Capital Outlay Overview

As shown in Figure 22, the Governor’s budget proposal includes about $1 billion in new capital outlay funding for 2009–10. Most of the proposed funding for UC and CSU would come from lease–revenue bonds. The remaining capital outlay funding would come from the balances of general obligation bonds authorized by voters in previous years.

Most Capital Outlay Projects Suspended in December

Although the Governor’s proposal includes funding for continuing and new projects, the Pooled Money Investment Board (PMIB) in December 2008 suspended bond funding for most state–funded projects at the three higher education segments. (See the box below for background information about PMIB and the suspension of bond funding.) The suspension affects approximately 400 projects in higher education. These projects range from $30,000 capital renewal projects to $50 million academic facilities.

Many of the projects were at convenient stopping points—such as the end of preliminary plans or preparing to go to bid. Others, however, were in the middle of construction, and thus incurred extra costs to close down and secure the construction sites. Additionally, projects under construction could incur extra costs through penalties paid to contractors if the suspension of work exceeds the terms allowed in the contract, usually 30 to 45 days.

These cost factors could cause numerous projects to exceed their budgets and require augmentations for completion. The segments, however, could cover the cost increases resulting from the suspension of projects without a new funding source in a number of ways. These include:

• Contingency Funds. A 5 percent to 8 percent contingency fund is allocated with each appropriation for state–funded capital outlay projects. The contingency funds are meant to cover unforeseen costs or necessary design changes. The contingency funds could offset cost increases resulting from the funding delay if these funds were not expended for other project costs.
• Bid Savings. State–funded projects are budgeted to allow for an annual 5–percent escalation of construction costs. Due to the economic downturn, costs have not escalated at this rate, and many projects could bid for less than budgeted. These bid savings would be available to cover cost increases related to delays from the suspension.
• Cancellation of Lower–Priority Projects and Reversion of Funds. The segments could also cancel lower–priority projects so that the projects’ unspent funds revert to replenish the segments’ bond fund balances. The balances could then be appropriated by the Legislature to cover the delay costs of other projects. The cancelled projects could be started again when additional general obligation bonds or other funding sources are available.
• Campus or Gift Funds. Campuses could raise funds to cover cost increases or to continue state–funded projects despite PMIB’s suspension of state funding. Also, community colleges potentially could access local funds.

These options are not ideal. Projects would still be delayed and savings that would normally go toward funding additional projects would be spent on the rising costs of current projects. However, these options provide ways for the segments to cope with potential delays without further state funding.

Limitations of Lease–Revenue Bonds

The Governor’s proposal relies heavily on lease–revenue bonds for funding projects at UC and CSU because their general obligation bonds are essentially exhausted. The 2008–09 Budget Act also used lease–revenue bonds for many UC and CSU projects in lieu of the Governor’s original proposal to fund education projects with a new general obligation bond. Financing with lease–revenue bonds costs slightly more than general obligation bonds, but in the current economic climate moving projects forward with lease–revenue bonds allows the state to take advantage of low construction costs. The exclusive reliance on lease–revenue bonds, however, creates capital–planning problems because the bonds are not appropriate for some types of projects.

Lease–Revenue Bonds Cannot Be Used for the Segments’ Highest–Priority Capital Projects. Due to requirements for selling the bonds, lease–revenue bonds are limited to funding new buildings, replacement buildings, additions, or significant renovations. Many of the segments’ top priorities—such as seismic upgrades, minor renovations of older buildings, campus infrastructure, capital renewal (upgrades to building systems), and minor capital outlay—cannot be funded with lease–revenue bonds. Older buildings and outdated infrastructure typically represent the greatest safety risks on campuses. Lease–revenue bonds can be used to demolish and replace older buildings, but cannot be used for minor renovations of the existing structures, which is often more cost efficient. Capital renewal and minor capital outlay are also cost efficient because they maintain existing buildings, extending their useful life. The Governor’s 2009–10 proposal for UC and CSU includes two replacement buildings and one extensive renovation, but otherwise proposes new buildings. Meanwhile, seismic renovations, infrastructure projects, and other priority projects in the segments’ capital outlay plans remain unfunded.

DOF Concluded Equipment Cannot Be Funded With Lease–Revenue Bonds. As recently as the 2007–08 Budget Act, lease–revenue bonds were used to cover all phases of higher education projects—including equipment. However, DOF has recently told state agencies that it will no longer allow lease–revenue bonds to finance the equipment phase of projects due to requirements in the underwriting process for the bonds. The Governor proposes using lease–revenue bonds to fund the initial phases of 14 projects at UC and CSU, requiring that additional funds be made available for their equipment phases in subsequent years. The total estimated equipment costs for these 14 projects would be $32 million. The 2008–09 Budget Act also used lease–revenue bonds to fund 11 projects at UC and CSU that will require an additional $18 million for equipment. The UC indicated that some campuses would use gifts or other funds to cover their equipment costs. Since UC and CSU’s general obligation bonds are depleted, the state voters would most likely need to approve additional general obligation bonds in order for the state to cover these equipment costs. In our view, the state should not invest in projects that lack sufficient funding for their completion. We therefore recommend that the Legislature require UC and CSU to commit to using nonstate funds for the equipment phases prior to appropriating lease–revenue funding to these new projects.

General Obligation Bonds Provide More Flexibility. Relying on lease–revenue bonds to finance higher education capital outlay limits the range of projects which the state can support. In the long run, it would promote costlier growth and replacement projects as opposed to renovations. It would also limit the ability of the state to support essential projects including seismic upgrades, campus infrastructure projects, and capital renewal. The segments hope that a federal stimulus package (see next section) would provide funds for these projects in the short term. However, over the long term, the state would need the flexibility of general obligation bonds to continue meeting higher education’s capital outlay demands. In the event additional general obligation bonds become available, the Legislature should consider reserving a large portion for renovations, renewals, and infrastructure as the other types of capital projects could continue to be funded with lease–revenue bonds when general obligation bonds have been spent.

Economic Stimulus

With the economic downturn, there has been added emphasis on the role of infrastructure spending in stimulating the economy based on the idea that the state or federal government’s investment in capital projects would help to create jobs. For funding to provide an immediate stimulus to the economy, it would need to be directed to projects that are “shovel–ready”—meaning the projects have completed their environmental studies and design plans and are ready to start construction. Work could also begin on projects that do not typically require extensive environmental studies or design plans, such as equipment purchases, deferred maintenance, capital renewal, and energy–efficiency improvements.

State’s Ability to Provide Economic Stimulus Through Higher Education Capital Outlay Spending Is Limited. The higher education segments do not have many shovel–ready projects ready for funding in the budget year. Due to many factors—most notably, planning funds from a 2008 general obligation bond did not materialize—the segments do not have many projects in advanced planning stages that could break ground soon. Additionally, many of the shovel–ready projects at UC and CSU—such as infrastructure, seismic upgrades, and capital renewal projects—are not eligible for funding with lease–revenue bonds. As a result, less than 25 percent of the projects proposed in the Governor’s budget could begin construction within the budget year.

Potential for Federal Stimulus. Given indications that the federal government is considering economic stimulus legislation that includes infrastructure funds for states, each of the higher education segments submitted a list of projects to the Governor’s office to be considered for federal funds. The lists mainly include those shovel–ready projects that could not be funded with lease–revenue bonds and smaller maintenance projects. However, the size of a potential federal stimulus award, the procedures for its distribution, and any conditions attached to the funds are unclear. The availability of federal funds could provide additional options for funding higher education’s capital outlay priorities. While relying on federal funds would be premature at this time, we believe the Legislature, if possible, should delay finalizing its 2009–10 capital spending plan for higher education to allow for the inclusion of any federal funds.

Evaluating the Governor’s Capital Outlay Proposals

Although the Governor’s proposal has limited potential for immediate economic stimulus, the construction climate makes it an appropriate time for the state to invest in capital projects. In our opinion, however, the Legislature should remain cautious in its funding decisions and only fund those projects which reflect state priorities, minimize costs, and for which funding is available. We offer recommendations in the next section on how the Legislature could apply this approach to the specific proposals in the Governor’s budget. The Legislature might have additional options if federal stimulus funds become available, but at this time we confine our recommendations only to the Governor’s proposals due to the uncertainty surrounding the federal stimulus plan. We summarize our recommendation in Figure 23.