SAN FRANCISCO - When your message is, "Raise money for California by increasing lottery revenue," it doesn't help when the state lottery reports it is making less money.
That's exactly what happened last week, as critics lined up to take potshots at Gov. Arnold Schwarzenegger's proposal to plug the state's budget gap by issuing bonds against future lottery revenue.
It is also a telling sign of the state's weak revenue position - and its perpetual legislative quagmire - that the California Legislative Analyst's Office, one of the most influential critics of Schwarzenegger's lottery bond proposal, felt compelled to offer its own lottery bond alternative.
"It indicates that we're getting down to the bottom of the toolkit we have to balance the budget without broad-based tax increases or much deeper service reductions to core programs," said LAO analyst Jason Dickerson, whose portfolio includes the state lottery.
Faced with dwindling revenue projections for fiscal 2009, the governor, as part of his May Revise budget, proposed raising $15 billion over three years through a lottery securitization. That would require the issuance of up to $22.3 billion of bonds, according to a report prepared for the administration by Lamont Financial Services.
Voters would have to approve the plan in November.
The LAO, in its analysis of the governor's budget, described the proposal as a risky one that could threaten the revenue the lottery currently generates for K-12 education. As an alternative, the LAO suggested a more modest plan to use lottery bonds to generate $5.6 billion over two years.
"The lottery as a form of borrowing was a toughest decision in this, and really shows how deep a problem we have," Dickerson said.
Legislative leaders from both parties in both chambers also criticized the plan for different reasons. Democrats didn't like the perceived threat to education funding, while Republicans are unhappy with the administration's backup plan to impose a temporary sales tax increase if the lottery referendum fails at the polls or is stalled in court. The LAO alternative would also include a backup sales tax for a shorter time.
The Schwarzenegger administration's plan is based on the idea that the state can raise its per-capita lottery sales - $91 per person in 2007 - to the national average of $189.
"We're looking into the future and we're pretty optimistic," said Tom Dunphy, executive director at Lamont Financial.
Oregon, West Virginia, and Florida have long track records of issuing bonds backed by their lottery revenue.
Unlike those three states, which have issued lottery revenue bonds, California is proposing a different structure. As was the case with revenue from the Master Settlement Agreement with tobacco companies, the Schwarzenegger administration would like to securitize the lottery by creating a special-purpose entity, akin to the Golden State Tobacco Securitization Corp., to issue the debt.
"It's a dedication of a percentage of the cash flow," Dunphy said. "Securitization - and this may be perception as much as anything else - would be received very well by investors."
In order to make investors comfortable from a credit standpoint, education, to which lottery surpluses are currently dedicated, would have to be subordinate to debt service.
The Schwarzenegger team is confident that it can raise lottery sales enough to protect lottery education funding at today's levels, around $1.2 billion a year.
Actually, make that $1.1 billion, because the California Lottery announced Tuesday that its sales have fallen behind budget for the current year, which will result in the lottery's contribution to education falling $94 million short of the $1.2 billion it had budgeted. It will also be down compared to the previous year.
The administration believes it can turn the lottery around with a series of reforms in the way it does business. The lottery was created in 1984 through a ballot measure campaign financed largely by lottery equipment vendors, and the measure locked in many policies and procedures.
Dickerson said the LAO also believes that the lottery can grow by implementing changes, such as making the games more enticing by devoting a larger share of revenue to prizes. But the LAO doesn't think it's reasonable to expect sales to double in five to 10 years, as the administration does.
"What the administration wants to do is place a very large bet on their forecasts," Dickerson said. "We don't think it's a good bet."
Instead, the LAO used what it believes is a more reasonable forecast, in which the lottery raises its 10-year average growth rate of 4.2% to 6%.