Looking ahead: deficit estimate differences
LAO will have a different estimate, as it always does: an estimate of the deficit the Governor actually aims to address in his proposals
I have mentioned in prior posts that I expect the Legislative Analyst’s Office (LAO) will release an updated 2024-25 deficit estimate of around $50 billion, which is higher than the May Revision estimate of $27.6 billion. Because of the outsized attention paid to these differences this year, this note attempts to explain the background and limited significance of these differences for the budget process. The LAO’s initial comments on the Governor’s May Revision eventually will appear here.
What is the deficit (or surplus) estimate? The annual estimate of the state’s deficit, or “budget problem,” historically has been a reference number for the dollar amount of corrective actions—that is, changing existing state budget policies—to bring that year’s General Fund budget to balance. Under the California Constitution and longstanding practices, General Fund balance means that this fund’s basic reserve, the Special Fund for Economic Uncertainties (SFEU), has a projected balance of $0 or above in the annual state budget plan. When resources exceed costs, an annual surplus, rather than a deficit, is estimated under a similar calculation. Historically, the annual deficit or surplus estimate has omitted a summary of Proposition 98, which is effectively a “budget within a budget” inside the General Fund—typically funded at or near the constitutional minimum funding guarantee for schools.
The headline deficit estimate does not account for future years’ deficits or surpluses, which are considered in separate multiyear forecasts (an increasingly important part of the budget process over the last 10 years).
Why have LAO deficit estimates differed from the administration’s? I ran the LAO’s state budget forecasting process for years prior to joining Assembly staff. LAO’s independent estimates of the annual surplus or “budget problem” (deficit) always differ from those of the administration. They always differ because the LAO’s revenue estimates (indeed, increasingly, the LAO’s process for revenue estimation) differ from those of the administration, and the LAO’s “baseline” cost estimates also differ. (“Baseline” refers to budget trends set by existing and often longstanding state financial policies and practices. If baseline costs are projected to be higher [lower] than baseline revenues, then there is a deficit to address in the annual budget process [or a surplus to dispose of].)
In the past decade, LAO’s revenue estimates often have been higher than the administration’s. In recent years, LAO’s surplus estimates were lower than the administration’s, and this year, its deficit estimates have been higher. In early 2024, the key differences between LAO and administration deficit estimates have been (1) differing revenue estimates and (2) a different classification of a key feature of the Governor’s Proposition 98 school funding plan—specifically, its manner of adjusting 2022-23 school funding due to declines in revenue estimates and the effects of that adjustment on later school funding levels. The administration’s deficit estimates implicitly treat that Proposition 98 adjustment as something akin to a “baseline” change, referencing the state’s typical policy of adjusting school funding to be equal or near equal to the constitutional minimum funding guarantee. The LAO’s deficit estimate treats the Proposition 98 adjustment as a policy change. As of the January Governor’s budget proposal, this Proposition 98 difference alone resulted in a $15 billion higher LAO deficit estimate.
What can we expect in the May LAO deficit estimate update? As noted above, I expect the LAO will continue to estimate a higher deficit than that calculated by the administration. Revenue estimating differences between the LAO and the administration have narrowed considerably since January. I expect the bulk of the difference now will be the difference in categorizing the Proposition 98 proposal of the Governor. The LAO will continue to count that 2022-23 adjustment and its later-year ramifications in this year’s annual deficit, while the administration excludes that change from its headline deficit number.
Why does this difference matter little for the state budget process? The deficit (or surplus) estimate is a reference number to give a rough sense to the public of how many changes are needed to bring that year’s state budget into balance. The state budget, in reality, is balanced based on the hard numbers: estimates of funds actually appropriated in the budget and other legislation, as well as the estimated revenues included in the annual budget act.
Moreover, as the LAO may continue to point out, its office’s estimates are estimates of the deficit that the Governor actually aims to address in his May Revision proposal. Under its revenue and spending estimates, the Governor’s 2024-25 budget is not only in balance, but with $3.4 billion more than legally required in the balance of the SFEU.
The biggest difference in deficit estimates likely will be the Proposition 98 proposal. That difference just reflects whether one puts the fiscal effect of that change in a “baseline” bucket (administration) or a “budget-balancing solution” bucket (LAO). Either way, the Governor has proposed that manner of funding Proposition 98, and the Legislature either will accept it or put in place alternative changes that meet Proposition 98 requirements.
In addition to Proposition 98, the deficit estimate differences will reflect some cost estimating differences, which the Legislature can consider in the budget process, and revenue estimating differences. Based on recent LAO statements, revenue estimates, now seem just several billion dollars apart—a relatively modest difference. In the end, the budget reflects the revenue estimates chosen by the Legislature, with the final annual budget typically relying on the administration’s May Revision revenue estimates.
How can official deficit (or surplus) estimates be more useful in the future? This year, in my work, the large differences in the LAO and administration deficit estimates have obscured, rather than revealed, the reality of the state’s budget picture. The differences have consumed far too much time and attention, effectively distracting from the substantive issues in the annual budget.
Ideally, in the future, the LAO and administration offices will work to make their deficit and surplus numbers more comparable (that is, “apples to apples”), while continuing to provide important, independent, and often differing views on projected state costs and revenues.
Here are my personal thoughts on what should happen in the future:
The headline deficit estimate generally should omit Proposition 98 amounts. Standard state policy has been to budget Proposition 98 near the minimum funding guarantee. If LAO has a critique of the administration’s Proposition 98 approach, as it often does, that is best expressed separate and apart from the headline deficit number. I observe that is more consistent with historical practice.
Similarly, in good financial years, Proposition 98 totals should be omitted from the headline surplus estimates. While surplus years can bring new investment to schools, it’s not as if the Legislature and the Governor have broad authority to dispose of those required Proposition 98 funds anywhere else in the budget. Those funds will go to schools one way or another, and as such, should be omitted from a surplus estimate of funds able to be disposed of anywhere in the budget.
When technical differences exist in how to categorize revenues or spending as baseline or policy change, the offices should attempt to align their methods to keep deficit and surplus estimates apples to apples as much as possible. In other words, avoid amplifying differences in these estimates wherever there is a plausible rationale for eliminating those differences. Substantive discussions of individual policy proposals, of course, should continue to be robust.
The administration, in the rush to meet deadlines for January and May budget proposals, sometimes has been unclear in adding up all of its new spending proposals, such as BCPs, that exceed current law and baseline practices. More clarity in estimating new spending proposals often would result in a cleaner estimate of deficits and surpluses.
Always keep focused on the deficit or surplus estimate being an estimate of the remaining work left to be done in the annual budget process by the Legislature and the Governor. In recent weeks, some have chosen to ignore the recent early action by the Legislature and the Governor that addressed a significant portion of the 2024-25 budget problem, despite a clear action by the Legislature to agree to billions of budget changes in advance of the formal annual budget act next month. The purpose of the headline number is to summarize the work “left to be done” in the annual budget process. Early action was real, even if this year’s budget peculiarities make its summarization somewhat complex.