BILL ANALYSIS                                                                                                                                                                                                    Ó


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                                    THIRD READING

          Bill No:  ACA 1X2
          Author:   John A. Pérez (D), et al.
          Amended:  5/12/14 in Assembly
          Vote:     27

           ASSEMBLY FLOOR  :  Not available

           SUBJECT  :    State Budget Reserve Fund

           SOURCE  :     Author

           DIGEST  :    This bill alters the state's existing budget reserve  
          requirements; mandates annual deposits of 1.5% of General Fund  
          revenues (plus, in specific circumstances, capital gains-related  
          tax revenues) to a budget reserve up to an amount equal to 10%  
          of General Fund revenues; and diverts, for the initial fifteen  
          years it is in effect, 50% of funds that would otherwise be  
          deposited to the budget reserve to the payment of debt or  
          outstanding liabilities.  This bill also sets forth provisions  
          regarding the withdrawal of funds from the reserve fund and the  
          suspension of otherwise required deposits; creates the Public  
          School System Stabilization Account; supplants the current  
          language governing the existing Budget Stabilization Account  
          (BSA) as specified in the Constitution; results in the  
          withdrawal of ACA 4 (Gatto and Niello); and serves as a  
          substitute for that measure on the November 2014 ballot.  This  
          bill goes into effect beginning with the 2015-16 fiscal year.

           ANALYSIS  :    



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          California currently has two principal General Fund reserve  
          accounts, specifically:

           Special Fund for Economic Uncertainties (SFEU)  .  Article XIII B,  
          Section 5.5 of the California Constitution directs the  
          Legislature to establish a 'prudent' reserve that it deems  
          reasonable and necessary.  However, the Constitution does not  
          specify the size of the reserve or the conditions under which  
          funds must be placed into the reserve.  The reserve for 2013-14  
          was budgeted at $1.1 billion upon the adoption of the budget,  
          and later reduced to approximately $700 million based on  
          additional budget actions related to corrections.  This general  
          reserve is known as the SFEU.

           BSA  .  In addition to this regular annual reserve, voters  
          established an additional reserve account, the BSA, with the  
          passage of Proposition 58 in March of 2004.  The proposition  
          requires that 3% of estimated annual General Fund revenues be  
          transferred into the BSA, beginning in 2008-09, and continuing  
          thereafter.  Transfers to the BSA are required until the account  
          balance reaches $8.0 billion or 5% of General Fund revenues,  
          whichever is greater.  The annual transfer requirement is in  
          effect whenever the balance in the BSA falls below either the  
          $8.0 billion or the 5% threshold.  During the time the Economic  
          Recovery Bonds are outstanding, 50% of the annual transfers to  
          the BSA are to be used for paying off the bonds.

          Spending from the fund may occur by transferring monies from the  
          BSA to the General Fund through a majority vote of the  
          Legislature and approval of the Governor.  In addition, there is  
          significant flexibility regarding transfers to the BSA, with the  
          ability to suspend or reduce such transfers for a fiscal year by  
          an executive order.  The state deposited funds to the reserve  
          twice (in 2006-07 and 2007-08) but subsequently used the funds  
          during each of those years.  The state has suspended the  
          transfer of monies to the BSA since that time and the BSA  
          currently has a zero balance.  The budget proposed by the  
          Governor includes a deposit of 3% of General Fund revenues, to  
          bring the balance in the BSA to $1.6 billion.

          In the January budget, the Governor proposed a constitutional  
          amendment to revise California's budget reserve policy.  The  
          Governor's initial proposal included the following provisions  
          that would revise the BSA:



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           1.Reserve Deposits  .  Require deposits to the reserve of capital  
            gains tax revenues in excess of 6.5% of General Fund tax  
            revenues (after funding of Proposition 98 and certain other  
            payments).  The deposit would be estimated in year one, then  
            subject to subsequent true-ups (positive or negative) in years  
            two and three in order to square the original estimate with  
            actual tax liability data.

           2.Proposition 98 Reserve  .  Create a Proposition 98 reserve equal  
            to 10% of the Proposition 98 guarantee, whereby spikes in  
            funding related to capital gains would be retained for future  
            years of decline, smoothing school spending to prevent  
            damaging cuts, while making no changes to the Proposition 98  
            guarantee.  Deposits would be made after required increases in  
            enrollment growth and cost-of-living and the current  
            maintenance factor has been paid.

           3.Size of Reserve  .  Double the maximum size of the Rainy Day  
            Fund from 5% to 10% of revenues, and allow supplemental  
            payments to the "wall of debt," or other long-term  
            liabilities, in lieu of a year's deposit.  Restrict uses of  
            revenues that would otherwise be available to certain onetime  
            uses, such as debt obligations, in the event the reserve fund  
            reaches the maximum funding level.

           4.Budget Emergency  .  Require a finding by the Governor of a  
            budget emergency (natural disaster, fiscal emergency, or an  
            inability to fund programs at the current year level  
            accounting for population and cost-of-living changes).  Limit  
            the maximum amount that may be withdrawn during the first year  
            of a recession to half of the fund's balance, ensuring that  
            the state does not overly rely on the fund at the start of a  

          This bill works from the same basic framework as the original  
          January proposal, but contains several specific modifications.   
          The proposal changes the existing constitutional requirements of  
          the BSA to reflect the following:

           Reserve Fund Deposits  .  This bill requires annual deposits to  
          the reserve fund equal to the sum of:  (a) 1.5% of General Fund  
          revenues; plus, (b) an amount equal to revenues derived from tax  
          liabilities associated with capital gains realizations if, and  



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          only to the extent, such associated revenues are in excess of  
          8.0% of General Fund revenues, less any amount required to be  
          transferred to the Public School System Stabilization Account,  
          as described below.  The deposits to the reserve would be made  
          no later than October 1 of each year, beginning October 1, 2015.  
           Deposits to the reserve fund would be made until or unless, the  
          account balance reaches an amount equal to 10% of General Fund  
          revenues.  Deposits to the budget reserve would be subject to  
          other provisions discussed below.

           Diversion for Debt Payments  .  For fiscal years 2015-16 until  
          2029-30, 50% of the revenues that would otherwise be deposited  
          in the budget reserve must be used to pay for unfunded prior  
          year General Fund obligations, budgetary loans to the General  
          Fund, payable claims for mandates incurred prior to 2004-05, and  
          unfunded liabilities of state-level pension plans.  After this  
          period, up to 50% of revenues that would otherwise be deposited  
          in the reserve fund may be used to pay such specified  
          obligations in lieu of being deposited.

           Revenues in Excess Balance Requirement  .  In the event the  
          reserve fund reaches a balance equal to 10% of General Fund  
          revenues, addition revenues that would otherwise be deposited in  
          the reserve fund may be expended only for infrastructure costs,  
          as defined by Section 13101 of the Government Code, including  
          any associated deferred maintenance.

           Reserve Withdrawals and Deposit Suspensions  .  If the Governor  
          declares a budget emergency, the Legislature may take action to  
          suspend or reduce required deposits to the reserve fund and  
          return and appropriate funds that have been deposited in the  
          reserve fund.  These withdrawal and suspension provisions also  
          apply to the Public School System Stabilization Account, as  
          defined below.  No more than 50% of the reserve fund balance may  
          be withdrawn for appropriation (unless a withdrawal occurred in  
          the immediately prior year).  A budget emergency is defined as:

          1.Conditions of disaster or extreme peril, such as a natural  
            disaster, as set forth in paragraph (2) of subdivision (c) of  
            Section 3 of Article XIII B of the California Constitution.

          2.A determination by the Governor that estimated resources are  
            inadequate to fund General Fund expenditures equal to the  
            highest amount of such expenditures over the most recent three  



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            prior years, after accounting for cost-of-living adjustments  
            and population growth.

           Proposition 98 Reserve  .  This bill establishes the Public School  
          System Stabilization Account ("Proposition 98 Reserve"), funded  
          by a transfer of that portion of tax revenues derived from  
          capital gains realizations that are in excess of 8.0% of General  
          Fund revenues and allocable to the Proposition 98 guarantee.   
          Transfers would occur if the state:  has met total school  
          funding requirements as increased for enrollment growth and the  
          higher of two cost-of-living factors; has repaid and allocated  
          the current Proposition 98 maintenance factor amount; is in a  
          Proposition 98 Test 1 funding level and the transfer is no more  
          than the difference 
          between the Test 1 and Test 2 level of funding; is not accruing  
          Proposition 98 maintenance factor; and, has not suspended  
          Proposition 98 in the year of the transfer.  Such transfers are  
          subject to true-up calculations and may not result in a balance  
          in the reserve in excess of 10% of the Proposition 98 guarantee.  
           Funds in the Proposition 98 Reserve may be used for General  
          Fund cash-flow requirements to the extent that such use does not  
          interfere with the purposes of the reserve.

          Funds would be appropriated from the Proposition 98 Reserve in  
          circumstances when the amount required to be applied by the  
          state for the support of K-14 education exceeds the allocation  
          of General Fund revenues, allocated local property taxes, and  
          other available resources.  These funds could be used all at  
          once and would be used to fund enrollment growth and  
          cost-of-living adjustments.  Funds transferred to the  
          Proposition 98 Reserve are considered Proposition 98 revenues in  
          the year of transfer, not the year in which such funds are  
          appropriated from the reserve.

           Administrative Provisions  .  The measure relies on various  
          estimation and deposit responsibilities by the Administration.   
          These include an estimate (and notification to the Legislature)  
          of General Fund proceeds of taxes, tax revenue derived from  
          capital gains realizations and subsequent follow-up  
          calculations, and schedules related to debt payments in lieu of  
          deposits to the reserve.  Because of the estimation issues  
          related to forecasting tax revenues on capital gains  
          realizations, the Administration would be required to make  
          so-called "true-up" calculations in the two subsequent years  



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          following the initial estimate of tax revenues derived from  
          capital gains realizations.  Over-estimation or under-estimation  
          amounts would generate debits or credits against the reserve  
          fund, with offsetting debits and credits to the General Fund.

          Fiscal Effect:  Could result in a reduction in annual  
          expenditures in initial years by the retention of funds in the  
          budget reserve that might otherwise be expended.  Potential  
          increase in spending that would otherwise occur in years using  
          such retained funds when available resources are insufficient to  
          support General Fund expenditures.  The Department of Finance  
          estimates the following deposits to the proposed budget reserve:

                         Source: Department of Finance

          The revised budget reserve proposal addresses a number of issues  
          that had been identified in legislative hearings and over  
          several months of discussion.  These modifications will result  
          in improved ability of the state to restore or maintain  
          necessary program funding, provide a more stable and predictable  
          source of deposits for the reserve fund, and improve the  
          budgeting process by reducing the frequency and magnitude of  
          unanticipated required reserve deposits.

          The modified proposal incorporates two important changes that  
          should allow for additional flexibility in maintaining public  
          services.  First, the bill specifically carves out 50% of  
          deposits that would otherwise go to the budget reserve and  
          diverts these to the payment of debt.  This avoids the potential  
          of a 'double hit' on the General Fund.  Second, the bill allows  
          for a three-year 'look-back' in determining whether a withdrawal  
          or suspension can occur and potentially allow for a higher level  
          of funding.  This could increase the chances of 'locking-in'  
          artificially low spending levels.

          The requirement to deposit 1.5% of General Fund revenues in the  
          budget reserve moves away from the problematic concept in the  
          original proposal that relied exclusively on "excess" capital  
          gains revenues.  While the measure provides for a supplemental  
          deposit to the reserve of revenues derived from capital gains  
          income in excess of 8.0% of General Fund revenues, less amounts  



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          deposited to the Proposition 98 Reserve, this source is  
          estimated to be a subordinate component of contributions to the  
          budget reserve, as shown in the table above.  This revision  
          implicitly recognizes that revenue components other than capital  
          gains income (bonuses, stock options, corporation taxes) are  
          also quite volatile by incorporating these revenues in the 1.5%  

          In addition, the reduced reliance on capital gains as a source  
          for reserve funding-which would only be operative in robust  
          periods of capital gains spikes-would eliminate or reduce the  
          impact of a number of technical and fiscal issues that have been  
          raised.  Specifically, the bill would in most years:  (1) lessen  
          the effect on the budget reserve of any changes in federal (or  
          state) tax rates or tax policy that would affect the capital  
          gains base or the realization of these gains; (2) reduce the  
          impact of inevitable misestimations of capital gains tax  
          revenues, thus avoiding large capital gains true-ups and  
          facilitating a more certain budgeting process; and (3) make the  
          selection of the capital gains as a percent of General Fund  
          revenues threshold less significant given the reduced importance  
          of these revenue sources to the funding of the budget reserve.

           FISCAL EFFECT  :    Appropriation:  No   Fiscal Com.:  Yes    
          Local:  No

          JA:e  5/14/14   Senate Floor Analyses 

                         SUPPORT/OPPOSITION:  NONE RECEIVED

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