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Gov. Brown Zeroes in on Budget

SAN FRANCISCO — California Gov. Jerry Brown placed the budget at the top of an ambitious agenda for the new legislative year during his state of the state address. He told lawmakers Wednesday that his proposed cuts and a ballot initiative to temporarily raise taxes are both needed to help close a $9 billion hole, even as the state economy seems to be recovering.

“It is said the road to hell is paved with good intentions,” Brown said. “In this time of uncertainty, prudence and paying down debt is the best policy.”

Aside from the budget, the governor also laid out an aggressive plan that includes funding the first leg of the state’s high-speed rail project, increasing renewable energy projects, improving education, fighting pollution, agreeing on a plan to fix the state’s Delta water system, making prison alignment work, and reforming pensions.

The governor “is trying to nudge the Legislature along,” said Larry Gerston, a political science professor at San Jose State University. “Until the state develops more resources, even beyond the governor’s temporary tax increase, it is hard to imagine that the various goals he set out today could all be accomplished.”

In October, Brown unveiled a pension reform plan that would affect both current and new workers in state and local government in an effort to control rising costs.

The 12-pronged plan includes equal pension contributions for all employees and employers. Outside of public safety, it raises the retirement age for new hires to 67 and creates a “hybrid” defined-benefit plan for new employees.

The main focus of the governor’s speech set the stage for a legislative and November ballot battle to get his budget vision passed before the end of the fiscal year on June 30.

The governor earlier this month announced a $92.6 billion fiscal 2013 spending plan to close an estimated $9.2 billion gap.

Brown’s plan leans heavily on passing a tax initiative to raise $4.4 billion for the budget by temporarily raising income taxes on those making more than $250,000 a year and by increasing the state sales tax by 0.5% to 7.25%.

The budget includes additional cuts that would be triggered if the ballot initiative doesn’t pass.

Brown’s spending plan would carve $4.2 billion mostly out of social services, and if the tax measure fails, another $5 billion in cuts would hit schools, universities and community colleges.

But the governor’s proposed budget only sets the table for the Legislature, which must ultimately send its own version to Brown’s desk.

One of the first questions raised about Brown’s proposal is the difference between its revenue estimates and those of the nonpartisan Legislative Analyst’s Office.

Last week, the LAO said in a report that the governor’s budget revenue estimates are a bigger “question mark” than usual in his proposed fiscal 2013 budget.

The LAO forecasts a budget deficit of $12.8 billion, $3.6 billion higher than the governor. Brown’s shortfall includes $4 billion left over from the fiscal 2012 budget, as well as a $5 billion deficit for fiscal 2013.

“Those numbers just don’t add up,” Gerston said of the difference between the governor’s budget deficit estimates and the LAO’s.

The analyst’s office said the Democratic governor’s budget includes a rosier revenue forecast, lower education-spending estimates, and higher spending in other areas.

To make matters murkier, Controller John Chiang said last week that December revenues came in $165 million below the projections in Brown’s proposed fiscal 2013 budget.

Rating analysts are still weighing the governor’s spending plan.

Gabriel Petek, Standard & Poor’s lead California analyst, said his agency is still evaluating the budget as well as the LAO analysis.

“At this point, in terms of the state’s credit, we are following the performance of its tax receipts and disbursements more than any specific legislation,” Petek said.

Standard & Poor’s and Fitch Ratings both assign California an A-minus. Moody’s Investors Service gives it an A1, two notches higher.

In a report released Thursday, Fitch analysts said the state’s current budget has eased the way for this year’s spending plan, but it said it still will likely be a challenge to pass one that is structurally sound.

“Despite the state’s more favorable fiscal position, Fitch believes that reaching agreement on the fiscal 2012-13 budget in the coming months and achieving savings will continue to be a challenge for the state,” Fitch said. “The extent and depth of budget cuts made since the fiscal crisis began in fiscal 2008 leaves a smaller spending base from which to cut.”

Compared to a year ago, California’s general obligation bond yields are dramatically lower. On Jan. 18, 10-year California paper was yielding 2.41%, according to the Municipal Market Data curve, which is a bit more than half the 4.76% a year earlier.

This week Municipal Market Advisors said in a report that it sees California’s credit profile as improving because of a demonstrated willingness to make structural budget changes.

“The governor really seems committed to making structural improvement in the budget,” said Matt Fabian, MMA’s managing director. “It is something we’ve generally appeared to lack over the last few administrations.”

The main weakness in previous budgets had been too many one-time fixes, according to Fabian.

He said putting the tax initiative on the ballot also appears to be a positive, even if it doesn’t pass, because it gives the voters the choice of policy.

“The principal risk to a state of California bondholder is some kind of voter proposition or political volatility that trumps the status quo,” Fabian said. “If you are getting popular support for something, there is less chance of an uprising to overturn it.”

Gerston said the governor’s tax initiative has a good chance of passing, if other competing initiatives move aside.

Brown got a boost this week when a group of billionaires and political insiders, the Think Long Committee, dropped their bid to put two tax reform initiatives on the November ballot.

However, the governor will still have to compete with an initiative with support from Molly Munger, a wealthy civil rights advocate, whose group has filed a proposed ballot initiative to raise income taxes to help fund public schools and preschools.

The ins and outs of the state budget are likely to have little impact on California’s bonds in the near term as the municipal market remains tight across the board. The market has continued to set record low yields this week across bond maturities.

California also appears likely to issue fewer bonds than it has typically in past years, reducing the supply component of the supply-demand equation.

Brown’s budget proposes about $5 billion of general obligation bond sales this year, an increase of 18% from last year, when the state government borrowed relatively little.

The budget outlines a spring sale of $2.3 billion and a fall sale of $2.9 billion. The state is expected to also hold its annual revenue anticipation note offering, which was $5.4 billion last year.

Over the last 10 years, California issued $87 billion of GO debt, averaging $8.7 billion a year and around 10% of market volume, according to Thomson Reuters data.

The scheduled dissolution of redevelopment agencies is likely to be another source of debate in this year’s Legislature.

Brown made no mention of redevelopment agencies in his speech. Some lawmakers have been pushing to delay the RDAs’ dissolution date, but later in Los Angeles the governor told reporters: “I don’t think we can delay this funeral.”



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