Building a Prudent Budget

California is at the very center of the New Economy. Many of the state’s principal industries are key contributors to the productivity revolution that has marked the last decade of sustained economic growth and rising prosperity nationwide. California is by far the nation’s—and the world’s—leader in high-technology manufacturing and services, including electronics, information technology, the Internet, computer programming and software, biotechnology, and entertainment.

California’s central role in this economic revolution has been reflected by gains in most measures of prosperity—including State tax revenues—that over the last two years have far exceeded even the most optimistic expectations. Despite this outstanding performance, the period immediately ahead is fraught with a significant degree of risk from several sources:

• Although this Budget agrees with the consensus view of a national economic slowdown or "soft landing," the recent weakening in many indicators of national economic activity has raised the risk of a possible recession in 2001.
• The decline in stock prices throughout most of last year will almost certainly lead to a reduction in stock option income and net capital gains realizations in the year ahead. Revenue estimates for the 2001-02 Budget reflect a moderate decline in both option and capital gains incomes.
• Dysfunctional wholesale markets for both electricity and natural gas—and the Federal Energy Regulatory Commission’s failure to deal effectively with them—threaten California consumers and businesses with higher prices and also risk the reliability of energy supply that is essential to many of the state’s key industries and to the people of California.

Again this year, a portion of the additional money available in the Budget reflects revised estimates of the economy’s performance and revenue receipts in 2000-01 and prior years. Because in part these additional resources reflect past appreciation in stock prices, these revenues should not be considered a source of funds for ongoing spending commitments.

In recognition of the windfall nature of a portion of these additional revenues, this Budget proposes $3.7 billion in one-time spending and set-asides. Utilizing these funds for one-time purposes recognizes the fact that these revenues are not part of current income in the budget year.

Major one-time items include:

• $1 billion set-aside for various energy issues
• $771.8 million for various capital outlay projects (excluding transportation)
• $250 million for local government fiscal relief
• $200 million for the Jobs Housing Balance Improvement Program
• $117.6 million to continue and expand local flood control subventions
• $100 million for the Diesel Engine Replacement Program
• $100 million for the Clean Beaches Initiative
• $155.8 million added to the reserve (as compared to 2000 Budget Act)

Lawsuits relating to past budget actions—particularly those of the early 1990s—have been a significant feature of the fiscal environment facing this Administration. This year’s Budget again sets aside funds to deal with a number of lawsuits that pose a significant fiscal threat. The proposed Budget contains a $500 million set-aside for legal contingencies.

During the current fiscal year, these funds were used in three significant cases that were settled:

• Brown v. U.S. HHS Settlement—In July 2000, the Administration settled an audit exception with the federal government arising from a statute enacted as a part of the 1991 Budget, where the federal government asserted a claim to part of a "credit" that the State received from the Public Employees Retirement System. Ending over six years of litigation, the Administration agreed to pay the federal government $240 million over five years.
• Special Education Settlement—In October 2000, the Administration settled a dispute with school districts dating back to the 1980-81 fiscal year, where the schools claimed that the State was under funding certain special education requirements. Ending nearly two decades of litigation, the Administration agreed to pay $520 million for past years and to increase future funding by $100 million a year for special education. The $520 million is to be paid $270 million in the current year and $25 million a year over the following 10 years.
• Orthopaedic Hospital Settlement—In December 2000, the Administration settled claims from hospitals dating back almost to 1985. Hospitals claimed that the State’s method for determining Medi-Cal hospital outpatient rates violated federal law. Ending nearly a decade of litigation, the Administration agreed to pay hospitals $350 million for past periods and to increase rates by 30 percent on July 1, 2001.

Even though the foregoing cases have been recently resolved, other long-litigated cases remain pending against the State. Prudence dictates that the State continue to set-aside the resources to meet our legal obligations whether through settlement or final court judgment.

The Budget proposes General Fund reserve of just over $1.9 billion, equating to 2.4 percent of revenues, to address the State’s budgetary needs for the coming fiscal year. Prudent budgeting dictates this course of action given the uncertainty of current revenues, the volatility of the stock market, and other economic risks. This reserve will safeguard the State in the event of any unanticipated economic downturn, caseload increases, or emergencies that may arise.