August 18, 2006 - From the August, 2006 issue

New California Network Presents Principles for Putting California's Fiscal House in Order

For all the complexities of the $100 billion state budget, a simple truth prevails: expenditures should equal revenue. But in recent years Sacramento has had difficulty balancing the budget, and the New California Network has emerged to promote fiscal responsibility in Sacramento and prosperity for all Californians. NCN Fiscal Affairs Advisor Fred Silva recently authored NCN's signature report, "In Search of Fiscal Responsibility: An Analysis of State Fiscal Choices" (read at newcalnet.org), and MIR was pleased to speak with Mr. Silva about NCN's principles as well as his conclusions about what California must do to right its fiscal course.


Fred Silva

What are the New California Network's guiding principles that inspired your study?

The principles that guided the analysis for the state's fiscal situation deal with state government leaders-both the governor and the legislative leaders-and the need to set priorities and to have sufficient resources in order to meet the state spending obligations.

The state's primary interest-relative to the amount of money it spends-is in education and health and human services. To the extent that the state is interested in limiting the amount of tax dollars it takes in, it has to look at its spending priorities. In the short term, external borrowing has filled much of the gap between revenues and expenditures. We've suggested in this report that borrowing is not the fiscally sound way to approach the state's long-term needs.

The second principal deals with the need to manage public dollars better. Much of that involves performance review of governmental programs and better oversight on the part of the Legislature. In the mid-1990s the state experimented with some performance-based budgeting and performance management. Some of those pilot projects worked well and some didn't, but state government has never institutionalized a performance-based budgeting system.

The third principle deals with the need for state and local governments to work together. State and local finance is so intertwined as to defy description. We suggest that we need to rethink the role of cities and counties and state governments in the way that public services are provided.

The fourth principal is all about infrastructure finance and committing to building infrastructure that will meet California's growing economy-that's an important principle.

The final principle concerns the tax system. California needs a 21st century tax system for a 21st century economy. The current tax system was adopted in the mid 1930s. Although tax rates have changed over time, the tax structure has basically remained the same. And so, the New California Network has suggested that it is time to look at a tax system that meets a 21st century economy.

Based on those principles, what endemic problems does your report identify?

The first problem focuses on the current imbalance between revenues and expenditures. The Schwarzenegger administration has made some progress in reducing the gap between revenues and expenditures. This year's adopted budget spends about $7 billion more than it takes in. The gap for the 2007–08 budget is likely to be in the $4 billion range.

The gap continues to shrink, but there is a point where you need, on an ongoing basis, resources that match expenditure obligations. But the state has been reluctant to either look at spending obligations or the tax base. Externally borrowed resources, for the most part, have made up the difference along with the benefit of year-end balances which can be used to fund the following year's programs.

If the state continues to use borrowing and prior year balances as a "release valve" for the pressure that builds up to balance our resources and expenditures, then it will never find its way out of an unbalanced system. In other words, it will always have some amount of debt that it has to put resources into that could otherwise fund programs that serve the state's growing population.

I have indicated that the primary solution is for legislative leaders and the governor to balance resources and expenditures. I am not convinced that having artificial limitations, like spending limits, will accomplish that. Frankly, it hasn't in the past. I'm not so sure the spending limit that was put into the constitution in 1979 was all that helpful in reducing spending.

The second problem is that annual increases in spending are simply billed into future budgets because the annual budget cycle leaves little time for oversight. A rubric sits over the door of the Department of Finance that says, "You get what you got in the prior year, plus growth." That's a natural law that governs the budgetary process. We've recommended the integration of program performance reviews into the budget process so that the governor's budget is built on objectives and what the money would produce in terms of increased productivity as opposed to simply explaining how much more money the program is going to spend.

The third problem is the fact that the state's budgeting process is annual and has been since the early 1960s. I've suggested that the planning horizon be for two years, rather than one. That is not to say that there ought to be a two-year budget-I am not suggesting that the state simply appropriate $200 billion of general fund revenue every two years.

Instead, California should have a two-year fiscal plan that would have annual appropriations to support it, so that in an odd numbered year the governor would produce a two-year fiscal plan for how he or she wants the state to operate over a two-year period. The Legislature would then have a longer term backdrop for an annual appropriation. They'll be able to do a performance review of a program over a two-year period. So, in January through June during the odd numbered year, they could look ahead over a two-year period as opposed to an annual period.

I have also suggested that it is probably time-certainly given term limits-to revise the way in which the Legislature itself does its fiscal work. The Legislature, upon receiving the governor's budget in January, doesn't do much until about March or April.

The Legislature used to work on the budget so that each respective house had a view about the governor's budget. The Assembly, through the budget subcommittees, through to the full Budget Committee and then on the floor of the Assembly, debated fiscal priorities. The Senate did the same thing: through the Senate, the old Senate Finance committee-now the Senate Budget committee-the full committee debated the topic, the Senate floor debated it, the Republicans often indicated their concerns and then gave the votes necessary to put the bill into conference.

That process has dissolved. The process currently has the subcommittees work on their particular issues and the subcommittee actions are then catapulted all the way into conference committee between the two houses. So the houses never speak, it is only the subcommittees. But if a subcommittee in the Senate, for example, has five members and a quorum is three, than two of the members determine the Senate's view of a particular item when it is heard in conference. There are also times when a given budget item isn't even heard in the subcommittee.

I am suggesting that the Legislature go to a joint-budget committee for the development of their answer to the governor's budget, and that as soon as the bill is introduced and placed before a joint committee of Assembly members and Senate members. Since each house is going to have to vote on this it is important for the Senate members to have a view and the Assembly members to have a view.

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Does the Legislature's political culture, given term limits, low voter participation, and the way the districts are drawn, have the will to implement these reform ideas?

I am looking at it from the other end because I don't have much hope for the level of comprehensive governance reform that would be required to bring some semblance of order back to budgetary process. The culture that has developed is that members who are recently elected don't know anything different. They don't know that the House is supposed to speak. They think all they do is they do their work in the subcommittees and it's over. And so I am trying to suggest that as a process for achieving public policy objectives, having a two-house process will invigorate a different culture.

In light of the damage that has been done in the last decade to representative government, is reform even possible?

Sure, because every two years, another group of people have made some commitment to public policy because they got elected. I haven't given up on the electorate, if they are interested in electing people who will want to work on public policy problems. I am just suggesting a new template for the process that they will use to develop that policy, which will, in effect, force them into a circumstance where they have to work with both parties and both houses.

I guess my underlying view is that hope springs eternal, that you could get people to look at the process that they are using now and see if a discussion about the budget process will produce a better process. That's the only observation I can make-otherwise there is no hope. Better to be an optimist and accused a fool than to be a pessimist and be right!

Some argue that the public, without any media to offer them context, has very little appreciation or understanding of the value of the proposals and recommendations you're making. Do you agree?

Sure, that is fair. The media has a role to play in opening up the public discus

So where do we find the political will to self-correct and reform the process?

It was suggested that before term limits was this "golden age" period. I would submit that about the same percentage of members who are seeking answers to public policy questions are there now that were there then. Whether it's Bob Hertzberg or Phil Isenberg or Dede Alpert, you can go down a long list of current legislators and find them. There will be a new group that will come in this December and again in December 2008, and they will invigorate the place again. I am simply suggesting that there are alternative ways of working on state finance other than the one that they have now.

From the fiscal policy point of view, how significant are the bonds on the November ballot? How do they relate the Legislature's strategies for financing deficits and infrastructure investment?

First, on the question of infrastructure, the state has averaged $10-12 billion in statewide bonds per election cycle over the last 20 years, most of which has gone for education. It has had a difficult time financing transportation because the financing has relied on the gasoline tax and the sales tax on gasoline.

In order to avoid raising either tax, the decision was to borrow money to invest in transportation infrastructure and pay the debt service out of the general fund. The fact that the bonds are so large is simply an acknowledgement of the backlog we have in transportation needs and the lack of tax revenue to support it.

The same thing can be said with respect to flood control. Housing is a little different. The issue there is making more financing available for folks who have otherwise can't get financing-to lower their financing costs for housing given California's expensive housing markets.

The voters are going to be asked to put more public resources into these major state assets, whether it is water, levees, highways, or school buildings. The education bond measure is pretty normal. That one looks very much like the ones in the past-the monies are the same as they were before. In the case of K-12 education, in the mid-1990s the decision was made that communities-local property taxpayers-ought to share in the burden of providing for school facilities, and so now there is a match requirement.

What signs of progress resulting from your recommendations and your recently released report for the New California Network should we look for?

Probably two things. One is that the Legislature makes a larger commitment to programmatic oversight and that the performance of government generally improves-measured by the Bureau of State Audits, the Little Hoover Commission, or the press, people who have watched government work.

The other is the timeliness of budgets and the methods for achieving fiscal balance do not include external borrowing or rely on a prior year balance to close a budget gap. Are they using some form of program evaluation to test to see if a program works and whether or not it needs more resources to work or whether it ought to be a government responsibility at all?

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