State Economic Forecast

The economic forecast underlying the initial state budget released in January 2001 assumes that California's economy will slow more in line with the nation's in 2001, before rebounding in 2002.

As shown in Table 1, the Governor's budget reflected a slowdown in real U.S. GDP from 5.1% in 2000 to 3% in 2001, before rebounding to 4.3% in 2002. While some slowing of consumer and business spending is projected in the first six months, the Governor's administration expects growth to be revived by a combination of lower interest rates, a slow reversal of recent energy price increases, and further productivity gains during the next 12 months.

Slowing economic growth is expected to result in a moderation in inflation, with growth in the Consumer Price Index (CPI) slowing from 3.5% in 2000 to 2.5% in 2001. Regarding California, the Governor's budget assumes that the State's economic expansion would continue but slow to a more moderate rate during the next 2 years.

Personal income growth is forecasted to slow from 11.7% in 2000 to 5.7% in 2001, before rebounding to 6.9% in 2002.

<top of page>
Governor's Proposed Budget - January 2001

The Governor's budget estimates General Fund revenues to be $79.4 billion, a 3.3% increase from the current year, with expenditures proposed at $82.9 billion. This is up $3.1 billion, a relatively modest 3.9% growth compared to the exceptionally strong 15-20% increases experienced in the current and prior years. This modest growth partially reflects the fact that one-time spending in the budget year ($3.3 billion) is less than in the current year ($5.8 billion). After adjusting for the reduced amount of one-time spending, as well as funding shifts and accounting changes, General Fund expenditure growth would be higher-about 7.5%.

<top of page>
Revenues

After strong growth in each of the past two years, General Fund revenues are projected to increase by a modest 3.3% in 2001-02.

This modest revenue gain is consistent with the State's economic forecast of slowing personal income and sales growth in 2001 and early 2002. It also reflects predictions that capital gains and stock option income will decline 10% between 2000 and 2001.

The budget's revenue forecast also reflects tax-related legislation passed in conjunction with last year's budget and proposed in this year's budget, as well as a triggered reduction in the Sales Use Tax rate.

• California's personal income tax, the single most important determinant of state revenues, is expected to increase by 9.4% for 2000-01 and only 3.5% for 2001-02.
  
  
• Sales and use tax is the General Fund's second largest revenue source, accounting for about one-third of the revenue total, is expected to increase 4.0% during 2000-01 and 6.6% in 2001-02. Budget assumptions regarding SUT legislation include:
  
  
  • 2000 Legislation. Last year the state enacted tax relief legislation that will reduce taxes by $2 billion in 2001-02 and $1.2 billion in 2002-03. The main provision was an acceleration of the Vehicle License Fee rate reductions, which under prior legislation would have been reduced by about one half. Other tax relief measures passed last year included a credit for credentialed teachers and partial conformity to the federal child care credit.
    
    
  • 2001 Proposals. The 2001-02 budget includes several targeted tax relief proposals, which would reduce General Fund revenues by a combined total of $108 million in the budget year. Other provision is an increase in the manufacturers' investment tax credit from 6% to 7%.
    
    
  • Triggered Sales Use Tax (SUT) Rate Reduction. Under legislation accompanying the imposition of a quarter-cent sales tax increase in 1991, this quarter-cent rate increase can "trigger off" in any year in which the Director of Finance certifies (by November 1) that the budgetary reserves are more than 4% of General Fund revenues. In October 2000, the Director of Finance made this certification, which resulted in a quarter-cent SUT reduction effective for calendar year 2001. The 2001-02 budget forecast assumes the quarter-cent tax rate will be reinstated on January 1, 2002.

<top of page>

Expenditures

• The proposed General Fund spending level is $82.9 billion in 2001-02, an increase of $3.1 billion or 3.9% above estimated current year General Fund spending.
  
  
• Over one-half (52%) of the total budget is devoted to education, with K-14 education accounting for about 43% of the total budget plan and Higher Education receives just under 10%. Combined, health and social services programs account for slightly more than one-fourth, while spending on youth and adult corrections accounts for about 6.5% of the total.
  

<top of page>
Higher Education Outlook

The 2001-02 Budget proposes combined general fund support for CSU and UC of $6.4 billion, an increase of $471 million or 9.8% compared to the current year.

The funding agreement, referred to as a "partnership", was renewed between higher education and the State. This agreement has been a critical budget component for both the UC and the CSU since higher education is not one of the entitlement programs with guaranteed funding levels, and it brings a measure of stability and predictability to budgeting.

Overall, spending on higher education has increased due both to enrollment growth and additional monies provided for stable student fees, building maintenance, new technology and research. Budgeted enrollment levels will increase by 3% at both institutions -- 5,700 full-time equivalent students (FTES) at the UC and 8,760 FTES at the CSU. Both segments will also receive funds to begin the conversion of summer enrollment to state supported instruction.

<top of page>
Governor's Proposal for the CSU

Overall, the proposed budget provides an increase for the CSU of $291 million (9% increase) over 2000-01, $267 million in additional General Fund support, and $24 million from student revenues associated with enrollment growth. The budget is the first developed in accordance with the terms of the Higher Education Partnership formalized last year with the Davis Administration.

The partnership contains specific commitments by the state to the CSU, including a 4% annual increase to the CSU's general fund base, funding for enrollment growth, an additional 1% increase to eliminate annual budgetary shortfalls in certain key areas (building maintenance, instructional equipment/technology, and libraries), and funds for new initiatives.

<top of page>
May Revision to the Governor's Budget

Each year, the Department of Finance re-exams and revises its projection of revenues after the tax period has closed.

This forecast, known as "the May Revise", provides updated economic and revenue forecasts, as well as the latest caseload, enrollment and population information for programs in the health and welfare, education and public safety areas. This becomes the new benchmark by which the final budget will be measured.

In striking contrast to the past several years, the 2001-02 May Revision reflects a sharp deterioration in the state's fiscal picture. The slower, near-term economic growth and recent weakness in the stock market have led to a sharp decline in the revenue outlook.

This, coupled with added costs in a variety of budget areas, has necessitated significant changes to the Governor's January Budget proposal.

The May Revision reports a $5.7 billion deterioration in the state's fiscal condition due to the combination of a net two-year reduction of $4.2 billion in revenues and a net two-year increase of $1.5 billion in the January plan's spending requirements.

The expenditure increases are due to higher retirement costs, legal settlements, energy costs, and prior year Proposition 98 requirements. Table 4 displays how the Governor proposes to solve the budgetary two-year imbalance of $5.7 million.

The CSU budget contained in the May Revise reflected a $233.4 million increase in the CSU's General Fund budget for 2001/02: $157.1 million within the Higher Education Partnership, and $76.2 million in state investments above the partnership. This represented a net reduction of $58 million of the amount provided in the January budget.

The May Revise budget provided full funding for enrollment growth of 3 percent, including conversion to year-round operations and student financial aid. Also included was a $34 million augmentation for increased natural gas costs, including $18.5 million in one-time funds.

The May Revision was released just after RPP was finishing its work and was therefore not specifically reflected in the planning figures or in the recommendations. The changes in the May Revision appear to be earmarked and do not impact discretionary funds available to support the Task Force recommendations. Nonetheless, the Task Force is prepared to reconvene should further work and advice be warranted.