The Fifty

Report: California could have $26B 'windfall' entering next budget cycle

The LAO says this windfall is onetime in nature and shouldn't be used to expand programs because the state still faces a structural deficit in the long term.

Money is printed.

The nonpartisan Legislative Analyst's Office projects California will have a $26 billion "windfall" entering the next budget cycle, a fiscal fortune that would have been unimaginable when state leaders crafted the June budget this summer.

In its latest fiscal outlook, the LAO says the state has not suffered the fiscal catastrophe that had been feared when the coronavirus pandemic first sent the economy into a downward spiral. At the same time, even demands for state services "have been consistent with a more positive economic picture."

What does it mean? The LAO says this windfall is onetime in nature and shouldn't be used to expand programs because the state still faces a structural deficit in the long term. Because it's hard to predict in this economic environment, the LAO says the revenues could be as high as $40 billion beyond what's expected over the next 18 months or as low as $12 billion.

At the very least, California should enter the January budget season with confidence that it can balance its immediate fiscal year plan without the dire cuts that Gov. Gavin Newsom previously proposed in May after the pandemic struck.

LAO recommendations: Because the cash is considered a onetime bounty, the analyst office recommends splitting the surplus between reserves and spending on Covid-19 response and other onetime purposes, "focusing on activities that mitigate the adverse economic and health consequences of the public health emergency."

Spending half the money on reserves will help shore up the state's structural deficit in future years, the LAO said.

The state still has a structural deficit because many of the cuts passed in the June budget were temporary. While the current windfall could help avoid those same cuts this fiscal year, the state can expect to face a growing deficit in future years if it restores them.

Among the cuts were reductions to higher education, courts and state workers. Already, Senate President Pro Tem Toni Atkins (D-San Diego) said Tuesday that restoring those programs is a priority.

Education: K-12 schools and community colleges should benefit on the natural because the state constitution requires they get a substantial share of any revenue increase. Indeed, the LAO says they would receive $13.1 billion in the current fiscal year if its forecast holds true.

"This increase is the largest change relative to the enacted budget since the passage of Proposition 98 in 1988," the LAO said.

The boost would certainly allow the state to wipe out $12.5 billion in budget deferrals for the current fiscal year that are due to begin in February. That would take a mid-year budget action, or lawmakers could build it into the next fiscal year.

Look for schools to demand much of the Covid-19 relief if state leaders decide to spend money that way. California has been particularly slow to reopen school campuses, and administrators, teachers and elected officials have called on more state assistance to ensure campuses are safe.

The economic picture: California's economy hasn't suffered overall the way many had feared, but the recovery has been unequal, hitting lower-wage, less-educated workers the hardest, while professional workers have kept their jobs and even benefited from stock market gains.

California has a progressive income tax structure that relies heavily on top earners, so the budget has been less impacted than the economy as a whole.

The LAO says unemployment wasn't as severe as expected, even though it remains at 11 percent. And the drop in spending didn't last long. By October, it had come back to within 10 percent of what it was before the pandemic.

Steady caseloads: Meanwhile, the expected rush for safety-net services hasn't materialized. In fact, applications for Medi-Cal were down 15.6 percent between July and October compared to the same period in 2019. The LAO suggests that lower-income workers were buoyed by federal stimulus and unemployment assistance, so caseloads could still rise should such help fade away without a new round of aid.

Responses: Newsom's Department of Finance offered a cautious response Wednesday: "We agree with the overall trajectory of the state’s fiscal condition that the LAO describes — a welcome but short-term revenue surge that will allow the state to make critical investments targeting the impacts of the Covid pandemic," said spokesperson H.D. Palmer. "While the budget is better off than we had feared several months ago, deficits are still on the horizon, and better-than expected revenues haven’t translated into an economy that’s fully rebounding."

Assembly Speaker Anthony Rendon (D-Los Angeles) said his house will focus on improving the Employment Development Department, reopening schools safely and improving protections for workers. He also said he agrees with Atkins' call to restore cuts from the June budget and protect safety-net programs that were facing potential reductions next fiscal year.

What's next: The Legislative Analyst's Office forecast relies on underlying data similar to what the Department of Finance will use to build the governor's budget proposal in January.

Finance has likely locked in caseload expectations, but it will have another two months to figure out if revenues will continue to trend favorably for the state.