“California for All”—Newsom Budget Includes Bold Spending, Fiscal Guardrails

California Government Update

Five months into his first term as California governor, and a week ahead of schedule, Governor Gavin Newsom rolled out his “May Revise” budget. The May Revise reflects state revenue projections based on tax receipts and spending adjustments from the governor’s January budget proposal, taking into account projected revenues. While the May Revise proposes an expansion of funding in many areas, including education, healthcare and public safety, Governor Newsom strikes a cautionary tone and a mindful approach to the likelihood of a potential recession.

California has benefitted from the unrivaled economic growth of the past decade, driven by the technology industry, recent IPOs and growth in the value of public equities, all of which have pushed the state’s revenues to record levels. With midcourse corrections, the new budget now projects nearly $146 billion in General Fund revenues, and proposes $147 billion in General Fund spending in the new fiscal year that begins July 1. That would result in a 2.6% increase over the $143.2 billion authorized last June for current-year spending. The updated spending plan totals $213.5 billion, up from the Governor’s initial budget proposal unveiled in January that totaled $209 billion, an increase of $4.5 billion.

Newsom spending priorities: Build reserves and pay down state debt with one-time payments

Still wary of an economic downturn after almost a decade of good news for state finances, the Newsom budget projects a cumulative surplus of revenues over spending, now estimated at a record $21.5 billion. Eighty-nine percent of all new spending will go for big one-time investments to promote “budget resiliency” to weather a recession, including paying down significant state pension debt and state retiree healthcare obligations, and adding more to the state’s record-high Rainy Day Reserve. Only 11% of all new spending—about $500 million—would go toward ongoing spending.

While not predicting a recession, the Governor highlighted concerns over stock market volatility, reduction in global economic growth, national economic policies, federal gridlock and the cyclical nature of economics.

Governor Newson focused on the priority of a structurally sound budget and indicated that California is heading into economic headwinds and that one-time revenues should match one-time expenditures. The May Revise estimates a potential impact of $70 billion over a three-year period in General Fund revenues when a recession occurs, with a structural impact of $40 billion over those three years (i.e., revenue compounded losses of $70 billion impacting $40 billion in programs during that period).

The Department of Finance is projecting long-term, year-over-year growth through 2022–23 of 2.8% in personal income tax, 3.4% in sales and use tax, and 3.7% in corporation tax, for a modest increase of 3% overall.

New help for parents and children, expanded healthcare, homelessness, new housing construction, taxes, emergency readiness

The Newsom budget also uses one-time spending and program savings for new signature investments in early childhood development, healthcare, affordable housing, combating homelessness and state emergency preparedness, while providing more funding for K–12 and higher education and also implementing targeted tax relief, including new tax credits for lower-income Californians and sales tax exemptions for menstrual products and diapers.

Most of the projected new revenues come from personal income taxes (up 4% over last year) and sales taxes (up 3.3%). Corporation tax revenues remain flat, and continue their downward trend as a share of overall state revenues, but the long-term revenue projections looking out over the next three years are viewed as realistic by most economists, barring a significant recession.

In spite of record state revenues, Newsom is proposing the use of some state tax conformity with federal tax changes, in order to pay for some new ongoing programs. In some cases, this could mean increased state taxes for individuals and businesses, and the California Legislature may not readily agree with the Governor on this subject despite the Democratic supermajority.

The budget also proposes a $3 billion new contribution to the state’s Rainy Day Fund, which would increase from the current $13.5 billion to $16.5 billion—an all-time high.

HIGHLIGHTS OF THE REVISED SPENDING PROPOSAL

TAXES

Governor Newsom proposed a series of tax exemptions and credits targeted at helping working families, including those listed below.

California EITC

  • In his January budget, the Governor proposed conformity to several federal tax law changes in order to pay for an expanded earned income tax credit (EITC) to roughly 3 million low-income households in California.
  • In 2017, the federal government passed the Tax Cuts and Jobs Act, which included major changes to corporate and individual taxes. The Governor proposed conformity with those changes that mainly impact business incomes.
  • These proposals are expected to generate approximately $1.7 billion in 2019–20 and $1.4 billion annually on an ongoing basis. Revenue estimates are subject to a high level of uncertainty due to the difficulty in anticipating taxpayer behavior in response to changes.
  • The May Revise includes $18.7 million in 2019–20 for the Franchise Tax Board to develop and administer a program that will give California EITC recipients the option to receive a portion of their EITC as monthly advance payments rather than as a lump sum at the end of the year when they file their taxes.
  • The May Revise eliminates the sales tax on the purchase of diapers and menstrual products.
  • Eight weeks of paid family leave are now permitted in order to care for a new baby or sick family member (an increase from current law, which allows for six weeks). The existing program provides workers with 60% to 70% of their salary during that time and is paid for by a payroll tax on workers in the state. This is a decrease from the January proposal of six months of paid family leave. The Governor has proposed a task force to implement a plan for Californians to have six full months of paid leave by 2021–22.

HEALTHCARE

Governor Newsom made a clear statement in his inaugural budget on the priority of healthcare for his administration, through proposed budget investments in this space and early executive action aimed at reducing prescription drug pricing.

His adjusted budget now includes $162.3 billion ($41.4 billion General Fund and $120.9 billion in other funds) for all health and human services programs.

Highlights of the various healthcare proposals include the following.

Medi-Cal

  • The Medi-Cal budget is $93.5 billion ($19.7 billion General Fund) in 2018–19 and $102.2 billion ($23.0 billion General Fund) in 2019–20.
  • The May Revise assumes that caseload will decrease by approximately 2.4% from 2017–18 to 2018–19 and increase by 0.02% from 2018–19 to 2019–20.
  • Medi-Cal is projected to cover approximately 13 million Californians in 2019–20, including 3.8 million in the optional expansion population. In 2019–20, the May Revise reflects an 8.5% state share of cost for the optional expansion population. The May revision includes $19.6 billion ($2.1 billion General Fund) in 2019–20 for this population.
  • The May Revise projects General Fund expenditures of $23 billion in 2019–20, a year-over-year increase of $3.3 billion compared with 2018–19. Approximately one-third of the increase is attributable to the expiration of the managed care organization tax. Another one-third is due to a higher average cost per eligible and and other factors. The remaining increase results from a shift in the timing of payments from current year to budget year and other factors.

Full-Scope Medi-Cal Expansion for Undocumented Young Adults

  • The May Revise includes $98 million ($74.3 million General Fund) to expand full-scope Medi-Cal coverage to eligible young adults aged 19 through 25 regardless of immigration status, starting no sooner than January 1, 2020, at a net state cost of $133.5 million in 2019–20. The proposed implementation date is six months later than originally assumed in the Governor’s January budget. This expansion will provide full-scope coverage to approximately 90,000 undocumented young adults in the first year. Nearly 75% of these individuals are currently in the Medi-Cal system.

Pharmacy Transition to Fee-for-Service

  • The transition of pharmacy services from Medi-Cal managed care to a fee-for-service benefit will help the state secure better prices by allowing California to negotiate with pharmaceutical manufacturers on behalf of a much larger population of Medi-Cal beneficiaries. Savings from the transition are estimated to reach $393 million for the General Fund by 2022–23. While the transition is scheduled for January 1, 2021, savings will not be realized immediately due to the timing of drug rebates and the managed care rate-setting process.

Whole Person Care Pilots

  • The May Revise includes a one-time $20 million Mental Health Services Fund over five years for counties that currently do not operate Whole Person Care Pilots. This is in addition to the $100 million one-time General Fund proposed in the Governor’s January budget for counties that currently operate pilots. With this funding, additional counties will be able to develop and implement essential programs focused on coordinating health, behavioral health (for individuals with a mental health and/or substance use disorder), and critical social services, such as housing. Priority will be given to individuals with mental illness who are also homeless or at risk of becoming homeless.

Proposition 56: Tobacco Tax–Funded Payments to Providers

  • In January, the Proposition 56 package totaled approximately $1 billion for 2019–20 for supplemental rate increases for physicians, dentists and various other Medi-Cal providers; funds for Medi-Cal women’s health, trauma and developmental screenings; and the Value-Based Payments program.
  • The May Revise includes approximately $263 million in additional Proposition 56 revenues due to a one-time fund reconciliation.

The May revision includes the following additional Proposition 56 investments:

  • $120 million additional one-time funding for the loan repayment program for physicians and dentists who commit to serving Medi-Cal beneficiaries.
  • $70 million additional one-time funding for the Value-Based Payments program, specifically for behavioral health integration. This brings the total allocation for Value-Based Payments to $250 million available for the program over the next several years.
  • $25 million in 2019–20 ($60 million over three years) to train providers to conduct the trauma screenings that were proposed in the Governor’s January budget.
  • $11.3 million to restore optician and optical lab services for adult beneficiaries in the Medi-Cal program, effective no sooner than January 1, 2020.

The Governor’s January commitment to make permanent the Prop 56-funded improvements in payments to physicians, dentists and other Medi-Cal providers appears to be tempered by concerns about lower future revenues, because his amended budget proposes to put a sunset date of December 31, 2021, on all Prop 56-funded “investments.”

California Individual Mandate and Increased Covered California Subsidies

  • The Governor’s January budget proposed to make California the first state in the nation to offer financial assistance to qualified individuals with incomes between 400% and 600% of the federal poverty level, while also increasing subsidies for individuals with incomes between 250% and 400% of the federal poverty level.
  • The May Revise expands on this proposal by offering subsidies to individuals between 200% and 250% of the federal poverty level.
  • In addition to the direct assistance for consumers receiving the additional subsidies, these subsidies will benefit all individual market consumers by encouraging younger, healthier consumers to enroll in coverage.
  • Combined with the Governor’s January budget proposal to create a state individual mandate to obtain comprehensive health care coverage, the subsidies will improve the overall risk pool in the individual market, reducing future premium increases.
  • Similar to the federal subsidies currently offered through Covered California, individual subsidy amounts will vary significantly depending on an individual’s income, family size, age, region and healthcare premium costs. Individuals with incomes between 200% and 400% of the federal poverty level would receive average state subsidies of around $10 per month, in addition to federal subsidies of hundreds of dollars per month.

EARLY CHILDHOOD

The Governor has proposed the following to promote a healthy start for young children:

  • $10 million for a long-term strategic plan for an early learning and childcare system
  • A $600 million (reduced from the $750 million proposed in January) one-time non–Proposition 98 General Fund for school construction to expand full-day kindergarten programs
  • Additional funding for childcare resources for CalWORKS recipients

EDUCATION

Governor Newsom touted this budget as the “highest investment in our K–14 Education in California history.” Highlights of education funding include the following:

  • 45% of state spending to be dedicated to education
  • $101.8 billion total funding ($58.9 billion General Fund and $42.9 billion in other funds)
  • Higher-than-expected revenue will trigger a spending increase in Proposition 98
  • $4.5 billion allocated above the Proposition 98 funding requirement
  • Proposed ongoing increase in special education and teacher retention funding
  • $32 million additional one-time funding increase to the University of California, with $25 million dedicated to pension obligations
  • $80.8 million increase to community colleges

HOUSING

Governor Newsom continues to demonstrate his commitment to address California’s housing crisis. In the May revision, Governor Newsom proposes the following:

  • $500 million refocused for the infill infrastructure grant program under the Department of Housing and Community Development (HCD), which will assist in removing barriers in building affordable housing.
  • $2.5 million for both the HCD and the Department of General Services to hire consultants to assist with evaluating housing developments and monitoring housing demonstration projects.
  • $20 million for legal aid grants to nonprofit service organizations to help address landlord-tenant disputes related to evictions.

HOMELESSNESS

To address California’s chronic homelessness issue, Governor Newsom proposes the following in his May revision:

  • $650 million (originally proposed at $500 million in January) to local governments for homeless emergency aid, of which 13 of California’s most populous cities will receive $275 million, counties will receive $275 million and Continuums of Care (CoCs) will receive $100 million.
  • $6.5 million ongoing General Fund to help rapid rehousing of homeless and housing-insecure students at the CSU system, and $3.5 million ongoing general fund for UC system students.
  • $20 million one-time funding (from the Mental Health Services Fund) for counties that do not operate Whole Person Care Pilots, to allow those counties to coordinate behavioral health and social services programs.

DISASTER PREPAREDNESS/WILDFIRES

Governor Newsom has prepared and continues to prepare California for disaster-related occurrences such as California’s devastating wildfires. In the May Revise, he proposes the following:

  • $20 million one-time General Fund within the Office of Emergency Services (OES) for state mission tasking, which will provide resources to backfill other departments for steady-state disaster-related activities.
  • $5.9 million and 76 positions to boost OES disaster preparedness and response capacity for future disasters.
  • $2 million to create a Disaster Response and Recovery Unit within HCD that will provide housing expertise whenever there is a statewide disaster.
  • $41 million for the Public Utilities Commission to fund inspections and improve review of utility wildfire mitigation plans.
  • $75 million General Fund to help investor-owned utilities (IOUs) further the use of Public Safety Power Shutdown actions on their power lines to prevent wildfires during severe weather conditions.
  • $10 million one-time General Fund to support local communities’ recovery in the Camp Fire of 2018.
  • $15.7 million one-time General Fund to help the Department of Forestry and Fire Protection increase the pace and scale of forest health and fire prevention activities.

SAFE DRINKING WATER

The state continues to face many challenges related to local water systems, particularly those that serve small, disadvantaged communities and that continue to fail to provide safe drinking water to their customers.

  • Currently, approximately 1 million Californians lack access to safe drinking water.
  • The most significant remaining challenge is the lack of a stable funding source for the long-term operation and maintenance of drinking water systems.

In recognition of the continued safe drinking water issues, the Governor’s revised budget proposes an additional $168 million in Proposition 68 funds to support capital water projects across the state.

The Governor’s May Revise also includes $4.9 million in General Fund revenues to support initial steps toward the implementation of the Safe and Affordable Drinking Water Program and statutory changes to establish ongoing sustainable funding that will assist disadvantaged communities in paying for the costs of obtaining access to safe and affordable drinking water.

TECHNOLOGY

The Governor’s May Revise did not propose changes to technology investments proposed in his January budget.

  • The budget requests $36.2 million in 2019–20 and $14.6 million ongoing thereafter for the establishment of the Office of Digital Innovation (ODI) within the Government Operations Agency.
  • This would provide 50 positions and includes a $20 million Innovation Fund.
  • Both the Senate and Assembly subcommittees reviewing this proposal raised concerns with potentially growing this office too fast.
  • The Assembly analysis explained, “While there might be a case to be made that this office should eventually be 50 staff members in size, history has shown that trying to build such an office in one year is a mistake.”
  • The Senate recommended approving only 20 staff for this office in the first year, while the Assembly held the item open, which means there will be continued negotiation between the Legislature and the Governor over the appropriate policy and level of funding for this office.

The May Revise did not include an augmentation for the Department of Justice beyond the proposal in January related to enforcement of the California Consumer Privacy Act.

  • The Governor’s January budget requested permanent funding for 23 staff positions, as well as $1.8 million in General Fund and $2.9 million in special funds for 2019–20 and $1.7 million and $2.8 million, respectively, on an ongoing basis.
  • The Legislative budget subcommittee has not acted on this proposal, so it remains open for revision. The Senate analysis noted concerns with the source of the funds but not with the level of resources being requested for enforcement.

ENVIRONMENTAL PROTECTION

Given the state’s actions to significantly reduce the use of and exposures to chlorpyrifos, and the beginning of a regulatory process to cancel the registration of chlorpyrifos, the Governor’s May Revise offers a significant adjustment dedicated to sustainable pest management, as follows:

  • A one-time increase of $5.7 million in General Fund revenues to assist in the transition to safer pesticide alternatives. In partnership with growers and workers, the state must support research and development of better and safer alternatives, including nonchemical pest management, to build a stronger, more resilient agricultural community in California. This proposal includes $125,000 for the Department of Pesticide Regulation and the California Department of Food and Agriculture to lead a newly created, cross-sector work group that will identify, evaluate and recommend alternative pest management tools.
  • In addition, the Governor’s May Revise includes $5.6 million for additional research and technical assistance for the development of safer, practical, more sustainable alternatives to chlorpyrifos.

REACTION OF LEGISLATIVE LEADERSHIP

Senator Toni Atkins, Speaker Pro Tempore

“I applaud Gov. Newsom for the way he has made his original budget proposal even stronger. The May budget revision reflects California’s fiscal strength, increases our prudent reserves, and makes important investments for the future. I am particularly pleased to see more funding for K–12 education and increases for the Earned Income Tax Credit to help even more working Californians. Given the critical challenges we face addressing homelessness and preparing and responding to natural disasters, the Governor has appropriately increased funding in those areas as well.”

Assembly Speaker Anthony Rendon

“The budget shows respect for our Assembly priorities, including new investments in early childhood education for infants, toddlers, and preschoolers. Those are the things that establish a stronger foundation for California’s future.”

NEXT STEPS

California legislators must send a final spending proposal to Governor Newsom by June 15.

There is speculation regarding motivation on behalf of the administration to complete the budget prior to the constitutional deadline.

While the state budget is sufficiently big and complicated, and although there are many competing interests to create controversy, this year’s budget should be concluded without a lot of public dispute among legislators and very much along the lines the Governor has proposed. The proposals to enact any new taxes, no matter how small, may nevertheless provide some pre-July fireworks in Sacramento. However, given the continuing strong state and national economy; adequate state revenues to achieve a good number of health, education and other broad public improvements this year; and strong Democratic majorities in both the Senate and the Assembly (which are generally aligned with the Democratic Governor), an on-time budget is a virtual certainty.

The new fiscal year begins July 1, 2019.

* * *

For more information on Manatt’s California state government practice and team, please see below.

California State Government and Regulatory Policy and Government Contracts

Thomas R. McMorrow, Partner and Leader
Bio | Email
916.552.2310

Steve Coony, Managing Director
Bio | Email
916.552.2380

Richard Costigan, Managing Director
Bio | Email
916.552.2370

McKay Carney, Legislative Advisor
Bio | Email
916.552.2335

Delilah Clay, Legislative & Regulatory Advisor
Bio | Email
916.552.2330

Alfredo Medina, Advisor
Bio | Email
916.552.2315

Armand Feliciano, Counsel
Bio | Email
916.552.2345