Shane Clary, Ph.D.
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On Monday, Governor Newsom and legislative leadership announced that they had reached agreement on a state budget.  

As you know, the Legislature adopted its own version of a budget last Monday to meet its constitutional deadline to do so by June 15.  In adopting their “legislative budget,” the Legislature rejected the Governor’s proposed $14 billion in painful trigger cuts to social safety net programs and K-12 schools, which would have been implemented on July 1.  Instead the Legislature adopted far fewer cuts, many of which would have been triggered on October 1, and relied more heavily on the state’s reserves, payment deferrals, and internal borrowing.  

For the first time in nine years, the Governor has had to give much more ground in the budget than legislative leadership.  The “compromise” budget the Legislature is poised to pass generally aligns with the Legislature’s proposal.  The “cuts” in the compromise budget will now be implemented July 1, and stay in place unless triggered away if the state receives federal funding to backfill the budget by October 15.

The compromise budget, passed by the Senate last night and poised to pass out of the Assembly today, is a big risk to the Governor and the state’s finances.  In the short run, numerous constituencies of democrats will be happy with the preservation of social safety net programs.  In the long run, very few of the budget solutions addressing the state’s $54 billion deficit are durable and some may not last until the ink from the Governor’s signature is dry.

One solution in the compromise budget is an assumption that the state will receive an additional $1 billion in revenue than previously projected.  This assumption seems to be based more on hope rather than tax receipts.  Meanwhile internal borrowing requires the Legislature to pay back the special funds they are raiding, creating obligations for future budget years.  Similarly, the $11 billion in deferrals to K-12 schools are not permanent cuts but must be paid back by the state over time.  In the meantime, K-12 schools still won’t receive funding and will have to rely on reserves and loans as a stop gap, especially since the budget will prohibit them from laying off school staff. 

Finally, relying on state reserves and hoping for federal funding are a big risk.  Reserves can be used once.  By drawing more down in 2020-2021 means less is available for 2021-2022.  If the economy improves, that choice will work out.  If the state and country are headed for a second wave of infections and shelter in place orders, California will be facing a similar budget shortfall next year, but with fewer reserves to stave off the most painful cuts.  Similarly, even if federal funds materialize before October 15, there is no guarantee they will be available in the next budget year.

The bottom line is that the Governor and Legislature could be setting themselves up for tougher budgets in future years.  This isn’t unprecedented.  During the Great Recession, Democratic leaders in the Legislature could not reach agreement on how to eliminate the state’s structural deficit with then Governor Schwarzenegger and Republican minority leaders.  Instead, the state adopted numerous budgets balanced on hopeful revenue projections, deferrals, internal borrowing, and budget gimmicks.  The state’s credit rating fell and a massive $34.7 billion “wall of debt” grew.  Governor Brown spent much of his second stint in the Governor’s Office addressing California’s structural budget deficit and paying down the “wall of debt.”  In the end, he had to rely on harsh cuts coupled with new taxes to do so.

It is possible that when the Legislature returns from its summer recess on July 13 that there will be a push for new taxes to help prop up the state’s finances.  That is a risky proposition for moderate Democrats in an election year, though.  Even if taxes aren’t put on the table, the Legislature and Governor are expected to revisit the budget after the July 15 tax filing deadline.  They will likely have to address various shortcomings in the compromise budget at that time.

COVID-19 and the Budget

Unfortunately, this week saw record high numbers of new COVID-19 cases in California.  With infections and hospitalization on the rise, the Governor is once again facing a difficult situation when it comes to reopening the economy.  

A provision of the budget compromise described above may help the Governor with this problem.  Under the new provision, the Governor’s Department of Finance (DOF) will be empowered to withhold a county’s share of $2 billion of social safety net and COVID-19 relief funding if that county is not adhering to state and federal guidance and directives related to COVID-19.  This includes the statewide order to wear masks and the guidance to businesses related to sanitation and social distancing.

The Governor continues to be savvy in his navigation of pandemic politics.  On the one hand, he has issued guidance to counties and residents to follow in reopening while delegating decision making based on that guidance to local public health officials.  He has now added some teeth to that guidance by making funding contingent upon compliance.  This choice gives the Governor the moral high ground to say he has encouraged Counties to do the right thing and even punished them for not doing so.  If Counties ultimately choose to ignore state guidance, the Governor will be able to say that he punished that behavior.

We expect work on the budget to continue on-and-off in the coming months.  We will keep you apprised of further developments.

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