New Davis Budget Seeks to Cut Less, Borrow More

As they prepare today to receive Gov. Gray Davis’ revised budget for the coming fiscal year, state officials are favoring the same approach they’ve relied on thus far in coping with the crisis: borrowing billions of dollars and creating more long-term costs for California.

More fiscally prudent solutions to the enormous gap between state spending and income are not that complicated, but they are politically painful: Either cut deeply into state services, which Republicans favor; or raise fees and taxes, which many Democrats endorse as part of the solution.

Deeply divided over that question, Democratic and Republican officeholders from Davis to members of the Assembly and Senate instead have backed creative financing that some say borders on gimmickry.

To keep spending, they have approved selling bonds to pay for employee pensions, cashed in future tobacco settlement funds, stretched out the state’s debt payments, and drained billions from many special-purpose funds. The state’s credit rating has suffered, which in itself makes it harder to raise cash.

In addition, senior Davis administration officials said Tuesday that they will propose creating a special authority to issue $10.7 billion in bonds and pay them back with a new sales tax. That idea previously had been reported, though the exact amount that the administration was seeking was not known. If approved, it would effectively roll out part of the deficit over at least five years, lightening the burden this year and spreading out the payments over time.

The state’s borrowing boom has ramifications for its fiscal health, and economists say an expansion comparable to the one that pulled California out of its last recession would be necessary to mitigate futureproblems.

Among the consequences are these:

* Unable to find the cash to make the state’s annual contribution to the Public Employees’ Retirement System, the governor and lawmakers recently approved the sale of $1.85 billion in pension obligation bonds. But repaying those bonds will add several hundred million dollars in interest to the state’s debt burden over the next five years. The exact cost is unknown.

* A one-time infusion of $3 billion from future tobacco settlement payments helped avoid deeper cuts in education, health and other programs. But next year alone, it will cost the state almost $182 million to start paying off the debt, a process that could take almost 40 years to complete. And California will have to find other ways to help pay for the Healthy Families program, which provides health coverage to uninsured children.

* Davis has borrowed heavily from special funds intended to pay for highway and transit projects, beverage container recycling programs and other uses. Unless those loans are forgiven by the Legislature, the money must be repaid with interest. In the meantime, those funds have been left short, which postpones projects that the money might have been spent to complete.

* Because it is short on cash, California must borrow $11 billion in coming weeks to pay off $12.5 billion in short-term notes that will come due in late June. The state’s cash crisis is so severe that only $4 billion of the new borrowing will be left over to pay bills after last fall’s borrowing is repaid.

* California’s credit rating has plummeted to the bottom of the barrel of all the states. And that drives up the cost of borrowing. The state’s bonds are paying a premium as much as half a percentage point above the average of highly rated states. Investors demanded as much as 7% interest to buy the first batch of California’s tobacco bonds.

When the state’s credit standing was downgraded in February, Raymond Murphy, an analyst at Moody’s Investors Service in New York, wrote: “These rating actions reflect the magnitude of the imbalance between the state’s revenues and expenditures, and the expectation the state will not be able to sufficiently address the imbalance in the upcoming fiscal year.”

Desperate for cash to cover the current gap, state lawmakers have found other ways to roll the budget deficit into the future.

To bring education spending nearer to the minimum allowable under Proposition 98, lawmakers approved a bill to delay $1.1 billion in payments to schools.

The weeklong delay from June 25 to July 2 relieves pressure on this year’s budget by pushing the spending into the next fiscal year. It does not, however, fundamentally improve the state’s financial position; it merely puts those expenditures into next year’s budget.

Davis noted that by lowering the current year Proposition 98 education spending “primarily through deferrals rather than reductions, this bill avoids short-term pain but makes the budget year outlook more difficult.”

Nevertheless, the governor signed the bill to make the shift.

Altogether, about half of the nearly $7 billion in budget actions taken this year have involved borrowing or deferring spending. None of those actions has raised more money for the state treasury or cut services that cost money. In other words, none of those actions has moved the state toward a long-term balanced budget.

Former state economist Ted Gibson said lawmakers and the governor may be “sowing the seeds of ongoing, difficult budgets” for years to come. Unless the state gets lucky and the economy and revenues improve rapidly, Gibson said -- a prospect that he considers unlikely -- California will be paying off the fiscal crisis for the foreseeable future.

“I just don’t think that we’re solving much here at this point,” he said.

The Legislature has made some real cuts, though most are relatively small compared with the overall size of the shortfall, which has been estimated at as much as $35 billion between now and July 1, 2004.

Lawmakers have made some cuts in spending for schools, the University of California, the state university system and community colleges. Social programs, including Medi-Cal’s health coverage for the poor, have been reduced. And lawmakers have eliminated the next cost of living increase for the aged, blind and disabled, although that bill has yet to reach the governor’s desk.

Borrowing, meanwhile, has attracted supporters from both parties -- among Republicans who see it as preferable to tax increases and Democrats who view it as an alternative to deep cuts in valued services. But borrowing to pay current expenses only aggravates the structural imbalance between spending and revenues because eventually the money has to be paid back, with interest.

Consider the case of the pension obligation bonds. Instead of making its annual contribution to the pension fund of many state workers, the state intends to borrow $1.85 billion and repay it over the next five years.

In approving the pension bonds, lawmakers disregarded the advice of the nonpartisan legislative analyst’s office that “incurring debt for operating costs is ill-advised” and represents “poor fiscal policy.”

The controller will have to sell $11 billion in revenue anticipation warrants next month to pay off last fall’s borrowing to meet the state’s cash needs.

State Treasurer Phil Angelides has refinanced or restructured $8 billion in general obligation bonds to delay principal payments in the next four years. The move temporarily reduces debt service costs, but they will increase rapidly, beginning in 2007.

The effects of that can be severe when plans fall through. The sale of another $2.3 billion in tobacco bonds, for instance, initially had been counted on for this year, but sources said Tuesday that it now has been eliminated from Davis’ plan. The market for tobacco bonds evaporated after Philip Morris lost a recent court case in Illinois. The company is appealing the decision.