Presented by:
Michelle McKay Underwood
Director, Legislative Services
School Services of California, Inc.
Chancellor’s Budget Workshop
State Economic and Fiscal Forecast
Overview
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This is going to be a good year for the State Budget
The economy is moving in the right direction, albeit slowly
Passage of Proposition 30 provides additional revenues, which benefit
education

Helped Governor Jerry Brown tackle the Budget problems that have
dogged the state for the past decade
The State Budget is legitimately balanced for the first time since 2002 and has
the first real reserve in years

Substantial progress is made toward reducing the state’s “wall of debt”
But not all of the state’s problems are behind us

The feds are all over the state on prison overcrowding

Interest rate increases or international events could derail the recovery
State Budget Sets Low Bar
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2012-13 revenues have come in $2.1 billion above the amount that was
forecast just two months ago

Governor Brown’s May Revision lowered the 2013-14 revenue outlook by
$1.3 billion
Strong revenue performance of the last two months more than makes
up for the downward revenue adjustment
Using the Governor’s estimates, the State Budget likely understates 2013-14
revenues

The Legislative Analyst’s Office (LAO) and other independent
economists estimate that revenues will actually come in more than
$3 billion higher

That portends greater flexibility in future funding and potential additional
one-time funds to Proposition 98
The National Economy
The U.S. economy is continuing its slow recovery:

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UCLA economists indicate the country would need 6% growth over the next
five years to catch up to a normal 3% rate of growth in our current economic
recovery
Moderate strength is attributed to:

Historically low interest rates

Housing recovery well underway – housing starts roughly double what they
were a year ago
Increased from depression-era level to recession level
– Still a ways to go – it is expected that housing will not fully recover
for two more years

Increasing auto sales, with the vehicle fleet the oldest on record

Federal stimulus and monetary policy increase spending and investment
The National Economy
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Recovery is fragile:
 While imports have increased, driven primarily by consumer spending,
exports have slowed:
Recessions in Europe and Japan
Slower growth in China
 First quarter Gross Domestic Product (GDP) growth revised downward
at second look from 2.4% to 1.8%
 Federal sequestration in both 2012-13 and particularly in 2013-14 has
reduced spending and investment
 Higher payroll and income taxes and Affordable Care Act (ACA)
implementation has left many consumers uncertain about the future
However, many states are reporting improvements in the job market
Optimism is building as personal consumption rates improve
U.S. Economic Outlook
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U.S. GDP
(Percent Change)
6.0%
4.0%
4.0%
1.4%
2.0%
4.1%
2.3% 2.2% 2.6% 2.4%
3.1%
2.5%
1.3%
2.0%
0.4%
0.1%
0.0%
1.8%
1.3%
-0.3%
-2.0%
-4.0%
-3.7%
-6.0%
-6.7%
-8.0%
-10.0%
-8.9%
Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
2008
2009
Source: U.S. Bureau of Economic Analysis, April 2013
2010
2011
2012
2013
The California Economy
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California has followed an uneven path to economic recovery
 Job growth is greater than any other state in the nation, with the
exception of Utah
Some sectors like leisure and hospitality and construction are
increasing, while state and local government are on the decline
 Median home prices in the state have increased by 32% in the last year
 Inflation-adjusted personal income is expected to increase 1.6% in 2013
and 3.6% in 2014
 By 2014, the California unemployment rate is expected to fall to 8.1%,
one percentage point higher than the 2014 projected U.S. rate – still very
high
Of concern, however, is the bifurcated path of the state economy
 The inland regions are characterized by continuing high unemployment
and ailing housing markets
 The coastal regions enjoy relatively low unemployment, improving
housing markets, and higher average incomes
California’s Unemployment Rate
Unemployment Rate
14%
12.3% 12.4% 12.1%
11.9%
11.7%
12%
11.0%
10.6%
9.8%
8.5%
7.3%
8%
6%
© 2013 School Services of California, Inc.
9.7%
10%
7
5.9%
4%
2%
0%
Jan
July
2008
Jan
July
2009
Jan
July
2010
Source: Employment Development Department, 2013
Jan
July
2011
Jan
July
2012
Jan
July
2013
California’s Unemployment Rate
vs. Other States
Highest State Unemployment Rates
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June 2013
10%
9%
Nevada
9.6%
Illinois
Mississippi Rhode North
New
9.2%
Island Carolina
Michigan Jersey Georgia
9.0%
8.9%
California
8.8%
8.7%
8.7%
8.6%
8.5%
8%
National
Average
7.6%
7%
6%
Source: Bureau of Labor Statistics, July 2013
California Personal Income Forecast
© 2013 School Services of California, Inc.
Percent Change
6.0%
5.5%
5.7% 5.8% 5.7%
5.0%
4.3%
4.1%
4.0%
2013-14 Governor's Budget
2013-14 May Revision
UCLA, March 2013
2.9%
3.0%
2.0%
UCLA, June 2013
2.1%
1.0%
DOF UCLA
2013
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DOF UCLA
2014
Slower Revenue Growth in 2013-14
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As a result of the drag that the federal tax hikes and spending cuts will have on
the economy, the Department of Finance (DOF) lowered the outlook for California
personal income growth in 2013 from 4.3% in January to 2.1% in the May Revision

We think this is overly pessimistic – more on that later
This slowdown in the economic outlook in turn lowers the revenue forecast
assumed in the 2013-14 State Budget

Total 2013-14 General Fund revenue drops $1.3 billion from the January
estimate to $97.1 billion in the May Revision
Each of the three major taxes are revised downward
A rebound, however, is forecast to begin in 2014-15, with the three major taxes
combined expected to grow 9.3% in that year and 6.7% in 2015-16
Recent studies still rank California’s business environment as nearly last in the
nation
Source: CNBC’s Annual Top States for Business Rankings, July 10, 2013
Budget Risks Are Few in 2013-14
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Compared to prior years, the proposed 2013-14 State Budget faces
considerably less risk

Unlike the 2012-13 spending plan, it is not dependent upon voter
approval of a major tax initiative
Proposition 30 provides both sales tax and income tax revenues

Unlike the 2011-12 State Budget, it is not dependent upon an unrealistic
revenue projection

The plan does not rely on an infusion of federal funds to maintain
programs

It is not reliant on unrealistic operational efficiencies in state programs
However, the recent changes in the business climate mentioned earlier could
affect state revenues (such as the reductions in export revenues) tempering
the state recovery
General Fund Revenues in 2013-14
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General Fund Revenues
(In Billions)
$100
$95
$98.2
$98.2
$97.1
$95.4
$90
$85
2012-13
2013-14
January Budget
Source: 2013-14 State Budget Summary, page 6
Final Budget
General Fund Budget Summary
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2013-14 General Fund Budget Summary
(In Millions)
2012-13
Prior-Year Balance
-$1,658
Revenues and Transfers
$98,195
Total Resource
$96,537
Total Expenditures
$95,665
Fund Balance
$872
Budget Reserve:
Reserve for Encumbrance
$618
Reserve for Economic
Uncertainties
$254
Budget Stabilization Account
Total Available Reserve
Source: 2013-14 State Budget, page 6
2013-14
$872
$97,098
$97,970
$96,281
$1,689
$618
$1,071
$0
$0
$254
$1,071
Revenues and transfers
drop $1.1 billion in
2013-14, or -1.1%
Expenditures increase
$616 million, or 0.6%
The reserve is 1.1% of
revenues and transfers
The Administration’s Revenue Forecast
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Recall that the Governor’s May Revision lowered the revenue outlook for
2013-14 by $1.3 billion from the January Budget Proposal forecast because of
the expected drag that federal budget policy would have on the economy

Sequestration cuts would reduce federal spending

Higher tax rates for high-income earners and the expiration of the
federal payroll tax holiday would depress consumer spending
The LAO offered a contrary view – the overall economy was gaining strength
compared to the January forecast

Revenues were forecast to exceed the May Revision by $3.2 billion
The Legislature initially adopted the LAO forecast, but the Governor ultimately
prevailed, with the 2013-14 State Budget Act based on the lower revenue
estimate
DOF Forecast Through 2016-17
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$120.0
(General Fund Revenues – DOF Forecast in Billions)
$116.1
$110.0
$110.2
$104.5
$100.0
$98.2
$97.2
2012-13
2013-14
$90.0
Source: Governor’s 2013-14 May Revision
2014-15
2015-16
2016-17
Is the Forecast Reasonable?
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In order to assess the risks of the DOF’s revenue forecast, not just for 2013-14
but through 2016-17, School Services of California, Inc., (SSC) commissioned
Capitol Matrix Consulting (CMC) to perform an independent analysis of the
DOF forecast
 Brad Williams, a partner with CMC, served as the LAO’s senior
economist for 12 years and was recognized by the Wall Street Journal as
the most accurate California forecaster of the 1990s
The SSC/CMC analysis finds that the DOF forecast is reasonable, with greater
upside potential than downside risks
 We assume that:
The U.S. expansion will continue at a moderate pace for several years
California personal income will rise from 3.4% in 2013-14 to an annual
average pace of 5.5% through 2016-17
Payroll jobs will grow at an annual average rate of about 2.2%
DOF vs. SSC/CMC Forecast
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$119.7
$120.0
(General Fund Revenues in Billions)
$112.7
$110.0
$100.0
$107.4
$99.5
$100.1
$98.2
$97.2
2012-13
2013-14
SSC/CMC Forecast
DOF Forecast
$116.1
$110.2
$104.5
$90.0
2014-15
2015-16
Source: General Fund Revenues and Proposition 98 Forecast, CMC, July 2013
2016-17
Measuring Risk of the Forecast
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All forecasts are ultimately proven wrong

Actual revenues are either above or below the forecast level, but almost
never exactly as projected
The more important question: What are the risks to the forecast and how can
these risks be measured?
The forecast risks include:

The economic impact of the federal ACA and how it will affect
employment

The Federal Reserve’s plan to retreat from “quantitative easing” and the
effect of higher interest rates on the stock market, housing sales, and
business investment

The weakness of the European and Asian economies and their impact on
U.S. and California exports
Confidence Intervals and Forecasting
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One method of quantifying forecast risk is to establish a confidence interval
around the forecast

The SSC/CMC analysis examined historical General Fund revenue
growth rates over a 30-year period, establishing standard deviations
around the growth rates for one-year through five-year sub-periods
Flashback to Statistics 101: A standard deviation (SD) measures the
average variation from the mean growth rate
– For normally distributed variables, about two-thirds of the
observations fall within one SD of the mean

Using +/- 1 SD from the forecast, there is a one-sixth chance that
revenues will fall below the confidence interval and a one-sixth chance
that revenues will exceed the confidence interval
Confidence Intervals and the Forecasts
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$140.0
(General Fund Revenues in Billions)
$130.0
$132.9
+ 1 SD
$121.7
SSC/CMC Forecast
$120.0
$113.7
$110.0
DOF Forecast
$104.6
- 1 SD
$106.5
$100.5
$100.0
$98.5
$101.0
$103.4
$95.6
$90.0
2012-13
2013-14
2014-15
2015-16
Source: General Fund Revenues and Proposition 98 Forecast, CMC, July 2013
2016-17
Conclusions About the DOF Forecast
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Based on the independent analysis conducted by CMC, the DOF forecast is
reasonable and falls within the +/- 1 SD confidence interval

There is more upside potential that actual revenues exceed the
Administration’s forecast than downside risks that revenues will fall
short

The Administration’s General Fund revenue forecast, therefore, provides
a reasonable basis to project Proposition 98 revenues
Proposition 98 Funding Guarantee
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Proposition 98 sets the minimum funding level for K-14 education, based on
the prior-year funding level and changes in workload (as measured by K-12
average daily attendance [ADA]) and inflation (as measured by the lesser of
per-capita personal income or per-capita General Fund revenues)

Adopted by state voters in 1988, this is a constitutional guarantee

The measure specifies only the minimum funding level, it does not
determine what programs will be funded
For 2013-14, the state fully funds Proposition 98 at $55.3 billion, a decline of
$941 million from 2012-13

There are no manipulations or reinterpretations of the constitutional
guarantee as there have been in prior years

The 2013-14 guarantee declines about 2% because of the lower General
Fund revenue forecast in the May Revision
Proposition 98 Forecast
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$70.0
(Proposition 98 in Billions)
$65.0
$66.5
$63.9
$60.5
$60.0
$56.5
$55.0
$55.3
$50.0
2012-13
2013-14
Actual
Budget
2014-15
2015-16
Forecast
2016-17
Who Will Benefit from Stronger Revenues?
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No other area of the 2013-14 State Budget gets increased as significantly as
education:
 Up to $120 million in additional funds to counties to accommodate new
workload associated with implementing the ACA
 $206 million for mental health
 An increase of $143 million for California Work Opportunity and
Responsibility to Kids (CalWORKs) employment services
 $34 million to begin providing preventative adult dental benefits in
May 2014
 $60 million augmentation to support trial courts to increase public
access
Demand for new revenues from other areas of the State Budget will be strong
going forward
Source: 2013-14 State Budget, DOF
Thank you
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