Proposition 2’s Deeper Rainy Day Fund Likely to be Approved with Strong Bipartisan Support

Voters will have the chance to decide whether or not to amend California’s constitution through Proposition 2 this election. The ballot initiative would change how the state saves money via the ‘Rainy Day’ Fund and how it repays debt. It also contains a new law, separate from the constitutional amendment, that puts a cap on school district reserves.

Lastly, Proposition 2 would constitutionally mandate the governor’s budget staff to estimate future spending and general fund revenues. The measure affects state reserves, state debts and school reserves.

What is a ‘Rainy Day’ Fund?

In 2004, Californians passed a proposition to create a rainy day fund called the Budget Stabilization Account (BSA), which takes revenue from the General Fund and saves it in a reserve.

The principle behind a Rainy Day Fund is fairly straightforward; if the state saves more during good economic times, it will have to cut less spending when the economy is struggling. Currently, each year, the governor decides whether to put 3 percent ($3 billion in today’s money) of the General Fund into the reserve fund. However, the governor can decide to put less or nothing at all in the reserve.

In 2014, the state will spend about $110 billion from the General Fund for education, health services, social services, and criminal justice programs. In the 2014-2015 enacted budget, the state has taken out $1.6 billion from the Rainy Day Fund (BSA).

Proposition 2 would require a basic minimum input of $800 million every year into the reserve fund — and up to $2 billion when the revenues from capital gains taxes are strong. There is an exception for meeting the minimum requirement if the governor declares a ‘budget emergency’ that was agreed upon by the legislature.

Prop. 2 also places tighter restrictions on the state’s use of funds within the reserve. If the previous fiscal year was not deemed a budget emergency, the state cannot take out more than half of the money from the reserve fund. However, if it is the second straight year of a budget emergency, the state can take out all the money.

The last aspect of the proposition that affects the ‘Rainy Day’ Fund or state reserves would increase the maximum size of the reserve fund from 5 percent to 10 percent of the General Fund revenues. Money will be funneled into the reserve account until it reaches 10 percent of the General Fund revenues — approximately $11 billion.

The Legislative Analyst Office is a nonpartisan state agency tasked with providing policy and fiscal counsel to the Legislature for the last 70 years. According the the LAO, “Historically, one of the most important responsibilities of the LAO has been to analyze the annual Governor’s budget.”

The LAO claims the fiscal effects of the new requirements for state reserves are dependent upon both the economy and the Legislature’s actions:

“In some situations, for example, Proposition 2 could make it harder to take money out of the state’s reserves, and this could lead to the reserves being larger over time.”

However, if the governor calls a budget emergency and the Legislature complies, less than the minimum could be put in the reserve. The LAO hypothesizes that if more money is placed in the reserve, “it could lessen some of the “ups and downs” of state spending that occurred in the past.”

Reducing California’s Debt

Under Prop. 2 the state will be required to pay a minimum amount every year in order to pay down its debt. Most importantly, debt payments could not be suspended. These debts include debt to local governments and debt from pensions and retiree benefits.

For the next 15 years, the state would be compelled to use at least 0.75 percent (about $800 million in today’s dollars) of General Fund revenues to pay down the state’s debt. The amount of money spent to pay down debt would be decided on a sliding scale from year to year, with $800 million marking the mandatory minimum.

The LAO estimates that Using more money to repay debts will mean the state will have less money to spend in other areas of the budget for the next 15 years, such as lowering taxes or public programs. However, in the long run, the LAO projects that Prop. 2 will allow the state to “spend less on its debts in future decades, freeing up money for other things in the state budget over the long term.”

School Reserves

This portion of Prop. 2 is a proposed state law, not a constitutional amendment. Hence, it could be changed by the Legislature in the future without a vote appearing on the ballot.

Prop. 2 will not change the total amount the state spends on schools and community colleges, but rather change when the state spends it.
Prop. 2 creates a new state reserve fund for schools. When capital gains tax revenues are strong, some of that money would be funneled into a state reserve for schools.

Certain conditions must be met before money can be placed in the reserve, such as ensuring that spending for schools and community colleges is keeping up with the number of students and the cost of living.

According to the LAO, Prop. 2 will not change the total amount the state spends on schools and community colleges, but rather change when the state spends it.

A more controversial aspect of Prop. 2 would place a cap on the amount of money K-12 school districts can keep in their local reserves.

Under the new law, districts could keep a maximum of 3 percent to 10 percent of their annual budget in reserve. However, the cap on reserves would only take effect after money has been put in the new state reserve fund by the state. In ‘extraordinary fiscal circumstances,’ a county superintendent of schools could exempt a district from the reserve cap for up to two years within a three-year period.

The cap on local reserves for K-12 districts will only go in place in a year after the state has put money into the new state reserve fund for schools. LAO estimates that because the state must meet certain conditions to place money in the new reserve fund for schools, “money would be unlikely to go into the state reserve for schools in the next few years.”

By virtue of Prop. 2, some school districts will have less money in their reserves, which will make them vulnerable the next time the economy is bad.

Bipartisan Support

Prop. 2 truly does have bipartisan support. Both the Democratic and Republican parties have endorsed the measure, along with Governor Jerry Brown (D) and his opponent, Neel Kashkari (R).

Governor Brown is among Proposition 2’s vocal supporters. He argues California needs tougher measures in place to ensure the state repays its debts and protects itself from the boom and bust cycle of budgeting. The foundation of proponents’ arguments rests on the simple idea that Prop. 2 will prevent the state from spending more than it can afford.

Opposition Spearheaded by Education Groups

Opposition to Proposition 2 has been predominantly led by education groups. 2 Bad For Kids, a subset of Educate Our State, is heading the opposition and is the only registered campaign committee against Prop. 2.

2 Bad For Kids argues that limiting school savings is dangerous for school districts’ budgets and flexibility. Another contention of the opposition has to do with school-allocated property taxes.

Since 2004, the government has diverted billions of dollars in revenues from school-allocated property taxes and has given that money to local governments to offset their sales tax losses in a move called the ‘triple-flip’. Educate Our State claims the state does not intend to fully pay schools back.

Lastly, according to an Education Week survey, California is ranked 50th in the nation in per-pupil spending. 2 Bad For Kids contends that Prop. 2 will only further exacerbate California’s low standing in the rankings.

Ultimately, the fiscal effect of Prop. 2 for state and school reserves depends heavily on how the economy performs. The LAO concludes that Prop. 2 will save the state money in the long term in regard to the debt measure by paying down the debt faster, thereby freeing up more money in the future.

Photo Source: AP