Uncertainty of an economic slowdown will complicate negotiations as Gov. Gavin Newsom and legislative leaders head toward a June 15 deadline to pass a state budget. The good news, at least for schools and community colleges, is that even if state revenues were to fall, they would be in a much better position to deal with a major downtown area than in the past – for foresight and luck. The Office of the Independent, Nonpartisan Legislative Analyst and other budget experts agree on this point.
In a mid-May analysis, LAO wrote that a combination of indicators pointed to an economic recession over the next two years: declining consumer confidence, rising inflation, tightening labor market and slowing home sales.
Although “past experience does not guarantee that we are headed for a recession,” the AJO wrote, “the likelihood of a recession is high enough to pose a significant risk to the budget.”
In other words, predicting a recession is like forecasting hurricanes: chances are a hurricane is coming, but you don’t know when it will hit or how destructive it will be.
In terms of state revenue, Newsom predicts slower growth over the next three years, but not a decline. After unprecedented two-year general fund increases of 25% and then 19%, Newsom assumes a decline of 2.6% in 2022-23, mainly due to taxpayer tax credits, not a recession . Then, it projects a 5.3% revenue gain in 2023-24 and another 4.4% in 2024-25.
It’s not entirely unreasonable, AJO said. An increased likelihood of a recession does not necessarily mean that one is right around the corner. It is plausible that the economy could continue to produce strong revenues in 2022-23, he writes. “Assuming very pessimistic revenues (such as those corresponding to a full-scale recession) would create a high risk of missing opportunities to fund worthwhile programs and services,” he said.
Then there’s the political reality that LAO failed to mention: A governor and legislature facing re-election this year will not pass a revenue cut, with the resulting cut in spending, on a hunch. .
For its projection, LAO took what it calls the middle path, the option that Ann Hollingshead, LAO’s senior budget and policy analyst, called the option “likely to be the least misguided.” . Instead of predicting recession revenue, it lowered estimates of Newsom’s general fund revenue by about $27 billion over the next four years.
Revenue from the general fund for Proposition 98, the formula that determines the share of state revenue for TK-12 and community colleges — about 38% — would be stable in 2022-23 under Newsom’s May review and gradually increase to $10 billion more in 2025-26, an increase of about 12%. According to LAO’s moderate projections, it would increase by half as much.
The legislature actually used the Treasury Department’s projections for the general fund in Newsom’s budget. The differences are in how they want to spend the money. Tempering revenue forecasts is just one way to hedge against a recession. Restricting money is another way.
Legislative leaders and Newsom differ widely on whether the governor has been conservative enough or too cautious in his hedge against a recession. The state budget alternatives that legislative leaders passed last week reflect that disagreement.
Due to three years of higher-than-expected state revenues, Newsom assumes an extraordinary $33 billion in additional funding in Proposition 98 in 2022-23. He proposes to budget the bulk, $19 billion, as one-time expenditures and $14 billion in ongoing funding that districts can rely on for years to come. That’s about a 60% to 40% split.
Opinions differ on what Newsom should do. Governing for Californiaa nonprofit that advocates conservative fiscal policies, said that with a looming recession, forecasting any surplus after July 1 is “both unreliable and dangerous”.
“California should set aside any excess revenue it collects in the current fiscal year and not base next fiscal year spending on optimistic revenue forecasts,” Chairman David Crane said.
The Challenges of One-Time Funding
But in the joint budget agreement which they passed on June 1, Senate and Assembly leaders felt that Newsom was too conservative. They moved an additional $4.5 billion in Proposition 98 from one-time funding to ongoing funding in the Local Control Funding Formula, the source for general district spending (see page 12). This would increase the funding formula by 16%, up from 9.9% under Newsom’s May budget review.
To make it work, legislative leaders eliminated some of Newsom’s priorities for one-time funding, including an additional $1.5 billion for community schools, $700 million for reading coaches and trainers, and language materials for low-income elementary schools and $1.8 billion for deferred maintenance. on repairs to school facilities.
The single money provides a cushion against a recession; it can be withdrawn mid-year if a recession is quick and deep, or simply cut from the following year’s budget without affecting districts’ current spending or forcing layoffs, said Bob Blattner, a Sacramento-based school consultant . Increases in ongoing funding for the funding formula can be used to increase salaries and hire permanent staff.
This is exactly why legislative leaders believe it is essential that more be transferred into the funding formula. Districts have been inundated with one-time funding over the past two years, and they have not been able to increase salaries enough to attract and retain staff and to fill the vacancies they need to meet the pandemic, said Assemblyman Kevin McCarthy, D-Sacramento, who chairs the Education Funding Subcommittee of the Assembly Budget Committee.
“I see that here in Sacramento, where it’s hard to hire people with one-time funding that’s going to expire, and then they can’t find people because we’re not paying adequate salaries,” he said. . And he said the increase in employee retirement costs and other expenses exceeds the cost-of-living adjustment that Newsom included in the funding formula.
Legislators are confident that they can transfer one-time funds because there is sufficient funding to meet contingencies. One source is Prop. 98 Reserve – a source that did not exist for the 2000 recession caused by the dotcom bubble and the Great Recession of 2008. This year it is expected to reach $9.5 billion, or 10% Prop Funding. 98. The electors created the reserve Prop. 98 and the larger general fund rainy day fund in 2014.
“Given the strength of this reserve, I think it would be unconscionable to direct the growth of Proposition 98 to ad hoc proposals when the needs today are so great,” the budget chair said. of the Assembly, Phil Ting, D-San Francisco. “If the economy slows down, these increases will still be sustainable.”
On top of that, districts’ own reserves—their year-end balance in their general fund—reached near or above record highs last year: 22.4% for the medium unified school district and 26% for an average elementary district, according to School Services of California, a consulting firm. And they have billions of dollars in unspent federal Covid relief funds, some of which can be spent through September 2024. In the event of a recession, districts could apply some of it to avoid layoffs.
LAO’s Hollingshead and Michael Fine, CEO of Fiscal Crisis and Management Assistance Team, a school funding agency charged with helping schools avoid financial crises, agree that most districts should be able to weather a moderate recession. for at least a year, maybe two.
“Generally they are in better shape than in the past, but that will depend on the depth of the recession,” Fine said.
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