Report 2008-603 Summary - February 2009

High Risk: The California State Auditor Has Designated the State Budget as a High-Risk Area

HIGHLIGHTS

Our review of the State's budget condition revealed the following:

RESULTS IN BRIEF

Based on the current fiscal crisis and a history of ongoing deficits, the Bureau of State Audits (bureau) has added the State's budget condition to its list of high risk issues. The record breaking delays in passing the fiscal year 2008-09 budget, the need for subsequent special sessions, and the multibillion dollar budget gap lawmakers are attempting to close highlight the potential for the State's budget process and condition to add significant roadblocks to the tasks of managing and improving state and local government. As of the publication of this report, the Legislature and the governor continue to negotiate in an attempt to address the gap in the fiscal year 2008-09 budget.

In analyzing information on budget deficits and surpluses during the last 20 years, using various methods of determining the budget condition, we found that all measures pointed to the same conclusion—the State has experienced ongoing deficits that greatly outweigh any surpluses. For example, when we examined the projected shortfalls and surpluses as of May in each of the past 20 years, we found projected budget surpluses for eight of those years, totaling about $30 billion, and projected shortfalls for 12 years, totaling $146 billion. Although these results indicate that the State has faced a long standing problem, nearly half of the amounts related to the budget solutions implemented to resolve the shortfalls have only pushed the problem into the future. Specifically, more than 27 percent of these amounts involved increasing the State's debt and another 22 percent were related to fund shifts and transfers, accelerated revenue payments that reduce future revenues, and expenditure deferrals. These solutions cause larger budget shortfalls in subsequent years.

Some of the factors that make it difficult for decision makers to correct this course are as follows:

Because the California Constitution requires that all state tax revenue increases be approved by the Legislature with a two thirds majority vote, this among other factors can make it difficult for decision makers to close budget shortfalls by increasing tax revenues.

In the last two decades, the populations served by some of the State's most significant programs have grown faster than the general population. Specifically, although the State's general population has increased by 28 percent, the number of inmates in correctional facilities has increased by 82 percent, the number of persons eligible for the California Medical Assistance Program has grown by 90 percent, and there are 32 percent more school age children. This disproportionate growth has caused increases in the State's General Fund expenditures to outpace the combined rate of inflation and general population growth.

Voters have approved ballot measures that add programs and projects but do not identify specific funding sources. Instead, these programs and projects are often financed with bonds that must be repaid over time from the General Fund. In the last 10 years, voters have approved roughly $105 billion in general obligation bonds. In addition to repaying the principal, the State could pay as much as $98 billion in interest on these bonds.

The State's revenue structure, which depends to a large degree on personal income taxes, is very sensitive to changes in the economy. As a result, decision makers tend to be constantly reacting to boom and bust cycles of the economy.

Because of various legal, political, business, and humanitarian considerations, it is difficult for decision makers to reduce expenditures to a level that will eliminate the ongoing deficits. For example, nearly 41 percent of the General Fund budget relates to expenditures that are mandated by the California Constitution. Additionally, another 22 percent relates to expenditures that secure federal funding and help support an underprivileged portion of the population. Although discretionary, other expenditures, such as those in support of the State's universities, represent investments in the future of California's economy that would be difficult, if not unwise, to significantly reduce.

The combination of all these factors has created a situation in which resolving the State's budget problems will not be easy. The bureau has added the state budget to its list of high risk areas because we recognize that it is an issue that will likely continue to affect the state government's ability to effectively carry out its mission. We will continue to monitor developments related to the state budget and will attempt to help decision makers find areas where expenses could be streamlined or revenues increased.