The State
Appropriations Limit
An
LAO
Report
Background
California’s state appropriations limit (SAL)—originally established by
Proposition 4 in 1979—places an “upper bound” each year on the
amount of monies that can be spent from state tax proceeds. The SAL
itself grows annually by a population and cost-of-living factor.
Most state appropriations are subject to the SAL. However, the law does
exempt certain types of appropriations from the SAL, including capital
outlay, local government subventions, and debt service.
Tax proceeds in excess of the SAL over a two-year period must be equally
split between rebates to taxpayers and expenditures on education.
The SAL has not been a constraint throughout the 1990s. In recent
years, however, California’s strong revenue performance has caused
the “room” under the limit to shrink.
LAO Findings
The 2000-01 Governor’s Budget introduced in January, estimated the
room under the limit to be nearly $3.8 billion in 1999-00 and $4 billion in 2000-01. However, if current revenue trends continue, these
margins could disappear.
Thus, the SAL could become a factor in the Legislature’s budgetary
deliberations as early as this spring, when decisions are made about
both the current and budget years.
Legislative
Considerations
Given recent revenue trends and their potential implications for the
SAL, it is important that the Legislature begin considering what policy
steps, if any, should be taken if the SAL indeed becomes a constraint.
The available options could include one or a combination of the following:
v
v
v
Elizabeth G. Hill
Legislative Analyst
Take no action, in which case any excess SAL revenues would
automatically be divided equally between tax rebates and educational expenditures.
Reduce taxes, so that no excess SAL revenues exist in the first
place.
Increase appropriations for SAL-exempt purposes, such as
local fiscal relief and infrastructure spending.
April 13, 2000
INTRODUCTION
After having been on the “back burner” for
more than a decade, the state appropriations limit
(SAL) could once again become an issue this
spring in the Legislature’s budget-related deliberations. This is because the extraordinary revenue
increases currently being experienced, if sustained, could result in the spending limit becoming a fiscal constraint in 1999-00 and/or 2000-01.
Given the emergence of this situation, it is
important that the Legislature re-familiarize itself
with what the SAL is, how it works, and the policy
options that are available should the limit be
reached. This report discusses these issues, along
with the budget-related considerations that will
face the Legislature should it have to deal with the
limit.
HISTORICAL BACKGROUND
When California’s voters approved Proposition 4 on the November 1979 special election
ballot, the SAL was established in Article XIII B of
the State Constitution. (The SAL is sometimes
referred to as the “Gann Limit,” in reference to
one of the author’s of Proposition 4.) The SAL has
been modified by two subsequent initiatives—
Proposition 98 in 1988 and Proposition 111 in
1990—but its basic framework remains in place
today.
Basic SAL Provisions
Article XIII B does three key things. Specifically, it:
u
u
2
Places annual limits (or ceilings) on the
appropriations of tax proceeds that can be
made by the state, school districts, and
local governments in California. These
limits are based on the amount of appropriations in the 1978-79 “base” year, as
adjusted each year for population growth
and cost-of-living factors.
Precludes state and local governments
from retaining any “excess revenues” (that
is, revenues above each jurisdiction’s SAL).
The measure originally required state and
local governments to return these excess
revenues to taxpayers in the subsequent
year; however, as discussed below, this
provision was later amended.
u
Requires the state to reimburse local
governments for the cost of certain state
mandates.
Historic Experience With the Limit
No Initial Effect. At the state level, the appropriations limit was not much of a factor during the
early years following its enactment. This is because in the early 1980s the combination of high
inflation and weak revenue growth during the
1980 through 1982 recession caused a large
amount of room under the limit to open up.
Limit Was Exceeded in 1986-87. After several
years of strong revenue growth, though, the limit
became a constraint in the second half of the
decade. In fact, the state exceeded its limit in
1986-87. This resulted in a $1.1 billion taxpayer
rebate in the following year.
Plenty of Excess Room Existed in the 1990s. As
indicated in Figure 1, state appropriations again
Legislative Analyst’s Office
fell below the limit in subsequent years, and the
room under the SAL became very large in the
early 1990s. This occurred when the combination
of voter-approved changes to the way the limit is
calculated (see below) and California’s severe
economic recession caused the gap between the
SAL and appropriations subject to the limit to
reach nearly $7 billion.
Little, If Any Room, Exists Today. As discussed
below, however, exceptionally strong revenue
growth in recent years has caused the room under
the limit to erode considerably. For example,
based on our February 2000 estimates, the gap
had shrunk to $1.8 billion in the current year.
Since our February projections, revenues have
continued to soar above expectations. If the current
positive revenue trends continue, the remaining
$1.8 billion current-year gap would be eliminated.
Past Changes to the Limit
Some significant modifications have been made
to the limit since it was first approved by the
voters in 1979. For example, appropriations
funded by new tobacco taxes enacted through
Proposition 99 (1988) and Proposition 10 (1998)
were designated as exempt appropriations, and
thus, not subject to the SAL. More significant
changes occurred when voters approved Proposition 98 in 1988, and Proposition 111 in 1990.
Figure 2 (see page 4) shows how key provisions of
the original spending limit were affected by these
two propositions.
Proposition 98. Prior to the passage of Proposition 98, Article XIII B had required that 100 percent of excess revenues be rebated to taxpayers.
Proposition 98 instead specified that the first
portion of excess revenues be allocated to
schools, up to 4 percent of the minimum funding
guarantee. Excess revenues above
Figure 1
the 4 percent level (equal to about
a
$400 million in 1988) continued to
SAL Could Once Again Become a Constraint
be rebated to taxpayers.
1986-87 Through 1999-00
Proposition 111. In addition to
imposing additional taxes on
gasoline and modifying
Proposition 98’s minimum funding formulas, Proposition 111
made several significant changes
to the SAL. Chief among these
were its changes to (1) the SAL’s
annual inflation and population
adjustment factors, and (2) how
excess revenues are to be calculated and allocated among school
spending and taxpayer rebates.
(In Billions)
Appropriations Limit
$60
Appropriations
Subject to Limit
55
50
45
40
35
30
25
20
86-87
88-89
90-91
92-93
a1999-00 data based on February LAO estimates.
94-95
96-97
98-99
u
Annual Adjustment Factors.
Proposition 111 modified
3
the statewide population factor to take
into account growth in K-14 average daily
attendance, instead of just overall statewide population growth. It also modified
the cost-of-living factor, basing it strictly on
the percent change in California per-capita
personal income (instead of the lesser of
the percent changes in California percapita personal income or the U.S. Consumer Price Index). These changes, which
were made retroactive to 1986-87, have
had the effect of increasing the state’s limit
by about $6 billion in 1999-00 from what
it would have been had the original factors
remained in place.
u
Excess Revenues. Article XIII B originally
required that excess revenues received by
the state and local governments be rebated to taxpayers in the following year.
Proposition 111 instead provides that
excess revenues be established over a twoyear period, and that they be divided
equally between rebates to taxpayers and
Proposition 98 educational spending.
Figure 2
Article XIII B: Changes Made by Propositions 98 and 111
Type of Provision
Original Provisions in
Proposition 4
Annual Adjustments Statewide population
to Spending Limit
growth plus lesser of
U.S. CPI or California
per-capita personal income growth.
Changes Made by:
Proposition 98
No changes.
Exempt
Appropriations
Includes subventions,
No changes.
debt service, retirement
costs, and unemployment insurance compensation.
Allocation of
Excess Revenues
Returned to taxpayers in
the following year.
First portion to Proposition 98 (up to 4 percent
of the minimum guarantee), with remainder to
taxpayers.
Proposition 111
Population growth based
on weighted average of
population and K-14
school enrollment growth.
Cost-of-living based solely
on California per-capita
personal income growth.
Added qualified capital
outlay spending, appropriations supported by increased gas taxes, and
appropriations resulting
from natural disasters.
Excess revenues determined over a two-year
period.
Total to be split between
taxpayer rebates and
Proposition 98 funding.
4
Legislative Analyst’s Office
EXACTLY HOW DOES THE SAL WORK?
Each year, both the state and each of its local
governmental jurisdictions are required to calculate their own spending limits and their appropriations that are subject to their limits. The process for
the state’s limit (the SAL) is outlined in Figure 3.
Calculation of the Spending Limit Itself
The calculation of the SAL for any given year is
accomplished by first taking the SAL for the
previous year and adjusting it for the population
and cost-of-living factors described
above. The limit is also adjusted in
Figure 3
the event that there is a transfer of
financial responsibility for a specific
How the State's Spending Limit Works
program between the state and
Calculation of the
Calculation of
another level of government. (In this
Appropriations Limit
Appropriations
case, any increase in the state’s limit
(SAL)
Subject to the Limit
would need to be offset by a
corresponding decrease in the
Tax Proceeds
Last Year's
other entity’s limit, and vice versa.)
Limit
- General Fund
- Special Funds
The limit is also decreased for
transfers of financial responsibility
Plus
Minus
for funding of a specific program
from taxes to fees or other nontax
Annual
Exempt
proceeds.
Adjustment
- Population Factor
- Cost-of-Living Factor
Plus/Minus
Transfers of
Responsibility
- From one level of
government to
another
- From taxes to fees
Appropriations
- Subventions to K-14
schools and local
governments
- Debt Service
- Qualified Capital Oulay
- Federal and Court
Mandates
Equals
Equals
Current-Year
Limit
Appropriations
Subject
to the Limit
Calculation of Appropriations
Subject to the Limit
In general, these represent all
appropriations funded from the
proceeds of taxes, except appropriations for purposes specifically
exempted under Article XIII B.
Proceeds of Taxes. Article XIII B
defines proceeds of taxes to include
(1) tax revenues, (2) investment
earnings on tax proceeds, and
(3) fees and charges in excess of the
cost of providing the specific
service for which they are intended
and/or imposed. Appropriations
financed by other forms of revenues—such as charges, licenses,
5
fees, proceeds of asset sales, and settlement
funds—are not subject to the limit.
Exempt Appropriations. As noted above,
basically all appropriations of tax proceeds are
subject to the limit except for those specifically
exempted under Article XIII B. Exempt appropriations include debt service, qualified capital outlay,
federal and court mandates, retirement and
unemployment insurance payments, and
subventions to other levels of governments (the
later of which are counted against the recipient
entities spending limits). Examples of subventions
exempt from the SAL include K-12 and community college spending for general apportionments,
and taxes that are collected by the state but then
allocated to local governments for locally determined purposes. The latter includes amounts to
backfill local vehicle license fee (VLF) revenue
losses due to the recent VLF rate reductions.
How Reserves Are Treated
A significant issue concerning the current fiscal
outlook involves how budgetary reserve funds are
treated under the SAL. Article XIII B specifies that
appropriations to reserve funds (including the
Special Fund for Economic Uncertainties, or SFEU)
represent appropriations subject to the limit in the
year in which they are made. In practical terms,
this means that all revenues received in a given
year are counted toward that year’s limit, unless
they are appropriated for exempt purposes. This
includes unanticipated receipts that end up in the
SFEU at year end, since under existing state law
these “unused” revenues are automatically appropriated to the SFEU.
6
Correspondingly, appropriations from the
reserve are exempt from the limit. In the context of
the current budget situation, this means that
appropriations from this year’s accumulated
reserve would not count against next year’s limit.
The Definition and Allocation of
Excess Revenues
How Are They Established? As a result of the
changes enacted by Proposition 111 in 1990,
“excess revenues” are established over a two-year
period. Specifically, the combination of revenues
in any given fiscal year and the subsequent fiscal
year that are in excess of the SAL during the same
two respective years, are considered excess
revenues. As an illustration, if state appropriations
subject to the SAL were to exceed the limit by
$100 million this year but fall below next year’s
SAL by an equal $100 million, there would be
zero excess revenues. Alternatively, if the state
were to exceed its limit by $100 million in both
this year and next year, it would have $200 million of
excess revenues at the end of this two-year cycle.
How Are Excess Revenues Then Allocated? Any
excess revenues are to be divided equally between Proposition 98 spending and taxpayer
rebates. The 50 percent going to schools would
be allocated between K-12 and community
colleges in proportion to their enrollments. Any
excess revenues going to schools would not
increase the base when computing the Proposition 98 minimum funding guarantee in future years.
The 50 percent going for taxpayer rebates would be
rebated during the following two fiscal years.
Legislative Analyst’s Office
LEGISLATIVE ISSUES REGARDING THE SAL
How Close Is the State to Its Limit?
As indicated earlier, recent revenue growth has
eroded most of the room under the limit, and
revenues could exceed the SAL as early as in the
current year if the extraordinary current economic
and revenue trends continue. As an indication of
how quickly the erosion has been occurring,
consider that as recently as January, when the
2000-01 Governor’s Budget was released, the
Department of Finance estimated that the room
under the limit was nearly $3.8 billion for 1999-00
and $4 billion for 2000-01. By mid-February,
however, due to booming tax receipts, we issued
revenue projections that were $2.1 billion above
the Governor’s for each year, bringing down the
room under the SAL to roughly $2 billion in each
year. Since then, revenues have substantially
exceeded our own expectations. Should these
current revenue trends continue during the remaining three months of the current year, full-year revenues could reach or exceed the SAL for 1999-00.
taxes and/or (2) increasing appropriations
for purposes that are exempt from the
limit.
In evaluating these policy options, it is important to remember that because Article XIII B
counts additions to the reserve as appropriations
subject to limitation, unallocated state revenues
will automatically count against the state’s spending limit. Thus, the Legislature does not have the
option of simply letting excess revenues flow into
the SFEU.
What About Timing Considerations? The
Legislature will also need to be aware of various
timing considerations. For example:
u
What Policy Options
Should Be Considered?
If revenues continue booming and the state
were to find itself above the SAL, the Legislature
would be faced with several basic options.
u
u
The first would be to simply let the provisions of Article XIII B “run their course,” in
which case any two-year excess revenues
would be equally divided between taxpayer rebates and Proposition 98 educational spending.
The second and third options include
establishing alternative priorities for any
excess funds—specifically, by (1) reducing
u
In the case of appropriating excess revenues for exempt purposes, this could be
done at any time over the particular twoyear period involved. Thus, if the SAL
became a consideration in the current
year, exempt appropriations could be
done either at any time this year, or the
excess revenues could be carried over
with any required net appropriations done
at any time next year. However, should the
Legislature wish to avoid having the “clock
start ticking” on the two-year SAL interval
for dealing with excess revenues, it may
make sense to increase exempt appropriations in 1999-00.
In the case of the tax-reduction option, the
timing of the tax changes would have to be
carefully planned so that the desired fiscalyear revenue reductions would in fact, be hit.
This is because of the need to correctly
interface income years (which tax liabilities
7
are based on) with fiscal years (which the
SAL is based on), including the particular
timing of the tax prepayments of the different types of taxes that might be reduced.
school districts limits, with any remaining state
funding counting towards the state limit. Our
review of State Department of Education data
indicates that most districts are at their limits.
Thus, there appears to be little room at the school
district level to absorb additional state spending
within their limits.
How Close Are Other Levels of
Governments To Their Limits?
Given that one of the key SAL-related legislative
policy options would be to increase local
subventions, an important consideration is the
extent to which such localities as schools, cities,
counties, and special districts have room to absorb
additional subventions without exceeding their
own appropriations limits.
Other Local Entities. With regard to nonschool
local entities (that is, cities, counties, and special
districts), however, there is considerable room
available. There are a few examples of local entities
that have reached or exceeded their limits during the
past two decades. However, the appropriations of
most cities and counties are generally only 40 percent to 80 percent of their respective limits.
Schools. Under existing law, the state counts as
much of its general apportionments as will fit into
CONCLUSION
Following several years of extraordinarily strong
revenue growth, the amount of room under the
SAL has dramatically decreased. In fact, if recent
revenue trends continue and booming tax collections continue to exceed expectations, the SAL
could be reached within the very near future—
possibly as early as this year. Given this, it is
important that the Legislature re-familiarize itself
with the SAL’s provisions and the various policy
options available for responding to it. This will
ensure that if the SAL is in fact reached, the state’s
response will effectively take account of the
Legislature’s taxation and spending priorities,
including priorities in such areas as education,
infrastructure, and local government fiscal relief.
Acknowledgments
This report was prepared by Brad Williams and
David Vasché, with the assistance of others
throughout the office. The Legislative Analyst’s
Office (LAO) is a nonpartisan office which
provides fiscal and policy information and
advice to the Legislature.
8
LAO Publications
v
To request publications call (916) 445-2375.
This report and others, as well as an E-mail
subscription service, are available on the
LAO’s Internet site at www.lao.ca.gov. The
LAO is located at 925 L Street, Suite 1000,
Sacramento, CA 95814.
February 2005
LAO
6 0 Y E A R S O F S E RV I C E
Proposition 98 Primer
ELIZABETH
G.
HILL
•
L E G I S L AT I V E
A N A LY S T
Proposition 98 is a complex formula for setting a minimum annual funding level for K-12
schools and community colleges. This primer
is intended to assist the Legislature in understanding the basic “mechanics” of the proposition and showing how it has affected school
spending since its passage in 1988. We also
describe the Governor’s proposed changes to
Proposition 98 and discuss our concerns about
how they would diminish legislative budget
authority. ■
AN LAO REPORT
2
Acknowledgments
LAO Publications
T his r ep o r t wa s p r ep ar e d by Robert
Manwaring. The Legislative Analyst’s Office
(LAO) is a nonpartisan office which provides
fiscal and policy information and advice to
the Legislature.
To request publications call (916) 445-4656.
■
This report and others, as well as an E-mail
subscription service, are available on the
LAO’s Internet site at www.lao.ca.gov. The
LAO is located at 925 L Street, Suite 1000,
Sacramento, CA 95814.
L E G I S L AT I V E A N A LY S T ’ S O F F I C E
AN LAO REPORT
INTRODUCTION
California voters enacted Proposition 98 in
1988 as an amendment to the State Constitution. This measure, which was later amended by
Proposition 111, establishes a minimum annual
funding level for K-14 schools (K-12 schools and
community colleges). Proposition 98 funding
constitutes over 70 percent of total K-12 funding
and about two-thirds of total community college
funding.
The Governor recently proposed major
changes to the Proposition 98 funding guarantee for K-14 schools. To help the Legislature put
the proposed changes into context, it is important to understand how the current guarantee
mechanism works. This primer provides some
basic information on Proposition 98 and how it
has affected spending on K-14 education.
THE ABCs OF PROPOSITION 98
What Is the Basic Purpose of
Proposition 98?
How Much Does Proposition 98 Take
Of the General Fund Budget?
While the formulas get rather complicated at
times, the goal of Proposition 98 is a relatively
straightforward one. Generally, Proposition 98
provides K-14 schools with a guaranteed funding source that grows each year with the
economy and the number of students. The
guaranteed funding is provided through a
combination of state General Fund and local
property tax revenues.
Currently, Proposition 98 spending (General
Fund) is almost 45 percent of General Fund
revenues. Test 1 of Proposition 98 requires the
state to provide K-14 education at least 39 percent of General Fund tax revenues. However,
this test was only operative in the first year of
Proposition 98 and is not likely to be operative
any time in the near future.
How Does the Guarantee
Grow Each Year?
Over the long run, the Proposition 98
calculation increases the prior-year’s Proposition 98 funding level by the growth in K-12
attendance and growth in the economy (as
measured by per capita personal income). The
actual amount the state is required to spend on
Proposition 98 each year, however, depends on
specific calculations or “tests” (see Figure 1 next
page).
L E G I S L AT I V E A N A LY S T ’ S O F F I C E
Under What Conditions Can
Proposition 98 Funding Grow More
Slowly Than the Economy?
Proposition 98 funding usually grows with
the economy (that is, Test 2 years). Proposition 98 funding, however, can grow more
slowly under two different conditions:
➢ Test 3—Slow General Fund Revenue
Growth. If General Fund revenues grow
slower than personal income, the
funding guarantee is driven by the
growth in General Fund revenues per
capita.
3
AN LAO REPORT
➢ Proposition 98 Suspension. The Legislature, with a two-thirds vote, can also
suspend the minimum guarantee for a
fiscal year. Under a suspension, the
Legislature can appropriate K-14 funding
at whatever level it chooses.
Figure 2 shows the history of which test was
operative. The figure shows that Test 2 has been
the predominant test factor (12 of 18 years).
This is not surprising given that the state’s tax
structure typically results in revenues growing
faster than personal income. Test 3 years have
tended to occur during state budget crises,
when General Fund revenues have fallen yearto-year. So, Test 3 has reduced the pressure of
Proposition 98 on the General Fund in years
when the state was facing difficult budgets.
Figure 3 (see page 6) illustrates how the
maintenance factor is created in one year and
restored through accelerated growth in future
years. In the figure, the state saves $2 billion in a
suspension year, thereby creating a maintenance factor of the same amount. In this example, General Fund revenues grow faster than
the economy in each of the next four years. As
a result, the state provides an additional
$500 million each year in accelerated growth or
maintenance factor restoration. By year five, the
state is back to a spending level that would have
occurred absent the suspension. Figure 3 also
shows that a suspension or Test 3 year results in
state savings for several years. The state pays
less than it otherwise would have until the
maintenance factor is fully restored.
What Is the “Maintenance Factor” and
How Does It Work?
Recall that the intent
of Proposition 98 is for
K-14 funding to grow with
attendance and the
economy. When Test 3
years or suspension
occurs, the state has
provided less growth in
K-14 funding than the
growth in the economy.
This funding gap is called
the maintenance factor.
Proposition 98 contains a
mechanism to accelerate
Proposition 98 spending
in future years. This is
called restoration of
maintenance factor.
4
Figure 1
Proposition 98 Basics
9
9
Over time, K-14 funding increases to account for growth in K-12
attendance and growth in the economy.
There Are Three Formulas (“Tests”) That Determine K-14 Funding.
Which test depends on how the economy and General Fund revenues
grow from year to year.
• Test 1—Share of General Fund. Provides 39 percent of General
Fund revenues. This test has not been used since 1988-89.
• Test 2—Growth in Per Capita Personal Income. Increases prioryear funding by growth in attendance and per capita personal income.
Generally, this test is operative in years with normal to strong General
Fund revenue growth.
• Test 3—Growth in General Fund Revenues. Increases prior-year
funding by growth in attendance and per capita General Fund
revenues. Generally, this test is operative when General Fund
revenues fall or grow slowly.
9
Legislature Can Suspend Proposition 98. With a two-thirds vote, the
Legislature can suspend the guarantee for one year and provide any
level of K-14 funding.
L E G I S L AT I V E A N A LY S T ’ S O F F I C E
AN LAO REPORT
When Has the State Owed
Maintenance Factor?
Figure 4 (see next page) shows how the
maintenance factor has fluctuated over time.
Generally, once a maintenance factor is created,
it carries forward for several years until stronger
General Fund revenue growth allows for a
reduction of this obligation. For example, as a
result of several Test 3 years, the state created a
maintenance factor in the early 1990s that grew
to $2.2 billion by 1993-94. As General Fund
revenues recovered in the mid-1990s, the state
provided accelerated Proposition 98 growth
and fully restored the maintenance factor by
1997-98. In recent years, the large outstanding
Figure 2
What Have Been the Operative Tests?
Growth Factors Per Capita
Year
Operative
Test
Personal
Income
General
Fund
1998-89
1989-90
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06b
1
2
3
2
3
3
2
2
2
2
2
2
2
3
2
2
Suspended
2
3.9%
5.0
4.2
4.1
-0.6
2.7
0.7
3.4
4.7
4.7
4.2
4.5
4.9
7.8
-1.3
2.3
3.3
4.5
—a
—a
-4.0%
8.0
-4.4
-3.4
6.6
8.1
5.6
10.7
6.5
18.3
6.9
-18.6
1.0
5.9
7.2
5.7
a Test 3 was added to Proposition 98 in 1990 by Proposition 111.
Thus, per capita General Fund revenues were not part of the
calculation in these years.
b Based on 2005-06 Governor's Budget.
L E G I S L AT I V E A N A LY S T ’ S O F F I C E
maintenance factors are due to: (1) the dramatic
revenue drop-off in 2001-02 (Test 3) and (2) the
2004-05 suspension.
Is Maintenance Factor a Loan
That Must Be Repaid?
Some have suggested that when the state
creates a maintenance factor, it is borrowing
from Proposition 98. This is not the case. When
the state creates a maintenance factor, the state
is saving the amount of the maintenance factor.
And, while the General Fund savings are not
permanent, the state never has to repay funding
not provided to schools as a result of the
maintenance factor.
For example, in 2004-05 under the
Governor’s proposed 2005-06 budget, the state
saves $3.1 billion by its suspension of Proposition 98 in the current year. Under the existing
Proposition 98 formulas, the state will over time
provide accelerated growth to build the $3.1 billion back into the Proposition 98 base. However,
until the entire $3.1 billion is restored, the state will
continue to have annual General Fund savings.
How Does Maintenance Factor
Restoration Interact With
Revenue Increases?
As noted above, in good revenue years, the
state makes accelerated payments to Proposition 98. As a result, the state must dedicate
around 55 percent of new General Fund
revenues to Proposition 98 in these situations.
Some people get confused by the 55 percent number, wrongly comparing it with
Proposition 98’s share of General Fund revenues—45 percent. The 45 percent figure is the
average share of General Fund revenues
devoted to Proposition 98 spending. The
55 percent figure only applies to additional
5
AN LAO REPORT
General Fund revenues
(year over year) and
only in years when the
state has an outstanding
maintenance factor. The
55 percent figure is
important to remember
in those cases where
General Fund revenues
may be going up (due
to updated projections,
final collections, or
proposed tax increases).
Can the Legislature
Provide More Than
The Minimum
Guarantee?
Yes. The state can
provide funding above
the Proposition 98
minimum guarantee in
any fiscal year. However,
since the additional
funding becomes part of
the Proposition 98 base
for the next year’s
calculation, it becomes a
permanent state obligation. Appropriations
above the minimum
(often referred to as
“overappropriations”)
occurred annually for
five years beginning in
1997-98, permanently
raising the long-run
Proposition 98 obligation level by almost
$3.7 billion.
6
Figure 3
How a Maintenance Factor Is Created and Restored
65
State Savings (Maintenance Factor)
Restoration
60
Proposition 98 Base
55
50
45
40
Year 1
$2 Billion
Suspension
Year 2
Year 3
Year 4
Year 5
Figure 4
Proposition 98 Outstanding Maintenance Factor
(In Billions)
$4
Maintenance Factor Due to:
Suspension
3
Test 3
2
1
90-91
92-93
94-95
96-97
98-99
00-01
02-03
04-05
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Does the Legislature Have Discretion
Over How the State Spends the
Proposition 98 Funds?
provide the funds for general purpose uses or
for specific categorical programs. The state can
also vary the mixture of funding that is used to
support K-12 schools, community colleges, and
child care.
Within the guaranteed funding level, the
Legislature has complete discretion on how it
spends monies on schools. The Legislature can
THE STATE’S EXPERIENCE WITH
PROPOSITION 98 TO DATE
How Well Has Proposition 98 Worked
At Providing Predictable Growth in
Funding?
General Fund revenues and the factors causing
this volatility.)
Has Education Spending
Not very well. Figure 5 shows the year-toGrown as Fast as the Economy?
year growth in Proposition 98 spending. It
Yes, it has over the life of Proposition 98.
shows that the guarantee has not provided K-14
However, as discussed below, education spendeducation with a consistent and predictable
ing has experienced ups and downs.
growth in education
funding. Part of the yearFigure 5
to-year volatility in
Year-to-Year Growth in Proposition 98
funding is linked to the
underlying volatility of
the economy. But
Proposition 98 funding is
4%
significantly more
volatile than the
3
economy. This is because of
2
Proposition 98’s reliance
on the year-to-year
changes in General
1
Fund revenue. (In our
recent report, Revenue
Volatility in California,
-0.5
we discuss the history of
-1.0
the state’s volatility in
89-90
91-92
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93-94
95-96
97-98
99-00
01-02
03-04
05-06
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Early 1990s Were Difficult Years for K-14
➢ Funding grew more slowly than the
Education Funding. Proposition 98 had a
economy in recent years (due to the
difficult start. After Proposition 111 added Test 3
Test 3 year in 2001-02 and suspension in
in 1990, three of the next four years were Test 3
2004-05).
years, providing K-14 resources that did not
keep pace with growth in attendance and
Does Proposition 98 Always Provide
inflation. The maintenance factor grew to
Enough Resources to Fund K-14 Basic
$2.2 billion (almost 10 percent of Proposition 98 Program (Growth and COLAs)?
funding at that time).
Usually, but not always. It depends on
In the mid-1990s, as General Fund revenues
whether the economy and General Fund
recovered (Test 2 years), the state provided
revenues grow faster than inflation. In some
accelerated growth, fully restoring the $2.2 bilTest 3 years, the Proposition 98 calculation does
lion in maintenance factor by 1997-98. So from
not provide enough resources to fully fund
the start of Proposition 98 to 1997-98, funding
growth and cost-of-living adjustments (COLAs).
grew in two distinct periods—slower than the
In most other years, the funding growth far
economy through 1993-94, then faster than the
exceeds growth and COLAs, leading to signifieconomy between 1994-95 and 1997-98.
cant program expansions like the creation of the
Spending Continues to Grow With Economy
K-3 class size reduction program in 1996-97.
in Recent Years. On average, Proposition 98
funding has grown
roughly as fast as the
Figure 6
economy over the last
Growth in Proposition 98 Compared to
decade. As Figure 6
Growth in the Economy
shows, 2005-06 Proposi(In Billions)
tion 98 spending is slightly
$55
higher than what the
Actual Appropriations
funding guarantee would
50
Growth in the Economy
have been in 2004-05 had
the state funded education
45
at the Test 2 level each
year over the period. This
40
overall trend, however,
masks the facts that:
➢ Proposition 98
funding grew
much faster than
the economy in
the late 1990s
(due to overappropriations).
8
35
30
25
96-97
98-99
00-01
02-03
04-05
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What Would Education Spending Be
If the State Had Spent at the Minimum
Guarantee Each Year?
Figure 7 shows the level of funding the
state would have provided for K-14 education if
the state had spent at the minimum guarantee
each year since 1996-97. In the current year, the
guaranteed level would have been $7.2 billion
less than is currently being provided. Much of
the gap between actual spending and the
minimum guarantee occurs in 2001-02, when
General Fund revenues fell 17 percent.
I Thought That “Bad” Fiscal Years Were
Test 3 Years. Why Are 2002-03 Through
2005-06 Not Test 3 Years?
of General Fund revenues. In 2001-02, General
Fund revenues fell over 17 percent. Since
2001-02, the state’s revenues have experienced
moderate to strong year-to-year growth
(2.6 percent in 2002-03, 7.5 percent in 2003-04,
8.7 percent in 2004-05, and 7.1 percent in
2005-06). Since Proposition 98 only looks at the
year-to-year changes, the moderate to strong
growth in revenues resulted in the recent years
being Test 2 years requiring maintenance factor
to be restored.
How Do Proposition 98 Requirements
Affect State Budget Choices During
Years of Recovery From an Economic
Downturn?
As the state budget begins to recover from
a period of low General Fund revenues, Proposition 98 requires a large portion of the growth
in General Fund revenues to be used for KFigure 7
14 education. In both
Proposition 98–If Legislature Had Appropriated
the mid-1990s and in
At the Minimum Guarantee
recent years, as General
Fund revenues recov50
ered from a significant
Actual Spending
downturn, ProposiMinimum Guarantee
45
tion 98 required the
state to accelerate the
year-to-year growth in
40
Proposition 98 funding
to restore maintenance
35
factor obligations. In
these years, the educa30
tion programs expanded
substantially, while
funding for other por25
tions of the budget were
1996-97
1998-99
2000-01
2002-03
2004-05
constrained. For ex-
Good question. Proposition 98 relies
completely on year-to-year changes in General
Fund revenues, and does not rely on the level
L E G I S L AT I V E A N A LY S T ’ S O F F I C E
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ample, if the state had not suspended the
guarantee in 2004-05, Proposition 98 would
have required the state to provide an additional
$3.1 billion above the budgeted level, which
already funded growth and COLA and provided
limited program expansion. This large augmentation of K-14 spending would have required
other General Fund supported programs to be
cut further. Alternatively, the state could raise tax
revenues, but since roughly 55 percent of
additional General Fund revenues would have
been required to be spent on K-14 education, it is
difficult to address the maintenance factor repayments with additional General Fund revenues.
In 2005-06 the State Has an $8 Billion
Structural Deficit. Why Does
Proposition 98 Require Maintenance
Factor to Be Restored?
Under the Governor’s economic forecast,
the state would be required to restore $375 million of maintenance factor in 2005-06 because
General Fund revenues grow faster than personal income (General Fund revenues grow
6.2 percent per capita, and personal income per
capita grows 4.5 percent). This funding is on top
of the $2.5 billion in regular Proposition 98
growth (Test 2). The Proposition 98 funding
formulas do not take into account the state’s
continuing structural imbalance between revenues and expenditures.
Why Has the General Fund Support for
Proposition 98 Increased So Much
Since 2003-04?
Between 2003-04 and the proposed
2005-06 budget, the General Fund cost of
Proposition 98 has increased from $30.5 billion
to $36.5 billion (a 20 percent increase). The
10
reason for the rapid increase in General Fund
costs is largely explained by two major local
government agreements. The state transferred
roughly $4.8 billion annually in local property
tax revenues from school districts to local
governments. These transfers were to compensate local governments for the vehicle license
fee “swap” and the “triple flip” payment mechanism for the deficit-financing bond passed in
March 2004. In both of these cases, local
government exchanged one funding stream—
state General Fund spending or the local share
of sales tax revenues—for an equal dollar
amount of school property taxes. The state, in
turn, backfilled the property tax loss to schools
with increased General Fund support under
Proposition 98. These changes mean that K-14
education has become more reliant on the
General Fund. The General Fund share of
Proposition 98 has increased from 66 percent in
2003-04 to 73 percent in 2005-06.
What Has Happened to Per Pupil
Funding Under Proposition 98?
Figure 8 shows how K-12 Proposition 98
funding per pupil in actual dollars has changed
over the last decade. Actual per pupil funding
increased each year, averaging 4.6 percent
annually over the last decade. Per pupil spending has increased by almost $2,500 per pupil
over the period (57 percent). These figures
however, do not take into account the increases
in costs that school districts face. Figure 9 shows
K-12 per pupil funding adjusted for inflation.
After adjusting for inflation, per pupil spending
has grown around $930 per pupil over the last
decade (14 percent). This means that schools
have been able to expand programs by around
14 percent over the last decade. Some of these
L E G I S L AT I V E A N A LY S T ’ S O F F I C E
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expansions included K-3
class size reduction,
large child care expansions, and new school
intervention programs.
The figure shows that
funding growth has
varied substantially over
the decade with three
trends—(1) growth in per
pupil spending between
1995-96 and 2000-01 of
$1,200 per pupil
(3.6 percent annual
growth), (2) a decline of
roughly $480 per pupil
between 2000-01 and
2004-05 (1.3 percent
decline annually), and
(3) the Governor’s
proposed $168 per pupil
increase in 2005-06 (a
change of 2.3 percent).
The state would need to
provide an additional
$313 per pupil to return
to the high point in
inflation-adjusted per
pupil spending
(2000-01). This would
cost roughly an additional $1.9 billion.
How Much Has
Education Been Cut
In Recent Years?
As shown in Figure 6, reductions in
recent years have
Figure 8
K-12 Per Pupil Spending
(Nominal Dollars)
$8,000
7,500
1.0%
rowth
Annual G
Average
5.2%
7,000
6,500
th
row
6.5
%
lG
6,000
ge
a
nu
An
era
Av
5,500
5,000
4,500
4,000
95-96
97-98
99-00
01-02
03-04
05-06
Figure 9
K-12 Per Pupil Spending Adjusted for Inflation
$8,000
Ave
rag
e An
7,500
th
row
ge
era
Av
7,000
nua
lG
rowt
%
3.6
h -1
.3%
2.3%
lG
ua
nn
A
6,500
6,000
5,500
5,000
95-96
L E G I S L AT I V E A N A LY S T ’ S O F F I C E
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99-00
01-02
03-04
05-06
11
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generally offset funding
Figure 10
gains that K-14 educaEducation Community’s Estimate of
tion made in the late
K-14 Funding Reductions Technically Flawed
1990s when the state
overappropriated the
Mixing Expenditure Reductions and Revenue Reductions Double
guarantee by a cumulaCounts Cuts ($3.5 Billion). Many of the K-14 expenditure reductions that
tive $3.7 billion. Some in
the state made in recent years were required because the state provided
$3.5 billion less in revenues over the period. The education community’s
the education commumethodology counts both the reduction to revenues and the resulting
reduction to expenditures caused by the lower spending level.
nity have suggested that
Does Not Offset Funding Reductions With Funding Augmentations
education has been cut
($500 Plus Million). Augmentations include High Priority Schools
as much as $9.8 billion
Program ($200 million), Special Education settlement ($125 million),
equalization ($110 million), and nonstatutory growth and cost-of-living
in cumulative reductions
adjustments for numerous categorical programs.
since 2000-01. We
Includes Rejection of Proposed Augmentation ($250 Million). The
believe this estimate is
estimate includes as a reduction an augmentation that the Legislature
chose not to fund ($250 million for K-12 equalization).
technically flawed for
Continues to Count Reductions That Have Been Restored (Nearly
several reasons dis$350 Million). The estimate includes reductions that the Legislature
cussed in Figure 10. The
restored in 2004-05 ($220 million for instructional materials and
$129 million for deferred maintenance).
difficulty in determining
how much has been cut
recent years. We estimate that the state would
really depends on the baseline used to deterneed to provide an additional $1.9 billion above
mine the reduction. We believe that the decline
the proposed 2005-06 funding level to restore
in inflation-adjusted Proposition 98 funding per
the real purchasing power of per pupil K-12
pupil for K-12 schools represents the magnitude
funding at its peak level in 2000-01.
of the reduction schools have experienced in
9
9
9
9
GOVERNOR’S PROPOSED CHANGES
TO PROPOSITION 98
How Would the Governor’s Budget
Reform Proposal Affect Proposition 98?
As part of his proposed constitutional
reforms to the state budget process, the Governor is proposing major changes to Proposition 98. The two biggest changes are:
➢ Eliminating Suspension and Test 3
Provisions. Starting with the 2006-07
budget, the Governor proposes to
eliminate the state’s ability to adjust K-14
12
education funding in difficult fiscal years
by eliminating the suspension and Test 3
provisions.
➢ Education Spending Subject to
Across-the-Board Cuts. In contrast to
this protection, the Governor also
proposes automatic proportional reductions to Proposition 98 and most other
spending programs whenever the
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administration determines the budget is
out of balance and a plan is not agreed
upon to address it in a specified period
of time. These reductions could occur at
any time throughout the fiscal year.
The Governor proposes other changes to
Proposition 98, which are summarized in the
nearby box.
IMPACT
OF
How Would These Changes Affect
Legislative Priority Setting?
In our view, the elimination of the suspension and Test 3 provisions would greatly reduce
legislative discretion during difficult budgetary
times. For example, if the proposal had been in
effect in 2001-02 when General Fund revenues
fell by 17 percent, the state would have had to
GOVERNOR’S BUDGET REFORMS
ON
PROPOSITION 98
In addition to the proposed elimination of the suspension and Test 3 provisions, the
Governor’s proposals would do the following:
Eliminate the “Ratchet Effect” for Proposition 98 Overappropriations. Currently, when
the state provides funding above the minimum guarantee, those additional funds become part
of the Proposition 98 base. This commits the state to higher K-14 spending levels for future
years. The Governor would amend Proposition 98 to make appropriations above the minimum guarantee discretionary—that is, they would not become part of the base in determining
the next year’s funding level.
Transition Existing Maintenance Factor to One-Time Payments ($3.7 Billion). The
proposed elimination of the suspension and Test 3 provisions means that the state would not
create any future maintenance factor. The Governor’s proposal also would eliminate the
existing obligation to make about $3.7 billion in maintenance factor restorations. Under
current law, the state would build the $3.7 billion back in K-14 base spending over time as a
result of good General Fund revenue years. The Governor instead would make one-time
payments over a 15-year period that totaled $3.7 billion. The timing of these payments would
be up to the discretion of the Legislature. If paid in annual increments, this would cost the
state roughly $250 million annually for the next 15 years.
Pay Off Prior-Year Proposition 98 Obligations Over a 15-Year Period ($1.3 Billion).
According to the Department of Finance, the state owes almost $1.3 billion to meet minimum
guarantee obligations for prior years. (These are one-time “settle up” obligations for selected
fiscal years between 1995-96 through 2003-04.) The proposal would require the $1.3 billion
to be paid in one-time payments averaging $83 million annually over a 15-year period. Current
law would require annual payments of $150 million starting in 2006-07.
Fully Reimburse Past State-Mandated Costs ($1.8 Billion). We estimate that the state
owes around $1.8 billion to reimburse school districts for the costs of implementing state
mandates in past years. The state would be required to use a portion of future Proposition 98
funding to pay for these mandates over the next 15 years.
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increase education spending by almost $4 billion more than what was budgeted. This, in turn,
would have required comparable reductions to
the rest of the budget—or significant revenue
increases, limiting the Legislature’s authority to
set priorities.
Do the Governor’s Proposals Reduce
Autopilot Budgeting?
In our view, they do not. In fact, they make
things worse at the time that policymakers need
the most tools—during difficult budget years.
This is because they would lock in year-to-year
spending in Proposition 98. As a result, the
Governor’s proposals would put Proposition 98
spending—almost one-half of the General Fund
budget—on cruise control.
How Would the Proposals Affect
Education Spending?
It is impossible to say. For school districts,
there are three potential positives:
➢ More stable funding, due to the elimination of suspension and Test 3 years.
➢ More overappropriations in some years,
as this spending would no longer be a
permanent increase in the “base.”
➢ A specific deadline for the payoff of
“settle up” and existing maintenance
factor obligations (within 15 years).
14
These potential positives, however, must be
considered along with the following:
➢ Proposition 98 would be subject to
across-the-board reductions during times
of budgetary shortfalls. This reintroduces
considerable uncertainty in the education funding process.
➢ The proposed treatment of maintenance
factor has the effect of reducing longrun Proposition 98 funding by several
billions of dollars.
➢ Appropriations above the minimum
guarantee would no longer be permanent increases to the base.
So, What Should the Legislature Do?
We concur with the Governor that there are
problems with the Proposition 98 funding
formula, particularly from a budgeting perspective. It involves complex calculations that few
fully understand and generates funding results
that are often unintuitive or—even worse—
counterintuitive. While the administration’s
proposals would greatly simplify the funding
formulas, it would do so at the expense of
legislative budgetary authority and discretion.
We believe the proposal, on balance, would add
to the problems of autopilot spending and that
the Legislature should consider other ways to
improve Proposition 98 that do not involve such a
serious diminution of legislative budget authority.
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