California LAO forecasts $7 billion surplus for fiscal year

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The California Legislative Analyst estimates the state will have a $7 billion surplus in the upcoming fiscal year if it maintains spending at current levels, but cautioned the Legislature against thinking it has that much to spend.

The LAO, which provides financial and budgetary guidance for the Legislature, released the report Nov. 20 that outlines the state’s economic condition annually before the governor’s January budget release.

“The report paints a fairly positive view of the state,” Gabriel Petek, the state’s legislative analyst, said during a media briefing. “We are estimating at the end of the 2020-21 budget year, the state will have $7 billion in discretionary reserves, but that assumes the current laws and policies remain in place.”

The unrestricted surplus dollars expected by July 2021 are considered to be one-time in nature, and the LAO report urges lawmakers to be cautious in how much they increase long-term government spending commitments when crafting a new budget next year. The report only estimated $1 billion in ongoing spending capacity in the state's overall general fund budget.

If there were any new laws or commitments, the legislative analyst’s office would have to review the surplus number, Petek said.


The $7 billion surplus comes on top of an expected $18.3 billion in "rainy day" reserves that must be set aside for an economic downturn and $900 million earmarked for social services meaning the state would bring $26 billion in total reserves by next summer. The LAO report also anticipates the first signs of a recession in early 2021.

Though Petek described the forecast as fairly positive, the report said an average recession would mean multi-billion cuts to education in one year that would reduce funding of schools to a minimum level. The LAO also cautioned the state may not have the capacity to withstand the kind of crisis the country experienced in 2008 or during the dot-com recession of 2001.

Petek said he wanted to be “guarded” in his response to the question of what kind of recession the state could withstand, because he wanted to give the state credit for building up reserves and paying down debt.

“I want to commend the Legislature, the last governor and current governor for the commitment to building reserves to the highest level historically,” Petek said. “The budget picture is strong, and it’s favorable, full stop. But that doesn’t mean there aren’t caveats.”

The state treasurer’s office through successive treasurer’s starting with Bill Lockyer and John Chiang during Governor Jerry Brown’s eight years in office, and now Treasurer Fiona Ma during the Gov. Gavin Newsom Administration, has steadily refinanced the state’s debt during the era of low interest rates.

Projections on growth in general fund costs for bond debt service has slowed substantially compared to even recent year projections, according to the report.

“One key reason is that we now are assuming a lower interest rate than we have in the last few years on recently issued debt,” the report said. “Facing a consistently low interest rate environmental for many years, the state treasurer has been able to refinance much of the state’s bond debt. Consequently, much of the state’s outstanding debt now carries a lower interest rate resulting in lower annual costs.”

The LAO’s report attempts to give the Legislature “the lay of the land based on what they have already committed to; and where they go from here is up to them,” Petek said.

He cautioned that they don’t view the $26 billion in reserves as a natural culmination of economic expansion. It came as a result of several factors including an economic expansion of historic duration and the strength of the stock market over the past decade. But it also resulted from the passage of Proposition 2 that expanded budget reserve requirements and Proposition 30 that created a temporary sales tax and a tax on high-income taxpayers.

One caution around the outlook, Petek said, is he doesn’t think all those variables will work in the state’s favor going forward.

Another caveat is that $1.5 billion of the initial $7 billion projected surplus depends on whether the federal government allows California to tax organizations that manage the state’s Medicaid plans.

California taxes managed care organizations and uses the proceeds to leverage federal funds to support Medi-Cal, the state’s Medicaid program.

The state needs approval from the federal government to allow the so-called MCO tax, but new rules recently proposed at the federal level would prevent the practice. It’s uncertain when the new federal rules would take effect.

Though the consensus among economists is that the U.S. economy will continue to grow in coming years, the LAO warned that the risks of a slowdown are higher than normal.

Key economic indicators for the state — housing markets, trade activity, new car sales and business start-up funding — are all demonstrating weakness, according to the report.

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