"(The) fiscal benefits of many of the budget's key proposals are overstated," the Legislative Analyst's Office said in a report on the $103 billion spending plan for 2007-08 that the governor released this week.

The report said Schwarzenegger made an "unusually high" number of overly optimistic assumptions about how the state could save money and how much it would earn in taxes during the 2007-08 fiscal year.

The analyst's office cited examples such as the governor's projection that the state would earn about half a billion dollars by agreeing to expand slot machines at tribal casinos. Those gambling expansions, which have yet to receive approval from the Legislature, would only bring in about $200 million, the report said.

"(It) will be important that the Legislature develop a more realistic budget," the report said.

By Clea Benson, The Sacramento Bee
Published 10:56 a.m., January 12, 2007

NOTE: The following is taken from the LAO's report, which can be read in its entirety by going to www.lao.ca.gov.

January 12, 2007

LEGISLATIVE ANALYST'S OFFICE

2007-08: Overview of the Governor’s Budget
The 2007-08 Governor’s Budget proposes a major redirection of transportation funds, reductions in social services, and a variety of other actions to eliminate a significant shortfall in 2007-08. The plan assumes that adoption of its proposals will result in a balanced budget with an over-$2 billion reserve. However, the budget contains a significant number of downside risks and is based on a number of optimistic assumptions. Its key proposals also raise serious policy and legal issues. Adverse outcomes in just a few of these areas could easily eliminate most or all of the proposed reserve.

After a year in which the state was able to use surging revenues to significantly increase education spending and prepay budgetary debt, the situation for 2007-08 is much tougher. Reflecting these more difficult circumstances, the Governor’s budget includes only a few program expansions, and instead proposes a number of budget-balancing actions, including a major redirection of transportation funds and significant reductions in social services, to eliminate a significant shortfall in the budget year.

Our Bottom Line
If the administration’s assumptions were to hold, the Governor’s proposal would both (1) produce a balanced budget with a healthy reserve in 2007-08 and (2) significantly reduce the state’s ongoing structural shortfall. Even if all the budget’s proposals were adopted, however, it is likely that the actual amount of budget savings and new revenues would fall short of the levels estimated by the administration. The Governor’s key budget proposals raise a number of serious policy and legal issues, which may make their implementation problematic, and the budget’s assumptions on matters ranging from the fiscal benefits of its solutions to the outcome of court cases appear to be optimistic. Adverse outcomes in just a few of these areas could easily eliminate most or all of the budget’s proposed reserve.

Given the above factors, as well as the continuing existence of the structural budget shortfall facing the state, it will be important that the Legislature develop a more realistic budget which includes alternative budgetary solutions and avoids raising ongoing commitments (absent identified funding to pay for them).

How the Budget Covers the Shortfall
In November, we estimated that, under current-law revenue and expenditure policies, the state would conclude 2007-08 with a deficit of $2.4 billion. This consisted of a carryover reserve of $3.1 billion from the current year to offset an operating shortfall of $5.5 billion in 2007-08.

In contrast, the 2007-08 Governor’s Budget includes a year-end reserve of $2.1 billion, an improvement of nearly $4.5 billion relative to our November baseline estimate. This difference reflects both policy actions assumed in the budget as well as its more optimistic assumptions relating to baseline revenues, expenditures, and the outcome of court cases. These factors, enumerated in Figure 1, can be separated into four major categories.

FIGURE 1

How the Governor’s Budget Closes the 2007-08 Shortfall
  (Dollars represented in millions)
 
LAO NOVEMBER FORECAST: -$2,411
 
NEW SPENDING: -$1,198
Supplemental deficit-financing bond payment:  -$595
Other: minus $603
 
BUDGET SOLUTIONS: $3,438
Substitute transportation special funds for General Fund expenditures: $1,111
New tribal gambling compacts: $506
Substitute bond proceeds for General Fund expenditures: $200
CalWORKs reductionS: $496
Shift some child care costs to Proposition 98: $269
Tax policy changes: $200
Other: $656
 
BASELINE ESTIMATES: $1,178
Higher revenue estimate: $641
Lower expenditure estimate: $ 537

COURT -RELATED ASSUMPTIONS: $1,078
CalWORKs (Guillen): $553
Pension obligation bonds: $525
 
BUDGET ESTIMATE OF 2007-08 RESERVE: $2,085

Spending Beyond Our November Baseline ($1.2 Billion). Relative to our baseline, the budget includes $595 million in additional spending for a supplemental payment toward retirement of outstanding deficit-financing bonds. It also includes $132 million above our baseline to University of California and California State University, and $471 million in various other state programs. In Figure 1, these factors have a negative sign, meaning that they worsen the deficit.

Budget Solutions ($3.4 Billion Savings). The single largest component is over $1.1 billion related to the redirection of monies from a transportation special fund to support certain transportation-related General Fund expenditures in the areas of Proposition 98, general obligation bond debt service, and the Department of Developmental Services.

Other solutions include: new revenues from amended tribal gambling compacts, California Work Opportunity and Responsibility to Kids (CalWORKs) savings related to a suspension of the July 2007 cost-of-living adjustment (COLA) and time limits for children; substitution of bond fund proceeds for General Fund flood protection expenditures; elimination of General Fund support for deferred park maintenance; a shift of CalWORKs childcare to Proposition 98 (thereby reducing General Fund spending in the CalWORKs budget); and permanent elimination of the teachers’ tax credit and permanent extension of recent changes involving application of the use tax to out-of-state sales of vessels, aircraft, and vehicles.

More Optimistic Baseline Estimates ($1.2 Billion). After adjusting for the impacts of policy-related changes, the budget’s underlying forecast of General Fund revenues for 2005-06 through 2007-08 combined is about $641 million above our November projections. On the expenditure side, the administration’s baseline estimate for the three years combined is $537 million below our November forecast. While there are a number of offsetting factors on the expenditure side, a key difference is that the administration is projecting higher local property taxes available to offset state spending on Proposition 98.

More Optimistic Assumptions About Pending Court Decisions ($1.1 Billion). Finally, the 2007-08 budget assumes that the state will prevail on its appeal in two cases where it has lost at the superior court level. One is the Guillen case, which involves retroactive application of a 2003 COLA to CalWORKs grants. The other is related to a validation case involving the sale of pension obligation bonds to cover a portion of the state contribution to its retirement fund. Our November estimates assumed that the state would incur added costs of over $500 million related to the Guillen case, and that no pension obligation bonds would be sold in the budget year or beyond.

As we note in the final section of this report, many of the assumptions regarding pending legal decisions, baseline estimates, and new revenues and/or savings from its proposed budgetary solutions are subject to considerable risk.