LAO Projects Smaller State Budget Deficit, Highlights Budget Uncertainties, May 8, 2020

This morning, the Legislative Analyst’s Office (LAO), the non-partisan budget advisor to the Legislature, released a  Spring Fiscal Outlook looking ahead to the 2020-21 fiscal year. Although the LAO recognizes the dramatic economic impacts of the COVID-19 crisis, and corresponding deep budget deficits, their fiscal assessment is significantly less dire than the Fiscal Update that we wrote about yesterday, after it was released by the Governor’s Department of Finance (DOF). DOF projected a $54 billion budget shortfall, while the LAO projects the shortfall to be between $18 and $31 billion. It is important to note that these shortfalls assume no cuts to K-14 education – that is, continued funding at the 2019-20 level, adjusted for growth and COLA.
LAO acknowledges that we are in a deep recession, but also notes that we are facing large uncertainties about many factors – from how long the recession will last, and what its revenue effects will be, to the extent of federal relief aid. Because of this uncertainty, LAO approaches its estimates of the impending budget deficits by building two scenarios – a somewhat optimistic U-shaped recession scenario (where some recovery begins this summer, but faster recovery would begin in 14 months), and a somewhat pessimistic L-shaped recession (where gradual recovery doesn’t begin for 14 months, and full recovery isn’t until 2023).
Under the U-shaped scenario the state would have to address an $18 billion budget shortfall, while under the L-shaped scenario that shortfall would be $31 billion. In both cases those projected budget deficits fall mainly in the 2020-21 fiscal year. The LAO notes that California should have about $9.5 billion of federal funding from the CARES Act to address the deficit in 2020-21. The LAO also points out that under each scenario, the budget problem persists into the future at least until 2023-24. Over that entire recession period the total deficits will amount to $64 billion and $126 billion for the U-shaped and L-shaped scenarios, respectively.
Under the U-shaped scenario the LAO projects a significant decline in the Proposition 98 Guarantee equal to $13.3 billion lower over the three budget years (2018-19, 2019-20 and 2020-21) as compared to that projected in the Governor’s January Budget. Under the L-shaped scenario that decline would be $18.6 billion. In both cases these declines primarily occur in the 2020-21 fiscal year, which reflects the drop in General Fund revenues related to the recession.
LAO’s projections are based on a number of assumptions and projections:
  • 2020-21 revenues and other resources fall by $26 billion and $39 billion, under the two scenarios, respectively
  • Direct COVID-19 costs amount to $7 billion, 75% of which is covered by federal relief funds
  • The state suspends deposits into the Rainy Day Fund for 2020-21
  • No cuts are made to K-14 funding in the current year, and flat funds schools in 2020-21 at that 2019-20 level adjusted for growth and COLA
  • Federal cost sharing for Medicaid programs saves the state $6 billion in costs
  • All discretionary funding proposals in the January budget are dropped.
The LAO does enumerate additional actions that could be taken to reduce the size of the projected budget deficit, including:
  • Securing additional federal funds
  • Eliminating COLAs, including the K-12 statutory COLA
  • Funding K-14 at the Proposition 98 Guarantee level in 2020-21, rather than flat funding from 2019-20
  • Clawing back and reverting to the General Fund any funds appropriated in 2019-20 that have not been expended
  • Revising baseline spending in some areas of the budget, though this could result in a reduction in services
As noted above, the DOF’s release yesterday projected a much larger budget problem (a $54.3 billion shortfall) than is reflected in the LAO’s update. However, the primary reason for that is that DOF focused on gross changes in the budget as a result of revenue declines and cost increases, while the LAO projections focus more widely on the net effects of what we are facing. In addition, the LAO notes that the DOF is projecting:
  • Slightly lower revenues than even the LAO L-shaped scenario
  • Billions of dollars more in increased caseload-driven costs (e.g., social program costs related to the recession)
  • That the budget continues to include all of the discretionary funding proposals that the Governor included in his January Budget
  • That spending for Proposition 98 remains unchanged from the January Budget
The top take-aways from these two days of fiscal updates from LAO and DOF is that we are facing a budget year, and probably a series of years of budget deficits, where funding for K-12 education suffers to some degree as a result. However, it is also clear that we are facing an unprecedented level of uncertainty over the state’s economy, tax revenues and budget circumstances, and that uncertainty falls on us as we are trying to craft budgets going forward.
We will continue to keep you advised as the May Revision is released next week, and as budget discussions progress through the Legislature. We will have some idea about next year when the Legislature passes its budget by June 15, but we also know that the June 15 budget will not be the last word. As happened in 2008-09, we expect to see later budget revisions as more information becomes available with respect to both revenues and costs. Stay tuned for more information over the coming months.
Please feel free to contact staff at Capitol Advisors if you have any questions on this information or any other issues that you are dealing with.
Gerry Shelton
Capitol Advisors Group