(January 14, 2008) If the Legislature does not act on the state’s budget crisis by February 1, California will be unable to pay all its bills beginning in March, state Finance Director Michael Genest said at the California Chamber of Commerce luncheon yesterday.
Genest emphasized to the more than 120 Luncheon Forum attendees that California, like the rest of the nation, is in the midst of a severe economic downturn. The combined effect of the state’s continuing structural budget deficit and the loss of revenues due to the economic downturn results in a budget gap of $41.6 billion — just less than half the revenues projected for 2009-10.
“This is the most challenging budget in the state’s history,” Genest said. “It demands quick actions and calls for every type of solution possible, including major spending cuts, revenue increases, borrowing and cash management strategies.”
Origins of the Budget Gap
Genest cited two factors contributing to the budget gap:
- The gap is partly due to the continued structural budget deficit that began 10 years ago and that never been completely eliminated.
- A major part of the state’s budget gap is due to the dramatic decline in revenues during the current recession.
In 1998-99, the state’s budget was balanced and projected to remain in balance. One year later, however, revenues increased by 23 percent due to a stock market and dot-com boom that drove unprecedented increases in stock option and capital gains income. These were magnified from a state revenue perspective, because the state’s income tax system relies disproportionately on the high-end earners most likely to receive such gains.
The surge in revenues resulting in massive — and unsustainable — new spending commitments. When revenues declined, the state relied on mostly one-time measures, such as borrowing, to temporarily reduce spending without cutting back underlying program commitments. Thus, the structural deficit was born.
Addressing the Budget Gap
The Governor’s budget proposal projects a deficit in the current year of $14.8 billion. If this continues unaddressed, the deficit will grow to $41.6 billion by the end of the next fiscal year.
Genest said that most budget solutions, spending cuts or revenue increases require significant time to achieve their full value. Therefore, it is imperative that solutions be enacted immediately, as opposed to waiting until the enactment of the 2009-10 budget, Genest said.
Genest reminded luncheon attendees that the Governor declared a fiscal emergency, called special sessions of the Legislature and asked for immediate action on November 6, 2008, December 1, 2008 and again on December 19, 2008.
Managing the Cash Shortfall
The proposed budget projects that even if the Legislature enacts all the special session solutions by February 1, 2009, the state will be unable to pay all of its bills beginning in March.
Absent legislative action or if the solutions adopted by the Legislature fall short of the level proposed by the Governor, Genest said, it may be necessary for the state to make some payments with registered warrants, or IOUs. Genest did however assure listeners that in spite of these challenges, there is no reason to expect any delay in paying debt service or in repaying the $5 billion in short-term Revenue Anticipation Notes (RANs) sold in October 2008.
“It will not be possible for the state to continue managing its cash flow into the budget year in the absence of a substantial infusion of cash,” Genest said.
The budget proposes selling Revenue Anticipation Warrants (RAWs) in July 2009. While RANs must be repaid within the fiscal year in which they are sold, RAWs can be repaid in the subsequent fiscal year.
Genest explained that this sort of cash flow management has always been a last resort in times when a sudden drop in revenues produces a deficit too large to be addressed with spending cuts and revenue increases alone. He predicted that it will be very difficult for the state to sell RAWs in the current credit environment.
Federal Economic Stimulus Proposals
When asked about the widely held belief that the incoming Congress will enact a major relief bill for the states, Genest explained that relying on funds from a relief bill to balance California’s budget would not be prudent for three reasons.
First, Genest said, the state must balance its budget on its own to have any chance of re-entering the credit market for General Obligation bonds or cash flow borrowing.
Second, any bailout would be temporary and the state needs to make permanent changes to restore balance to its budget for the long term.
Third, most of the proposals for sending federal funds to states focus on infrastructure construction as fiscal stimulus — not on giving states unencumbered money to balance their budgets.
Summarizing the difficulty of any budget solution, Genest commented, “Everyone’s got to bite a bullet.”
Governor Schwarzenegger appointed Genest as finance director on December 1, 2005. Genest first joined the department as chief deputy director in November 2003. He left the department in February 2005 to serve as undersecretary of the Health and Human Services Agency and returned to finance in September 2005 as acting director.
The Governor’s budget proposal, summaries and charts are available on the Department of Finance website at www.ebudget.ca.gov.