Governor-elect Jerry Brown and the new state Legislature face at least four years of horrifically bleak fiscal conditions, starting next year with a budget abyss of $25.4 billion. And it doesn’t get much better in subsequent years, according to the Legislative Analyst’s California’s Fiscal Outlook for the budget year that begins July 1, 2011. 

“We project annual budget problems of about $20 billion each year through 2015–16,” the report says.  An estimated $22.4 billion hole is projected for the fiscal year starting July 1, 2012.  Even more grimly, the analysis says: 

      “Because our methodology generally assumes no cost–of–living adjustments, our projections probably understate the magnitude of the state’s fiscal problems during the forecast period. 

And, the analyst says, the magnitude of the problem is such that lawmakers and the governor should consider increasing taxes.  “The LAO forecast is sobering, but we have been through worse.  It’s time to shake things up," said Senate president Pro Tempore Darrell Steinberg, a Sacramento Democrat, in a statement. 

      "There is a third way beyond the tired and old debate over state expenditures.  We must fundamentally restructure government by bringing government closer to the people so they can make clear and more direct choices about the services they want and how to pay for them." 

A variety of factors contribute to the perfect budgetary storm described in the 23-page report.  Not the least of those factors is a slow-to-recover national and state economy. California, which has more than 2 million unemployed, won’t return to pre-recession levels of employment until 2016, the report says – although the number of job losses slowed in 2010. 

      “While residential building permits are up in 2010, they are still below 2008 levels which, at the time, was the worst year in recent memory,” the analyst notes. “Commercial building also continues to be exceptionally weak.” 

Actually, next year’s budget hole is $19 billion, $2 billion less than the analyst predicted last year.  However, the problem grows to $25.4 billion because the state will end this year with a $6 billion deficit, the third time it has done so in as many years.  Most of the deficit comes from lawmakers and Gov. Arnold Schwarzenegger claiming in this year’s budget that the state would receive $5.3 billion in additional federal money. To date, California has received only $1.8 billion, leaving a $3.5 billion hole. 

      “This is exactly why the governor pushed for deeper cuts and it underscores the importance of the spending reforms he won,” said Aaron McLear, Schwarzenegger’s press secretary. “We’re talking with legislative leaders to decide the best course of action.”  

In 2011, the state’s coffers face a double-whammy: the drying up of billions in federal economic stimulus funds and expiration of temporary taxes enacted as part of the 2009 budget.  The federal funds were used during the past two years to offset state support for public schools, and lower the state’s contribution to various health, welfare and social programs.  With the disappearance of those funds, state spending must increase.  For example, the loss of federal funds means the state must spend $5 billion more on Medi-Cal, California’s health care program for the poor. 

A temporary .25 percent surcharge on personal income tax expires December 31, dropping state tax collections by some $2 billion.  A 1 percent sales tax rate increase, which generates $4.7 billion annually, expires on June 30, 2011.  On the same date, the state loses $1.4 billion when a vehicle license fee increase expires. 

At the same time, several corporate tax breaks that would have been repealed by Proposition 24 on the November ballot (the measure was defeated) will further lighten state coffers.  One of the tax breaks, which changes the ways companies doing business in multiple states calculate their California taxes, will result in $1 billion in lost revenue within several years.  Several changes in the law to accelerate receipt of corporate tax revenues did add $1.2 billion to revenues in the current year, but there will be lower business tax collections starting in July 1, 2012. 

This year, nearly one-sixth of the $6 billion deficit is: costs for prisons being nearly $950 million more than the budget claims, costs for Medi-Cal being $400 million higher because of the lateness of the budget, and the unrealistic expectation that $323 million in costs can be shaved from the health program. 

Passage of Proposition 22, which prevents the state from borrowing redevelopment money or transportation funds, also worsens the state’s fiscal picture by prohibiting it from using transportation funds to pay debt service on transportation bonds. That cost – some $800 million, will now come from the cash-starved general fund. 

The state’s fiscal calamity has a direct impact on public schools, already shorted some $14 billion over the past two budget cycles.  Formulas contained in Proposition 98, approved by voters in 1988, dictate the level of state support for public schools. Generally, schools and community colleges receive a minimum of 40 cents for every dollar that comes to the state.  Because the end of the temporary taxes reduces the amount of money the state takes it, it lowers the amount of money schools will receive.  The analyst estimates the minimum amount owed schools will fall $2 billion as a result.  This reduction comes at the same time billions in federal dollars evaporate, sharply increasing the hit on already-strained public school budgets. 

      “For these reasons, it may be very difficult to achieve substantial additional budget reductions in Proposition 98 … compared to the levels already reflected in our forecast,” the analyst says. 

      “In other words, if the Legislature funds schools at our projected minimum … it would mean billions of dollars in programmatic cuts to education but not contribute a single dollar to closing the $25 billion budget problem.” 

The Legislative Analyst, as it often does, offers some strategic recommendations to lawmakers and the governor.  First, the report says that a problem of this magnitude can’t be solved in one year. Accordingly, the analyst recommends tackling the problem over several years. For the fiscal year that begins July 1, the analyst recommends $10 billion in permanent spending reductions or tax increases or a combination of both.  That, in turn, shrinks the following year’s problem, as does a further pay down the following year.  But, the analyst cautions, these tax increases or cuts can’t be temporary or fictional like so much of this year’s budget: 

      “To make progress over several years in tackling the ongoing deficit, the Legislature should minimize the use of risky budget solutions that contribute to year–end deficits." 

      “Instead, budget solutions need to be real—by which, we mean those that have a high probability of achieving budgeted savings." 

      “The Legislature can maximize the probability of achieving solutions by passing budgets on time --preferably early --and, in the case of spending reductions, providing specific direction and authority to the administration in well–crafted legislation on how reductions are to be realized.”

But, the analyst says, lawmakers and the governor will be tempted to do otherwise.