Gaming The Budget: Governor Newsom’s $8 Billion Maneuver

When Gov. Gavin Newsom announced his annual budget proposal at a news conference in January, things got a little contentious.

The governor insisted that the budget “problem” ― no one in Sacramento likes to call it a “deficit” ― was $38 billion. He pushed back against reporters who asked him about the estimate from the nonpartisan Legislative Analyst’s Office in December that the budget shortfall is actually $68 billion.

The LAO explained the conflicting numbers tactfully. “The main difference between our estimate and the administration’s estimate is related to revenues,” they said. “In our view, the administration’s revenue forecast is optimistic, but plausible.”

The Legislative Analyst’s Office was more critical of the governor’s “novel proposal” related to $8 billion in excess school spending.

The problem arose because of the tax filing extensions that were granted to California taxpayers in nearly every county in 2023 for the 2022 tax year.

“Typically, the budget process does not involve large changes in revenue in the prior year (in this case, 2022–23),” the LAO explained. “This is because prior-year taxes usually have been filed and associated revenues collected by April of any given year.” But because of the tax filing extensions, “the Legislature only gained a complete picture of 2022–23 tax collections late in 2023 — after the fiscal year already ended. Those data showed a severe revenue decline, with total income tax collections down 25 percent. A decline of this magnitude is unprecedented for the prior fiscal year. It also results in an unprecedented prior-year reduction to the minimum funding requirement for schools and community colleges.”

Under Proposition 98 (1988), there is a minimum annual funding guarantee for schools and community colleges that is established with a set of formulas. “General fund spending on K–14 education tends to increase when revenues grow and decrease when revenues decline,” the LAO said.

Throughout 2022–23, the state controller distributed funds to K–14 schools based on expenditure levels that aligned with the minimum funding guarantee based on projected revenue. But the projection turned out to be too high.

Now that the real revenue numbers have come in, the LAO says the payments to schools exceeded the minimum funding guarantee by $8 billion. But the governor’s budget proposes “not recognizing the expenditures above the minimum requirement, despite allowing schools to keep the funding.”

What does that mean, exactly?

The LAO explains: “Under this proposed maneuver, the state would generate budget savings by not recognizing a budgetary expenditure, despite the fact that the cash has gone out the door.”

If you find this hard to understand, you’re not alone.

“The best way to conceptually understand this proposal is that the state would make an interest-free loan to itself using its own cash resources,” the LAO wrote. “In short: the unacknowledged $8 billion in cash disbursements in 2022–23 create an outstanding ‘principal’ due from the state’s cash resources. The state would make ‘re-payments’ on this principal balance beginning in 2025–26 as it acknowledges the cash disbursement on a budgetary basis.”

What does the non-partisan Legislative Analyst’s Office think of the governor’s proposed maneuver?

“We have major concerns,” they wrote.

The first concern expressed by the LAO is transparency. It “obfuscates the budget’s true condition” by creating a new budget obligation in future years that is “virtually invisible.”

Another problem is the projected $30 billion in annual deficits on the horizon for the next several years, which will require “even more difficult decisions” about cuts to state programs or tax increases.

The LAO also pointed out that the repayment of the $8 billion “loan” to cover school funding will come from all other state General Fund programs, not from the funding for education alone.

Finally, the LAO voices concern about the precedent this “novel” maneuver would set. “It would likely create an expectation that the state would continue to use maneuvers like this to pay for spending in the presence of budget deficits.” Eventually, “the bill comes due,” the LAO warned. “This proposed maneuver is bad fiscal policy, sets a problematic precedent, and creates a binding obligation on the state that will worsen out-year deficits and require more difficult decisions. We strongly recommend that the Legislature reject the proposal.”