Chancellors Budget Workshop State Economic and Fiscal Forecast Presented by: Michelle McKay...

Chancellor’s Budget WorkshopState Economic and Fiscal Forecast

Presented by:

Michelle McKay UnderwoodDirector, Legislative Services School Services of California, Inc.

© 2013 School Services of California, Inc.

2Overview

This is going to be a good year for the State Budget

The economy is moving in the right direction, albeit slowly

Passage of Proposition 30 provides additional revenues, which benefit education

Helped Governor Jerry Brown tackle the Budget problems that have dogged the state for the past decade

The State Budget is legitimately balanced for the first time since 2002 and has the first real reserve in years

Substantial progress is made toward reducing the state’s “wall of debt”

But not all of the state’s problems are behind us

The feds are all over the state on prison overcrowding

Interest rate increases or international events could derail the recovery


3State Budget Sets Low Bar

2012-13 revenues have come in $2.1 billion above the amount that was forecast just two months ago

Governor Brown’s May Revision lowered the 2013-14 revenue outlook by $1.3 billion

Strong revenue performance of the last two months more than makes up for the downward revenue adjustment

Using the Governor’s estimates, the State Budget likely understates 2013-14 revenues

The Legislative Analyst’s Office (LAO) and other independent economists estimate that revenues will actually come in more than$3 billion higher

That portends greater flexibility in future funding and potential additional one-time funds to Proposition 98


4The National Economy

The U.S. economy is continuing its slow recovery:

UCLA economists indicate the country would need 6% growth over the next five years to catch up to a normal 3% rate of growth in our current economic recovery

Moderate strength is attributed to:

Historically low interest rates

Housing recovery well underway – housing starts roughly double what they were a year ago

Increased from depression-era level to recession level

– Still a ways to go – it is expected that housing will not fully recover for two more years

Increasing auto sales, with the vehicle fleet the oldest on record

Federal stimulus and monetary policy increase spending and investment


5The National Economy

Recovery is fragile: While imports have increased, driven primarily by consumer spending,

exports have slowed:

Recessions in Europe and Japan

Slower growth in China First quarter Gross Domestic Product (GDP) growth revised downward

at second look from 2.4% to 1.8% Federal sequestration in both 2012-13 and particularly in 2013-14 has

reduced spending and investment Higher payroll and income taxes and Affordable Care Act (ACA)

implementation has left many consumers uncertain about the future

However, many states are reporting improvements in the job market

Optimism is building as personal consumption rates improve


6U.S. Economic Outlook

Q 3 Q 4 Q 1 Q 2 Q 3 Q 4 Q 1 Q 2 Q 3 Q 4 Q 1 Q 2 Q 3 Q 4 Q 1 Q 2 Q 3 Q 4 Q 1-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

-3.7%

-8.9%

-6.7%

-0.3%

1.4%

4.0%

2.3% 2.2%2.6% 2.4%

0.1%

2.5%

1.3%

4.1%

2.0%1.3%

3.1%

0.4%

1.8%

U.S. GDP(Percent Change)

2008 2011 201220102009 2013

Source: U.S. Bureau of Economic Analysis, April 2013


7The California Economy

California has followed an uneven path to economic recovery Job growth is greater than any other state in the nation, with the

exception of UtahSome sectors like leisure and hospitality and construction are increasing, while state and local government are on the decline

Median home prices in the state have increased by 32% in the last year Inflation-adjusted personal income is expected to increase 1.6% in 2013

and 3.6% in 2014 By 2014, the California unemployment rate is expected to fall to 8.1%,

one percentage point higher than the 2014 projected U.S. rate – still very high

Of concern, however, is the bifurcated path of the state economy The inland regions are characterized by continuing high unemployment

and ailing housing markets The coastal regions enjoy relatively low unemployment, improving

housing markets, and higher average incomes


8California’s Unemployment Rate

Jan July Jan July Jan July Jan July Jan July Jan July0%

2%

4%

6%

8%

10%

12%

14%

5.9%

7.3%

9.7%

11.7%12.3% 12.4% 12.1% 11.9%

11.0% 10.6%9.8%

8.5%

Unemployment Rate

Source: Employment Development Department, 2013

2008 2009 2010 2011 2012 2013


9California’s Unemployment Rate vs. Other States

6%

7%

8%

9%

10%9.6%

9.2%9.0% 8.9% 8.8% 8.7% 8.7% 8.6% 8.5%

Highest State Unemployment RatesJune 2013

NationalAverage

7.6%

Nevada

Illinois Mississippi

California

North Carolina

RhodeIsland

MichiganNew

Jersey Georgia

Source: Bureau of Labor Statistics, July 2013


10California Personal Income Forecast

DOF UCLA DOF UCLA1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

4.3%

5.5%

2.1%

5.7%

2.9%

5.8%

4.1%

5.7%

Percent Change

2013-14 Governor's Budget

2013-14 May Revision

UCLA, March 2013

UCLA, June 2013

2013 2014


11Slower Revenue Growth in 2013-14

As a result of the drag that the federal tax hikes and spending cuts will have on the economy, the Department of Finance (DOF) lowered the outlook for California personal income growth in 2013 from 4.3% in January to 2.1% in the May Revision

We think this is overly pessimistic – more on that later

This slowdown in the economic outlook in turn lowers the revenue forecast assumed in the 2013-14 State Budget

Total 2013-14 General Fund revenue drops $1.3 billion from the January estimate to $97.1 billion in the May Revision

Each of the three major taxes are revised downward

A rebound, however, is forecast to begin in 2014-15, with the three major taxes combined expected to grow 9.3% in that year and 6.7% in 2015-16

Recent studies still rank California’s business environment as nearly last in the nationSource: CNBC’s Annual Top States for Business Rankings, July 10, 2013


12Budget Risks Are Few in 2013-14

Compared to prior years, the proposed 2013-14 State Budget faces considerably less risk

Unlike the 2012-13 spending plan, it is not dependent upon voter approval of a major tax initiative

Proposition 30 provides both sales tax and income tax revenues

Unlike the 2011-12 State Budget, it is not dependent upon an unrealistic revenue projection

The plan does not rely on an infusion of federal funds to maintain programs

It is not reliant on unrealistic operational efficiencies in state programs

However, the recent changes in the business climate mentioned earlier could affect state revenues (such as the reductions in export revenues) tempering the state recovery


13General Fund Revenues in 2013-14

2012-13 2013-14$85

$90

$95

$100

$95.4

$98.2$98.2$97.1

General Fund Revenues (In Billions)

January Budget Final Budget

Source: 2013-14 State Budget Summary, page 6


14General Fund Budget Summary

Revenues and transfers drop $1.1 billion in 2013-14, or -1.1%

Expenditures increase $616 million, or 0.6%

The reserve is 1.1% of revenues and transfers

2013-14 General Fund Budget Summary (In Millions)

2012-13 2013-14 Prior-Year Balance -$1,658 $872 Revenues and Transfers $98,195 $97,098 Total Resource $96,537 $97,970 Total Expenditures $95,665 $96,281 Fund Balance $872 $1,689 Budget Reserve: Reserve for Encumbrance $618 $618 Reserve for Economic Uncertainties $254 $1,071

Budget Stabilization Account $0 $0

Total Available Reserve $254 $1,071

Source: 2013-14 State Budget, page 6


15The Administration’s Revenue Forecast

Recall that the Governor’s May Revision lowered the revenue outlook for 2013-14 by $1.3 billion from the January Budget Proposal forecast because of the expected drag that federal budget policy would have on the economy

Sequestration cuts would reduce federal spending

Higher tax rates for high-income earners and the expiration of the federal payroll tax holiday would depress consumer spending

The LAO offered a contrary view – the overall economy was gaining strength compared to the January forecast

Revenues were forecast to exceed the May Revision by $3.2 billion

The Legislature initially adopted the LAO forecast, but the Governor ultimately prevailed, with the 2013-14 State Budget Act based on the lower revenue estimate


16DOF Forecast Through 2016-17

2012-13 2013-14 2014-15 2015-16 2016-17 $90.0

$100.0

$110.0

$120.0

$98.2 $97.2

$104.5

$110.2

$116.1

(General Fund Revenues – DOF Forecast in Billions)

Source: Governor’s 2013-14 May Revision


17Is the Forecast Reasonable?

In order to assess the risks of the DOF’s revenue forecast, not just for 2013-14 but through 2016-17, School Services of California, Inc., (SSC) commissioned Capitol Matrix Consulting (CMC) to perform an independent analysis of the DOF forecast Brad Williams, a partner with CMC, served as the LAO’s senior

economist for 12 years and was recognized by the Wall Street Journal as the most accurate California forecaster of the 1990s

The SSC/CMC analysis finds that the DOF forecast is reasonable, with greater upside potential than downside risks We assume that:

The U.S. expansion will continue at a moderate pace for several years

California personal income will rise from 3.4% in 2013-14 to an annual average pace of 5.5% through 2016-17

Payroll jobs will grow at an annual average rate of about 2.2%


18DOF vs. SSC/CMC Forecast

2012-13 2013-14 2014-15 2015-16 2016-17 $90.0

$100.0

$110.0

$120.0

$98.2 $97.2

$104.5

$110.2

$116.1

$99.5 $100.1

$107.4

$112.7

$119.7

(General Fund Revenues in Billions)SSC/CMC Forecast

DOF Forecast

Source: General Fund Revenues and Proposition 98 Forecast, CMC, July 2013


19Measuring Risk of the Forecast

All forecasts are ultimately proven wrong

Actual revenues are either above or below the forecast level, but almost never exactly as projected

The more important question: What are the risks to the forecast and how can these risks be measured?

The forecast risks include:

The economic impact of the federal ACA and how it will affect employment

The Federal Reserve’s plan to retreat from “quantitative easing” and the effect of higher interest rates on the stock market, housing sales, and business investment

The weakness of the European and Asian economies and their impact on U.S. and California exports


20Confidence Intervals and Forecasting

One method of quantifying forecast risk is to establish a confidence interval around the forecast

The SSC/CMC analysis examined historical General Fund revenue growth rates over a 30-year period, establishing standard deviations around the growth rates for one-year through five-year sub-periods

Flashback to Statistics 101: A standard deviation (SD) measures the average variation from the mean growth rate

– For normally distributed variables, about two-thirds of the observations fall within one SD of the mean

Using +/- 1 SD from the forecast, there is a one-sixth chance that revenues will fall below the confidence interval and a one-sixth chance that revenues will exceed the confidence interval


21Confidence Intervals and the Forecasts

2012-13 2013-14 2014-15 2015-16 2016-17 $90.0

$100.0

$110.0

$120.0

$130.0

$140.0

$98.5 $95.6

$101.0 $103.4

$106.5 $100.5

$104.6

$113.7

$121.7

$132.9 (General Fund Revenues in Billions)+ 1 SD

SSC/CMC Forecast

DOF Forecast

- 1 SD

Source: General Fund Revenues and Proposition 98 Forecast, CMC, July 2013


22Conclusions About the DOF Forecast

Based on the independent analysis conducted by CMC, the DOF forecast is reasonable and falls within the +/- 1 SD confidence interval

There is more upside potential that actual revenues exceed the Administration’s forecast than downside risks that revenues will fall short

The Administration’s General Fund revenue forecast, therefore, provides a reasonable basis to project Proposition 98 revenues


23Proposition 98 Funding Guarantee

Proposition 98 sets the minimum funding level for K-14 education, based on the prior-year funding level and changes in workload (as measured by K-12 average daily attendance [ADA]) and inflation (as measured by the lesser of per-capita personal income or per-capita General Fund revenues)

Adopted by state voters in 1988, this is a constitutional guarantee

The measure specifies only the minimum funding level, it does not determine what programs will be funded

For 2013-14, the state fully funds Proposition 98 at $55.3 billion, a decline of $941 million from 2012-13

There are no manipulations or reinterpretations of the constitutional guarantee as there have been in prior years

The 2013-14 guarantee declines about 2% because of the lower General Fund revenue forecast in the May Revision


24Proposition 98 Forecast

2012-13 2013-14 2014-15 2015-16 2016-17$50.0

$55.0

$60.0

$65.0

$70.0

$56.5 $55.3

$60.5

$63.9

$66.5 (Proposition 98 in Billions)

Actual Budget Forecast


25Who Will Benefit from Stronger Revenues?

No other area of the 2013-14 State Budget gets increased as significantly as education: Up to $120 million in additional funds to counties to accommodate new

workload associated with implementing the ACA $206 million for mental health An increase of $143 million for California Work Opportunity and

Responsibility to Kids (CalWORKs) employment services $34 million to begin providing preventative adult dental benefits in

May 2014 $60 million augmentation to support trial courts to increase public

access

Demand for new revenues from other areas of the State Budget will be strong going forward

Source: 2013-14 State Budget, DOF

Thank you


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