California 2017-18 Governor’s Budget Proposal

We have done a quick review and analysis of the 2017-18 Governor’s Budget Proposal that we sent to you earlier today.  As expected, Governor Brown took a cautious and fiscally conservative approach to California’s revenue volatility (which we have been reporting on over the last several months) and the general uncertainty regarding the national economy and possible changes in federal policy.

Governor Brown stated that adjustments are necessary to keep the state’s general fund in balance, but fortunately revisions to the Proposition 98 guarantee are handled in a manner that avoid cuts compared to 2016-17 spending levels.  Having said that, after a number of years of strong growth in funding for LCFF implementation and other education priorities, the Governor proposes overall K-12 funding that is essentially flat for 2017-18.  With rising costs related to CalSTRS and CalPERS, this is likely to cause fiscal pressure on many local education agencies (LEAs).  The Governor did acknowledge that spending will be adjusted depending on revenue figures that will be available in May, and if more optimistic forecasts (such as those by the Legislative Analyst’s Office (LAO)) turn out to be accurate the news for LEAs could improve.  We will discuss these issues, and many more, at our Budget Perspectives Workshops starting next week. You can register here.

Revenue Volatility and Fiscal Prudence – It was no surprise that Governor Brown opened his press conference with concerns about an economic downturn.  He utilized two familiar charts that indicated that most balanced budgets have been quickly followed by huge deficits and that the “tide” of revenues (after several very good years) has begun to turn.  The Governor noted that California has a very progressive tax system that relies on high income earners generally, and capital gains revenue in particular, for a large proportion of annual revenue.  He commented that it was fine to rely on the wealthiest Californians to pay a fair share for spending programs, but that the price of a progressive tax system is extreme revenue volatility.  He argued that a progressive tax system requires constant fiscal prudence and a large budget reserve to deal with inevitable downturns.

The Proposition 2 “Rainy Day Fund” is calculated to require $1.156 billion in payments for state debts and liabilities, with an equal amount to the Budget Stabilization Account (BSA), which is the Prop 2 general fund reserve.  The BSA is projected to reach $7.9 billion by the end of 2017-18, with an additional $1.5 billion in the discretionary general fund reserve, for a total of almost $9.5 billion.  Perhaps recognizing other spending and cost pressures, unlike last year, the Governor is not proposing an additional discretionary transfer to the BSA.

Governor Brown’s letter to the Legislature, to which his larger 2017-18 Budget Summary is attached, states that this budget “will be the most difficult we have faced since 2012.”  While the general fund does continue to grow slowly compared to the prior year, tax receipts are slightly lower than was projected in the 2016-17 Budget Act.  The Governor proposes balancing the budget through spending adjustments over the three-year fiscal years covered by the Budget.  He acknowledges, however, that “it is possible that revenues will recover in the coming months, particularly if final income tax receipts in April surge.”  We believe there is a fair chance that revenues will come in higher than projected in this January proposal, but agree with the Governor that the overall economic picture is more uncertain and unpredictable than in past years.  While the Governor declined to anticipate possible changes in federal funding, potential reductions in for specific programs (particularly healthcare) could have significant impacts on the California budget.

Actions to Balance the Budget – The Governor proposes $3.2 billion in “budget solutions” to prevent a new general fund deficit, with the goal of minimizing actual cuts to programs.  $1.7 billion is achieved by adjustments to the Proposition 98 guarantee from 2015-16 through 2017-18, which are discussed in detail below.  The Governor notes that even with the adjustments, the Prop 98 guarantee continues to grow in 2017-18 compared to the prior year.  The remaining adjustments are in the non-Prop 98 portion of the budget, and are primarily realized by the elimination of unallocated prior year one-time spending for affordable housing and modernizing state office buildings, and by suspending planned rate increases for child care in 2017-18. 

K-12 Spending and LCFF Implementation – After several years of strong growth in Prop 98 spending, and larger than expected allocations toward full implementation of the LCFF, 2017-18 will level off considerably.  This is consistent with what we’ve been predicting for the last 18 months or so.  While the Prop 98 guarantee continues to grow modestly, overall funding is largely “flat” for a number of reasons.

First, the Prop 98 calculation is adjusted downward in 2015-16 by $400 million and in 2016-17 by $500 million, the amounts DOF believes are necessary to satisfy the minimum funding guarantee.  These adjustments act to reduce the guarantee in 2017-18 as well, with an overall savings to the state of about $1.7 billion.  The Prop 98 guarantee still increases in 2017-18 over prior year, and is projected to be $73.5 billion.  For comparison, in November the LAO projected that the Prop 98 guarantee for 2017-18 would be $1 billion higher at about $74.5 billion.

The Governor does not propose trying to make retroactive cuts to prior year spending for K-12, but instead essentially shifts costs from prior years to the beginning of 2017-18.  So the reductions are largely achieved through accounting amendments to expenditures in the 2015-16 and 2016-17 budget years.  A little over $300 million of one-time discretionary money from 2015-16 is shifted to 2016-17, and then a little over $850 million in LCFF funding for 2016-17 is shifted to the first month of 2017-18.  In essence, this is a one-time “deferral” of 2016-17 LCFF payments from June, 2017 to the first month of FY 2017-18 (thus the deferral is immediately paid off in July, 2017).

The Prop 98 shifts and deferral described above leave considerably less funding available for LCFF implementation in 2017-18.  According to the Department of Finance (DOF), the proposed $744 million allocation will be sufficient to cover the cost for the COLA on the statewide LCFF Target.   Please note this does not mean each district will receive prior year funding plus a COLA, it just means total LCFF funding is being increased only by the amount of the COLA and LEAs may or may not receive additional LCFF funding based on their actual funding and “gap.”  This modest allocation for LCFF means no overall closure of the statewide gap, and for 2017-18 the LCFF will remain funded at the same proportion as in 2016-17, which is 96%.

One-Time Discretionary Funding – The Governor proposes to provide $287 million in 2017-18 of fully flexible, one-time funding for school districts, charter schools and county offices of education.  As predicted, this is a smaller amount compared to the last three years, which provided a total of nearly $5 billion in one-time funds.  However, LEAs will still welcome this one-time funding which is distributed on a per ADA amount.  This funding will again be used to offset any prior year mandate claims.

Rising Pension Costs – Proactively paying down the state’s long-term liabilities remains a principal legacy issue for Governor Brown. In 2017–18, the employer contribution rates for CalSTRS and CalPERS will climb to 14.43% and 15.8%, respectively, before continuing their sharp, upward trajectory over the next several years. Already, the CalPERS employer contribution rate is expected to exceed 28% in 2023-24. Despite Governor Brown’s insistence that the pension plans be more aggressive about paying down future liabilities, the budget proposal does not propose any augmentation to cover the higher school employer contribution rates.

School Facilities – California voters passed Proposition 51, the state school facilities bond which authorizes $7 billion in general obligation bonds for K-12 schools allocated through the current School Facilities Program (SFP).  The Governor’s concerns with the current SFP are well known, and the January proposal suggests that some shortcomings with the current funding and allocation system are apparent in recent audit findings issued by the Office of State Audits and Evaluations.  The Administration proposes to work with the State Allocation Board and the Office of Public School Construction to revise policies and regulations to ensure that “basic terms, conditions, and accountability measures” are clear for all participants in the program.  The Governor also states his intent to introduce legislation that will add facility bond expenditures to the annual K-12 Audit Guide.  However, the Director of the Department of Finance did acknowledge that the basic rules of the SFP were included in Proposition 51 and cannot be altered by the Governor and Legislature.  The proposal concludes that once the accountability and audit measures described above are in place, “the Administration will support the expenditure of Proposition 51 funds.”

Reforming Special Education’s Funding Distribution – While not providing any specific new proposal related to special education, the Governor called for a renewed discussion with stakeholders on redesigning the state’s special education funding model. Governor Brown has long favored a system that funds districts directly through an adjustment to their LCFF, rather than through SELPAs. However, such a change may be attractive in theory but raises many practical concerns about the delivery of services to children and, more importantly, leaves the issue of adequate special education funding unaddressed.  Any reforms, according to the Governor, must incorporate the following principles:

  • “School funding mechanisms should be equitable, transparent, easy to understand, and focused on the needs of students. 
  • “General purpose funding should cover the full range of costs to educate all students.
  • “School districts should be provided the flexibility to establish goals and design innovative ways of delivering services to all students.
  • “School districts are responsible for planning and implementing programs that lead to continuous improvement, measured by academic outcomes.”

Teacher Shortage – The Administration does not propose additional resources to address the growing educator shortage. The Governor’s proposal does highlight a number of investments contained in the 2016-17 State Budget and some of the on-going work at the Commission on Teacher Credentialing, including:

  • Updating teacher and administrator standards to reflect adoption of the Common Core and Next Generation Science Standards (NGSS).
  • Creating an online dashboard of information on teacher supply and demand and educator preparation.
  • Extending the validity period for teacher licensing exams.
  • Establishing the Teacher Permit for Statutory Leave to authorize long-term substitutes for teachers on extended leave.

We expect a number of legislative proposals in 2017 to make further attempts at addressing this growing problem.

Child Care – In last year’s Budget Act, the Legislature and Administration agreed on a three-year, $100 million investment in 8,877 California State Preschool Program (CSPP) slots though 2019-20. This augmentation plan adds 2,959 slots on April 1 each year ending in 2020. The Administration proposes $87.9 million in General Fund dollars for rate and CalWORKs increases, as well as $23.5 million in Proposition 98 dollars to pay for the planned additional slots – each budget adjustments from 2016-17; however, they also propose pausing this augmentation plan for 2017-18 for both CSPP slots and provider standard reimbursement rate increases, essentially implementing this plan over four years instead of three. The Administration estimates that pausing this plan for the 2017-18 budget year saves $121.4 million in non-Proposition 98 General Fund and $105.4 million in Proposition 98 General Fund. The Administration also proposes a net increase of $4.8 million in federal Child Care and Development funds and $120.1 million federal funds for Temporary Assistance for Needy Families (TANF), bringing the total federal funding to $736.6 million for these purposes.
Additionally, the Governor suggests streamlining various eligibility rules and policy changes to better align early education programs to transitional kindergarten to foster efficiency.  The Governor proposes the following:

·        Authorize the use of electronic applications for child care subsidies, making it less burdensome for eligible families to access care and more efficient for providers to process applications.
·        Allow children with exceptional needs whose families exceed income eligibility guidelines access to part-day state preschool if all other eligible children have been served. This allows part-day state preschool providers the flexibility to
fill unused slots with other students who would benefit from early intervention or education.
·        Align the state’s definition of homelessness with the federal McKinney-Vento Act for purposes of child care eligibility. Many providers receive both federal and state funds and different definitions of homelessness can be confusing.
·        Eliminate licensing requirements for state preschool programs utilizing facilities that meet transitional kindergarten facility standards, specifically K-12 public school buildings.
·        Allow state preschool programs flexibility in meeting minimum adult-to-student ratios and teacher education requirements, allowing for alignment with similar transitional kindergarten requirements.
·        Simplify the process by which school districts can align program minutes for state preschool and transitional kindergarten students.

Career Technical Education Incentive Grant Program  The Administration propose to fund the final year of the three-year program at $200 million, calling the program the largest of its kind in the country, investing $900 million over a three-year period.

Adult Education Block Grant Program – The Governor proposes to fund the program at $500 million with on-going Prop 98 funding, with no changes to the program.

Proposition 39 – The January proposal provides nearly $423 million to support school district, county office and charter school energy efficiency projects in 2017-18.  Without action by the Legislature, 2017-18 would be the final year of the five-year funding commitment for schools.

Cost of Living Adjustments – DOF calculates the COLA at 1.48 percent, which impacts the LCFF Target as well as categorical programs that remain outside of the LCFF.

Accountability – The Administration does not propose any additional funding for the new statewide accountability system, and the State Board will develop its state plan with federal funds.  We will be providing a report on State Board actions at the conclusion of their meeting later this week.