California may go forward without a financial reserve


SACRAMENTO — Arnold Schwarzenegger persuaded voters nine years ago that if they let him borrow money to cover the budget deficit, California’s financial woes would end for good. A key part of his plan was a new rainy-day fund to insulate the state from further crisis.

“It will be a whole new ball game,” Schwarzenegger said. “Trust me.”

But California was roiled by financial turmoil for years afterward, and today the reserve is empty. With more than $5 billion in bonds left to repay, Gov. Jerry Brown apparently plans to leave it that way.

The reserve was created without a firm requirement to fill it, and Brown’s proposed budget contains no allocation for the fund. Without a financial cushion, some experts say, California is more vulnerable than many other states to drops in revenue that can lead to social-services cuts or pink slips for teachers.


Sacramento relies heavily on income taxes paid by the wealthy — revenue that lags in every downturn and can be subject to swings in the stock market — and California has not fully recovered from the recession.

“We’re still in an uncertain economy,” said Tracy Gordon, a fellow at the Brookings Institution, a Washington think tank. “In a state like California, where things can change very quickly, it’s a good idea to be cautious.”

Plenty of other states are playing it safer. Maryland’s rainy-day fund has grown since the recession, and Democratic Gov. Martin O’Malley hopes it will protect the state as federal spending is cut during Washington’s budget standoff.

Ohio has replenished its reserve, and Republican Gov. John Kasich wants to boost it further. New York added to its fund last year while wrestling with deficits and now has $1.3 billion socked away.

California, however, has a tradition of boom-and-bust budgeting. When times are good, surplus tax dollars are often used to boost the state payroll and expand government programs. When the economy craters, state leaders reach for their red pens to close deficits.

Brown is scheduled to issue a revised budget plan next month, and officials won’t say whether it includes cash for the reserve fund. But his administration has projected that tax revenue will rise for the next four years, and Brown has indicated that he wants to use the opportunity to pay off Schwarzenegger’s borrowing plus billions of dollars owed to local governments, schools and other programs.


The bill for those debts and others incurred during years of budget crisis is expected to be almost $28 billion by the end of June, according to state officials, and will take years to erase.

The debt “has been ignored for too long,” said H.D. Palmer, a spokesman for Brown’s Department of Finance.

Gabriel Petek, who tracks California finances for the Wall Street ratings agency Standard & Poor’s, said that starting to pay into the reserve now “would be like building up a savings account when you still have a lot of credit-card debt.”

Still, he and other analysts said, Sacramento will need to start saving or the state will remain vulnerable to swings in the economy.

“You can’t really predict when the next decline is coming,” said Elizabeth McNichol, who researches state finances at the Center on Budget and Policy Priorities, a Washington think tank.

Even though states are unlikely to completely withstand any recession, reserve funds can play a key role, she said. After the dot-com bubble burst more than a decade ago, states slashed $81 billion from their budgets and tapped into their savings to avert an additional $20 billion in cuts, according to a report McNichol wrote.


The pair of ballot measures that contained Schwarzenegger’s rescue plan allowed the state to borrow up to $15 billion to bridge the deficit, created the rainy-day fund and barred further outside borrowing to plug budget gaps.

Three percent of general fund revenue was to go into the reserve each year until the state had saved $8 billion or 5% of its general fund, whichever was greater. But a governor can easily waive the requirement by executive order, as Schwarzenegger did multiple times and Brown did for his first two budgets.

Lawmakers have paid into the fund only twice since it was created in 2004. They moved nearly $1.5 billion there over two years, but that was reduced to zero to help pay the state’s bills in the 2007-08 fiscal year.

The rainy-day fund law was “a joke,” said Mark Paul, who has co-written a book on dysfunction in California government.

Democrats and advocates for the poor balked at stashing money away while the state was slashing billions from healthcare and social services. Nevertheless, three years ago the Legislature passed a constitutional amendment to put before voters that would make it harder to avoid paying into the reserve and harder to pull money out.

The amendment was originally set for last November’s ballot, but Democrats delayed it until November 2014. Republicans want it on the June 2014 primary ballot. And they want Brown to start saving now.


Top GOP lawmakers said in a February letter to the governor that the “devastating impact of future budget cuts can be avoided if we act responsibly today.”

Steve Maviglio, a spokesman for Assembly Speaker John A. Pérez (D-Los Angeles), said the measure was hastily crafted and needs to be reworked. The calculation used to determine how much money goes into the reserve would function as an undesirable spending cap, he said.

“While we continue to believe in the need for a rainy-day fund,” Maviglio said, “this measure has flaws that need to be corrected or it will lead to major cuts to schools, higher education and healthcare, which is just what Republicans would like.”