Earlier in the week, DOF also released trailer bill language providing additional details about their proposed maneuver to lower the prior year (2022-23) Proposition 98 Guarantee by $8 billion without impacting LEA budgets.
The LAO also produced two new documents at the end of the week outlining the revised numbers for their overall state budget forecast and implications for school funding, as well as recommendations on key parts of the Governor’s proposals for K-14 education. Their review produced a decidedly critical review of the specific transaction the Governor is proposing to reduce the 2022-23 Prop 98 Guarantee while avoiding cuts to education.
Our goal is to provide an update on current revenue projections and what they might mean for the K-14 budget development and to explain and assess the Prop 98 maneuver. The Prop 98 reduction proposed by DOF has benefits for existing LEA budgets but also trade-offs in the budget year and some risks in future years if it sets a precedent for always reducing prior year spending to the bare minimum required by Prop 98.
Revenue Picture
At this point, both DOF and LAO have revenue projections that are clearly lower than those used in the Governor’s January budget proposal. At our Capitol Advisors Budget Perspectives Workshops, we noted the difference between the LAO and Governor’s assessment of overall projected revenues, which has been in the tens of billions of dollars throughout the three-year forecast period that includes 2022-23, 2023-24 and the next fiscal year.
The LAO updated its forecast of General Fund revenues a week ago, estimating that the Governor’s projections will end up $15.3 billion short for 2023-24 and another $8.4 billion down in 2024-25. For the current year, it is a combination of less than anticipated income-related revenue as well as shortfalls in sales tax and corporation taxes. While they note the anticipated decline in the General Fund over the budget forecast period, they also point out their more optimistic estimates of local property tax revenue growth over the same time.
DOF does its own revenue projections, but has not made any new predictions since the release of the January budget proposal. However, they do note the revenue collections are already lower than expected. Due primarily to lower revenue from January estimated quarterly tax payments and regular income tax withholding, the State’s fiscal challenges got nearly $6 billion larger than the Administration’s January forecast.
Assuming DOF is correct that we remain in Test 1 in the current and budget years, the loss of general fund revenue will have a direct, negative impact on Prop 98 calculations. Generally, we can assume a loss of about 40 cents to Prop 98 for every dollar lost to the general fund. As mentioned above, the DOF does not have a new revenue estimate for the budget period, but notes we are down about $6 billion in revenue collections so far. In total, the LAO estimates of the Prop 98 minimum guarantee are $7.7 billion below the Governor’s projections for 2023-24 and 2024-25.
Obviously, if the numbers come in anywhere close to what the LAO is predicting, we are looking at some significant cuts to the budget laid out by the Governor in January. Unfortunately, there is no longer a large amount of one-time spending in the budget year that can be easily reduced or eliminated, leaving difficult choices among existing, ongoing programs. We don’t want to start negotiating with ourselves over which programs to cut, but need to be prepared for a challenging budget if revenues do not rebound in the second half of this fiscal year.
Proposition 98 Maneuver
The recently released trailer bill language provides additional details to the Governor’s proposal to reduce the Prop 98 Guarantee in 2022-23 without impacting LEA budgets. While this Prop 98 transaction is fairly complex, we note that the bottom-line objective is to reduce the Guarantee in 2022-23 without actually reducing K-14 spending, but also to prevent the Prop 98 Guarantee from increasing beyond what the state can afford to spend in the current and budget years.
We won’t get into all the details of the possibility of the Prop 98 Guarantee increasing while General Fund revenues decrease, but the short version is that (1) if the Prop 98 Guarantee is not significantly reduced in 2022-23 (by the way, the LAO notes we have never before attempted to reduce prior year spending at this scale), and (2) general fund revenue collections continue to slide, then it is possible the Prop 98 test in current and budget years will not be Test 1, but will shift to Test 3 and Test 2, respectively. The LAO laid out this scenario in it’s Fiscal Outlook released in December, 2023. Under Tests 2 and 3, Prop 98 is funded on adjustments to base funding provided the prior year, not on a percentage of general fund revenue. So, assuming the 2022-23 base is not adjusted down, it appears that the Prop 98 funding guarantee will grow by at least several billions of dollars in the budget year despite lower general fund revenues. This is an outcome which the Governor understandably wants to avoid – it could lead to draconian cuts on the non-education side of the budget.
The LAO also provided a review and critique of the newly released trailer bill language that outlines the Prop 98 approach the Governor is proposing. However, it is important to note that the LAO objections are related to the fact that the reduction to the Prop 98 Guarantee in 2022-23 does not actually involve decreased Prop 98 spending, but instead involves borrowing money from the general fund in future years to account for the paper reduction in 2022-23. While the LAO strongly objects to the Administration’s approach as fiscally unsound, their own plan would likely inflict more budget pain on K-14 education in the interest of attaining more out-year stability for the state’s general fund. The education community, including Capitol Advisors, has signaled significant appreciation for the Governor’s focus on protecting K-14 education from budget reductions, but we remain concerned that the budget language may not be written in a way that applies only to the unique 2022-23 circumstances and could create negative ongoing precedence regarding adjusting the prior year Prop 98 base spending down to the absolute minimum required by the Constitution. This plays into our general concern that Prop 98 has become a funding ceiling, not the floor it was intended to be.
With regard to the specific Prop 98 maneuver laid out in the trailer bill, essentially the DOF reopens the prior fiscal year to make a change on paper that reduces the minimum guarantee by $8 billion to correspond to where the guarantee would have fallen due to lower overall general fund revenues if tax receipts were available in time to make the adjustment that year. After that adjustment, they declare that all of the funds provided to K-14 schools above that lower Prop 98 base is a “supplemental payment” that they do not expect education agencies to repay. We got the funding and we would keep that funding. The $8 billion would be considered an expenditure from future general fund dollars where the state would essentially pay itself back over time. There are no loans to K-14 schools or funding deferrals as part of this plan.
Among the questions that are raised by this transaction is that they wouldn’t count any of the dollars associated with the supplemental payments to education toward building the Prop 98 guarantee in out years, which would otherwise be anticipated under current law. The other complication is the notion of reopening a year that has passed and redefining the amounts of funding that count for purposes of building the Prop 98 minimum guarantee. While a process known as “certification” does exist for determining exactly what constituted expenditures that count toward the guarantee in any given year, it does not involve redefining the very nature of what counted toward State support for K-14 education that has been utilized in all prior years.
What's next?
Over the next several weeks there will be efforts to align the advocacy around a no-cuts objective for schools while coming to an understanding about the approach used to accomplish this in statute and in consideration of the constitutional language of Prop 98. We will also be providing a more in-depth look at the budget ideas presented by the LAO, which involve cuts to K-14 programs under all their current proposals. In addition, we will continue to provide updates on the overall revenue picture and how it impacts the various proposals being considered for overall education funding.
Please let us know if we can provide any additional information.
Thanks,
Kevin Gordon and Abe Hajela
Capitol Advisors Group