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LAO report: The state appropriations limit

The Legislative Analyst’s Office has just published the following report:

The State Appropriations Limit

Executive Summary

The State Appropriations Limit (SAL) Likely to Limit Spending Growth in the Budget Year and Future Years

SAL Will Be an Important Issue at May Revision. Proposition 4 (1979) established an appropriations limit on the state and most types of local governments. The appropriations limit is based on appropriations from tax revenue. If the state has revenues above the limit over two consecutive years, the State Constitution requires the state to split the excess between taxpayer rebates and additional spending on schools. In the Governor’s budget, the administration estimated the state would have revenues in excess of the limit in some years between 2018‑19 and 2021‑22. Specifically, according to initial estimates, the state has excess revenues of about $100 million between 2018‑19 and 2019‑20 and about $500 million between 2019‑20 and 2020‑21. These amounts represent less than 1 percent of the limit in these years. The administration will update its estimates at the May Revision. In light of strong revenue collections that have occurred since January, we anticipate responding to the requirements of the SAL will be an important issue for the state budget this year.

SAL Likely to Be a Major Issue Over the Next Few Years. Our analysis suggests the SAL will be an even more important factor in the state budget in the coming years. The figure below shows our projections of the likely “room” under the limit over the next few years. Projections of the amount of room under the limit are highly uncertain, as shown by the wide range of possible outcomes in the figure. That said, under the vast majority of likely outcomes, we anticipate the state will have “negative room.” That is, the state either would need to reduce taxes or issue refunds to taxpayers and make additional payments to schools in these amounts. Further, without significant budget changes, the state likely does not have the capacity for new services or program expansions.

Why Is the Limit an Issue Now?

There are two primary reasons that room under the limit has diminished. First, growth in personal income tax revenue—the state’s largest revenue source—has exceeded the SAL’s growth rate. There are a few reasons for this, but two important factors are: (1) the state’s tax rate structure combined with (2) faster income growth among high‑income earners. As a result, year‑to‑year growth in appropriations has been higher than increases in the SAL. Second, constitutionally required school spending—driven by faster state revenue growth—has increased faster than school limits. Because the state absorbs appropriations above school limits, this trend has resulted in diminished room for the state.

How Can the Legislature Respond?

Options for Legislative Consideration. In the coming months and years, the Legislature will face decisions about how to respond to state tax revenues nearing the limit. This report describes various options that the Legislature could consider in response. They fall into five categories: (1) issue tax refunds and allocate excess revenues to schools, (2) increase spending on excluded purposes, (3) reduce proceeds of taxes and spending, (4) make statutory changes to the SAL, and (5) go to the voters.

Short‑ and Long‑Term Options Needed. Few of these options, in isolation, are likely to be sufficient to keep the state from exceeding the limit over the next few years. For example, this year, the Legislature could decide to issue refunds and provide additional funding to schools. This response might not be sustainable over the long term, however. As existing program costs increase, revenues available for appropriation could be insufficient to meet current service levels. Consequently, changes to the state’s revenues and expenditures would be required. Alternatively, should the Legislature pursue statutory changes to the SAL, those changes would be unlikely to be sufficient to avoid reaching the limit in the next few years. In that case, considering placing a measure before the voters could be needed.

Constructing a Plan. We recommend the Legislature construct a short‑ and long‑term plan for how it wishes to respond. To aid the Legislature in constructing this plan, the figure below summarizes the options presented in this report, when each option could take effect, and our estimate of the potential magnitude of each potential change.

This report is available using the following link: https://lao.ca.gov/Publications/Report/4416?utm_source=laowww&utm_medium=email&utm_campaign=4416

This article was released by the Legislative Analyst’s Office.