Riverside County government’s income will be higher than originally expected — by almost $100 million — as the current fiscal year draws to a close, but “financial pressure” continues to build as priorities demand more outlays, according to a report that the Board of Supervisors will review Tuesday.

The Executive Office’s 2023-24 third-quarter budget report will be among the top items on the board’s agenda. It will be the final analysis of existing finances prior to the start of 2024-25 budget hearings next month.

“While the near-term financial outlook appears stable, challenges are looming in the years to come,” the EO stated in the 50-page report. “While we are projecting increases this fiscal year and next, it should be noted that the pace of growth is slowing, while costs continue to rise to maintain the status quo, let alone increase service levels. Additionally, the need to maintain or replace our aging facilities adds financial pressure.”

Aggregate discretionary revenue is projected to reach $1.224 billion, just over $80 million more than first estimated at the beginning of the current fiscal year, when officials expected inflows by June to total $1.14 billion.

According to the report, property tax revenue, motor vehicle in lieu of property taxes and interest earnings on county treasury pool investments are all coming in at higher levels, driven in part by inflation.

There was no reference in the third-quarter update to the state’s sizable budget deficit, which the California Legislative Analyst’s Office estimated to be $68 billion, and how that may impact funding levels for a number of state-supported programs countywide going into 2024-25.

The board generally has a free hand in allocating discretionary funds, as opposed to programmed, or non-discretionary, appropriations, which are earmarked for a range of social, health and other budget mechanisms.

The 2023-24 budget is roughly 15% larger than 2022-23’s, which was about $7.45 billion.

A bright line in the midyear budget report issued in February was that aggregate reserves would likely reach $677 million, as opposed to the initial prediction of $555 million, by June.

The county received almost $500 million in 2020 Coronavirus Aid, Relief & Economic Security Act allocations and another $480 million in 2021 American Rescue Plan Act money. Just under 10% of the federal infusions have been applied to “budget stabilization.” Some of the revenue remains available and is being allocated to community development and related programs.

The funds were previously used for homeless and rental assistance programs, along with other social welfare efforts, but they’ve also been appropriated for capital improvement projects.

Hearings on the proposed 2024-25 fiscal year budget are slated for June 10-11.

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Unfortunately, the proposal still relies on too many budget gimmicksand fund shifts. The Newsom plan also underestimates the severity of the current budget shortfall that must be addressed. Making matters worse, growing economic headwinds, including the tech industry laying off over 81,000 people and California’s subpar personal income growth, raises concerns that the deficit will continue to widenthroughout the year.

The focus on budget responsibility obscures some troubling trends. For example, while focusing on administrative efficiencies, the Governor fails to demand efficiencies in the programs that can yield substantial long-term budgetary savings.

Consider the Administration’s own admission at an Assembly Budget Committee hearing this week that they have no idea whether billions in Project Homekey homelessness expenditures have worked. Taxpayers deserve better with California facing a massive shortfall.

The May Revise also focuses too much on one-time budgetary savings, budget gimmicks, and fund shifts in the hope of restoringspending once revenues have returned to “normal.” But what Gov. Newsom calls normal are the unsustainable revenue surges that are inevitably followed by revenue crashes.

Spending these revenue surges has caused the growth in state expenditures to outpace growth in residents’ incomes. A budget that temporarily reduces spending and plays budgetary games only to continue the Governor’s profligate spending ways sets the state budget up for a future budget crisis.

This approach also wastes the important breathing room that the rainy-day fund reserve is supposed to provide – blowing through half the fund’s balance this year and next while failing to put the state on a sustainable budget path.

Basic budget arithmetic demonstrates that there are three options going forward – greater spending restraint, increased borrowing, or higher taxes.

There are many other ways to reduce spending including making more proposed one-time spending cuts permanent and further reducing Proposition 98 education spending. These reductions are by no means easy or costless, although the sheer amount of ineffective spending by the state (such as Project Homekey spending) demonstrates the many opportunities for the state to do better with less.

More budgetary borrowing, which took the state years to pay off when widely used in the 2000’s, is simply another way of kicking the problem down the road.  Nor is now the time to embrace billions in new borrowing for housing, the environment, schools, or other priorities we cannot afford.

This leaves the tax increase option. While he rejects tax increases this year, not making sufficient additional cuts this year makes future tax increases more likely.

Remember the 2009 budget crisis.  Politicians of both parties embraced budgets during the 2007-09 economic meltdown thatavoided tough spending choices and set the state up for a devastating 2009 budget that included billions in painful cuts to important programs and billions in tax increases.  

Like today, problems were evident well before the 2008-09 budget crisis. The failure to take sufficient actions caused credit rating agencies to downgrade California’s rating five times. Lower credit ratings increased borrowing costs, making addressing the problem more expensive.

Only after the crisis was undeniable, did politicians finally implement actual painful budget solutions that included nearly $60 billion in budget actions. These efforts required actual declines in year over year spending in excess of 15 percent relative to 2007.

The 2009 budget crisis should have taught our political leaders that spending gimmicks and blind hope turns today’s troubles into a worsecrisis tomorrow.

Now action on the Newsom budget turns to the Legislature.  One major question looms – will liberal lawmakers who never met a spending increase they didn’t like embrace cuts – even temporary ones – to CalWORKs, childcare and environmental programs?  Not likely.

Californians are now watching to see if Gov. Newsom and legislative leaders have learned their lesson and will pass a final state budget that reins in the state’s excessive spending sooner rather than later.

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The governor’s proposed budget would cut one-time spending by $19.1 billion and ongoing spending by $13.7 billion through fiscal year 2025-2026, according to the fact sheet. It would enact a nearly 8% cut to state operations, eliminating 10,000 unfilled positions.

The sheet said the governor plans to balance the budget by “getting state spending under control — cutting costs, not proposing new taxes.” He also wants to do this by “reducing reliance on the state’s ‘Rainy Day’ reserves this year.”

The true deficit number may actually be closer to $45 billion, as the administration subtracted a $17.3 billion package of budget fixes Newsom, Assembly Speaker Robert Rivas, D-Hollister, and Senate President Pro Tem Mike McGuire, D-Healdsburg, agreed to in April.

The administration acknowledged it had cut the $17.3 billion from the overall shortfall number in a fact sheet released just before the governor’s press conference Friday.

It was immediately unclear how exactly the administration calculated the deficit, aside from subtracting the legislative agreement.

Newsom pegged the spending gap at $38 billion in January, although the independent Legislative Analyst’s Office later suggested it could be as high as $73 billion.

California’s fiscal year-over-year revenues were $5.8 billion or 4% below Department of Finance forecasts as of March, indicating the overall deficit likely grew.

Budget-watchers had predicted Newsom’s strategy in advance, suggesting he may present a rosier shortfall number by incorporating a handful of previously planned fixes.

The governor’s revised budget announcement kicks off a month of negotiations involving his administration, Assembly Speaker Robert Rivas, D-Hollister, and Senate President Pro Tem Mike McGuire, D-Healdsburg.

The Legislature must pass a budget by June 15 for lawmakers to continue getting paid. The new fiscal year begins on July 1, meaning Newsom has to sign budget legislation by the end of the month.

Just two years ago, the governor was celebrating a budget with a large surplus. This allowed him to invest in a series of bigger policy initiatives, including transitional kindergarten, or pre-kindergarten, Medi-Cal coverage for undocumented immigrants and CARE Court to compel treatment for the seriously mentally ill.

The state in January enacted the final piece of its expansion of Medi-Cal — California’s version of the federal Medicaid program — allowing all those who income-quality to enroll, regardless of immigration status.

But the post-COVID-19 pandemic economy hit California hard. That’s because the state is heavily dependent on its highest-income earners due to its graduated tax structure, the tourist industry was hit hard and supply chains were disrupted.

Federal efforts toeaseinflation by raising interest rates have cooled industries sensitive to rate hikes. This has affected some activities, such as home buying and startup and tech investing.

Also hamstringing the state’s efforts to gauge the government’s economic condition, those involved in crafting the state’s 2023-2024 budget were unable to get the most accurate picture of the state’s finances until November, long after lawmakers and the governor had agreed to a spending plan.

The delay was caused by a large number of Californians who could delay filing their 2023 taxes until November due to deferrals the IRS granted to those affected by winter storms. The situation helped complicate the state’s financial outlook heading into 2024.

Newsom in 2023 and in January committed to some cuts while preserving his major initiatives and social safety net programs.

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Even with the new spending restraints in the debt limit deal that cut borrowing by $1.5 trillion, the U.S. government’s deficits are still on course to keep climbing to record levels over the next few decades.

The projections are a sign that the two-year truce between President Joe Biden and House Speaker Kevin McCarthy, R-Calif., might be only a pause before a far more wrenching set of showdowns over the federal budget.

The Congressional Budget Office said Tuesday that the agreement would reduce spending by $1.3 trillion and interest payments by $188 billion over 10 years. But that sum is too modest to fully offset the growing costs of Social Security, Medicare and Medicaid. Both Biden and McCarthy ruled out any cuts to Social Security and Medicare, two programs that benefit older voters, before their teams even began their budget talks. That omission reflects the politics around two popular programs as Democrats and Republicans prepare for next year’s presidential election.

It also means the agreement finalized on Sunday keeps the risk of ever-escalating debt on the table, setting up the possibility of another bruising battle when the debt limit needs to be raised again in 2025. “You should think of this as one step,” said Marc Goldwein, senior vice president at the Committee for a Responsible Federal Budget. “The question is, can they take the next step after that?” Lawmakers know there are difficult choices ahead and that the only way through them likely involves some combination of deep spending cuts, broad tax hikes and major changes to the retirement income and health care programs that consume an ever-growing share of federal spending.

Mandatory spending — which includes Social Security, Medicare and Medicaid — already account for the majority of government spending. That category is equal in size to 14% of U.S. gross domestic product, and the CBO expects it will grow to 15.6% by 2023. By contrast, discretionary spending was 6.5% of gross domestic product last year and was already projected to fall to 6% within 10 years. Goldwein said he’s optimistic that leaders in both parties will find ways to reduce the growth in spending for health care programs. Social Security will also face a reckoning as its trust fund will be unable to pay out full benefits within a decade.

But some budget experts saw the deal as more focused on optics than sustainability. “This debt limit agreement is shaking out to be a political face-saving deal without much substance in terms of changing the U.S. debt trajectory,” said Romina Boccia, director of budget and entitlement policy at the libertarian Cato Institute.

The agreement, which still has to be approved by Congress, would hold discretionary spending essentially flat for the coming year, while allowing increases for military and veterans accounts. Spending growth would be capped at 1% for 2025, essentially a cut given the likely rate of inflation.

Some Democratic allies see the deal as problematic because it cedes ground to Republicans who want to use the debt limit fight as an opportunity to press their policy aims, despite the risk of a default. “Looking forward, we must find a path to abolish the debt ceiling and end the absurd debt ceiling hostage-taking that Republicans engage in when they can use it as a bludgeon against a Democratic president,” said Sharon Parrott, president of the Center on Budget and Policy Priorities, a liberal think tank.

Other economic analysts took issue with GOP suggestions that the U.S. was already hamstrung by debt, even though investors continue, for the moment, to buy Treasury notes. While total federal debt — including money the government owes itself — exceeds $31 trillion, the U.S. economy possesses more than $143 trillion worth of non-financial assets in a sign that the current debt loads are manageable. “It is simply not true that the United States is broke and on the verge of a debt and deficit crisis,” said Joe Brusuelas, chief economist at the consultancy RSM U.S.

But even if there isn’t an immediate reckoning over debt, there is a long-term problem that the talks purposefully ignored. The president challenged Republicans to shield Social Security and Medicare from cuts at his State of the Union address in February. GOP lawmakers jeered him for suggesting they would dare to cut the programs, leading Biden to declare, “We’ve got unanimity.”

Biden specifically hailed the bipartisan agreement on Sunday for protecting Social Security and Medicare, while saying the agreement that must pass the House and Senate would prevent a possibly catastrophic default that could occur on June 5. “This is a deal that’s good news,” the president said, “for the American people.” Yet House members received a specific briefing in March indicating that entitlement programs would drive up the debt.

CBO director Phillip Swagel gave a presentation showing that publicly held debt would more than double to 195% of gross domestic product in 2053. The key challenge is that an aging population means that programs for older people have costs that exceed tax revenues. Swagel provided 17 policy options for reducing the debt, six of which were tax hikes that could raise trillions of dollars over 10 years.

Tax increases have been a nonstarter with Republicans, while Democrats have generally shied away from reductions to benefits. His slide deck included this warning: “The longer action is delayed, the larger the policy changes would need to be.”

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Alejandro Lazo and Jeanne Kuang | Calmatters.org

California faces a projected deficit next year even if the U.S. avoids a recession. Despite the expected shortfall, policymakers say they’ll maintain spending on social programs though advocates are calling for more.

The Legislative Analyst’s Office recently said in its annual forecast that Gov. Gavin Newsom and the Democratic Party-controlled Legislature are facing a $24 billion projected budget deficit for the next fiscal year.

If the state enters a recession the outlook is even worse, with revenues predicted to fall short by $30 billion to $50 billion. The governor signed a record-breaking $308 billion budget in June.

The legislative analyst attributes the projected shortfall to California’s reliance on those whose incomes often ebb and flow with the price of stocks, real estate and other investments.

“Those are the same people who get a lot of their income from financial investments,” said Legislative Analyst Gabriel Petek. “That volatility then gets transmitted directly to the state budget.”

The governor will present a proposed budget in January and then a revision in May. The budget, which the Legislature must approve, will fund state government for the fiscal year beginning July 1.

H.D. Palmer, spokesperson for the state Department of Finance, declined to comment on whether social spending cuts might be proposed.

He did say, however, that the governor’s priority was to not scale back programs that people have come to depend on, or to begin new ones. Some program expansions in later fiscal years could be delayed if there isn’t enough revenue to support them, he said. The goal is to avoid the kind of drastic program reductions enacted during the Great Recession that took years for the state to restore.

Building reserves

The state’s Democratic legislative leaders have said they are not inclined to cut recently expanded programs, such as the extension of free health care to low-income undocumented immigrants, which began with older adults this year and is slated to open up to all ages in January 2024. The expansion is expected to cost more than $2 billion annually.

The budget is in a much stronger position than it was during the state’s last fiscal crisis, said Phil Ting, the Assembly budget committee chair from San Francisco.

“We have a significant amount of cash available, both in terms of reserves, but also in terms of liquidity,” Ting said. “So this is a very different situation than the state faced in 2008-2009, where they were running out of cash.”

The governor, nevertheless, has signaled he is being cautious. Newsom in October said he had vetoed 169 bills and saved taxpayers billions. Seventy-five of those vetoes were directly budget related, with many including boilerplate language that the state was facing “lower-than-expected revenues” and that it was “important to remain disciplined when it comes to spending, particularly spending that is ongoing.”

Among the bills vetoed by the governor earlier this year were proposals to expand government-funded care for new mothers, expand free transit programs for California students and create grants for graduate students in mental health who commit to working at certain California-based nonprofits.

Newsom, whom voters elected to another four-year term, has used surpluses to pay down debts, build reserves and provide direct payments to millions of Californians. 

Recently Moody’s Analytics rated California one of the states most prepared for a recession, citing its reserves.

Nevertheless, California’s budget enacted in June 2021 committed to $3.4 billion in new ongoing spending and is expected to grow to $12 billion in the 2025 budget year. The budget enacted in June of this year committed an additional $2.3 billion, expected to grow to nearly $5 billion by the 2026 budget year, the Legislative Analyst’s Office said.

The state has $37 billion in specific reserve funds. That includes about $23 billion in a rainy day fund voters agreed to strengthen in 2014 at the urging of then-Gov. Jerry Brown. The state also has $900 million in a reserve account for safety net programs. The rest of those reserve funds are in school-specific and general operating reserves.

But, Palmer noted, the state can only draw down the rainy day fund by half in any year. The Legislative Analyst’s Office has advised the Legislature to slow down or pause program expansions before dipping into reserves.

Ting’s office contends the state has billions in unspent federal and state dollars in its coffers that could address a potential deficit. Using that money would avoid cuts to programs but delay other projects. 

Is it time to spend?

Anti-poverty advocates said in interviews they plan to continue pushing for program expansions, arguing the precipice of a downturn is the time to bolster social spending, not cut it. 

Nearly 30% of California residents live in or near poverty, according to the Public Policy Institute of California. Experts expect poverty rates to increase after the end of a boost in federal cash aid, which came in 2021 in the form of an expanded child tax credit included in the American Rescue Plan Act.

Advocates are proposing that California mimic that federal expansion by opening up the state’s Young Child Tax Credit, currently a $1,000-a-year credit for low-income families with children under age 6, to include all children in low-income households. 

They estimate 1 million children live in families that would qualify, at an additional cost of $700 million a year.

Additional tax credits could make a difference to people like Ivonne Sonato-Vega, a medical assistant in Santa Rosa. 

Last year she used some of the $4,000 in federal child tax credits on school supplies and clothes for the four children she and her boyfriend are raising, she said. With prices rising this year, she was unable to save any of that subsidy. 

If the credits were an annual payment, she said, it would allow her to plan for expenses, maybe use it as “a little savings account” to draw on when the children grow out of their clothes or save it for a security deposit if the family needs to move.

“It was kind of like a tease,” she said of the credit. “It was here and then not.”

Advocates said they also want the state to create an unemployment benefits program for undocumented immigrants and to include all low-income immigrants, regardless of immigration status, in its food assistance program. 

“We know the projected budget shortfalls make it more challenging, but the past few years highlighted why something like this is so important,” said Sasha Feldstein, economic justice policy manager at the California Immigrant Policy Center. “People who are excluded from our safety net have been the most adversely impacted from the COVID-19 pandemic and are the most harmed during times of economic downturn.”

Lawmakers and Newsom this year allocated money to expand the California Food Assistance Program, a state version of food stamps, to include undocumented immigrants age 55 and older; the benefits are expected to become available late next year. Newsom vetoed a bill that would have tested an unemployment benefits program for undocumented immigrants, citing costs.

The makings of a budget problem

The projected shortfall is the state’s first major fiscal challenge since Newsom’s office predicted a $54 billion shortfall in May 2020, when the country was in the grips of the COVID-19 pandemic. After financial markets rebounded and the federal government provided unprecedented stimulus, the anticipated shortfall resulted in surpluses.

The Federal Reserve began hiking interest rates in March 2022 to cool inflation. Then housing sales, initial public stock offerings and stock markets fell. All are important sources of personal income tax revenue.

In California, personal income withholding fell even as the job market recovered.

Over the last decade, California has increasingly relied on some of the state’s highest earners to fund its budget which, among other things, takes aim at poverty and some of the nation’s starkest income inequality.

Much of the state’s general fund is paid for by its progressive personal income tax, which voters in 2012 raised on the state’s highest earners after Brown warned of cuts to health and education. In 2016 voters extended those higher income tax rates through 2030 while also allowing a temporary sales tax to expire. The increases, meant for education and healthcare spending, have also paid for increased social safety net spending.

About 49% of the personal income tax paid in California in 2020 came from just 1% of tax filers, according to the state’s finance department. And in the past decade, taxes collected from the most volatile form of income — capital gains — have doubled, making up a larger share of the state’s revenue and tying the state’s budget to particularly unstable economic cycles. 

To address that, voters approved changes to the state’s rainy day fund in 2014. The changes serve as a check on spending, directing California to capture additional dollars in reserve when capital gains tax receipts are high. 

Building reserves large enough for a state to ride through a recession is difficult, said Donald Boyd, a state finance expert at the University of Albany in New York. 

“As a practical matter, it is very hard to build a rainy day fund that’s big enough to get you through a rainy season,” Boyd said. “You need huge amounts of money to offset the effects of even a modest recession.”

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