LOS ANGELES — California's independent budget analyst added more happy numbers to the state government's financial picture this week, along with a note of caution.

The Legislative Analyst's Office, in its annual Fiscal Outlook report Wednesday, cautioned legislators against increasing spending on programs that could be hard to maintain if a downturn occurs despite the state's current rosy economic outlook.

"The strong economy is good news for California, but the recession scenario outlined by the Legislative Analyst is a sobering reminder that we must continue to pursue fiscal discipline, pay down liabilities, and build up our Rainy Day Fund during these fleeting good times," the state's finance director, Michael Cohen, said in a statement.

State revenues are currently $1.1 billion ahead of projections for the first four months of fiscal year 2016. The LAO's report predicts that general fund revenues will exceed June 2015 budget assumptions by $3.6 billion when the fiscal year ends July 2016. If no new budget commitments are made, the report says, the state could enter fiscal 2017 with reserves of $11.5 billion.

The LAO's report presented alternative scenarios. The optimistic main scenario has economic growth continuing through fiscal 2019-20, but a more sobering economic downturn, based on a slightly less severe downturn than the 2000 dot.com bust, would have the state returning to deficit spending.

The good news in a downturn scenario, according to Jason Sisney, the chief deputy legislative analyst, is that steps taken to bolster reserves since the 2009 financial crisis mean those deficits would be substantially less than they have been in previous years.

While the state has the capacity in the 2016-17 time frame to increase spending or reduce taxes, Sisney said, state leaders could then face difficult choices such as spending cuts and tax increases if the economy slows.

The current economic expansion at 77 months is already the longest in U.S. history post World War II exceeding the previous 58 month high, according to the LAO's report.

"The first page of the LAO report notes that a sizeable reserve would be the key to making it through the next downturn with a minimal disruption in programs," said H.D. Palmer, spokesman for Gov. Jerry Brown's Department of Finance. "We are mindful of the deep cuts the state had to endure during the last recession."

Standard & Poor's, which rates California AA-minus, highlighted the LAO report in a comment piece Thursday.

The fact that the state is in this position is favorable. Lawmakers have managed the state's finances well over the past several years," the piece said. "But it's clear that the sense of urgency in Sacramento is shifting away from ensuring the state's fiscal solvency toward addressing some of California's pressing needs in other policy areas."

The state had to make $9 billion in cuts to programs from 2008 to 2011, adversely affecting public schools and community colleges, Palmer said.

Retirement costs also remain a big variable for the state.

The LAO's report also warned that if the state's two key pension boards – the California Public Employees' Retirement System and the California State Teachers' Retirement System – lower their assumptions about future investment returns, state contributions to the pension funds could be billions of dollars higher than estimated by 2019-20.

Brown wants CalPERS to quickly reduce its current 7.5% long-term annual earnings assumption, or discount rate, to 6.5%, but the CalPERS board pushed back this week, agreeing to change the assumed investment returns but phasing in the change slowly, over years.

The governor's desire to change the assumptions more quickly would have cost the state more in the near term, but potentially less than the plan CalPERS adopted in the long term, Sisney said.

"I am deeply disappointed that the CalPERS Board reversed course and adopted an irresponsible plan that will only keep the system dependent on unrealistic investment returns," Brown said in a statement. "This approach will expose the fund to an unacceptable level of risk in the coming years."

CalPERS Board President Rob Feckner said in a statement the policy ensures the long-term sustainability of the fund and "makes significant strides in lowering risk and volatility in the system, and helps lessen the impacts of another financial downturn."

Under the policy, the discount rate will be reduced a minimum of 0.05% to a maximum of 0.25% in years when investments returns outperform the current discount rate, by at least four percentage points. The four percentage point threshold would help offset increases to employer contribution rates when the discount rate is lowered, and help pay down CalPERS' unfunded liability, according to CalPERS.

By rejecting the faster shift to a 6.5% discount rate, CalPERS mitigates some of the near-term budget risk for retirement funding discussed in the Fiscal Outlook, the LAO's office said in an addendum issued after CalPERS board made its announcement.

The plan adopted by the CalPERS board would not "necessarily increase costs above our assumptions between now and 2019-20, because it changes the system's discount rates so gradually," according to the addendum.

The issues related to potential near-term cost pressures for the CalSTRS and retiree health prefunding remain, as they are not directly affected by this CalPERS action, Sisney said.

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