February 17, 2005
Dear Attorney General Lockyer:
Pursuant to Elections Code Section 9005, we have reviewed the proposed
initiative entitled “The California Deficit Prevention Act” (File No.
SA2005RF0012). This measure makes changes to the California Constitution related
to state and local appropriations limits, the budget process, voting
requirements relating to tax measures, state debt, fees, and local mandates.
Article XIII B of the Constitution places annual limits on the
appropriations of tax proceeds that can be made by the state, school districts,
and local governments in California.
Calculation
of the Spending Limit. The
annual spending limit for each jurisdiction is based on the amount of
appropriations in 1978‑79 (the base year), as adjusted each year for
population growth and cost-of-living factors. For the state, “population” is
equal to a weighted average of statewide population and K-14 school average
daily attendance (ADA), and “inflation” is equal to the growth in California
per-capita personal income.
Appropriations
Subject to the Limit. In
general, appropriations subject to the limit are equal to all appropriations
funded from the proceeds of taxes (both General Fund and special funds), except
for those which are specifically exempted under Article XIII B. Exempt
appropriations include debt service, qualified capital outlay spending, local
mandate subventions, retirement and unemployment insurance payments,
transportation expenditures supported by a portion of the state excise tax on
gasoline, and subventions to other levels of governments (the latter being
counted against the recipient entities’ spending limits).
Disposition
of Excess Revenues. At the
state level, revenues are defined as “excess” if they exceed the
appropriations limit over a two-year period. Such revenues are then divided
equally between taxpayer rebates and onetime appropriations to K-14 schools.
Current
Room Under State’s Limit. Based
on estimates in the Governor’s 2005‑06 proposed budget, the state is
$9.4 billion below its appropriations limit in 2004‑05 and will be
$9.7 billion below the limit in 2005‑06. This large gap opened up in
2001‑02 following the steep revenue downturn in that year.
Reserve Provisions. The
current limit requires that the state maintain a prudent reserve. Proposition 58
(approved by voters in March 2004) established a specific General
Fund reserve entitled the Budget Stabilization Account (BSA), and requires that
annual amounts of General Fund revenues be transferred to the account beginning
in 2006‑07. Each year, 50 percent of revenues allocated to the fund
will be used to repay any outstanding deficit-financing bonds. The remainder is
available to the General Fund upon a majority vote of the Legislature.
Legislative
Spending. Annual growth in the
Legislature’s budget is limited to the change in the state’s appropriations
limit.
Beginning in 2006‑07, this measure eliminates the existing
constitutional provisions relating to state and local appropriations limits and
replaces them with a new, more comprehensive limit on state government spending.
Local jurisdictions would no longer be subject to an appropriations limit.
However, the measure prohibits a local government from spending in any year more
than it receives in revenues (including reserve funds).
Some of the main provisions related to the coverage, level, and annual
growth rates for the proposed limit are as follows:
The
new state limit would generally apply to all state General Fund and
special funds spending (versus appropriations). Annual transfers to
the BSA would not count against the limit (although spending from the
BSA would).
The
spending limit in the initial 2006‑07 year would be equal to the
actual amount of spending in 2004‑05 as adjusted for the two-year
increase in California population and the cost of living. The increase in
cost of living is based on a weighted index consisting of (1) the U.S.
consumer price index for health care (weighted according to the share of
state expenditures devoted to health programs) and (2) the lesser of
(a) per capita personal income or (b) the California consumer price index
(weighted according to share of state expenditures devoted to
non-health-care programs).
The spending limit in
subsequent years would be based on actual spending in the prior year as
adjusted for changes in population and the cost of living as defined.
The
proposal does not modify the Proposition 98 minimum funding guarantee
growth factors.
Disposition
of Excess Revenues. In contrast to the current
limit, where excess revenues are established over a two-year period, this
measure requires excess revenues to be established annually. Any such excess
would first be proportionally allocated between the General Fund and each
special fund. The portion attributed to special funds would be held in reserve
for expenditures in a subsequent year. The General Fund’s share would be
allocated in the following manner:
Twenty-five
percent would be deposited into a newly created Special Reserve Account,
until the account’s balance reaches 5 percent of allowable
expenditures for the year. Money from the reserve account could be used for
either an emergency (as defined in the measure), or to support spending in
years that revenues fall below the expenditure limit.
Up
to 50 percent would be allocated through the annual budget acts for one
or more of the following purposes: to (1) repay maintenance factor
outstanding as of June 30, 2005 at a rate of no more than one-fifteenth of
the amount per year; (2) repay loans made from the Transportation Investment
Fund in 2003‑04 and 2004‑05, with annual amounts not to exceed
one-fifteenth of the balances as of June 30, 2005; and (3) repay outstanding
deficit-financing bonds.
Twenty-five
percent could be used for local school or highway construction projects.
Any remaining funds would go to the Sales Tax Rebate Account. Moneys in this account would accumulate until there were sufficient amounts to allow for the reduction of the state sales tax rate by at least one-quarter cent for a 12-month period.
Proposition 98 Interactions. The measure would not affect the Proposition 98 minimum funding guarantee growth factors. As a result, total (that is, combined state and local) funding for K-14 education would generally grow faster than the proposed limit over time. General Fund support for Proposition 98, however, is influenced by both the overall growth in the guarantee and the growth rate in local property taxes (which offset, dollar-for-dollar, General Fund spending requirements for K-14 education). We project that relatively high growth in property taxes will reduce General Fund spending growth for K-14 education during the next several years.
Other
Provisions and Definitions. The measure
would allow spending in excess of the limit for an emergency. It defines
“emergency” for this purpose to be a natural disaster or a condition of
extreme peril to public safety. It states that an emergency does not include
fiscal peril caused by revenue shortfalls, excessive spending, or imprudent
budgetary decisions. The measure also:
Provides that the limit could be increased for a four-year period upon approval by a two-thirds vote of each house of the Legislature and a majority of the voters in the following statewide election.
Ties annual growth in the Legislature’s budget to the revised spending limit growth factor.
Makes a minor change to current constitutional provisions related to employee rights mandates.
Background. The Constitution vests the power to appropriate funds with the Legislature. The annual state budget is the Legislature's primary method of authorizing expenses for a particular year. The Constitution requires that (1) the Governor propose a budget on January 10 for the next fiscal year (beginning the following July 1), and (2) the Legislature pass a budget by June 15.
When the Governor receives a budget bill he or she may then either sign or veto it. The Governor may also reduce certain individual appropriations in the budget before signing the measure. However, this line-item veto authority cannot be applied to some programs where expenditures are governed by separate laws. Also, once the budget is signed, the Governor may not unilaterally reduce any appropriations.
Balanced Budget Requirements. As amended by Proposition 58 (approved by the voters in March 2004), the budgets passed by the Legislature and ultimately signed into law must be balanced, meaning that revenues must exceed expenditures.
Late Budgets. When a fiscal year begins without a state budget, most expenses do not have authorization for payment. Over time, however, a number of court decisions and legal interpretations of the Constitution have expanded the types of payments that may continue to be made when a state budget has not been passed. Consequently, when there is not a state budget, payments now continue for some portion of state employees' pay, debt service, and various programs authorized by the Constitution, federal law, or initiatives.
Midyear Adjustments. If an
enacted budget falls out of balance, the Governor may declare a fiscal emergency
and call the Legislature into special session to consider proposals to deal with
the fiscal imbalance. If the Legislature fails to pass and send to the Governor
legislation to address the budget problem within 45 days after being called into
special session, it is prohibited from acting on other bills or adjourning in
joint recess.
This measure makes changes to the budget process relating to late budgets and midyear adjustments.
Late Budgets. If the Legislature fails to pass a budget before a new fiscal year commences, this measure states that the appropriation levels in the prior-year’s budget will remain in effect until a new budget is passed. If the continuing budget is not balanced, then the Governor is authorized to reduce appropriations proportionally to bring the budget back into balance. The reductions would apply to all appropriations except those for debt service, those required by federal law or regulations, or those required by contracts to which the state is a party.
Midyear Adjustments. Following the enactment of a budget, this measure permits the Governor to declare a fiscal emergency when either (1) the budget is falling out of balance (same as current law) or (2) expenditures are exceeding the spending limit (as revised by this measure). As in current law, the Legislature would have 45 days to pass legislation to address the fiscal emergency and, if it failed to do so it would be prohibited from considering other legislation or adjourning in joint recess. In addition, however, this measure would:
Allow the Governor to reduce all items of appropriation proportionally, except for those which support debt service, are required by federal law or regulations, or are required by contracts to which the state is a party.
Prohibit the Governor or legislative members from receiving pay, per diem, or expense allowances until midyear legislation is enacted. No forfeited salary, per diem, or expense allowance could be paid retroactively.
Current Law. Legislation resulting in a tax increase must be approved by a two-thirds vote of both houses of the Legislature. Other tax-related legislation can be enacted with a simple majority vote of both houses. The determination of whether a measure constitutes a tax increase—and thus requires a two-thirds vote—is currently based on the net fiscal impact of its provisions. For example, a measure that results in higher taxes from some taxpayers but an equal (or larger) reduction in taxes from other taxpayers would not result in an aggregate increase in taxes, and thus can be passed with a majority vote.
Proposal. This measure requires that a tax measure be subject to the two-thirds vote requirement if it results in a tax increase for any individual taxpayer—regardless of whether it raises or lowers aggregate taxes.
Current Law. In addition to taxes, the Legislature and local governments may impose fees, assessments, and other charges on individuals and businesses. While the constitutional requirements regarding imposition of these levies vary, the requirements generally involve lower approval thresholds by the governing body and/or voters than is the case for taxes. Current law generally defines fees to be charges related to specific services or regulatory activities. Past court decisions, however, have allowed levies imposed on businesses for remediation or mitigation of past damages to be classified as fees. As a result, these levies are subject to approval by (1) a majority vote of the Legislature (instead of a two-thirds vote that would be required for a state tax) or (2) the local governing board (instead of approval by the local governing board and local voters that would be required for a local tax).
Proposal. The measure expands the definition of what is considered a state or local tax. For example, fees imposed for certain remediation and mitigation purposes and fees for services previously financed by tax revenues would be classified as taxes under this measure. As a result, after January 1, 2005, these levies would be subject to (1) a two-thirds vote requirement of the Legislature in the case of a state levy or (2) a vote of the local electorate in the case of a local levy.
Current Situation.
California issues general obligation (GO) and lease-revenue (LR) bonds to
finance major capital outlay projects such as roads, educational facilities,
prisons, parks, water projects, and office buildings. Annual General Fund debt
service for these types of bonds is estimated to be about $3.6 billion in
2004‑05, representing about 4.6 percent of projected General Fund
revenues during the year. (These numbers exclude the effects of Proposition 57
deficit-financing bonds.) Although financial markets consider debt-service
ratios among many other factors when considering the creditworthiness of a
state, there are no specific limitations on the amount of state indebtedness
imposed by the credit markets or by state law.
Proposal. This measure
prohibits the State Treasurer from issuing GO and LR bonds whenever the
Department of Finance’s projected debt-service ratio for the current year or
any of the four subsequent fiscal years exceeds 6 percent of estimated
General Fund revenues. The debt-service ratio calculations would not take into
account costs associated with deficit-financing bonds.
This measure prohibits the state from making any changes to existing
budgetary/legal accounting practices that are not in compliance with Generally
Accepted Accounting Principles.
This measure would have potentially major fiscal impacts on state and
local governments, beginning in 2006‑07.
Near-Term
Effect. Since 2001-02, the
state has faced a large “structural” shortfall between revenues and
expenditures. Recent budgets have covered this shortfall partly through spending
deferrals, loans, and other onetime or limited-term solutions. As the savings
from these limited-term solutions expire, spending under current law will
increase faster than revenues in both 2005-06 and 2006-07, leading to a
re-emergence of the structural shortfall in those years, absent corrective
actions.
Given these circumstances, the impact of the proposed spending limit on
the 2006-07 budget would depend in large part on how the state addresses the
structural shortfall during the 2005-06 and 2006-07 budgets. This is because the
proposed limit would be roughly similar to current-law revenues in 2006-07, but
be substantially below current-law state expenditures during 2005-06 and
2006-07. Thus, if the budget imbalances are eliminated through ongoing
expenditure reductions, then the proposed limit would be reasonably close to
estimated state spending in 2006-07. However, if the shortfalls are not
addressed in this manner, then the proposed limit could be substantially below
projected current-law expenditures. Similarly, if revenue growth proves to be
stronger than currently expected, this measure would preclude the state from
using the added revenues to address the budget shortfall.
Longer-Term Effects. Over the longer term, the proposed limit would likely grow somewhat more slowly than projected spending and revenues under existing law. As a result, this constraining feature of the new limit would have two impacts on the state:
First, it would result in slower growth in state spending relative to current law.
Second, it would trigger the excess revenue provisions of the measure.
The operation of the excess revenue provisions would result in a reallocation of spending away from most existing non-Proposition 98 programs and toward the repayment of deficit bonds, outstanding Proposition 98 maintenance factor, outstanding transportation loans, and local school or road construction. After the build up of a reserve and the payoff of the above obligations, the measure could also lead to lower sales tax rates in the future.
Local Government Spending. The combination of a tighter state limit and the repeal of local limits could result in increased pressure on local spending over time. This could occur, for example, if the new spending limit caused the state to reduce support for local assistance programs in the areas of health, social services, criminal justice, or other programs.
The provisions allowing the Governor to make proportional reductions when budgets are delayed or fall out of balance would provide the executive branch more authority to unilaterally reduce spending. To the extent this authority was exercised, it would result in more immediate spending reductions when budgets fell out of balance. The impact of these reductions on individual programs would depend on various factors, such as which spending was excluded from the reductions because of federal requirements. For example, if a significant portion of spending on health and social services were excluded because of federal maintenance-of-effort requirements, the reductions in education, criminal justice, and other areas of the budget would be correspondingly greater. Also, it is unclear whether this measure would permanently reduce appropriations for certain state entitlement programs. This is because the language of the initiative does not explicitly adjust or suspend the underlying laws affecting the funding levels for the programs. Absent changes to these underlying laws, the reductions could need to be subsequently repaid.
The initiative would also have a variety of other fiscal impacts.
Voting Requirements. By increasing voting requirements for certain tax-law changes, this measure could result in a different distribution of taxes and tax burdens in the future compared to what would occur under current voting requirements. However, it is not possible to determine the aggregate impact of these changes on state and local government revenues.
Determination of Fees. The tightening of the definition of which levies are classified as fees would increase the voting requirements for certain types of levies. This could result in a reduction in certain fee revenues to the state and local governments.
Debt-Related Provisions. The prohibition on borrowing in circumstances where the debt-service ratio exceeds 6 percent would not have an immediate effect on capital outlay borrowing, since the state’s current debt-service ratio is below this threshold. However, the limitation could restrict borrowing at some point in the future, depending on borrowing needs, interest rates, and revenue levels. In such cases, there would be both reduced capital outlay spending and lower debt-service costs.
The measure would have the following major fiscal impacts:
Potentially significant reduction in the growth in state spending beginning in 2006‑07 from the imposition of a new spending limit, accompanied by potential reductions in taxes over time.
Various other fiscal impacts on the level and mix of state spending due to other provisions of the measure.