State budget deficit continues to widen, threatening K-12 education funding

STATE BUDGET

Governor’s January Budget includes concerning Proposition 98 funding maneuver

With Gov. Gavin Newsom’s introduction of his January Budget, the Legislature has begun 2024–25 budget deliberations. Unlike past years, this budget is influenced heavily by unprecedented circumstances. Due to the severe storms the state experienced during the winter months of 2022–23, both the federal Internal Revenue Service and the California Franchise Tax Board delayed the deadline to submit income tax filing by seven months, from April until November 2023. This delay forced the Governor and Legislature to rely upon revenue projections instead of actual revenues in the adoption of the 2023–24 budget.

It was only after the adoption of the 2023 Budget Act that it was revealed income tax collections fell 25 percent, which, according to the Legislative Analyst’s Office (LAO), “results in an unprecedented prior‑year reduction to the minimum funding requirement for schools and community colleges.” As a result, the Proposition 98 Guarantee for the 2022–23 fiscal year was funded $8 billion above what it should have been. This has created a substantial shortfall within Prop 98, and the budgetary actions required to bridge this gap are complex and raise serious concerns about the future of Prop 98 funding levels.

State’s revenues continue to worsen

The LAO on Feb. 20 released an update on the state’s budget deficit, estimating that the deficit has grown by $15 billion to $73 billion. In response to Gov. Gavin Newsom’s January Budget Proposal, the LAO estimated the state’s budget shortfall to be $58 billion, as compared to the Governor’s estimated budget deficit of about $38 billion — a $20 billion difference. Using updated state revenue data, the LAO expressed greater uncertainty on whether the state will realize the revenues it needs to meet the Governor’s budget projections come May, when the state releases the revision to the Governor’s January Budget, predominantly reflecting personal income tax revenues in the prior tax year. Citing “weak cash collections” in the months of December and January, the LAO has downgraded their projections to reflect these drops in revenue.

New Prop 98 funding maneuver proposed

To address the $8 billion funding shortfall in the 2022–23 fiscal year, using optimistic out-year state revenue estimates, the Governor is proposing a new maneuver to fully fund Prop 98 in the prior fiscal year by borrowing against future-year state general fund revenues. Essentially, if adopted, the state would fund the $8 billion Prop 98 shortfall in the 2022–23 fiscal year using projected future state general fund revenues. According to the LAO, this would retain all funding previously provided in the 2023 Budget but recognize it over a five-year period beginning in 2025–26. In essence, the state is loaning Prop 98 $8 billion with general fund money that would be repaid over a five-year period.

teacher and students smiling in a classroom as someone raises their hand to answer a question

Additionally, the proposed budget trailer bill establishes this maneuver in statute, thus making it permanent, which would provide the state with the ability to use it again should it face similar fiscal challenges in the future.

“The Governor’s manipulation of Prop 98 has the unfortunate and unacceptable consequence of setting a lower floor for school funding and decreasing the Prop 98 Guarantee to the tune of $8 billion by the 2029–30 fiscal year,” CSBA CEO & Executive Director Vernon M. Billy said. “Any short-term benefit for the state from the Governor’s funding proposal is vastly outweighed by the negative impact of artificially lowering funding for local schools indefinitely and shortchanging students.”

“The proposed maneuver is bad fiscal policy. It sets a problematic precedent.”

Legislative Analyst’s Office

In response to the Governor’s Prop 98 proposal, the LAO writes that the “proposed maneuver is bad fiscal policy. It sets a problematic precedent for the state and creates a binding obligation that will worsen out‑year deficits and require more difficult decisions in the future.” In developing their recommendation, the LAO cites growing concerns that the administration is relying on more optimistic budget revenue projections that may not materialize, thus leading to greater budget deficits in the coming years. The LAO states this sets a “problematic precedent,” and also raises the concern that “there is a good chance that the administration’s revenue projections are too low and the state will face an even larger budget problem in May.”

Prop 98 maneuver — short-term benefit for long-term impacts

Because the maneuver would loan Prop 98 $8 billion from the general fund side of the state budget, and because that $8 billion would be repaid over a five-year period, it would not be counted towards the guarantee. The consequence of this action is that it would permanently lower the Prop 98 Guarantee by an equivalent amount — funding that would likely never be reinstituted or realized.

It is important to note that the state has faced difficult budget times in the past — during the recession in the early 1990s, the dot.com recession of the early 2000s, and the Great Recession caused by the housing crisis in 2008. In all of these instances, where the Prop 98 Guarantee was under threat, the state ultimately chose to suspend Prop 98 to protect the guarantee, rather than borrow from the general fund or some other funding gimmick. Although a suspension of Prop 98 is often considered a worst-case scenario, it ensures that the funding is repaid in subsequent years. This ultimately protects the guarantee since it keeps Prop 98 whole in the long run.

What’s next?

Budget hearings have begun in the Legislature as the Senate and Assembly work their way through the Governor’s budget before Gov. Newsom releases his May Budget Revision by May 15. Negotiations between the administration and the Legislature will be ongoing until the June 15 deadline for the Legislature to pass the budget bill, at which point the Governor will then have until July 1 to sign the bill. The budget will be a significant focus of CSBA’s advocacy this year.

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