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California’s Budget Whirlwind


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Overall Budget Process

Each fiscal year, California goes through several rounds of budget estimates for revenues and expenditures. At the various stages of the budgeting process, several parties are involved in the forecasting process. The Department of Finance (DOF) weighs in on behalf of the Governor’s Office. The Legislative Analyst’s Office also provides sets of forecasts at different stages of the process as an alternative and/or contrast to the DOF. The first major budget is referred to as the Budget Act. This is typically passed at the beginning of each fiscal year (around June—though during the current fiscal year, these estimates were delayed due to budget wrangling and were not ultimately passed until September), and provides revenue and expenditure projections for the upcoming and next fiscal years. Next, these estimates are revised based upon actual data collected during the first half of each fiscal year. These revised estimates are traditionally put forward in January and are referred to as the “Governor’s Budget.” Finally, as the fiscal year winds down toward a close, these revenue and expenditure forecasts are updated again in May of each year in what’s known as the “May Revision.”

Background Information

California’s Budget has been in flux since the onset of the Great Recession. The deterioration of the economy caused a marked deterioration in revenues during the downturn and many measures have been enacted since then aimed at preserving California’s budget position. Many of these measures have included temporary fixes, such as temporary income tax rate hikes, which have since expired, and changes to the way corporations record sales in the state for corporate tax purposes (e.g. elective single-sales factor apportionment and limits on deducting prior year losses). All of these issues combined with a variety of different forecasts produced by the Department of Finance (DOF), the Legislative Analysts’ Office (LAO), and Beacon Economics make it difficult to understand exactly what has been developing in California’s General Fund over the past year and where revenues are headed. As demonstrated in the following timeline, the revenue estimates produced by the DOF and LAO have varied substantially over the past twelve months. This can make an interpretation of the current situation more difficult. This analysis seeks to demystify some of the numbers and provide insights as to where California revenues are now, and where they are headed over the next 12-15 months.

Revenue Forecasts Over Past Year

 

In September, the legislature passed the 2011 Budget Act as part of a compromise deal with the Governor’s Office. In that budget, the DOF estimated that General Fund revenues would come in at roughly $88.5 billion in the current fiscal year. However, that budget also noted that revenues were anticipated to come in roughly $4 billion higher as a result of various items that were not fully detailed at that time. While Beacon Economics largely agreed with the current-year base forecast, we acknowledged that the additional $4 billion was not likely to materialize.

Initial Forecast of 2011-12 General Fund Revenues

 

 

Revenue Category

2011
Budget Act

2012-13 Governor's Budget

Difference

$ Millions

%

Personal Income Tax

50,408

51,937

1,529

3.0%

Sales and Use Tax

19,009

18,777

(232)

-1.2%

Corporate Taxes

9,012

9,479

467

5.2%

Other Revenues

10,027

6,116

(3,911)

-39.0%

Total Revenues

88,456

86,309

(2,147)

-2.4%

 

As 2011-12 progressed, the fact that the $4 billion in “phantom revenues” was not realistic became apparent. In January, the DOF released revised forecasts for General Fund revenues in 2011-12 and 2012-13 as part of the 2012-13 Governor’s Budget. At this time, the $4 billion in additional revenues were allocated to specific revenue streams, but those underlying forecasts were also augmented so that the additional $4 billion in allocated revenues were lowered, which offset some of that additional revenues that were anticipated back in September 2011. Specifically, total revenues were revised downward by $2.1 billion, recognizing that the revenue estimates produced in September were optimistic at best.

What were these changes that shifted the estimates so much? Some of the additional $4 billion in revenues was allocated to personal income tax, which was forecasted to be $1.5 billion higher in January than was projected in September. The Corporate tax forecast produced by the DOF was also revised upward by $461 million in January. However, sales and use taxes were revised downward by $232 million, and the “other revenues” category declined by $3.9 billion for the current fiscal year while part of those mysterious $4 billion were allocated to specific sources; the remainder were dropped from the forecast. As a result, the DOF was roughly $2.1 billion less optimistic on 2011-12 revenues during January than they had been in September 2011, and were forecasting $86.3 billion in total revenues for 2011-12.

At that time, Beacon Economics was comfortable with the estimates for 2011-12. Actual revenues had been tracking below the previous estimates and that justified a downward revision to the forecast. However, we felt that the revenue outlook for 2012-13 was too pessimistic given the ongoing nature of California’s economic recovery. Specifically, Beacon Economics forecasted roughly $91 billion in revenues for 2012-13 compared with $89 billion forecasted by the DOF.

Revised Forecast of 2011-12 General Fund Revenues

 

Revenue Category

2012-13 Governor's Budget

2012-13
May Revision

Difference

$ Millions

%

Personal Income Tax

51,937

49,803

(2,134)

-4.1%

Sales and Use Tax

18,777

18,921

144

0.8%

Corporate Taxes

9,479

8,208

(1,271)

-13.4%

Other Revenues

6,116

6,306

190

3.1%

Total Revenues

86,309

83,238

(3,071)

-3.6%

 

Since January, revenues have continued to underperform the 2012-13 Governor’s Budget estimates. Through April, total General Fund revenues were tracking $3.5 billion below the Governor’s Budget estimates. Of this, $2.7 billion of the underperformance stems from lower than anticipated income tax revenues, with another $464 million of the shortfall coming from less than expected sales tax revenues, and another $411 million in weaker corporate taxes. As a result, the most recent forecast provided by the DOF pins revenues at $83.2 billion for 2011-12—an additional reduction of $3 billion over the January estimates.

Specifically, the personal income tax forecast for 2011-12 was revised downward by the DOF by roughly $2 billion and corporate taxes were also downwardly revised by $1.3 billion for the current fiscal year. Sales taxes, however, were revised upward by $190 million. Overall, the current forecast included in the 2012-13 May Revision estimates is roughly $5.2 billion lower than originally forecasted in September, which means that the DOF has abandoned the original $4 billion lumped-in in September 2011 and have also revised the underlying numbers down by an additional $1 billion as a result of lackluster revenue growth, which ultimately highlights how unrealistic those figures were at the time the 2011 Budget Act was passed.

Forecast of 2012-13 General Fund Revenues

 

 

Revenue Category

2012-13 Governor's Budget

LAO November 2011 Forecast

2012-13
May Revision

Beacon May 2012

Personal Income Tax

56,025

53,134

55,495

53,163

Sales and Use Tax

19,595

19,980

19,997

20,899

Corporate Taxes

9,342

9,432

8,488

8,652

Other Revenues

4,259

3,492

4,156

3,454

Total Revenues

89,221

86,038

88,136

86,168

 

Currently, Beacon Economics feels the DOF’s numbers are fairly close for 2011-12, though we have forecast slightly higher revenues ($83.6 billion vs. the $83.2 billion being forecasted by the DOF). Total revenues could be slightly better than expected in 2011-12 if sales taxes come in above projections in May and June, which they appear poised to do based upon daily tracking of sales tax receipts. This forecast puts Beacon Economics directly in between estimates made by the DOF ($83.2 billion) and the LAO in November ($84.8 billion) for the current fiscal year.

Back in January, Beacon Economics had predicted that the DOF’s forecast of General Fund revenues for 2012-13 could be roughly $2 billion too pessimistic. However, this was largely based on the information provided in the DOF’s economic forecast for economic growth released in January, which painted a dire picture for the recovery including a higher unemployment rate in 2012 relative to 2011 and a bearish forecast for real economic growth for the current year.

While the unemployment rate has not increased, the speed of the recovery has not accelerated as quickly as we had been forecasting in January. As a result, Beacon Economics has dialed down its forecast for General Fund revenues for 2012-13 to $86.2 billion. This is roughly $2 billion lower than forecasted by the DOF in their most recent estimates, with most of that difference coming from lower personal income taxes forecasted by Beacon Economics. However, it is important to note that our current forecast does not include a bump in revenues from the recent Facebook IPO, which has been estimated to provide an additional $2 billion in revenues according to the LAO. If these revenues do materialize, our estimates will begin to look similar to the current estimates provided by the DOF.

Current Outlook

Overall, Beacon Economics is forecasting that the current DOF estimates provided in the 2012-13 May Revision estimates are slightly pessimistic for the current fiscal year, but slightly optimistic on revenues for 2012-13. This year, sales and use tax and personal income taxes could come in slightly higher than where we are currently tracking on a year to date basis in April. However, the pace of the recovery in California is not expected to drive a nearly 6% increase in revenues next year, which is what the current DOF forecast calls for. Instead, Beacon Economics is forecasting a 3.1% increase in total General Fund revenues next fiscal year, though solid capital gains receipts associated with the Facebook IPO could help to narrow that gap.

It is important to note that although there has been a flurry of budget forecasting activity, some of which has been contradictory, most forecasts are focusing on magnitudes rather than directions. For example, while Beacon Economics feels that the DOF may be painting too rosy a picture for 2012-13 and being a bit bearish on the current fiscal year, both groups are forecasting continued improvement. Obviously, this does little to alleviate the need for permanent solutions to our budget woes, but it does show that the consensus among the state’s major forecasting groups is that the worst is behind us.

The Budget Gap

According to the Governor’s May Revision Estimates, California will face nearly a $16 billion budget gap next year. Those estimates expect the 2011-12 fiscal year to end with roughly $6.9 billion in shortfall of receipts over expenditures, and that the shortfall will grow to $15.7 billion in 2012-13 after setting aside additional monies for the Special Fund for Economic Uncertainties.

California's Budget Gap

 

 

 

 

FY 2011-12

FY 2012-13

Difference

Resources

 

 

 

Prior Year Balance

-2,508

-6,879

-4,371

Revenues/Transfers

83,238

88,137

4,899

Total Resources

80,730

81,258

528

 

 

 

 

Expenditures

 

 

 

Non-Prop. 98 Expenditures

54,195

59,074

4,879

Prop. 98 Expenditures

33,414

37,157

3,743

Total Expenditures

87,609

96,231

8,622

 

 

 

 

Fund Balance

-6,879

-14,973

-8,094

Reserves

719

719

0

Total Available Reserves

-7,598

-15,692

-8,094

 

Although General Fund receipts are projected to rise next year, expenditures are currently projected to increase by even more, thus increasing the budget gap in 2012-13. This illustrates how the modest increase in revenues, and the general improvement in broader economic conditions, fails to alleviate the need for tough choices on revenues and expenditures. The temporary tax measures being pursued by the Governor will help the state cover some of this shortfall over the next few years, but serious effort is needed to bring the General Fund back into balance on a more permanent basis. This will most likely have to include permanent measures on revenues, of which there are a variety of proposals being discussed in the economic, and policy communities, as well as a compromise on expenditures. Much of the borrowing that has taken place to date is the result of internal borrowing—meaning that the state has had to rely on funds slated for a specific purpose in order to finance its operations. Thus, while it has been able to meet its obligations over the short run, a long-run solution is still needed.




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