as was originally scheduled), it would provide a jump start for stalled STIP and TCRP projects, as well as delayed improvements on local streets and roads. However, if these funds arrive late in the budget year or are delayed to 2007-08, they will provide less timely assistance to these projects.

No Spillover Revenues for Public Transportation in 2006-07. Current law provides that, in years in which revenue from the state’s sales tax on gasoline is relatively high and revenue from the sales tax on all other goods is relatively low, some of the gasoline sales tax revenue that would otherwise go to the General Fund is to be transferred to the PTA for mainly rail and transit uses. This is known as spillover.

In recent years, due to the state’s fiscal condition, spillover revenues have often been retained in the General Fund. From 2003-04 through 2005-06, a total of $735 million in spillover to the PTA was suspended. For 2006-07, current law requires that the first $200 million of spillover be retained in the General Fund with the next $125 million used to fund the toll bridge seismic retrofit program. Any remaining spillover revenues (in excess of $325 million) would then be available for public transportation. The Governor’s budget projects spillover revenue to be less than $325 million in 2006-07. Accordingly, the Governor’s budget proposes no spillover for rail and transit uses.

Tribal Gaming Bond Revenue Will Likely Be Delayed to 2006-07; Availability Still Uncertain. To aid the state’s fiscal condition, a total of about $1.4 billion was loaned from the TCRF to the General Fund in 2001-02 and 2002-03. Of that amount, $183 million was repaid in 2004-05. Under Chapter 91, Statutes of 2004 (AB 687, Nuńez), the remaining $1.2 billion would be repaid from bonds backed by tribal gaming revenues.

Due to pending lawsuits, the state did not issue tribal gaming bonds in 2004-05. Instead, the sale of the bonds was assumed to occur in the current year. The current-year budget also reduced the amount of the loan to be repaid by bond revenues to $1 billion. The Governor’s budget assumes that $1 billion in bond revenues would be available in 2005-06. However, there is currently one pending lawsuit with the potential to further delay the issuance of the bonds and another case is being appealed. On this basis, the Department of Finance recently indicated that the funding would most likely not be available until 2006-07. If these funds materialize in 2006-07, total transportation funding for the budget year would be correspondingly higher.

Delay in Tribal Gaming Bond Proceeds Could Adversely Impact TCRP Project Delivery. Failure to generate $1 billion in tribal gaming bond revenue in 2006-07, however, would cause major delays to TCRP projects. This is because $290 million of the bond funds are designated for TCRP projects, which is roughly 20 percent of the proposed funding for these projects in 2006-07. In addition, current law requires TCRF to repay SHA, by the end of 2006-07, $465 million for a past loan. If TCRF does not receive tribal gaming bond funds in 2006-07, the repayment to SHA would have to come from Proposition 42 resources ($678 million) allocated to TCRF in 2006-07 or from its proposed share ($410 million) of the 2004-05 suspension repayment. To the extent that neither the 2004-05 suspension repayment nor the tribal gaming bond revenues materialize in the budget year, funding for TCRP projects would be significantly lower than what is proposed in the 2006-07 budget.

Budget Proposes Transportation Funds for General Fund Use. The Governor is also proposing to transfer to the General Fund $9.3 million in SHA revenues that are not restricted by Article XIX of the State Constitution. The amount includes mainly income from rental property and revenue from the sale of documents. Similar transfers have been made in past years to aid the General Fund.

Budget Proposals Boost Short-Term Funding

If all of the transportation funding proposed for 2006-07 materializes, it would enable many transportation projects to proceed, and begin to “catch up” on prior-year delays. The funding increase, however, would not provide any additional transportation projects beyond what has already been scheduled for delivery.

If the proposed early repayment of the 2004-05 Proposition 42 loan materializes, together with the full transfer of Proposition 42 funds in 2006-07, a substantial amount of transportation capital projects would be able to be funded sooner than expected. Many of these projects have been delayed repeatedly as transportation funds were loaned to the General Fund. As Figure 4 shows, the proposals combined would provide about $1.1 billion for TCRP projects, $837 million for STIP projects, $146 million for public transportation, and $255 million for local streets and road improvements.

The budget proposals are of particular significance for the progress of TCRP. As Figure 5 shows, lack of funding in prior years has set the program far behind the originally anticipated funding level. Assuming further delays in the availability of tribal gaming bond revenues in 2005-06, the program will have received slightly more than one-fourth of the total funding intended for the program by the end of the current year. As regards 2006-07, if the Governor’s budget proposal materializes with full funding of the Proposition 42 transfer, early partial repayment of the suspension and receipt of tribal gaming proceeds, then cumulative funding for TCRP would be much closer to the amount that was originally anticipated, as shown in Figure 5. (However, as we indicated earlier, there is still some uncertainty as to whether these funds would be available in the budget year.)

The budget year proposals would also have a positive impact on the STIP. Specifically, the proposed funding levels would allow CTC to allocate funds for STIP projects that have been programmed but up until now have not received funding.

While a number of projects can proceed due to the substantial funding level proposed for 2006-07, it is important to note that the funding would allow only a “catching up” of prior-year delays in the state’s transportation programs. This is because there is still about $1.4 billion in loans yet to be repaid to fund various transportation projects, even if $1 billion in tribal gaming bond revenues and the partial 2004-05 suspension repayment materialize in the budget year.

Allocation of Proposed Loan Repayment Does Not Align With Statute

Current law specifies how any repayment of the 2004-05 Proposition 42 suspension will be allocated among various transportation programs. The Governor proposes to allocate the $920 million early repayment in a different manner. We recommend that Caltrans and the California Transportation Commission report at budget hearings on how the programmatic impacts of the proposed allocation would differ from the allocation required under current law.

The Governor’s proposed early repayment of $920 million for the 2004-05 Proposition 42 suspension, if received, would help advance many TCRP and STIP projects, as well as local street and road improvements. The proposed allocation of the $920 million, however, is not consistent with the repayment requirement set forth in current law. Chapter 212, Statutes of 2004 (SB 1098, Committee on Budget and Fiscal Review), requires that repayment of the 2004-05 suspension, regardless of the fiscal year in which it is made, be allocated in the same manner as funds would have been allocated had the suspension not occurred. This means that rather than receiving $410 million (as proposed in the budget), the TCRF should receive the first $720 million (principal plus interest) out of the $920 million in repayment. According to Chapter 212, the remaining funds would be allocated as follows: 40 percent to local streets and roads, 40 percent to STIP and 20 percent to PTA. Figure 6 displays how the $920 million would be distributed in accordance with Chapter 212 compared to the allocation proposed in the Governor’s budget. As the figure shows, the Governor’s proposed allocation would provide a lower funding level for TCRP projects and PTA than required by Chapter 212, but provides significantly higher funding levels for STIP projects and local streets and roads.

The Department of Finance indicates that the proposed allocation reflects a policy decision by the administration and it will propose trailer legislation to effectuate this policy change. In order that the Legislature can assess whether the proposed allocation is warranted, we recommend that the department and CTC report at budget hearings on the programmatic impacts of the proposed allocation on STIP and TCRP projects compared to the impacts that would result under Chapter 212.

Strategic Growth Plan

In addition to the various transportation funding proposals specific to the 2006-07 budget, the Governor is proposing a Strategic Growth Plan (SGP) that lays out a ten-year funding plan totaling $223 billion to improve state infrastructure, including $107 billion for transportation in particular. In this section, we discuss the key funding features of the transportation component of the plan.

Key Elements for Transportation

Ten Year Funding to Come From a Mix of Existing and New Sources, Including Bonds. The Governor proposes funding to include the following:

• $47 billion in existing transportation funding sources such as state gas tax and weight fee revenues, the Proposition 42 transfer and federal funds.

• $48 billion in new funding including private investments, future local sales tax revenues for transportation, and bonds backed by future state and federal transportation funds. Specifically, the Governor proposes $14 billion in bonds to be backed by future state gas tax and weight fee revenues.

• $12 billion in general obligation (GO) bonds, including $6 billion each to be authorized by voters in 2006 and November 2008 elections.

Bond Funding Focuses on State Highway System. A significant element of the SGP for transportation is the proposed use of GO bonds for transportation. Figure 7 summarizes the proposed allocation of $12 billion in GO bonds over ten years. As the figure shows, most of the GO bond money would be for improvements on the state highway system and the state intercity rail services.

The bond funds would not be allocated according to the current STIP fund allocation process, where 25 percent of funding is used for interregional improvement and 75 percent for regional improvements. Instead, the Governor proposes that most of the bond funds be allocated to projects proposed by the Business, Transportation and Housing Agency and Caltrans. The plan would allow for project changes only if specified conditions are met.

Significant Reliance on Future Revenue Bonds. The SGP also calls for the issuance of $14 billion in revenue bonds backed by future state gas tax and weight fee revenues. Beginning in 2015 and continuing for 30 years, 25 percent of these revenues-up to $1.025 billion per year-would be set aside to pay debt service on these bonds. As with the proposed GO bonds, allocation of these revenue bond funds would not be subject to the current statutory STIP allocation process. Instead, the bond funds would be allocated to projects proposed primarily by the Business, Transportation and Housing Agency and Caltrans. The plan would allow for project changes only if specified conditions are met.

Permanently Firewall Proposition 42 for Transportation. As part of the SGP, the Governor is proposing to amend the State Constitution to delete the authority to suspend the Proposition 42 transfer after 2006-07. This would ensure future transfer of gasoline sales tax revenues to transportation.

Other Provisions. The SGP also calls for:

• Authorizing public-private partnerships whereby the state enters into long-term lease agreements with the private sector for the latter to construct, operate, and maintain transportation facilities over an extended period of years. The SGP proposes to use $4 billion in GO bond money to leverage about $14 billion in private investments through these partnerships.

• Authorizing Caltrans and local transportation agencies to use design-build to deliver capital projects.

Implications of Strategic Growth Plan On Long-Term State Transportation Funding

In general, the Governor’s proposals to provide bond funds to transportation over the next ten years and to firewall Proposition 42 would provide the state transportation system with both increased investment and funding stability. These proposals, in conjunction with the passage of SAFETEA-LU and resolution of the state’s role in financing the toll bridge seismic retrofit program, would significantly improve California’s transportation funding picture relative to past years. Nonetheless, the Legislature should consider a number of issues in assessing the Governor’s proposals and their impact on the state’s transportation program over the long term.

Bonds Provide One-Time Funding Increase

The California Transportation Commission has identified substantial unfunded transportation demands throughout the state, and most have not yet been addressed. The proposed general obligation bonds would provide a one-time infusion of funding to transportation. How effectively this additional funding would address the state’s transportation priorities, however, depends on the types of projects funded.

Gas Tax Revenues Have Not Kept Pace With Increasing Travel. The number of miles traveled on California roads has steadily increased over the past 15 years. As Figure 8 indicates, vehicle-miles traveled on all California roads are projected to increase 35 percent between 1991-92 and 2006-07. However, gas excise tax revenues, a major source of transportation funding in the state, have not kept pace with this trend. Figure 8 shows that this tax roughly kept pace with miles traveled through much of the 1990s, as the tax was gradually increased in that period from 9 cents to 18 cents per gallon. From 1998-99 through 2006-07, however, inflation-adjusted state gas tax revenues are projected to decline 8 percent while vehicle-miles traveled increase by more than 16 percent. (Gas tax rates are not adjusted for inflation. As a result, inflation erodes the purchasing power of the revenues over time.)

As Funding Has Declined, Demands Remain High. In 1999, as required by SR 8 (Burton), CTC produced 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 annual Proposition 42 funding would have addressed a portion of these demands, 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 annual redirections of transportation funding to other uses combined with the declining value of the gas excise tax suggest that the state still faces large, unfunded transportation demands, likely of the magnitude identified in the SR 8 report.

Bonds Would Provide Additional Funds to Address Demands; Efficacy Depends on Types of Projects Funded. Providing $12 billion in GO bonds would substantially increase the state’s level of investment in transportation infrastructure over the next ten years. Nonetheless, how effectively the one-time bond funds address the state’s transportation priorities ultimately depends on how the money is targeted and the types of projects that are funded. These decisions have not yet been made. At the time this analysis was prepared, the administration had proposed a “working list” of projects that it maintains are targeted to reduce congestion and improve throughput on the state highway system. These projects focus mainly on improvements to the interregional segments of the state highway system and the intercity rail system.

Administration Has Failed to Demonstrate Projects’ Congestion Benefits

The Strategic Growth Plan proposes a major infusion of state funds into a list of projects selected exclusively by the administration. So far, it has not provided the Legislature with basic information necessary to assess the merit of these proposals. Accordingly, we recommend that the Legislature not approve the Governor’s bond proposals until the administration provides the requested information.

Instead of allocating the proposed $12 billion GO bond funds in accordance with the current STIP process, the SGP would infuse $12 billion in GO bond funds into a list of projects proposed exclusively by the administration. (The Business, Transportation and Housing Agency and Caltrans will select the projects to receive bond funds. The Environmental Protection Agency will provide input on a subset of these projects.) While many of the projects proposed for bond funding undoubtedly are of high priority, the administration has failed to provide essential information that is necessary to assess the merits of the projects, including information regarding the congestion benefits that would be realized through these investments. Specifically, we have asked the administration to provide the following information, but to date have received no response:

• The total cost of each project in the proposed list and the proportion of total project costs that would be funded through the bond funds. This would allow an assessment of how much, if any, additional funding would be needed to fully pay for the proposed projects.

• How well the proposed projects align with currently programmed STIP and TCRP projects, as well as high priority earmarks in SAFETEA-LU. The state has already programmed many projects in the STIP for the next five years, and it has also committed to funding 141 TCRP projects. Many of these projects do not yet have full funding. Thus, additional resources will be needed to complete them. Similarly, the federal act has earmarked a significant amount of federal dollars to provide partial funding to many projects statewide. To the extent the projects proposed for the bond funds result in providing full funding for projects that are of high statewide priority, the impact on mobility and congestion could be significant. Otherwise, the effect on congestion and mobility would be less noticeable.

• The estimated amount of congestion relief to be achieved by each proposed project and how the department estimated the congestion reduction effect. This information would allow a relative ranking of the proposed projects based on how well each project is expected to reduce congestion. The information would also facilitate a comparison of the proposed projects with other improvements that are not on the proposed list in terms of their relative impact on congestion reduction.

• The current state of development for each of these projects and the estimated project delivery date. This information would provide an indication as to when the bond funds would be used, as well as when projects can be expected to be completed. To the extent the proposed projects have been defined and scoped, delivery of the projects could be sooner than if the projects are not yet defined.

In order to assess whether the proposed bond funds would be used effectively, the Legislature needs to receive the above information. Without this information, it is impossible to determine how the proposed projects rank in reducing congestion relative to other improvements, such as enhancements to commuter rail systems, as well as improvements on regional segments of state highways and principal arterials. Accordingly, we recommend that the Legislature not approve the Governor’s bond proposals until the administration provides this information.

Revenue Bonds Would Negatively Impact Future Highway Maintenance and Rehabilitation

The proposal to use state gas tax and weight fee revenues to pay debt service on future revenue bonds would reduce the amount of funding available for highway maintenance and rehabilitation. Providing adequate funding for these activities would necessitate either an increase in the gas tax or weight fees in the future, or a redirection of Proposition 42 funds to these activities. We recommend that the Legislature reject this proposal absent additional revenues being provided to back these bonds.

Gas Tax Mostly Funds Highway Maintenance. Currently, state gas tax and weight fee revenues are used mostly for highway maintenance and to fund projects in the State Highway Operation and Protection Program (SHOPP), which include rehabilitation and safety improvement projects. (Projects that expand transportation capacity are generally funded with gas sales tax revenues, federal funds and other nonstate sources.) These revenues are the only source of state funding available for highway maintenance. This is because federal funds generally are not available for maintenance purposes, nor are Proposition 42 funds. While SHOPP projects can be funded with federal funds (when matched with state funds), Proposition 42 funding is not statutorily available for this purpose.

Modest Growth in Gas Tax Revenue. As noted above, growth in state gas tax revenue has not kept pace with inflation. This revenue stream grows with increases in the consumption of gasoline and diesel. In past years, the growth has been relatively modest, at around 2 percent a year. In the long run, as the consumption of alternative fuel increases, growth in the state gas tax revenue could be even slower. However, given an aging transportation system, highway maintenance and rehabilitation requirements will increase over time, and in all likelihood will outpace the revenue growth. For instance, Caltrans issued a five-year maintenance plan in January 2005 which showed that annual expenditures on the roadway, drainage, and bridge component of the highway system would have to more than double the current level (from $147 million to $397 million a year) in order to address the maintenance backlog for these facilities.

Governor’s Proposal Squeezes Highway Maintenance and Rehabilitation. Beginning in 2015 and continuing for 30 years, the Governor’s proposal would take “off the top” up to $1.025 billion a year from state gas tax and weight fee revenues for debt service on the revenue bonds he proposes. Our review shows that given the relatively modest revenue stream and growth in maintenance and rehabilitation needs, this would leave inadequate state funds for these activities. Maintaining the current level of funding for highway maintenance and rehabilitation after 2015 while paying the debt service on the proposed revenue bonds would necessitate an increase in future state gas tax or weight fees. Alternatively, a portion of future Proposition 42 funding could be redirected to these purposes. This would require a change in the Proposition 42 formula which currently allocates funds to the STIP, PTA, as well as local streets and road improvements. (This would require a vote by the electorate to make Proposition 42 funds available for this purpose.) Absent these actions, the state would fall short of maintaining and preserving the current highway system.

Using Revenue Bonds for Transportation Has Merit; but Should Not Crowd Out Essential Functions. As we discuss in a later section, bonding provides an appropriate means to finance capital investment under certain circumstances. Using revenue bonds for transportation has merit particularly where the revenue used to back the bonds are generated from user fees such as gas tax and weight fees. This is because these fees provide users a clear signal of the costs of the facilities being funded. However, the use of the bonds should not crowd out other essential services that are funded by the same revenues. Accordingly, we recommend that the Legislature reject the Governor’s proposal unless a new stream of user fee revenues is provided for the debt service payments of these bonds.

Proposal Improves Transportation Funding Stability; But Removes a Tool to Close the State’s Budget Gap

Transportation funding has been highly uncertain for several reasons, including uncertain annual Proposition 42 commitments and repayment of prior year loans made from transportation. The Governor’s proposal would improve the predictability of transportation funds by guaranteeing future Proposition 42 transfers. However, this removes a tool to close the state’s budget gap.

Uncertain Funding Delays Projects, Causes Waste. Large transportation projects tend to be funded from multiple sources, making them particularly vulnerable to funding fluctuations. If expected funding does not materialize, a project may have to be cancelled or delayed. Funding fluctuations in recent years have delayed and increased construction costs for many STIP and TCRP projects. (Please see our write-up on this issue in the Analysis of the 2004-05 Budget Bill, page A-33.)

In addition, some funding sources are contingent on other funding sources remaining in place. For example, much of the federal transportation funding provided in SAFETEA-LU requires additional funds from nonfederal sources to cover full project costs. If these additional funds do not materialize, federal funds are lost. Thus, a project’s funding is only as stable as its least predictable source.

Funding for State Transportation Capital Projects Relies Heavily on Proposition 42 Money. State gas tax and weight fee revenues provide the largest source of ongoing state funding for transportation. However, these revenues are mostly dedicated to highway maintenance and rehabilitation. State funding for capital improvements that expand the capacity of the state’s transportation system (such as adding traffic lanes, constructing new highways, and expanding rail services) relies mainly on the availability of Proposition 42 funds. The CTC estimates that for the 2006 STIP period (2006-07 through 2010-11), additional new projects can be programmed for funding only if Proposition 42 funds are forthcoming for the entire five-year period and past transportation loans are repaid in full. Without these funds, there would be no resources to fund additional projects, over and above the ones that have already been scheduled for funding through 2008-09 (in the 2004 STIP).

Guaranteeing Proposition 42 Transfers Improves Funding Predictability; Removes Budget Balancing Tool. Currently, the state can suspend partially or fully the Proposition 42 transfer when the Governor and the Legislature agree that making the transfer “will result in a significant negative fiscal impact on the range of functions of government funded by the General Fund.” This provides the state with the flexibility to redirect Proposition 42 funding to other nontransportation priorities in times of tight fiscal conditions, such as the state has experienced in the past few years. However, this also creates uncertainty regarding the availability of Proposition 42 funds for transportation from year to year.

The Governor’s proposal to eliminate the suspension authority would make Proposition 42 funding a certainty. This would allow for better long-term capital planning; allow projects to be programmed on a steady, even-flow basis from year to year; reduce project delays and costs; and lessen Caltrans staffing fluctuations. However, eliminating that suspension provision would also remove a tool the state could use as it continues to confront budgetary imbalance.

Analyst’s Assessment of Governor’s Proposals

The Governor’s Strategic Growth Plan would provide an increase in funding for transportation and make ongoing state support for transportation more certain. However, the administration has not provided information to justify its proposed use of general obligation bond funds. Furthermore, its proposal to improve transportation funding stability would adversely impact the state’s ability to address tight fiscal conditions.

Figure 9 summarizes our assessment of the Governor’s proposals in his Strategic Growth Plan. As we discussed, these proposals have certain merits. Specifically, the SGP would provide a significant increase in one-time funding for transportation in the form of GO bonds. Additionally, the SGP would improve funding predictability by guaranteeing the Proposition 42 transfer of gasoline sales tax revenue to transportation.

However, the Governor’s proposals also raise fiscal and policy concerns. The projects funded by SGP bond funds would be selected outside of the STIP process. This means that regional transportation planning agencies would have little influence over which projects get funded. Projects would be selected primarily by the Business, Transportation and Housing Agency and Caltrans, based on criteria to be determined by the administration. In addition, the Governor proposes $14 billion in revenue bonds to be issued in 2015 that would be backed by existing gas tax and weight fee revenues. Absent an increase in the gas tax or weight fee revenues, this bond could crowd out highway maintenance and rehabilitation. Lastly, while the Governor’s firewall of Proposition 42 revenues would make transportation funding more stable, it would reduce the flexibility of the state in the event of tight fiscal conditions.

Legislature Should Assess Funding Requirements; Enhance Funding Stability

In assessing the Governor’s proposal, the Legislature should consider two primary issues. First, should additional funding be provided to transportation? Second, how should transportation funding be stabilized while providing the state with maximum fiscal flexibility?

Long-Range Funding Requirement Should Be Assessed

The state does not currently have an up-to-date assessment of its transportation needs. Therefore we recommend that the Legislature direct the California Transportation Commission, working with Caltrans and regional agencies, to (1) estimate the amount needed to complete currently programmed projects in the state’s transportation programs and federal-earmarked projects which are high in state priority, and (2) provide an updated assessment of what the state’s needs are beyond what projects have already been programmed. We further recommend that project selection for bond funding not occur until this study is complete.

Transportation Demands Exceed Recent Funding Levels. As noted earlier, CTC identified in 1999 roughly $100 billion in unfunded statewide transportation demands over a ten-year period. Despite the enactment of TCRP and Proposition 42, there has not been a significant increase in transportation funding since 2000, due mainly to the redirection of transportation funds to other uses. As a result, numerous projects designated in the TCRP and programmed in the STIP and SHOPP await funding. For the 2006 STIP period, funding for new projects would be available only if Proposition 42 funds are available annually over the next five years and all past loans are repaid. In addition, the reauthorization of the federal transportation program included over 500 earmarks to projects in California; however, the vast majority of these earmarks do not cover full project costs. If the state chooses to maximize its use of the earmarked federal funds, it may have to provide part of the funding necessary to cover full project costs. All of these demands suggest that additional funding for transportation is warranted.

To determine how much funding the state should provide, we recommend that the Legislature direct CTC, working with Caltrans and the regional agencies to do the following:

• Estimate (1) the total costs of all programmed STIP and TCRP projects, as well as the earmarked projects in SAFETEA-LU, and (2) the unfunded portion of the costs associated with these projects. This together with an identification of the priorities of SAFETEA-LU earmarked projects (as we have recommended in the report on the federal act) would provide a rough estimate of how much funding in total would be needed to complete programmed STIP and TCRP projects.

• Provide a current assessment of what the state’s needs are beyond what have already been scheduled for funding. The updated assessment should also identify the areas (such as goods movement and trade corridors) where the state may need additional investment. This assessment should be based on long-range transportation plans that have been prepared for various regions as well as Caltrans’ long-range plan for interregional transportation.

The above information would allow the Legislature to determine what the state’s priorities should be and the total funding that the state should provide over the next decade to meet these priorities. We recommend that the Legislature not allow any GO bond funds to be programmed until such a study is available. This recommendation would not, in any way, delay voter consideration of bond funds for transportation, it would merely ensure that the bond funds be targeted and programmed to meet the highest identified needs.

How Should Stable Funding Be Provided?

We recommend that the state rely on user fees to provide ongoing funding for transportation. To provide the state with the greatest fiscal flexibility while ensuring a stable source of ongoing transportation funding, we continue to recommend that Proposition 42 be repealed and the state gas tax be increased correspondingly and indexed for inflation. Other user fees such as tolls should also be considered. The state should also encourage private and local investments.

User Fees Should Be the Basis of Transportation Funding. Transportation spending has traditionally been funded from user fees. The primary transportation user fee in California is the state’s 18 cent per gallon excise tax on gasoline and diesel fuel. The tax is charged to drivers only, in rough proportion to the amount of driving they do. Thus, it approximates a fee charged for the provision of roads used by the driver. User fees provide a clear signal to road users of the cost of the service they receive, and users can respond to this signal and adjust their driving patterns accordingly. In this regard, direct tolls for road use are even closer to a user fee for driving than the gas tax.

As we indicated in past analyses (please see 2004-05 Analysis, page A-36), we think the state gas tax should be relied upon to generate the bulk of state transportation funding. This is because in addition to being roughly a user fee, the tax has other qualities that make it a preferred source for transportation funding. These include:

• 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 encouraging a lower level of fuel consumption. 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.

• Constitutional Restriction Provides Predictability of Funding Availability. Article XIX of the State Constitution restricts the use of the state gas tax (and weight fee) revenues to specified transportation purposes only. Thus, it provides a predictable stream of funding for the purposes of long-term capital planning.

Recommend Repeal of Proposition 42 and Increase in State Gas Tax. The Governor’s proposal to firewall Proposition 42 would increase the long-term stability of state transportation funding, but would reduce the state’s overall fiscal flexibility. For more than 25 years, beginning in 1973, sales tax collections on gasoline were a General Fund revenue used to support general government purposes-principally education, health, and social services. In 2000, during good economic times, the Legislature directed this revenue source to instead meet transportation priorities for a limited period of time (through 2007-08). This change was made permanent by the voters in 2002 with the provision that funds could remain in the General Fund under specified conditions.

As discussed in “Part I” of our companion volume, the 2006-07 Budget: Perspectives and Issues the state continues to face multibillion dollar shortfalls between spending and revenues under the Governor’s proposed policies throughout the forecast period. In order for the state to get and keep its fiscal house in order, we believe the Legislature needs all budget tools at its disposal, we therefore recommend, as we have in prior analyses, the repeal of Proposition 42 and raising the state gas tax correspondingly to generate an equivalent amount of funds for transportation. An increase of about 8 cents per gallon would generate the amount of Proposition 42 funding projected for 2006-07. We further recommend that the tax be indexed to inflation to prevent erosion of the revenue over time relative to road use.

Pay-As-You-Go or Bonding. The state has, for the most part, funded transportation infrastructure improvements through annual appropriations of taxes and fees using a pay-as-you-go approach. This approach limits annual expenditures to available resources generated each year and provides for a relatively steady level of capital improvements from year to year.

However, if the state wants to increase transportation investments significantly for a specific period of time, bonding provides a means to generate upfront the large amount of funds necessary for the capital improvements. Bonding for capital improvements is also appropriate because these improvements and facilities typically provide services over many years, thus different generations of taxpayers will benefit from the facilities. There are two major types of bonds that usually apply to transportation projects:

• General Obligation Bonds. The $12 billion included in the Governor’s proposals for transportation are GO bonds. These bonds are supported by the General Fund. While they add new resources to transportation, the cost of debt service is borne by all taxpayers and not exclusively by those who use transportation facilities and services.

• Revenue Bonds. The Governor’s proposed $14 billion revenue bonds would fall into this category. These bonds are backed by a dedicated stream of revenue. For transportation, the revenue generally comes from user fees such as the gas tax and weight fees. However, as discussed earlier, the Governor’s proposed revenue bonds would crowd out future funding for ongoing highway maintenance and rehabilitation. Providing adequate funding for these essential expenditures would necessitate future gas tax and weight fee increases.

Other Nonstate Funding of Transportation Should Be Encouraged. The state could provide incentives for other entities, including local governments and the private sector to invest in transportation.

• Local Funding. Many counties already have local sales tax measures with revenues dedicated to fund transportation. Because the benefits of transportation investments are felt most at the local level, the state may want to encourage more local investment in the transportation system. The state could provide matching grants to further induce the use of local funds particularly for high priority transportation improvements. An example of such an approach is the State-Local Transportation Partnership Program created in 1989 which provided matching funds for certain locally funded transportation projects.

• Private Investment. Public-private partnerships provide a means to generate private investment in the construction of transportation facilities. These partnerships often take the form of a state or local government entering into a lease arrangement with a private entity to design, construct, maintain, and operate a facility for an extended period of time. The federal act, SAFETEA-LU, includes provisions to encourage private sector investments in transportation. The Governor’s SGP includes a proposal to authorize the state to enter into such lease agreements with local entities or the private sector for up to 99 years.

• Current state law does not authorize Caltrans to engage in additional public-private partnerships. As a result, Caltrans’ experience with these partnerships is limited to two pilot projects authorized under Chapter 107, Statutes of 1989 (AB 680, Baker). Nonetheless, there may be merit to allowing Caltrans to engage in public-private partnerships, as it could attract much needed investment in the state’s transportation infrastructure. It should be noted, that private investment may work well in specific types of projects, such as truck lanes and toll facilities, but has limited potential for widespread use as many state projects might not generate an adequate return on investment to entice the private sector.

Conclusion

The funding outlook for transportation looks brighter in 2006-07 than in prior years. The Governor’s 2006-07 budget proposals, as well as his Strategic Growth Plan, add to this outlook by increasing the investment in the state’s transportation system and proposing to make funding more reliable by guaranteeing the Proposition 42 transfer. However, as we have discussed, the Governor’s proposed methods for providing these funds raise a number of fiscal and policy concerns. Specifically, the Governor’s plan would allocate state funds in a way that is not consistent with the current STIP process. Additionally, to date, the administration had failed to provide the Legislature with adequate information to assess the merit of these proposals.

Given that both the Legislature and the Governor have expressed a common interest in improving California’s transportation infrastructure, we have presented a list of issues for the Legislature to consider when developing a strategic infrastructure investment plan. First, we recommend that the state reassess its transportation funding requirement. While this task was performed in the late 1990s, transportation demands such as goods movement and trade corridors might have moved up in state priority since then. Secondly, there are a number of ways that the Legislature could fund transportation infrastructure improvements. While we continue to recommend that the Legislature ask voters to repeal Proposition 42 and replace the funding with a gasoline excise tax that is indexed to inflation, we recognize that infrastructure can be financed through a number of other methods. In addition to GO and revenue bonding, we have highlighted the possible roles of local government and the private sector in funding transportation infrastructure.