Introduction
Governor Brown formulated his 2012-13 fiscal year state budget based on the assumption that Proposition 30 would be approved by the voters in this November?s election. This proposition would raise income tax for seven years on taxpayers with incomes of $250,000 or more, and raise the sales tax for four years by a quarter percent. To provide historical perspective, this blog examines monthly state revenue and expenditures beginning in January 1999.
Monthly State Revenues
Monthly data on total state revenue for the General Fund, as well as its sub-components, such as sales tax and income tax, is published in the State Controller?s Monthly Financial Reports. This data is in current total dollars. It was corrected for inflation and converted to August 2012 dollars using the consumer price index for the Los Angeles Consolidated Metropolitan Statistical Area, published by the California Department of Finance. This constant dollar data was then put on a per capita basis using annual population figures taken from the state Statistical Abstract, and interpolated to obtain monthly values. The resulting total revenue per capita, corrected for inflation, is highly seasonal, with peaks in April, June, and September, for example. To control for seasonality, year over year changes were used for each month (January 2000 minus January 1999, etc.), as illustrated in Figure 1.
Note that the year over year changes tend to be clustered around zero, with a median of $-2.80 per capita. There are several positive exceptions and several negative exceptions. Of the five negative changes, three are associated with the 2001 recession, and one is associated with the Great Recession (recessions are indicated by the shaded areas). Recessions are random events or shocks, and are not predictable. For example, none of the business economists in the Survey of Professional Forecasters?foresaw the Great Recession until it was well underway. That leaves only one exceptional negative year-over-year change without explanation.
Of the five positive year-over-year changes, two are in the big income tax month of April (2000 and 2005). The other three are in three, seemingly, unrelated months: January 2001, September 2003, and March 2010. Thus, there seems to be little predictability for exceptionally good months. The Financial Research Unit?at the Department of Finance, which is responsible for the budget forecasts, has a different view. They focus on forecasting personal income tax, or PIT.
These ten exceptional year-over-year changes, both positive and negative, can be confirmed using a visual tool known as the box diagram, developed by the renowned statistician John Tukey. The vertical line in the box is the median or middle value. The box contains 50% of the 152 observations. The upper whisker represents the largest 25% of the observations with the exception of the outliers. If any year-to-year change is greater than 1.5 times the length of the box, it is an outlier. There are five positive and five negative outliers, as depicted by the red dots (two of the positive outliers are close in value to other outliers, so only three are visually distinct).
If these ten outliers are removed from the year-over-year changes in total revenue per capita in August 2012 dollars, then the remaining 142 observations are normally distributed. From this analysis we conclude that large increases or decreases in year-over-over-year total revenue, i.e. outliers, are not predictable because of their nature. The remaining observations of year-over-year changes are positively auto-correlated, which means that while times are good they will tend to stay that way. The same goes for when times are not so good.
To gain insight into factors affecting real per capita revenue, it was regressed against seasonal indices to control for seasonality, trend, the Case-Shiller Ten City Composite House Price Index (not seasonally adjusted), and an index of the 2001 recession. All of these variables were significant.
Total Expenditures
Monthly data for disbursements from the General Fund is also published by the Controller. It is available for expenditures on state operations and on local assistance. The plot of the year-over-year changes for the sum of these two is shown in Figure 3. There are six positive outliers and seven negative outliers. There is no apparent pattern to the positive outliers, although two thirds came during or after the Great Recession. The impact of the Great Recession is even more noticeable on the negative outliers, where six out of seven came during or after this most recent downturn. The median of year-over-year changes in expenditures is $1.3 billion per capita.
Real expenditures per capita were regressed against seasonal indices, trend, indices controlling for the 2001 recession and the Great Recession, and the Case-Shiller Ten City Composite House Price Index. The Great Recession was not significant.
Figure 3: Graph showing seasonal differences in expenditures per capita from the General Fund since 1999
Budget Balance and State Government Borrowing
The difference between state government revenue per capita and state expenditures per capita, i.e. the approximate budget balance, tends to be negative. As a consequence, the state has resorted to borrowing. The amount borrowable and the amount of loans, both in billions of nominal dollars, can be obtained from the California Controller?s Monthly Financial Reports. These amounts are depicted in Figure 4 for the terms of three Governors: Gray Davis, January 1999-November 2003; Arnold Schwarzenegger, December 2003-December 2010; and Jerry Brown, January 2011 to date.
When Gray Davis succeeded Pete Wilson as Governor, California was borrowing money, but less than $5 billion in any month. The first years of Governor Davis? governorship were also the years of the dot-com boom, and by June 2000, Davis reduced the amount of loans to zero, and kept it at that level through July 2001.? By then the legislature had spent the capital gains tax windfall on permanent increases to the budget. ?Although Governor Davis had not stopped this from happening, he had warned against it. Loan amounts increased rapidly, and, by October 2002, reached $18.3 billion. The potential amount that could be borrowed had also been increased dramatically, as shown in Figure 4. In May of 2003, the loan balance of $23.5 billion was comprised of $11 billion of internal borrowing, and $12.5 billion of external borrowing. In November 2003, Governor Davis was recalled.
After Schwarzenegger became governor, he managed to reduce borrowing to zero after seven months, and kept it below $10 billion until March of 2007. He was also successful in reducing the potential amount borrowable. However, by ten months into his new term, in October 2007, state borrowing had reached $13.5 billion, and remained above $10 billion for six months. During the remainder of Schwarzenegger?s tenure, state loans trended upwards hitting a peak of $24.8 billion in December 2009. The potential amount borrowable also grew dramatically in Schwarzenegger?s second term, as illustrated in Figure 4. Since some of the borrowing was internal, i.e. from other funds, it highlights the importance of other funds as part of the state budget process. Note that borrowing tends to peak in the middle of the fiscal year, circa December, and then declines toward June (the end of the fiscal year), as other funds get paid back.
The Wall of Debt
Governor Brown refers to accumulated state borrowing as the ?Wall of Debt,? and included a listing of monies owed in his Introduction to the 2012-2013 Budget Summary, reproduced below as Figure INT-04. The state has borrowed from various constituencies, including schools and local governments. Of particular interest is borrowing from special funds, which is listed as $3.4 billion, up from $749 million in June 2008. The State Controller published a report, Cash Management and General Fund Borrowing, which explains in general terms how the state borrows both externally and internally, and how it can borrow interest free on up to ten percent of a threshold from special funds.
The Role of Other Funds in State Finance
The General Fund has been the main fund collecting revenues and spending on state operations and local assistance. However, there are about 560 special funds, most of which are financed from user fees, to be spent solely on specific purposes. In recent years, the state has resorted to borrowing billions from these special funds, which has increased their prominence in state finance. One of the largest special funds is the State Highway Account, with a balance of $1.77 billion. (A fund?s balance is the net of assets minus liabilities.) Another special fund from which the state has borrowed is the Beverage Container Recycling Fund, with a balance of $226 million. There are scores of smaller funds with zero balances, such as the Charity Bingo Fund.
In August 2012, the Legislative Analyst?s Office (LAO) published special report for the legislature, entitled Issues Concerning the Accounting of California?s Special Funds. Among the issues this report mentions is the use of $16 billion of special fund and other fund cash to pay General Fund bills during this fiscal year. The report also recommends the development of a strategy for the state to repay these special fund loans in the years ahead. One issue the LAO report did not focus on is the Mental Health Services Fund, with a balance of $1.46 billion. This fund diverts income tax dollars away from the General Fund, which exacerbates the state fiscal crisis.
The Mental Health Services Act
In the November 2004 election, California voters passed Proposition 63, The Mental Health Services Act. It imposed an additional one percent income tax on incomes in excess of one million dollars. This may sound attractive, but it was simply a diversion of state income tax away from the General Fund. As policy, it ignored fundamental economic truths. First. There is no free lunch. Second, There is an opportunity cost: the personal income tax revenue that finances the Mental Health Services Fund is no longer available to the General Fund. Third, this constrains the flexibility of the governor and the legislature to fund state services since it pigeonholes money in this specific fund, and these constraints lead to a sub-optimal allocation of the budget. It short, it was, and is, bad policy. It also diverts large amounts of money, as shown in Table 1.
?Table 1: California Personal Income Tax Allocated to the General Fund and the Mental Health Services Fund in Billions of Nominal Dollars
The fact that the state is outspending its revenue, and is looking for money and for new sources to borrow from, places local governments at increasing risk that their resources may attract state attention.
Summary
This blog has focused on the developing state fiscal crisis, which has grown during the terms of the last three governors. We found that there were a few months of exceptionally high or low revenue outliers, which were unpredictable, large swings. The same was true of a few exceptional high and low months of expenditures. This underscores the need for a ?rainy day fund,? known as the Special Fund for Economic Uncertainties (SFEU). Unfortunately, the state is so strapped it cannot finance the SFEU, and has to, increasingly, borrow billions from the special funds. This has created new issues, since these special funds usually are financed from user fees to meet specific and restricted purposes. The state can borrow up to ten percent of threshold amounts from these special funds, interest free. The state debt to these special funds is already several billions of dollars, with no clear plan, as well as no current means, for repayment.
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Source: http://www.ucsb-efp.com/index.php/2012/10/23/california-state-revenue-expenditures-and-debt/
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