Coronavirus drives California's budget into massive deficit

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California is going into next week’s May budget revision with a much less optimistic outlook than earlier in the year.

The state government, which was looking at multibillion-dollar surpluses before the coronavirus struck, is now facing a $54.3 billion deficit, the state Department of Finance announced Thursday.

California Gov. Gavin Newsom says the state can't balance the budget without both substantial cuts and federal help.

"We can’t balance the budget without substantial cuts and without federal help," California Gov. Gavin Newsom said this week during a press conference.

The surplus and rainy-day reserves that California built up in recent years will help, but won’t eliminate the problem.

Newsom and the Legislature will likely have to abandon liberal policy goals to pass what the DOF has called a “workload budget” in June, but further cuts could be needed as the state grapples with the costs of the outbreak. The legislative leaders have told all lawmakers they need to restrict themselves to two or three bills this year, not the 20 or 30 they usually introduce. Essentially the only policy goal now is dealing with COVID-19.

The so-called "May Revise" budget the Newsom administration will submit to the Legislature by the May 14 statutory deadline will reflect the extraordinary impacts of the COVID-19 pandemic on the state’s fiscal condition, Keely Bosler, director of the state's Department of Finance, wrote in an April 30 letter to the Legislature.

“The Administration will continue to work with the Legislature during this unprecedented crisis to maintain a balanced budget that promotes opportunity, and supports an equitable economic recovery,” Bosler wrote.

"Job losses and business closures will sharply reduce state revenues," the Department of Finance wrote in its Thursday update. For fiscal 2021, which begins July 1, personal income tax revenues are expected to drop more than 25%, sales and use tax more than 27%, and corporation tax more than 22%. Those are the three primary revenue sources for the state General Fund.

The California Department of Finance told the Legislature in mid-April that it would require an additional $6 billion for COVID-19 response beyond the $1 billion it asked for in March.

Revenue losses and higher spending on health and human services and pandemic response mean the state faces a $13.4 billion deficit in the current fiscal year and $40.9 billion in the next, totaling $54.3 billion, according to the Department of Finance.

The pandemic response, including stay-at-home orders, threw millions of Californians out of work, stressing the state's unemployment insurance system. In April it was the first of what will be many states to borrow money from the federal government to pay claims.

“We have had our bond rating increased, not once, but twice in the past few years and had the lowest unemployment in the state’s history going into this,” Newsom said Monday in a press conference. “The last time we borrowed money for unemployment was during the Great Recession and we were able to pay it back. We would once again work to pay it back.”

“We are good for our word,” Newsom said. “The state balances its budget.”

The governor said he has been "working with U.S. Rep. Nancy Pelosi, the Speaker of the House, who is working on legislation that could bring $1 trillion in aid to states and local governments that would not just help California, but red and blue states, also cities and counties,” Newsom said.

The State Assembly, which had recessed in March amid the stay-at-home orders, resumed work Monday. The Senate is expected to return to work next week.

So far, the costs of battling COVID-19 have not affected the state’s ratings, its rating outlooks or ability to access the bond markets. The state holds ratings of AA from Fitch Ratings, Aa2 from Moody's Investors Service and AA-minus from S&P Global Ratings. All have stable outlooks.

The treasurer’s office declined to comment specifically on the fact the state has maintained its ratings and stable outlook while other states have had their outlooks revised to negative.

Deputy Treasurer Tim Schaefer responded by saying: “We are days away from May Revise, the maximum risk period for 'speaking to the market.'"

Fitch analyst Karen Krop, the rating agency’s lead analyst for California, wrote Monday in a report that the rating agency believes the state can withstand the projected decline in income tax collections.

Fitch “believes that the state of California has sufficient liquidity to absorb the significant drop in personal income tax collections being reported by the state Controller for the month of April, an impact of deferring the income tax filing date from April to July,” Krop wrote.

It is unlikely California will need to issue tax and revenue anticipation notes, or other forms of external liquidity to cover this period between April and the revised tax deadline of July, Krop said in an emailed response.

"I also think they are in a position, given the actions taken since the Great Recession, to not need to borrow to fund operations," she said. "But that is a little broad in that internal borrowing is certainly an available tool for managing both cash flow and the budget."

The governor’s original budget proposal for fiscal 2021, released in January, assumed the state would collect $18.4 billion in April, or about 18% of annual collections, including both regular withholding and final 2019 tax payments.

According to State Controller Betty Yee's daily informal tally of PIT collections, as of April 29, the state has collected $5.1 billion, $13.3 billion below target.

“PIT collections are down $8.6 billion year-to-date as compared to last year, having started the month $5.8 billion ahead of last year's collections,” Krop wrote. “Some portion of this shortfall will be made up by July 15, the new deadline for PIT payments, but a portion will be lost entirely given the significant economic dislocation driven by the coronavirus pandemic.”

Fitch "believes the state has sufficient internal liquidity to absorb the expected delay and drop in collections between now and the new income tax filing date of July 15, including from borrowable resources, which were $42.8 billion as of the end of February and are expected to be reduced to approximately $8.7 billion by the end of the fiscal year,” Krop wrote. “With enhanced cash tools developed both during and after the Great Recession, a strong cash position entering this crisis and the receipt of federal aid, the state does not expect it will need to access external liquidity.”

April revenue data for states across the country is likely to reflect the effect of widespread stay-at-home orders, Krop wrote, adding that Fitch is monitoring revenue collection data as it is made available.

The state sold $1.4 billion in general obligation bonds April 6 achieving $275 million in present value savings on refunding, according to California Treasurer Fiona Ma. The deal included $617.7 million for capital projects and $821.4 million in refundings of existing debt.

“We were anxious about heading into this dreary market,” Ma said April 16 in a statement. “We ended up getting sunshine with a pot of gold at the end. I think this is a good sign for the market.”

Demand resulted in the state selling $446 million more of refunding bonds than had been anticipated, according to the treasurer’s office.

The DOF modeled a moderate recession scenario in January in which unemployment was projected to peak at 9.1% in the second quarter of 2021, compared to 6.9% and 12.3% for the 2001 and 2009 recessions.

Due to the scope of the COVID-19 pandemic, unemployment could peak at a level higher than the Great Recession, according to the DOF.

Newsom has faced criticism from some state lawmakers that he is making unilateral spending decisions like the $1 billion BYD mask contract that some lawmakers have claimed is circumventing the legislative process.

H.D. Palmer, a spokesman for the DOF, has said the Newsom administration has been making sure to keep lawmakers in the loop on any decisions.

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