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Later this week Governor Brown is set to release the May Revision to his proposed budget for 2017-18, the state fiscal year that begins on July 1. In the days after the revised budget comes out, the California Budget & Policy Center will issue our “first look” analysis. Also, next Friday morning, May 19, we’ll host a webinar briefing (register here) to discuss the May Revision and the issues that will shape the remaining weeks of this year’s budget debate.

The following are five key issues that we’ll be watching for in the Governor’s May Revision and in the budget deliberations that follow in the coming weeks.

1. Updated Revenue Projections and Their Implications

The issue:
The Governor’s January proposal projected that California would face a budget shortfall of $1.6 billion in 2017-18, absent action by policymakers to address this gap, as a result of revenue collections falling short of expectations and a shortfall in the Medi-Cal budget in the current (2016-17) fiscal year. The Governor’s revenue projections in the May Revision are closely watched because the Department of Finance (DOF) has several more months of information on the performance of state revenue collections. April is a particularly important month for state tax collections due to filing deadlines for the personal income tax (PIT) and corporation tax (CT). Preliminary estimates from the Legislative Analyst’s Office (LAO) project that slower-than-expected tax collections in April likely negate gains made in earlier months, with updated estimates to be provided this week. The Governor’s January proposal also assumed a moderate pace of economic growth, tempered by national economic performance and federal policy changes that could threaten California’s economic and fiscal health. It remains to be seen whether recent state revenue collections and the Governor’s outlook for the economy will be enough to alter the earlier projection of a $1.6 billion shortfall for 2017-18, while also freeing up funds for other priorities.

What we’re watching for: whether the updated revenue projections in the May Revision provide additional revenues and, if so, how the Governor proposes to allocate those funds.

Governor Brown has maintained a relatively cautious approach toward the state budget since winning his third term as California’s chief executive in 2010. This has included conservative revenue projections; limiting, to some extent, the state’s long-term spending obligations; paying down state debts; and building up reserves in order to help offset a future budget deficit. A highly uncertain federal policy environment, particularly in terms of federal support for Medi-Cal and an array of non-defense domestic programs, may prompt the Governor to urge additional caution when it comes to future spending commitments. As a result, the Governor’s May Revision likely will reflect his generally cautious stance toward new spending and his focus on setting aside dollars to prepare for state budget challenges.

If the May Revision projects somewhat higher revenues compared to the January forecast, the state Constitution requires portions of those revenues to be allocated to the state’s rainy day fund (called the Budget Stabilization Account) under Proposition 2 (2014) and to meet the minimum guarantee for K-12 schools and community colleges under Prop. 98 (1988). Beyond these requirements, we will be watching to see if the Governor’s updated revenue forecast provides any room in the state budget for additional investments, especially those — a couple of which are described in the sections below — that put economic security and opportunity within more people’s reach. However, the Governor could also propose to use any additional revenues to further build up the state’s reserves and pay down the state’s debts and long-term spending obligations.

2. “Un-Pausing” Plans to Boost Investment in Early Care and Education

The issue:

Funding for California’s subsidized child care and development system was cut dramatically during and after the Great Recession, resulting in a loss of over 100,000 child care and preschool “slots.” The 2016-17 budget agreement built on recent years’ momentum in restoring funding for these slots. Specifically, the 2016-17 budget agreement increased provider payment rates and funded almost 3,000 additional full-day state preschool slots. What’s more, trailer bill language accompanying the budget agreement signaled legislative intent to both 1) update provider payment rates to keep pace with California’s increasing state minimum wage and 2) fund even more full-day state preschool slots in coming years. However, facing the forecasted $1.6 billion budget shortfall in the 2017-18 fiscal year (as noted above), the Governor proposed to “pause” this multiyear agreement in his January budget proposal. This affected the 5 percent increase to the Standard Reimbursement Rate that was to take effect on July 1, 2017, and the nearly 3,000 full-day preschool slots that were to be added during the 2017-18 fiscal year.

What we’re watching for: whether the Governor will keep his end of the bargain and continue to fund the multiyear investment in California’s subsidized child care and development system.

With the most recent revenue estimates showing that the forecasted budget shortfall for 2017-18 is not as severe as expected, the Governor could choose to use this “wiggle room” to move forward with the multiyear investment in the subsidized child care and development system. Recent years’ budget agreements have boosted support for these programs, but funding in the current fiscal year is still $700 million lower than funding in 2007-08, after adjusting for inflation, and overall the number of subsidized slots remains far lower than prior to the Great Recession.

3. Strengthening, Expanding, and Promoting the CalEITC

The issue:

Established in 2015, the California Earned Income Tax Credit (CalEITC), is a refundable state tax credit that helps low-earning workers and their families make ends meet and build toward economic security. In its first year, the credit benefited around 815,000 Californians, and more than 9 in 10 CalEITC dollars went to low-income working families with children.

What we’re watching for: whether the Governor proposes to strengthen, expand, or promote the credit.

Evidence suggests that the CalEITC was significantly underutilized in its first year. The Franchise Tax Board (FTB) estimates that around 200,000 families might have missed out on the credit. Part of the problem is that the majority of people who qualify for the CalEITC are not required to file state income taxes due to their very low incomes. Indeed, a survey conducted by California Budget & Policy Center last fall found that only half of respondents who were likely eligible for the credit filed their taxes. This means that promoting the credit — particularly among “nonfilers” — will be key to the credit’s success. While the 2016-17 budget agreement included $2 million to support community-based efforts to raise awareness of the CalEITC, the Governor’s proposed budget for 2017-18, released in January, did not include funding to maintain or expand these efforts. New FTB data underscore the need for ongoing state support for CalEITC outreach efforts. In testimony at a recent Senate budget hearing, FTB officials said that only one-quarter of tax filers who claimed the CalEITC in tax year 2016 had also claimed it in tax year 2015. In other words, there is significant “churn” in the population that is eligible for the credit. This makes a strong case for California to maintain, and ideally expand, efforts to promote the credit in order to reach newly eligible workers each year. In addition to watching for greater investments in CalEITC outreach, we will be looking to see if the 2017-18 budget strengthens or expands the credit itself. Several proposals are moving through the Legislature’s policy committees, including one by the chair of the Assembly budget committee, Assemblymember Phil Ting, who last December said that expanding the CalEITC was a top priority in this year’s budget.

4. The State’s Use of Prop. 56 Tobacco Tax Revenues That Go to Medi-Cal

The issue:

Approved by voters last November, Prop. 56 raised the state’s excise tax on cigarettes by $2 per pack and triggered an equivalent increase in the state excise tax on other tobacco products. These increases took effect on April 1. In his January budget proposal, the Governor projected that Prop. 56 will raise $1.8 billion by June 2018, with most of these new revenues — $1.3 billion — going to Medi-Cal as required by the measure. The dollars directed to Medi-Cal must be used “to increase funding for the existing [program]…by providing improved payments for all healthcare, treatment, and services,” according to Prop. 56. These “improved payments” must be based on criteria developed as part of the state budget process — criteria that must include “ensuring timely access, limiting specific geographic shortages of services, or ensuring quality of care.” Furthermore, these Prop. 56 dollars cannot be used to supplant “existing” state General Fund support for Medi-Cal. Despite these directives on how to spend Prop. 56 dollars within Medi-Cal, competing interpretations have emerged, pitting the Governor against an array of provider associations and health care advocacy groups.

What we’re watching for: whether the Governor modifies his interpretation of how Prop. 56 dollars may be used in Medi-Cal.

The Governor proposes to use Prop. 56 dollars “to pay for typical year-to-year cost increases in Medi-Cal,” rather than using these funds to expand the scope of the program, according to the Legislative Analyst’s Office (LAO). The Governor argues that his approach is consistent with the measure’s requirements. Others disagree. For example, provider associations representing doctors and dentists argue that the Governor’s interpretation “conflicts with the plain language” of Prop. 56, which – in their view – “directs funds to be spent to improve access [to Medi-Cal services] by improving provider payments.” Not surprisingly, provider groups want most Prop. 56 funds to go toward Medi-Cal payment increases. In a separate proposal, a coalition of health care advocacy organizations has called for using some Prop. 56 funds to expand Medi-Cal coverage to certain undocumented adults, increase dental provider rates, and reinstate dental benefits for adults that state policymakers eliminated in 2009.

5. Shifting In-Home Supportive Services (IHSS) Costs From the State to the Counties

The issue:

Currently, California and its 58 counties share the nonfederal costs for IHSS, with the cost split being based on a formula adopted in 2012. (IHSS helps roughly half a million low-income older adults and people with disabilities live safely in their own homes.) Under this formula, counties’ share of IHSS spending has grown modestly and predictably, as the state has taken on a relatively larger proportion of the program’s rising costs. However, this formula is contingent on certain conditions, and the Governor indicates that these conditions are not being met. As a result — and barring a change to state law — the current IHSS cost-sharing formula will be automatically rescinded this coming July and replaced with a new formula that would shift substantial costs from the state to the counties. By 2022-23, counties’ total IHSS spending would rise to a projected $3 billion — $1.6 billion higher compared to what the counties would be expected to pay based on the current cost-sharing formula. Governor Brown acknowledges that the funds counties rely on to pay their share of IHSS costs — “1991 realignment” revenues — “will not be sufficient to cover” the higher costs that counties are expected to take on. The Governor has offered to help mitigate the financial hardship that cash-strapped counties would experience, although his proposed 2017-18 budget does not spell out what such mitigation might look like.

What we’re watching for: assuming that at least some IHSS costs are shifted to counties — as seems likely — whether the May Revision includes a plan to offset the financial impact on counties.

The IHSS cost-shift that is assumed in the Governor’s proposed budget would create substantial, ongoing General Fund savings for the state. For this reason alone, the May Revision is likely to maintain some version of an IHSS cost-shift beginning in 2017-18. However, the Governor could offer a plan that both scales back the size of this shift and mitigates the financial impact on counties, while still generating ongoing General Fund savings. For example, an Assembly budget subcommittee recently approved a plan to 1) reduce the size of the IHSS cost-shift and 2) “protect county budgets” by temporarily supplementing counties’ 1991 realignment revenues with other state (non-General Fund) dollars. The Governor’s May Revision could propose a similar approach. However, even the Assembly’s approach might not be sufficient to eliminate the cost-squeeze on county budgets. Counties use their 1991 realignment revenues to fund a number of other services in addition to IHSS. To the extent that more of these dollars are used to fulfill counties’ IHSS obligations, fewer funds would remain to support other critical local services, such as health and mental health programs.

*  *  *

It’s important to note that there are some key issues we don’t expect to see addressed via the revised budget. One that looms especially large is affordable housing. In his initial budget proposal in January, the Governor acknowledged California’s serious housing crisis, but proposed no new funding to address this challenge. Since January, legislators have proposed some major state investments to address housing affordability, including increasing funds for the state Low Income Housing Tax Credit (paid for by eliminating the mortgage interest state income tax deduction for second homes), establishing a permanent state funding source for affordable housing through a new real estate transaction recording fee, and issuing $3 billion in state bonds to replenish existing state housing finance programs. But given the Governor’s earlier stance on this issue, it would be surprising to see any major investment in affordable housing proposed in the May Revision.

Similarly, the Governor’s initial proposal in January did not include any additional investments in CalWORKs or Supplemental Security Income/State Supplementary Payment (SSI/SSP), programs that provide cash assistance to low-income families, seniors, and people with disabilities. It would be surprising to see that change in the May Revision, despite the importance of these programs in helping to combat economic hardship.

— The Staff of the Budget Center

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