CA Legislative Update: Latest on State Revenue Estimates, Pension Costs

Late last week, two important reports became available – State Controller Betty Yee released tax receipt data for the fiscal year through January 31, 2017, and the Legislative Analyst’s Office (LAO) published their Proposition 98 Analysis.  Together, these documents reinforce the message we conveyed at our Budget Workshops regarding our cautious optimism for 2017-18 revenues (compared with the Administration’s projections) combined with our serious concerns about increases in employer pension costs in out years.  

Revenue Estimates

Let’s look first at tax receipts and revenue estimates for 2016-17.  We now have data through January 31, 2017 – the first seven months of the fiscal year – which continue to show month to month volatility in tax revenue, but no clear and consistent trend downward or upward.  What we know so far is, compared to projections in the 2016 Budget Act, tax receipts were lower than estimated in July and December, higher than estimated in November and January, with the other months coming in closer to projections.  At this point the State Controller’s Office reports that most of the revenue deficit from December was made up in January.  The bottom-line is that revenue is now only down about one-half of one percent ($392 million) compared to the estimates in the 2016 Budget Act.  

Turning to 2017-18, unless Personal Income Tax (PIT) growth ends up being among the very lowest it has been in the last couple decades, we believe revenues will be closer to the LAO’s November 2016 projection than the very conservative estimates from the Governor’s January Proposal.  So we remain cautiously optimistic that revenues for 2017-18 could be about $4 billion higher than the amount projected by the Administration in January.

Yesterday afternoon the LAO confirmed that they continue to believe their 2017-18 revenue estimate is accurate, and noted that tax receipts are slightly better than anticipated when they estimated revenues in their November 2016 analysis.  If an additional $4 billion of revenue is recognized, the 2017-18 Prop 98 guarantee would increase by about $1.5 billion.

Note, however, that Governor Brown and the Legislature have frequently chosen to adopt conservative revenue estimates and, when needed, adjust for higher revenues through relatively large one-time expenditures in the following year.  In other words, even if the LAO has the more accurate revenue forecast, there is no guarantee that the Governor will use that higher estimate when he revises budget numbers in May.

Pension Costs

The most recent LAO report takes into account recent actions by CalSTRS and CalPERS, in addition to annual CalSTRS rate increases enacted into statute in 2014, to estimate that employer pension costs will increase by about $1 billion in 2017-18 compared to 2016-17.  As we noted at our Budget Workshops last month, employer pension costs in 2017-18 grow faster than the LCFF funding increase ($744 million) proposed in the Governor’s budget. 

While the LAO report notes that LCFF funding increases over the last few years were significantly larger than increases in pension costs over those same years, they agreed yesterday that the situation could be quite different in the future.  When looking at an LCFF implementation period of 2013-14 through 2020-21, the big LCFF funding increases are “front-loaded” while the big pension cost increases are “back-loaded.”  Over time, it appears that cumulative increases in pension costs will account for a larger percentage of cumulative increases in LCFF funding, so that by 2020-21 the LAO estimates that increased pension costs will account for 30-40% of all LCFF funding gains.  And the math may actually be worse after 2020-21, as employer contribution rates continue to rise and increases in spending are less certain.  

For many school districts and county offices, increasing costs are already outstripping any increases in revenues.  This dynamic will create challenges both for districts with little or no LCFF funding growth (most likely because they have relatively few students eligible for supplemental and concentration grants and received relatively high funding under the old distribution system), and for those districts with higher LCFF entitlement targets that must demonstrate increased or improved services for students with limited ability to account for higher pension costs

Another perspective on statewide spending power for school districts and county offices becomes apparent when comparing 2007-08 (pre-recession) spending per-pupil with 2016-17 spending per-pupil.  Taking into account inflation, the LAO estimates that spending over that period has increased by only about $600 per-pupil.  While the LAO did not provide an inflation-adjusted figure for the increase in pension costs from 2007-08 through 2016-17, it seems fairly clear that a significant proportion of funding increases were offset by increases in pension costs.  While much attention is focused on future pension costs compared to revenue growth, it appears that pension costs also impact the assessment of whether aggregate spending on K-12 education has actually increased compared to pre-recession spending.

This update was prepared on courtesy of Capitol Advisors Group